Avista Corporation
Table of Contents

CONFORMED

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

   
(Mark One)  
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002 OR
   
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM                   TO                

Commission file number 1-3701

AVISTA CORPORATION


(Exact name of Registrant as specified in its charter)
     
Washington

(State or other jurisdiction of
incorporation or organization)
  91-0462470

(I.R.S. Employer
Identification No.)
     
1411 East Mission Avenue, Spokane, Washington

(Address of principal executive offices)
  99202-2600

(Zip Code)
     
Registrant’s telephone number, including area code:   509-489-0500
Web site: http://www.avistacorp.com

Securities registered pursuant to Section 12(b) of the Act:

     
    Name of Each Exchange
Title of Class

Common Stock, no par value, together with
Preferred Share Purchase Rights appurtenant thereto
  on Which Registered

New York Stock Exchange
Pacific Stock Exchange
     
7 7/8% Trust Originated Preferred Securities, Series A   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

Title of Class


Preferred Stock, Cumulative, Without Par Value

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

Yes    [X]    No    [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [  ]

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act):

Yes    [X]    No    [  ]

The aggregate market value of the Registrant’s outstanding Common Stock, no par value (the only class of voting stock), held by non-affiliates is $660,054,800, based on the last reported sale price thereof on the consolidated tape on June 28, 2002.

As of February 28, 2003, 48,118,294 shares of Registrant’s Common Stock, no par value (the only class of common stock), were outstanding.

Documents Incorporated By Reference

     
    Part of Form 10-K into Which
Document

Proxy Statement to be filed in
connection with the annual meeting
of shareholders to be held May 8, 2003
  Document is Incorporated

Part III, Items 10, 11,
12 and 13


AVISTA CORPORATION

TABLE OF CONTENTS

ACRONYMS AND TERMS
PART I
Available Information
Item 1. Business
Company Overview
Avista Utilities
General
Electric Operations
Electric Requirements
Electric Resources
Future Resource Needs
Forecasted Electric Energy Requirements and Resources
Hydroelectric Relicensing
Natural Gas Operations
Natural Gas Resources
Regulatory Issues
Industry Restructuring
Federal Level
State Level
Environmental Issues
AVISTA UTILITIES OPERATING STATISTICS
Energy Trading and Marketing Line of Business
Avista Energy
Avista Power
Information and Technology Line of Business
Avista Advantage
Avista Labs
Other Line of Business
Discontinued Operations — Avista Communications
Item 2. Properties
Avista Utilities
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Safe Harbor for Forward-Looking Statements
Avista Corp. Lines of Business
Avista Utilities – Regulatory Matters
Power Market Issues
Results of Operations
Overall Operations
Avista Utilities
Energy Trading and Marketing
Information and Technology
Other
Discontinued Operations
Earnings Outlook
New Generation Resource — Avista Utilities
New Accounting Standards
Critical Accounting Policies
Liquidity and Capital Resources
Review of Cash Flow Statement
Overall Liquidity
Capital Resources
Inter-Company Debt; Subordination
Pension Plan
Off-Balance Sheet Arrangements
Total Company Capitalization
Credit Ratings
Avista Utilities Operations
Energy Trading and Marketing Operations
Information and Technology Operations
Other Operations
Contractual Obligations
Additional Financial Data
Future Outlook
Business Strategy
Competition
Business Risk
Risk Management
Economic and Load Growth
Information Services Contract
Environmental Issues
Dividends
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
INDEPENDENT AUDITORS’ REPORT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
Item 14. Controls and Procedures
PART IV
Item 15. Financial Statements, Financial Statement Schedules, Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS
INDEPENDENT AUDITORS’ CONSENT
EXHIBIT INDEX
EXHIBIT 3(B)
EXHIBIT 10(B)-3
EXHIBIT 10(B)-4
EXHIBIT 10(B)-5
Exhibit 10(Q)-8
Exhibit 10(Q)-10
Exhibit 10(Q)-11
EXHIBIT 10.(Q)-12
EXHIBIT 12
EXHIBIT 21
EXHIBIT 99.(A)


Table of Contents

INDEX

                 
Item           Page
No.           No.

         
   
Acronyms and Terms
  iv
        Part I        
    Available Information     1  
1.  
Business
  1  
       
Company Overview
    1  
       
Avista Utilities
    3  
       
General
    3  
       
Electric Operations
    3  
       
Electric Requirements
    4  
       
Electric Resources
    4  
       
Future Resource Needs
    6  
       
Forecasted Electric Energy Requirements and Resources
    6  
       
Hydroelectric Relicensing
    7  
       
Natural Gas Operations
    7  
       
Natural Gas Resources
    8  
       
Regulatory Issues
    8  
       
Industry Restructuring
    10  
       
Federal Level
    10  
       
State Level
    11  
       
Environmental Issues
    12  
       
Avista Utilities Operating Statistics
    13  
       
Energy Trading and Marketing Line of Business
    15  
       
Avista Energy
    15  
       
Avista Power
    16  
       
Information and Technology Line of Business
    16  
       
Avista Advantage
    16  
       
Avista Labs
    17  
       
Other Line of Business
    17  
       
Discontinued Operations – Avista Communications
    17  
2.  
Properties
    18  
       
Avista Utilities
    18  
3.  
Legal Proceedings
    19  
4.  
Submission of Matters to a Vote of Security Holders
    19  
        Part II        
5.  
Market for Registrant’s Common Equity and Related Stockholder Matters
    20  
6.  
Selected Financial Data
    21  
7.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
    22  
       
Safe Harbor for Forward-Looking Statements
    22  
       
Avista Corp. Lines of Business
    23  
       
Avista Utilities – Regulatory Matters
    24  
       
Power Market Issues
    26  
       
Results of Operations
    28  
       
Overall Operations
    28  
       
Avista Utilities
    31  
       
Energy Trading and Marketing
    33  
       
Information and Technology
    37  
       
Other
    37  
       
Discontinued Operations
    38  
       
Earnings Outlook
    38  
       
New Generation Resource – Avista Utilities
    38  
       
New Accounting Standards
    39  
       
Critical Accounting Policies
    39  

ii


Table of Contents

AVISTA CORPORATION

                 
Item           Page
No.           No.

         
       
Liquidity and Capital Resources
    43  
       
Review of Cash Flow Statement
    43  
       
Overall Liquidity
    43  
       
Capital Resources
    44  
       
Inter-Company Debt; Subordination
    45  
       
Pension Plan
    46  
       
Off-Balance Sheet Arrangements
    46  
       
Total Company Capitalization
    46  
       
Credit Ratings
    47  
       
Avista Utilities Operations
    47  
       
Energy Trading and Marketing Operations
    48  
       
Information and Technology Operations
    48  
       
Other Operations
    49  
       
Contractual Obligations
    49  
       
Additional Financial Data
    49  
       
Future Outlook
    50  
       
Business Strategy
    50  
       
Competition
    50  
       
Business Risk
    51  
       
Risk Management
    53  
       
Economic and Load Growth
    54  
       
Information Services Contract
    55  
       
Environmental Issues
    55  
       
Dividends
    55  
7A.  
Quantitative and Qualitative Disclosure about Market Risk
    56  
8.  
Financial Statements and Supplementary Data
    56  
       
Independent Auditors’ Report
    57  
       
Financial Statements
    58  
       
Notes to Consolidated Financial Statements
    64  
9.  
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    *  
        Part III        
10.  
Directors and Executive Officers of the Registrant
    99  
11.  
Executive Compensation
    100  
12.  
Security Ownership of Certain Beneficial Owners and Management
    100  
13.  
Certain Relationships and Related Transactions
    101  
14.  
Controls and Procedures
    101  
        Part IV        
15.  
Financial Statements, Financial Statement Schedules, Exhibits and Reports on Form 8-K
    102  
   
Signatures
    103  
   
Certifications
    104  
   
Independent Auditors’ Consent
    106  
   
Exhibit Index
    107  

* = not an applicable item in the 2002 calendar year for the Company

iii


Table of Contents

AVISTA CORPORATION

ACRONYMS AND TERMS
(The following acronyms and terms are found in multiple locations within the document)

     
Acronym/Term   Meaning

 
aMW  
- - Average Megawatt - a measure of the average rate at which a particular generating source produces energy over a period of time
     
AFUCE  
- - Allowance for Funds Used to Conserve Energy; a carrying charge similar to AFUDC (see below) for conservation-related capital expenditures
     
AFUDC  
- - Allowance for Funds Used During Construction; represents the cost of both the debt and equity funds used to finance utility plant additions during the construction period
     
APB   - - Accounting Principles Board
     
Avista Capital   - - Parent company to the Company’s non-utility businesses
     
Avista Corp.   - - Avista Corporation, the Company
     
BPA   - - Bonneville Power Administration
     
Capacity   - - the rate at which a particular generating source produces energy, measured in KW or MW
     
Centralia   - - the coal-fired Centralia Power Plant in western Washington State
     
Colstrip   - - the coal-fired Colstrip Generating Plant in southeastern Montana
     
Coyote Springs 2   - - the natural gas-fired Coyote Springs 2 Generating Plant located near Boardman, Oregon
     
CFTC   - - U.S. Commodity Futures Trading Commission
     
CPUC   - - California Public Utilities Commission
     
CT   - - combustion turbine
     
Energy   - - the amount of electricity produced or consumed over a period of time, measured in KWH or MWH
     
EITF   - - Emerging Issues Task Force
     
ERM   - - the Energy Recovery Mechanism in the State of Washington
     
FASB   - - Financial Accounting Standards Board
     
FERC   - - Federal Energy Regulatory Commission
     
IPUC   - - Idaho Public Utilities Commission
     
KV   - - Kilovolt - a measure of capacity on transmission lines
     
KW, KWH   - - Kilowatt, kilowatt-hour, 1000 watts or 1000 watt hours
     
MTN   - - Medium-Term Note
     
MW, MWH   - - Megawatt, megawatt-hour, 1000 KW or 1000 KWH

iv


Table of Contents

AVISTA CORPORATION

     
     
OPUC   - - Oregon Public Utility Commission
     
PCA   - - the Power Cost Adjustment mechanism in the State of Idaho
     
PGA   - - Purchased Gas Adjustment
     
PUD   - - Public Utility District
     
PURPA   - - the Public Utilities Regulatory Policies Act of 1978
     
RTO   - - Regional Transmission Organization
     
SFAS   - - Statement of Financial Accounting Standards
     
SMD   - - Standard Market Design
     
Therm  
- - Unit of measurement for natural gas; a therm is equal to approximately one hundred cubic feet (volume) or 100,000 BTUs (energy)
     
VAR  
- - Value-at-Risk, measures the expected risk of portfolio loss under hypothetical adverse price movements, over a given time interval within a given confidence level
     
Watt  
- - Unit of measurement for electricity; a watt is equal to the rate of work represented by a current of one ampere under a pressure of one volt
     
WECC   - - Western Electricity Coordinating Council
     
WUTC   - - Washington Utilities and Transportation Commission

v


Table of Contents

AVISTA CORPORATION

PART I

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Forward-looking statements should be read with the cautionary statements and important factors included in this Annual Report on Form 10-K at Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Safe Harbor for Forward-Looking Statements.” Forward-looking statements are all statements other than statements of historical fact, including without limitation those that are identified by the use of words such as, but not limited to, “will,” “anticipates,” “seeks to,” “estimates,” “expects,” “intends,” “plans,” “predicts,” and similar expressions. Such statements are inherently subject to a variety of risks and uncertainties that could cause actual results to differ materially from those expressed. Most of these risks and uncertainties are beyond the Company’s control.

Available Information

The Web site address of Avista Corporation (Avista Corp. or the Company) is http://www.avistacorp.com. Avista Corp. makes available free of charge, on or through its Web site, its annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the Securities and Exchange Commission. Information contained on Avista Corp.’s Web site is not part of this report.

Item 1. Business

Company Overview

Avista Corp. was incorporated in the State of Washington in 1889. Avista Corp. is an energy company engaged in the generation, transmission and distribution of energy as well as other energy-related businesses. As of December 31, 2002, the Company’s employees included approximately 1,410 people in its utility operations and approximately 540 people in its subsidiary businesses. The Company’s corporate headquarters are in Spokane, Washington, which serves as the Inland Northwest center for manufacturing, transportation, health care, education, communication, agricultural, financial and service businesses.

The Company’s operations are exposed to risks, including, but not limited to, the price and supply of purchased power, fuel and natural gas, recoverability of power and natural gas costs, streamflow and weather conditions, the effects of changes in legislative and governmental regulations, availability of generation facilities, competition, technology and availability of funding. Also, like other utilities, the Company’s facilities and operations may be exposed to terrorism risks. In addition, the energy business exposes the Company to the financial, liquidity, credit and commodity price risks associated with wholesale purchases and sales.

The Company is organized into four lines of business – Avista Utilities, Energy Trading and Marketing, Information and Technology, and Other. Avista Capital, a wholly owned subsidiary of Avista Corp., is the parent company of all of the subsidiary companies engaged in the non-utility lines of business. As of December 31, 2002, the Company had common equity investments of $457.6 million and $255.2 million in Avista Utilities and Avista Capital, respectively.

Avista Utilities, an operating division of Avista Corp. and not a separate entity, represents the regulated utility operations. Avista Utilities generates, transmits and distributes electricity and distributes natural gas. Avista Utilities also engages in wholesale purchases and sales of electric capacity and energy. Avista Utilities seeks to maintain a strong, low-cost and efficient electric and natural gas utility business focused on providing reliable, high quality service to its customers. The utility business is expected to grow modestly, consistent with historical trends. Expansion is expected to result primarily from economic growth in its service territory. It is Avista Utilities’ strategy to own or control a sufficient amount of resources to meet its retail and wholesale energy requirements on an average annual basis.

The Energy Trading and Marketing line of business includes Avista Energy, Inc. (Avista Energy) and Avista Power, LLC (Avista Power). Avista Energy is an electricity and natural gas marketing and trading business, operating primarily within the Western Electricity Coordinating Council (WECC) geographical area, which is comprised of eleven Western states. Avista Energy focuses on asset-backed optimization of combustion turbines and hydroelectric assets owned by other entities, long-term electric supply contracts, natural gas storage, and electric and natural gas transmission and transportation arrangements. Avista Energy’s marketing efforts are driven by its base of knowledge and experience in the operation of both electric energy and natural gas physical systems in the WECC, as well as its relationship-focused approach with its customers. Avista Power was originally formed to develop and own

1


Table of Contents

AVISTA CORPORATION

generation assets. During 2001, the Company decided that Avista Power would no longer pursue the development of additional non-regulated generation projects. Avista Power continues to manage the generation assets it currently owns, primarily its 49 percent interest in a 270 megawatt (MW) natural gas-fired combustion turbine plant in northern Idaho (Lancaster Project), which commenced commercial operation in September 2001.

The Information and Technology line of business includes Avista Advantage, Inc. (Avista Advantage) and Avista Laboratories, Inc. (Avista Labs). Avista Advantage is a provider of internet-based facility intelligence, cost management, billing and information services to retail customers throughout North America. Avista Advantage remains focused on growing revenue, improving margins, reducing fixed and variable costs and improving client satisfaction. Avista Labs has patented and developed a modular air-cooled, self-hydrating Proton Exchange Membrane (PEM) fuel cell that delivers reliable and clean distributed power solutions. In addition to developing its modular fuel cell products, Avista Labs is contracting with selected market channels to deliver system solutions to industrial, commercial and residential markets. Avista Labs holds a 70 percent equity interest in H2fuel, LLC, a developer of fuel processors for the production of hydrogen. Avista Corp. continues discussions with selected companies in its search for a financial partner for Avista Labs with the goal of owning less than 20 percent of this company.

The Other line of business includes Avista Ventures, Inc. (Avista Ventures), Avista Capital (parent company only amounts), Pentzer Corporation (Pentzer) and several other subsidiaries. The Company continues to limit its future investment in this line of business.

The Company’s current lines of business, and the companies included within them, are illustrated below:

Company current line of bussiness

      o - - denotes a business entity.

      O  - denotes an operating division or line of business.

See “Item 6. Selected Financial Data” and “Schedule of Information by Business Segments in the Consolidated Financial Statements” for information with respect to the operating performance of each business segment.

2


Table of Contents

AVISTA CORPORATION

Avista Utilities

General

Avista Utilities generates, transmits and distributes electricity and distributes natural gas. Retail electric and natural gas customers include residential, commercial and industrial classifications. Avista Utilities also engages in wholesale purchases and sales of electric capacity and energy as part of its resource management and load-serving obligations.

Avista Utilities provides electric and natural gas distribution and transmission services in a 26,000 square mile area in eastern Washington and northern Idaho with a population of approximately 813,000. It also provides natural gas distribution service in a 4,000 square mile area in northeast and southwest Oregon and in the South Lake Tahoe region of California, with the population in these areas approximating 611,000. At the end of 2002, Avista Utilities supplied retail electric service to approximately 320,000 customers in eastern Washington and northern Idaho and retail natural gas service to approximately 290,000 customers in parts of Washington, Idaho, Oregon and California.

Avista Utilities anticipates residential and commercial electric load growth to average between 2.5 and 3.5 percent annually for the next four years, primarily due to expected increases in both population and the number of businesses in its service territory. The number of electric customers is expected to increase; however, the average annual usage by residential customers is not expected to change significantly. For the next four years, Avista Utilities expects natural gas load growth to average between 3.0 and 4.0 percent annually in its service territory. The natural gas load growth is primarily due to expected conversions from electric space, oil space and electric water heating to natural gas, and increases in both population and the number of businesses in Avista Utilities’ service territories. These electric and natural gas load growth projections are based on purchased economic forecasts, publicly available studies, and internal analysis of company-specific data, such as energy consumption patterns and internal business plans. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Future Outlook” for additional information.

During 2001 and 2002, Avista Utilities experienced decreased loads and decreased use per customer with respect to both electric and natural gas retail sales. The decrease in use per customer appears to be primarily due to a response to the increase in rates and the resulting conservation efforts of individual customers. The decrease in use per customer in 2002 and 2001 as compared to 2000 also appears to reflect milder weather in 2002 and 2001 as compared to 2000. The decrease in total kilowatt-hours (kWhs) and therms sold primarily relates to industrial customers and appears to reflect a general downturn in the economy of Avista Utilities’ service territory. However, as described above, based on economic forecasts, publicly available studies and internal analysis of company-specific data, the Company does not expect the trend of declining loads to continue over the next four years.

Electric Operations

In addition to providing electric transmission and distribution services, Avista Utilities generates electricity for sales to customers. Avista Utilities owns and operates eight hydroelectric projects, a wood-waste fueled generating station, a two-unit natural gas-fired combustion turbine (CT) generating facility and two small generating facilities. It also owns a 15 percent share in a two-unit coal-fired generating facility and leases and operates a two-unit natural gas-fired CT generating facility. In mid-2003, it is expected that the natural gas-fired Coyote Springs 2 Generation Project (Coyote Springs 2) will be placed into operation. Avista Utilities has a 50 percent ownership interest (140 MW) in Coyote Springs 2. In addition to company-owned resources, Avista Utilities has a number of long-term power purchase and exchange contracts that increase its available resources. See “Item 2. Properties” for further information with respect to generation properties.

Historically, Avista Utilities’ electric rates to retail customers have been among the lowest of investor-owned utilities in the United States, due primarily to its large proportion of hydroelectric resources as compared to other investor-owned utilities. Retail electric rates remain low, relative to other investor-owned utilities in the United States, even after the enactment of rate increases in 2001 and 2002. See “Regulatory Issues-Power Cost Deferrals” and “Regulatory Issues-General Rate Cases” for further information.

Avista Utilities sells and purchases electric capacity and energy to and from utilities and other entities in the wholesale market under long-term contracts having terms of more than one year. In addition, Avista Utilities engages in an ongoing process of resource optimization which involves short-term purchases and sales in the wholesale market in pursuit of an economic selection of resources to serve retail and wholesale loads. Avista Utilities makes continuing projections of (1) future retail and wholesale loads based on, among other things, forward estimates of factors such as customer usage and weather as well as historical data and contract terms and (2) resource availability based on, among other things, estimates of streamflows, generating unit availability, historic and forward market information and

3


Table of Contents

AVISTA CORPORATION

experience. On the basis of these continuing projections, Avista Utilities makes purchases and sales of energy on an annual, quarterly, monthly, daily and hourly basis to match actual resources to actual energy requirements. This process includes hedging transactions.

Participants in the electric wholesale market include other utilities, federal marketing agencies and power marketers. The electric wholesale market has changed significantly over the last few years with respect to market participants involved, level of activity, variability in market prices, liquidity, Federal Energy Regulatory Commission (FERC)-imposed price caps and counterparty credit issues. During 2000 and the first half of 2001, the electric wholesale market in the WECC region was more turbulent than previously experienced and marked by significant volatility, service disruptions and defaults by certain participants. During the second half of 2001 and 2002 wholesale market prices and volatility both decreased to levels similar to those experienced before 2000. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Power Market Issues” for more information.

Challenges facing Avista Utilities’ electric operations include, among other things, the timing of the recovery of deferred power supply costs, changes in the availability of and volatility in the prices of power and fuel, generating unit availability, legislative and governmental regulations, potential tax law changes, customer response to price increases and surcharges, streamflows and weather conditions. Avista Utilities may also be exposed to refunds for wholesale power sales depending on the outcome of the FERC’s retroactive price cap proceeding for the Pacific Northwest; however, Avista Utilities would have the opportunity to assert offsetting claims. See “Industry Restructuring,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Power Market Issues” and “Note 1 of Notes to Consolidated Financial Statements” for additional information.

Electric Requirements

The peak electric load requirement for 2002 was 1,855 MW (including retail native load of 1,389 MW, long-term wholesale obligations of 320 MW and short-term wholesale obligations of 146 MW). This peak occurred on July 12, 2002 at which time the maximum resource capacity available from Avista Utilities was 2,287 MW. The maximum resource capacity included 1,362 MW of company-owned electric generation, 119 MW of long-term hydroelectric contracts, 210 MW of other long-term wholesale purchases and 596 MW of short-term wholesale purchases. Variations in energy usage by Avista Utilities’ customers occur from year to year, from season to season and hour to hour as a result of varying weather conditions and other energy usage behaviors. This necessitates a continual balancing of loads and resources, and requires both purchases and sales of energy for annual, quarterly, monthly, daily and hourly periods in order to meet electric requirements and to prudently manage and optimize available resources.

Electric Resources

General Avista Utilities’ diverse electric resource mix of hydroelectric projects, thermal generating facilities, and power purchases and exchanges, enables it to remain a low-cost and reliable provider of electric energy. At the end of 2002, Avista Utilities’ facilities had a total net capability of approximately 1,511 MW, of which 64 percent was hydroelectric and 36 percent was thermal. See “Avista Utilities Operating Statistics – Electric Operations” for energy resource statistics.

Hydroelectric Resources Hydroelectric generation is Avista Utilities’ lowest cost source per MWh of electricity and the availability of hydroelectric generation has a significant effect on its total power supply costs. Under normal streamflow and operating conditions, Avista Utilities projects that it would be able to meet approximately one-half of its total electric requirements (both retail and long-term wholesale) with its own hydroelectric generation and long-term hydroelectric contracts with certain Public Utility Districts in Washington state. Total hydroelectric resource generation (both company-owned and purchased under long-term hydroelectric contracts) was 4.8 million MWhs in 2002, compared to 3.2 million MWhs in 2001 and 4.7 million MWhs in 2000.

Total hydroelectric resources (including resources purchased under long-term hydroelectric contracts) generate 550 average megawatts (aMW) (or 4.8 million MWhs) annually under normal streamflow conditions. Hydroelectric resources generated 553 aMW during 2002. The streamflows to company-owned hydroelectric projects were 112 percent, 56 percent and 86 percent of normal in 2002, 2001 and 2000, respectively. In a “critical water” year (defined by the Northwest Power Pool as the worst water conditions on record), Avista Utilities would expect hydroelectric generation of 400 aMW, 150 aMW below normal. Hydroelectric generation for the year 2001 was 369 aMW, which was 181 aMW below normal and the lowest level in the 73 years in which records have been kept. The combination of low hydroelectric production and other factors resulted in Avista Utilities incurring power supply costs during the second half of 2000 and the year 2001 significantly in excess of the amount of power supply costs recovered through retail rates in effect at the time. See “Regulatory Issues – Power Cost Deferrals” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Avista Utilities-Regulatory Matters” for more information.

4


Table of Contents

AVISTA CORPORATION

The following table shows Avista Utilities’ hydroelectric generation (in thousands of MWhs) during the years ended December 31:

                           
      2002   2001   2000
     
 
 
Noxon Rapids
    1,816       1,021       1,635  
Cabinet Gorge
    1,085       694       1,057  
Post Falls
    87       67       88  
Upper Falls
    75       66       76  
Monroe Street
    105       89       109  
Nine Mile
    126       99       135  
Long Lake
    511       370       511  
Little Falls
    205       158       208  
 
   
     
     
 
 
Total company-owned hydroelectric generation
    4,010       2,564       3,819  
Long-term hydroelectric contracts
    837       631       929  
 
   
     
     
 
 
Total hydroelectric generation
    4,847       3,195       4,748  
 
   
     
     
 

Thermal Resources Avista Utilities owns a 15 percent interest in a twin-unit, coal-fired generating facility, the Colstrip 3 & 4 Generating Project (Colstrip) in southeastern Montana. Additionally, Avista Utilities owns a wood-waste-fired generating facility known as the Kettle Falls Generating Station (Kettle Falls) in northeastern Washington and a two-unit natural gas-fired CT generating facility, located in northeast Spokane (Northeast CT). Avista Utilities also leases and operates a two-unit natural gas-fired CT generating facility in northern Idaho (Rathdrum CT). In addition, Avista Utilities owns two small generating facilities (Boulder Park and Kettle Falls CT) that were placed into service in 2002.

Avista Utilities owns a 50 percent interest in the natural gas-fired Coyote Springs 2 located near Boardman, Oregon. It is expected that Coyote Springs 2 will be placed into operation in the middle of 2003. In January 2003, Avista Power’s 50 percent ownership interest in Coyote Springs 2 was transferred to Avista Corp. for inclusion in Avista Utilities’ power generation resource portfolio. In May 2002, a transformer at Coyote Springs 2 failed and caught fire resulting in the release of an estimated 17,000 gallons of coolant oil. The Company worked closely with the appropriate environmental agencies to complete a satisfactory cleanup of the oil. In December 2002, the replacement transformer was received, but it was determined to be damaged. The problems with the transformer have delayed the scheduled completion of Coyote Springs 2 from the third quarter of 2002 to the middle of 2003.

Until May 2000, Avista Utilities had a 15 percent interest in a twin-unit, coal-fired generating facility, the Centralia Power Plant (Centralia) in western Washington. In May 2000, the owners of Centralia sold the plant to TransAlta. Avista Utilities is purchasing energy from TransAlta to replace the output from Centralia for the period from July 1, 2000 through December 31, 2003, excluding April, May and June of each year. Avista Utilities receives approximately 200 megawatts per hour during the term of the contract.

Fuel Supply for Thermal Resources Coyote Springs 2, which will be operated by Portland General Electric, will be supplied with natural gas under natural gas supply contracts through October 2004, and transportation agreements with unilateral renewal rights are in place.

Colstrip, which is operated by PPL Global, Inc., is supplied with fuel from adjacent coal reserves under coal supply and transportation agreements in effect through December 2019.

Kettle Falls’ primary fuel is wood-waste generated as a by-product from forest industry operations within 100 miles of the plant. Natural gas may be used as an alternate fuel. A combination of long-term contracts plus spot purchases provides Avista Utilities the flexibility to meet expected future fuel requirements for the plant.

The Northeast CT, Rathdrum CT, Boulder Park and Kettle Falls CT are generating units that are primarily used for peaking electric requirements. Due to the shortage of hydroelectric generation during 2000 and 2001 and the relative operating cost compared to higher wholesale market prices, the Northeast CT and Rathdrum CT units were operated on a more frequent basis. These generating facilities have access to natural gas supplies that are adequate to meet their respective operating needs.

5


Table of Contents

AVISTA CORPORATION

The following table shows Avista Utilities’ thermal generation (in thousands of MWhs) during the years ended December 31:

                           
      2002   2001   2000
     
 
 
Centralia
                493  
Colstrip
    1,397       1,617       1,473  
Kettle Falls
    261       361       370  
Northeast CT and Rathdrum CT
    39       1,023       817  
Boulder Park and Kettle Falls CT
    17              
 
   
     
     
 
 
Total thermal generation
    1,714       3,001       3,153  
 
   
     
     
 

Purchases, Exchanges and Sales Avista Utilities purchases power under various long-term contracts. Avista Utilities also enters into a significant number of short-term sales and purchases with terms of up to one year.

Under the Public Utility Regulatory Policies Act of 1978 (PURPA), Avista Utilities is required to purchase generation from qualifying facilities, including small hydroelectric and cogeneration projects, at rates approved by the Washington Utilities and Transportation Commission (WUTC) and the Idaho Public Utilities Commission (IPUC). These contracts expire at various times through 2022.

See “Avista Utilities Operating Statistics – Electric Operations - Electric Energy Resources” for more detailed information with respect to purchased power and power from exchanges in 2002, 2001 and 2000.

Future Resource Needs

Avista Utilities has operational strategies to ensure that it has available resources sufficient to meet the increased demand for energy. The following is a forecast of Avista Utilities’ average energy requirements and resources for the period 2003 through 2005:

Forecasted Electric Energy Requirements and Resources
(aMW)

                               
          2003   2004   2005
         
 
 
Requirements:
                       
 
System load
    1,010       1,039       1,070  
 
Contracts for power sales
    21       1       1  
 
   
     
     
 
   
Total Requirements
    1,031       1,040       1,071  
 
   
     
     
 
Resources:
                       
 
System and contract hydro (1)
    458       550       550  
 
Company owned thermal generation (2)
    301       365       362  
 
Contracts for purchased power
    261       216       217  
 
   
     
     
 
   
Total Resources
    1,020       1,131       1,129  
 
   
     
     
 
     
Surplus (Deficit) Resources
    (11 )     91       58  
     
Additional available capacity (3)
    274       274       274  
 
   
     
     
 
     
Total surplus resources
    263       365       332  

(1)   Preliminary forecasts and snowpack conditions indicate streamflows are expected to be approximately 70 percent of normal in 2003. Avista Utilities currently estimates that hydroelectric generation will be 458 aMW in 2003, which is 92 aMW below normal. The forecasts for 2004 and 2005 assume normal water conditions, which is the mean of the 60 years between 1928 and 1988.
 
(2)   Forecast assumes that Coyote Springs 2 will be placed in operation in mid-2003.
 
(3)   Forecast assumes no generation from the Northeast CT, Rathdrum CT, Kettle Falls CT and Boulder Park, which are generally only used to meet electric load requirements due to either below normal hydroelectric generation and increased loads, and/or when operating costs are lower than short-term wholesale market prices. The combined maximum capacity of the Northeast CT, Rathdrum CT, Kettle Falls CT and Boulder Park is 274 MW.

Significant Customer A contract with Potlatch Corporation (Potlatch), expired on December 31, 2001. Potlatch’s Lewiston, Idaho facility has electric requirements of about 100 aMW. The facility also produces approximately 60 aMW of self-generation. The parties have agreed that Potlatch will receive electric service from Avista at the retail tariff rates established for large industrial customers. Potlatch is currently using its generation for its own electric requirements,

6


Table of Contents

AVISTA CORPORATION

which results in a net electric requirement on Avista Utilities’ system of approximately 40 aMW. In December 2002, Potlatch filed a complaint with the IPUC requesting that Avista Utilities be required to purchase its self-generation at a rate equivalent to Avista Utilities’ avoided costs. Hearings before the IPUC are currently scheduled for June 2003.

Hydroelectric Relicensing

Avista Corp. is a licensee under the Federal Power Act, which regulates certain of its hydroelectric generation resources, as administered by the FERC. Avista Corp.’s licensed projects are subject to the provisions of Part I of the Federal Power Act. These provisions include payment for headwater benefits, condemnation of licensed projects upon payment of just compensation, and take-over of such projects after the expiration of the license upon payment of the lesser of “net investment” or “fair value” of the project, in either case, plus severance damages. All but the Little Falls Plant of the Company’s hydroelectric plants are regulated by the FERC through project licenses issued for 30-50 year periods.

In February 2000, Avista Utilities received a 45-year operating license from the FERC for the Cabinet Gorge and Noxon Rapids Hydroelectric Generating Projects. The Clark Fork Settlement Agreement that was entered into during 1999 and incorporated into the FERC license, preserved the projects’ economic peaking and load following operations. Also, as part of the Clark Fork Settlement Agreement, Avista Utilities initiated implementation of protection, mitigation and enhancement measures in March 1999. Measures in the agreement, which cost approximately $4.7 million annually, address issues related to fisheries, water quality, wildlife, recreation, land use, cultural resources and erosion. Recovery of previously deferred hydroelectric relicensing costs, as well as estimated levels of ongoing costs associated with implementation of the Clark Fork Settlement Agreement, were addressed by both the WUTC and IPUC and received favorable regulatory recovery treatment. Costs of approximately $15 million deferred during the licensing phase were allowed in rate base and are being amortized over the 45-year license term. See “Item 2. Properties - Avista Utilities” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Future Outlook” for additional information.

The issue of high levels of dissolved gas which exceed Idaho and federal water quality standards downstream of the Cabinet Gorge Hydroelectric Generating Project (Cabinet Gorge) during spill periods continues to be studied, as agreed to in the Clark Fork Settlement Agreement and incorporated in the renewed FERC license. To date, intensive biological studies in the lower Clark Fork River and Lake Pend Oreille have documented minimal biological effects of high dissolved gas levels on free ranging fish. Under the terms of the Clark Fork Settlement Agreement, the Company developed an abatement and mitigation strategy during 2002 with the other signatories to the agreement. In December 2002, the Company submitted its plan for review and approval by the other signatories as well as the FERC. The structural alternative proposed in the plan provides for the modification of the two existing diversion tunnels built when Cabinet Gorge was originally constructed. The costs of modifications to the first tunnel are currently estimated to be $37 million (including allowance for funds used during construction (AFUDC) and inflation) and would be incurred between 2004 and 2009. The second tunnel would be modified only after evaluation of the performance of the first tunnel and such modifications would commence no later than 10 years following the completion of the first tunnel. It is currently estimated that the costs to modify the second tunnel would be $23 million (including AFUDC and inflation). As part of the plan, the Company will also provide $0.5 million annually commencing as early as 2004, as mitigation for aquatic resources that might be adversely affected by high dissolved gas levels. Mitigation funds will continue until the modification of the second tunnel commences or if the second tunnel is not modified to an agreed upon point in time commensurate with the biological effects of high dissolved gas levels. The Company will seek regulatory recovery of the costs for the modification of Cabinet Gorge and the mitigation payments.

The Company operates six hydroelectric plants on the Spokane River, and five of these (Long Lake, Nine Mile, Upper Falls, Monroe Street and Post Falls) are under one FERC license and referred to herein as the Spokane River Project. The sixth, Little Falls, operates under separate Congressional authorization and is not licensed by the FERC. The license for the Spokane River Project expires in August 2007; the Company filed a Notice of Intent to Relicense on July 29, 2002. The formal consultation process involving planning and information gathering with stakeholder groups is underway. The Company’s goal is to develop with the stakeholders a comprehensive and cost-effective settlement agreement to be filed as part of the Company’s license application to the FERC in July 2005.

Natural Gas Operations

Avista Utilities provides natural gas distribution services to retail customers in parts of Washington, Idaho, Oregon and California. Natural gas commodity costs in excess of the amount recovered in current rates are deferred and recovered in future periods with applicable regulatory approval through adjustments to rates. Market prices for natural gas continue to be competitive compared to alternative fuel sources for residential, commercial and industrial customers. Avista Utilities believes that natural gas should sustain its market advantage based on the levels of existing reserves and potential natural gas development in the future. Growth has occurred in the natural gas business in recent years due to

7


Table of Contents

AVISTA CORPORATION

increased demand for natural gas in new construction, as well as conversions from electric space, oil space and electric water heating to natural gas.

Avista Utilities makes sales and provides transportation service directly to large natural gas customers. The majority of Avista Utilities’ large industrial customers purchase their own natural gas requirements through natural gas marketers. For these customers, Avista Utilities provides transportation from its pipeline interconnection to the customers’ premises. Thirteen of Avista Utilities’ largest natural gas customers are provided natural gas transportation service under individual contracts. These negotiated contracts were entered into to retain these customers who can either by-pass Avista Utilities’ distribution system or have competitive alternative fuel capability. All individual contracts are subject to regulatory review and approval. The competitive nature of the natural gas spot market results in savings in the cost of purchased natural gas, which encourages large customers with fuel-switching capabilities to continue to utilize natural gas for their energy needs when economic. The total volume transported on behalf of transportation customers for 2002, 2001 and 2000 was 174.9, 180.9 and 224.8 million therms, which represented approximately 34 percent, 33 percent and 38 percent of Avista Utilities’ total system deliveries, respectively.

Challenges facing Avista Utilities’ natural gas operations include, among other things, volatility in the price of natural gas, the timing of recovery of increased commodity costs, customer response to changes in prices, changes in the availability of natural gas, legislative and governmental regulations and weather conditions.

Natural Gas Resources

Natural Gas Supply Natural gas supplies are available from domestic and Canadian sources through both long- and short-term, or spot market, purchases. Avista Utilities has capacity delivery rights on seven pipelines and owns natural gas storage facilities. A diverse portfolio of natural gas resources allows Avista Utilities to capture market opportunities that benefit its natural gas customers.

The Company’s energy trading and marketing subsidiary, Avista Energy, is responsible for the daily management and optimization of these resources for the requirements of customers in the states of Washington, Idaho and Oregon under an agreement with Avista Utilities. Under this relationship, Avista Utilities retains ownership of its transportation, storage and long-term contracts and Avista Energy acts as an agent to optimize these important resources. See “Regulatory Issues: Natural Gas Benchmark Mechanism” and “Note 1 of Notes to Consolidated Financial Statements” for additional information.

Approximately 25 percent of Avista Utilities’ natural gas supplies are obtained from domestic sources, with the remaining 75 percent from Canadian sources. Nearly all natural gas purchased from Canadian sources is contracted in U.S. dollars, limiting any foreign currency exchange exposure. Canadian natural gas supplies are not considered to be at greater risk of non-delivery than supplies from the United States.

Jackson Prairie Natural Gas Storage Project (Jackson Prairie) Avista Utilities owns a one-third interest in Jackson Prairie, an underground natural gas storage field located near Chehalis, Washington. Jackson Prairie has a total peak day deliverability of 8.8 million therms, with a total working natural gas inventory of 190.3 million therms. The role of Jackson Prairie in providing flexible natural gas supplies is important to Avista Utilities’ natural gas operations. It enables Avista Utilities to place natural gas into storage when prices are low or to meet minimum natural gas purchasing requirements, as well as to meet high demand periods or to withdraw natural gas from storage when spot prices are high. During 1999, the capacity at Jackson Prairie was increased. This increased capacity is being operated and managed by Avista Energy for a ten-year period with Avista Energy incurring the associated costs of the increased capacity. During 2002, a multi-year project to further increase the capacity at Jackson Prairie commenced. Avista Utilities has contracted to release a total of approximately 37 percent of its Jackson Prairie capacity to two other utilities. One of these contracts requires two-years notice for termination and one contract is renewed on a year-to-year basis.

Regulatory Issues

Avista Corp., as a regulated public utility, is currently subject to regulation by state utility commissions with respect to prices, accounting, the issuance of securities, and other matters. The retail electric and natural gas operations are subject to the jurisdiction of the WUTC, the IPUC, the Oregon Public Utility Commission (OPUC) and the California Public Utilities Commission (CPUC). The Company is also subject to the jurisdiction of the FERC for its wholesale natural gas rates charged for the release of capacity from Jackson Prairie, and for electric transmission service and wholesale electric sales.

In each regulatory jurisdiction, rates for retail electric and natural gas services (other than specially negotiated retail rates for industrial or large commercial customers, which are subject to regulatory review and approval) are currently

8


Table of Contents

AVISTA CORPORATION

determined on a “cost of service” basis and are designed to provide, after recovery of allowable operating expenses, an opportunity to earn a reasonable return on “rate base.” “Rate base” is generally determined by reference to the original cost (net of accumulated depreciation) of utility plant in service, subject to various adjustments for deferred taxes and other items. Over time, rate base is increased by additions to utility plant in service and reduced by depreciation of utility plant. As the energy business is restructured, traditional “cost of service” ratemaking may evolve into some other form of ratemaking. Rates for electric and natural gas transmission services are based on the “cost of service” principles and are set forth in tariffs on file with the FERC. See “Note 1 of Notes to Consolidated Financial Statements” for additional information about regulation, depreciation and deferred income taxes. See “Industry Restructuring” for additional information about deregulation, as well as changes with respect to transmission and wholesale electricity markets.

Power Cost Deferrals Avista Utilities defers the recognition in the income statement of certain power supply costs as approved by the WUTC. A portion of power supply costs are recorded as a deferred charge on the balance sheet for future review and the opportunity for recovery through retail rates. The deferred power supply costs include certain differences between actual power supply costs incurred by Avista Utilities and the costs included in base retail rates. This difference in power supply costs primarily results from changes in short-term wholesale market prices, changes in the level of hydroelectric generation and changes in the level of thermal generation (including changes in fuel prices). Avista Utilities accrues interest on deferred power costs in the Washington jurisdiction at a rate, which is adjusted semi-annually, of 8.9 percent as of December 31, 2002. Total deferred power costs were $123.7 million for Washington customers as of December 31, 2002, a decrease from $140.2 million as of December 31, 2001.

In June 2002, the WUTC issued an order that became effective July 1, 2002 with respect to a general electric rate case filed by Avista Utilities in December 2001. Rate increases previously approved by the WUTC totaling 31.2 percent (a 25 percent temporary surcharge approved in September 2001 for the recovery of deferred power costs and a 6.2 percent increase approved in March 2002) were restructured. The general increase to base retail rates was 19.3 percent (or $45.7 million in annual revenues) and the remaining 11.9 percent represents the continued recovery of deferred power costs over a period currently projected to continue into 2009.

In the June 2002 rate order, the WUTC approved the establishment of an Energy Recovery Mechanism (ERM). The ERM replaced a series of temporary power cost deferral mechanisms that were in place in Washington since mid-2000. The ERM allows Avista Utilities to increase or decrease electric rates periodically with WUTC approval to reflect changes in power supply costs. The ERM provides for Avista Utilities to incur the cost of, or receive the benefit from, the first $9 million in annual power supply costs above or below the amount included in base retail rates. Because the ERM was implemented on July 1, 2002, the Company’s expense or benefit was limited to $4.5 million for 2002. Under the ERM, 90 percent of annual power supply costs exceeding or below the initial $9 million ($4.5 million for 2002) is deferred for future surcharge or rebate to Avista Utilities’ customers. The remaining 10 percent is an expense of, or benefit to, the Company.

Avista Utilities has a power cost adjustment (PCA) mechanism in Idaho that allows it to modify electric rates periodically with IPUC approval to recover or rebate a portion of the difference between actual and allowed net power supply costs. The PCA mechanism allows for the deferral of 90 percent of the difference between actual net power supply expenses and the authorized level of net power supply expenses approved in the last Idaho general rate case. Avista Utilities accrues interest on deferred power costs in the Idaho jurisdiction at a rate, which is adjusted annually, of 2 percent as of December 31, 2002. Avista Utilities anticipates making a filing with the IPUC requesting that the interest rate be modified to more closely approximate Avista Utilities’ costs of short-term borrowings until the current PCA surcharge is eliminated. In October 2002, the IPUC issued an order extending a 19.4 percent PCA surcharge for Idaho electric customers. The PCA surcharge will remain in effect until October 2003. The IPUC directed Avista Utilities to file a status report 60 days before the PCA surcharge expires. If review of the status report and the actual balance of deferred power costs support continuation of the PCA surcharge, the IPUC has indicated that it anticipates the PCA surcharge will be extended for an additional period. Total deferred power costs for Idaho customers were $31.5 million as of December 31, 2002, a decrease from $73.1 million as of December 31, 2001.

See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Avista Utilities-Regulatory Matters” for additional information.

General Rate Cases On December 3, 2001, the Company filed a general electric rate case with the WUTC, as ordered by the WUTC in September 2001. Issues addressed included, among other things, the recovery of cash outlays for increased power supply costs and expenses related to building additional generation. The rate case requested by Avista Corp. proposed a 10.39 percent overall rate of return. In June 2002, the WUTC issued an order that became effective July 1, 2002 with respect to the general electric rate case. The order provides for an overall rate of return of 9.72 percent and a return on equity of 11.16 percent. The order provided for no incremental rate increase to Avista Utilities’

9


Table of Contents

AVISTA CORPORATION

Washington electric customers above the rates in effect at the time; however, rate increases previously approved by the WUTC totaling 31.2 percent were restructured. For further information about this WUTC order, see “Power Cost Deferrals” above.

In Avista Utilities’ last general electric rate case in Idaho, the IPUC granted a rate increase of $9.3 million, or 7.6 percent, with an authorized overall rate of return of 8.98 percent and a return on equity of 10.75 percent, effective August 1999.

Avista Utilities is currently planning to file a natural gas general rate case in Oregon during the first half of 2003. The Company regularly reviews the need for natural gas or electric rate changes in each state in which it provides service.

Purchased Gas Adjustment (PGA or Natural Gas Trackers) Natural gas trackers are supplemental tariffs designed to pass through to customers changes in purchased natural gas costs, and do not normally result in any changes in net income. During the fourth quarter of 2002, Avista Utilities adjusted its natural gas rates in all jurisdictions in response to a decrease in current and projected natural gas costs. Natural gas rates were decreased 17.4 percent, 15.5 percent, 7.1 percent and 16.2 percent in Washington, Idaho, Oregon and California, respectively. Total deferred natural gas costs were $11.5 million as of December 31, 2002, a decrease from $52.7 million as of December 31, 2001.

Natural Gas Benchmark Mechanism The IPUC, WUTC and OPUC approved Avista Utilities’ Natural Gas Benchmark Mechanism in 1999. The mechanism eliminated the majority of natural gas procurement operations within Avista Utilities and consolidated gas procurement operations under Avista Energy, the Company’s non-regulated subsidiary. The ownership of the natural gas assets remains with Avista Utilities; however, the assets are managed by Avista Energy through an Agency Agreement. Avista Utilities continues to manage natural gas procurement for its California operations, which currently represents approximately four percent of its total natural gas therm sales.

The Natural Gas Benchmark Mechanism provides benefits to retail customers and allows Avista Energy to retain a portion of the benefits associated with asset optimization and the efficiencies gained in purchasing natural gas for Avista Utilities. In the first quarter of 2002, the IPUC and the OPUC approved the continuation of the Natural Gas Benchmark Mechanism and related Agency Agreement through March 31, 2005. In January 2003, the WUTC approved the continuation of the Natural Gas Benchmark Mechanism and related Agency Agreement through January 29, 2004. Hearings will be held before the WUTC during 2003 to determine whether or not the Natural Gas Benchmark Mechanism and related Agency Agreement will be extended beyond January 29, 2004.

Industry Restructuring

Federal Level

Industry restructuring to open the electric wholesale energy market to competition was initially promoted by federal legislation. The Energy Policy Act of 1992 (Energy Act) amended provisions of the Public Utility Holding Company Act of 1935 (PUHCA) and the Federal Power Act to remove certain barriers to a competitive wholesale market. The Energy Act expanded the authority of the FERC to issue orders requiring electric utilities to transmit power and energy to or for wholesale purchasers and sellers, and to require electric utilities to enlarge or construct additional transmission capacity for the purpose of providing these services. It also created “exempt wholesale generators”, a new class of independent power plant owners that are able to sell generation only at the wholesale level. This permits public utilities and other entities to participate through subsidiaries in the development of independent electric generating plants for sales to wholesale customers without being required to register under the PUHCA.

FERC Order No. 888, issued in April 1996, requires public utilities operating under the Federal Power Act to provide access to their transmission systems to third parties pursuant to the terms and conditions of the FERC’s pro-forma open access transmission tariff. FERC Order No. 889, the companion rule to Order No. 888, requires public utilities to establish an Open Access Same-Time Information System (OASIS) to provide transmission customers with information about available transmission capacity and other information by electronic means. It also requires each public utility subject to the rule to functionally separate its transmission and wholesale power merchant functions. The FERC issued its initial order accepting the non-rate terms and conditions of Avista Utilities’ open access transmission tariff in November 1996. Avista Utilities filed its “Procedures for Implementing Standards of Conduct under FERC Order No. 889” with the FERC in December 1996 and adopted these Procedures effective January 1997. FERC Orders No. 888 and No. 889 have not had a material effect on Avista Utilities’ operating results.

Avista Corp. is negotiating with nine other utilities in the western United States in the possible formation of a Regional Transmission Organization (RTO), RTO West, a non-profit organization. The potential formation of RTO West is in response to a FERC order requiring all utilities subject to FERC regulation to file a proposal to form a RTO, or a

10


Table of Contents

AVISTA CORPORATION

description of efforts to participate in a RTO, and any existing obstacles to RTO participation. RTO West filed its Stage 2 proposal with the FERC in March 2002 and received limited approval from the FERC of this initial plan in September 2002. The FERC’s goal with respect to the formation of RTOs is to promote efficiency in wholesale electricity markets and in the operation of transmission systems by way of standardized and independent operation of transmission systems.

Avista Corp. and two other utilities have also taken steps toward the formation of a for-profit Independent Transmission Company, TransConnect, which would be a member of RTO West, serve portions of five states and own or lease the high voltage transmission facilities of the participating utilities. TransConnect filed its proposal with the FERC in November 2001 and received limited approval from the FERC in September 2002.

The final proposals must be approved by the FERC, the boards of directors of the filing companies and regulators in various states. The companies’ decision to move forward with the formation of TransConnect or RTO West will ultimately depend on the conditions related to the formation of the entities, as well as the economics and conditions imposed in the regulatory approval process. If TransConnect were formed, it could result in Avista Utilities divesting its electric transmission assets. The formation of RTO West or TransConnect could have an impact on the Company’s transmission costs.

On July 31, 2002, the FERC issued a Notice of Proposed Rulemaking proposing a Standard Market Design (SMD) that would significantly alter the markets for wholesale electricity and transmission and ancillary services in the United States. The new SMD would establish a generation adequacy requirement for “load-serving entities” and a standard platform for the sale of electricity and transmission services. Under the new SMD, Independent Transmission Providers would administer spot markets for wholesale power, ancillary services and transmission congestion rights, and electric utilities, including Avista Utilities, would be required to transfer control over transmission facilities to the applicable Independent Transmission Provider. As the SMD proposal develops, the Company continues to assess the impact the SMD would have on its operations as well as how the SMD would impact the RTO West and TransConnect proposals. The Company is subject to state regulation in each of the states in which it operates. State regulatory agencies are actively involved in the SMD rulemaking process and there have been significant concerns at the state and regional level raised with the FERC with respect to the SMD, particularly in the western United States. In February 2003, Avista Utilities and several other western utilities filed comments with the FERC expressing their concerns with respect to the SMD proposal.

The North American Electric Reliability Council and the WECC have undertaken initiatives to establish a series of security coordinators to oversee the reliable operation of the regional transmission system. Accordingly, Avista Utilities, in cooperation with other utilities in the Pacific Northwest, established the Pacific Northwest Security Coordinator (PNSC), which oversees daily and short-term operations of the Northwest sub-regional transmission grid and has limited authority to direct certain actions of control area operators in the case of a pending transmission system emergency. Avista Utilities executed its service agreement with the PNSC in September 1998.

State Level

Further competition may be introduced by state action. Competition for retail customers is not generally allowed in Avista Utilities’ service territory. While the Energy Act precludes the FERC from mandating retail wheeling, state regulators and legislators could open service territories to full competition at the retail level. Legislative action at the state level would be required for full retail wheeling and customer choice to occur in Washington and Idaho. For the past several years, the legislatures and public utility commissions in Washington and Idaho have conducted a series of hearings and several studies regarding electric industry restructuring. Issues such as unbundling, deregulation, reliability and consumer protection were examined. Impacts on customer service quality and system reliability (generation, transmission and distribution) were considered on a “macro” basis under various restructuring scenarios. Public policy makers in Washington and Idaho continue to examine other states’ experiences with restructuring, while cognizant that the Pacific Northwest generally benefits from the lowest electric rates in the country. There is generally no movement toward deregulation in Washington or Idaho.

11


Table of Contents

AVISTA CORPORATION

Environmental Issues

The Company is subject to environmental regulation by federal, state and local authorities. The generation, transmission, distribution, service and storage facilities in which Avista Utilities has an ownership interest were designed to comply with all applicable environmental laws. Furthermore, the Company conducts periodic reviews of all its facilities and operations to respond to or anticipate emerging environmental issues. The Company’s Board of Directors has an Environmental Committee to deal specifically with these issues.

Air Quality The most significant impact on the Company related to the Clean Air Act (CAA) and the 1990 Clear Air Act Amendments (CAAA) pertains to Colstrip, which is a “Phase II” coal-fired plant under the CAAA. Colstrip is not expected to be required to implement any additional sulfur dioxide (SO2) mitigation in the foreseeable future in order to continue operations. Avista Utilities’ other thermal projects are subject to various CAAA standards. Every five years each project requires an updated operating permit (known as a Title V permit) which addresses, among other things, the compliance of the plant with the CAAA. The operating permit for the Rathdrum CT was renewed in 2000 and the operating permit for Kettle Falls was renewed in 2002.

During 2001, Avista Corp. extended the operating hours of the Northeast CT with an agreement with the Spokane County Air Pollution Control Authority (SCAPCA) under a special operating order called an Assurance of Discontinuance (AOD). The SCAPCA has allowed for continued operation of the Northeast CT upon the condition that a payment of $150 for each hour of operation will be paid into a mitigation fund for assistance to low-income customers and the payment of $10,000 for each day of operation to fund an environmental offset project. The AOD allows Avista Utilities to use the Northeast CT to temporarily bring on added generating capacity for the benefit of its customers and the region during a time of increased energy demand and limited energy resources. Extended operation of the Northeast CT was approved after the SCAPCA determined, through air emission modeling and projections, that extended operation of the turbine would not adversely impact air quality. The AOD and associated funding of the environmental offset project will be in effect until a new air permit is issued by the SCAPCA. The Company expects to be issued a new permit for operation of the Northeast CT in 2003.

Water Quality The issue of high levels of dissolved gas which exceed Idaho and federal water quality standards downstream of Cabinet Gorge during spill periods continues to be studied, as agreed to in the Clark Fork Settlement Agreement and incorporated in the renewed FERC license. See “Hydroelectric Relicensing” for further information.

In June 2001, Avista Development received official notice that it had been designated as a potentially liable party with respect to contaminated sites on the Spokane River. The Department of Ecology (DOE) discovered PCBs in fish and sediments in the Spokane River in the 1970s and 1980s. In the 1990s, the DOE performed subsequent sampling of the river and identified potential sources of the PCBs, including the Spokane Industrial Park and a number of other entities in the area. The Consent Decree and Scope of Work for the remedial investigation and feasibility study of the site were finalized during the fourth quarter of 2002. It is currently expected that the actual cleanup of PCB sediments in the Spokane River will be coordinated to the extent possible with the EPA’s separate plan to remove heavy metals from the Spokane River, contamination that resulted from decades of mining upstream at locations in Idaho and is in not related to the activities of Avista Development. See “Spokane River” in “Note 28 of the Notes to Consolidated Financial Statements” for additional information.

See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Future Outlook” and “Note 28 of the Notes to Consolidated Financial Statements” for additional information with respect to environmental issues.

12


Table of Contents

AVISTA CORPORATION

AVISTA UTILITIES OPERATING STATISTICS

                                         
                    Years Ended December 31,
                   

                    2002   2001   2000
                   
 
 
ELECTRIC OPERATIONS
                               
   
ELECTRIC OPERATING REVENUES (Dollars in Thousands):
                               
     
Residential
          $ 196,156     $ 158,847     $ 158,065  
     
Commercial
            194,732       155,371       149,770  
     
Industrial
            68,096       80,433       82,992  
     
Public street and highway lighting
            4,683       3,790       3,612  
 
           
     
     
 
       
Total retail revenues
            463,667       398,441       394,439  
     
Wholesale revenues
            64,082       480,903       864,754  
     
Other revenues
            56,392       42,861       28,062  
 
           
     
     
 
       
Total electric operating revenues
          $ 584,141     $ 922,205     $ 1,287,255  
 
           
     
     
 
   
ELECTRIC ENERGY SALES (Thousands of MWhs):
                               
     
Residential
            3,203       3,219       3,279  
     
Commercial
            2,837       2,882       2,886  
     
Industrial
            1,519       1,892       2,048  
     
Public street and highway lighting
            25       25       25  
 
           
     
     
 
       
Total retail energy sales
            7,584       8,018       8,238  
     
Wholesale energy sales
            2,216       6,262       15,807  
 
           
     
     
 
       
Total electric energy sales
            9,800       14,280       24,045  
 
           
     
     
 
   
ELECTRIC ENERGY RESOURCES (Thousands of MWhs):
                               
     
Hydro generation (from Company facilities)
            4,010       2,564       3,819  
     
Thermal generation (from Company facilities)
            1,714       3,001       3,153  
     
Purchased power – long-term hydro
            837       631       929  
     
Purchased power – wholesale
            3,732       8,065       16,111  
     
PURPA and other contracts
            96       559       595  
     
Power exchanges
            17       (104 )     67  
 
           
     
     
 
       
Total power resources
            10,406       14,716       24,674  
     
Energy losses and Company use
            (606 )     (436 )     (629 )
 
           
     
     
 
       
Total energy resources (net of losses)
            9,800       14,280       24,045  
 
           
     
     
 
   
NUMBER OF ELECTRIC CUSTOMERS (Average for Period):
                               
     
Residential
            279,735       276,845       273,219  
     
Commercial
            35,910       35,454       35,060  
     
Industrial
            1,420       1,434       1,254  
     
Public street and highway lighting
            413       402       392  
 
           
     
     
 
       
Total electric retail customers
            317,478       314,135       309,925  
     
Wholesale
            46       44       58  
 
           
     
     
 
       
Total electric customers
            317,524       314,179       309,983  
 
           
     
     
 
   
ELECTRIC RESIDENTIAL SERVICE AVERAGES:
                               
     
Annual use per customer (KWh)
            11,450       11,629       12,003  
     
Revenue per KWh (in cents)
            6.12       4.93       4.82  
     
Annual revenue per customer
          $ 701.22     $ 573.77     $ 578.53  
   
ELECTRIC AVERAGE HOURLY LOAD (aMW)
            935       975       1,012  
 
           
     
     
 
   
RESOURCE AVAILABILITY at time of system peak (MW):
                               
     
Total requirements (winter):
                               
       
Retail native load
            1,346       1,500       1,491  
       
Wholesale obligations
            297       1,734       2,338  
 
           
     
     
 
       
Total requirements (winter)
          1,643       3,234       3,829  
     
Total resource availability (winter)
            2,213       3,553       4,194  
     
Total requirements (summer):
                               
       
Retail native load
            1,389       1,379       1,473  
       
Wholesale obligations
            466       1,332       2,756  
 
           
     
     
 
       
Total requirements (summer)
        1,855       2,711       4,229  
     
Total resource availability (summer)
            2,287       2,927       4,656  

13


Table of Contents

AVISTA CORPORATION

AVISTA UTILITIES OPERATING STATISTICS

                                 
            Years Ended December 31,
           

            2002   2001   2000
           
 
 
NATURAL GAS OPERATIONS
                       
   
NATURAL GAS OPERATING REVENUES (Dollars in Thousands):
                       
     
Residential
  $ 183,964     $ 179,584     $ 128,240  
     
Commercial
    104,974       104,012       69,982  
     
Industrial
    7,127       11,130       7,680  
 
   
     
     
 
       
Total retail natural gas revenues
    296,065       294,726       205,902  
     
Wholesale revenues
    695       1,762       5,691  
     
Transportation revenues
    9,664       8,576       10,242  
     
Other revenues
    3,399       3,579       3,011  
 
   
     
     
 
       
Total natural gas operating revenues
  $ 309,823     $ 308,643     $ 224,846  
 
   
     
     
 
   
THERMS DELIVERED (Thousands of Therms):
                       
     
Residential
    199,686       198,413       212,198  
     
Commercial
    126,220       126,869       135,126  
     
Industrial
    11,243       15,523       18,350  
 
   
     
     
 
       
Total retail sales
    337,149       340,805       365,674  
     
Wholesale sales
    2,306       4,831       4,034  
     
Transportation sales
    174,891       180,918       224,803  
     
Interdepartmental sales and Company use
    2,145       15,430       1,391  
 
   
     
     
 
       
Total therms delivered
    516,491       541,984       595,902  
 
   
     
     
 
   
SOURCES OF NATURAL GAS SUPPLY (Thousands of Therms):
                       
     
Purchases
    344,793       348,620       372,795  
     
Storage – injections
    (53 )     (62 )     (467 )
     
Storage – withdrawals
    60       54       403  
     
Natural gas for transportation
    174,891       180,918       224,803  
     
Interdepartmental transportation
    1,513       14,662       589  
     
Distribution system losses
    (4,713 )     (2,208 )     (2,221 )
 
   
     
     
 
       
Total natural gas supply
    516,491       541,984       595,902  
 
   
     
     
 
   
NUMBER OF NATURAL GAS CUSTOMERS (Average for Period):
                       
     
Residential
    254,700       249,650       242,983  
     
Commercial
    30,823       30,355       29,739  
     
Industrial
    315       328       334  
 
   
     
     
 
       
Total retail customers
    285,838       280,333       273,056  
     
Wholesale customers
    1       2       2  
     
Transportation customers
    88       86       96  
 
   
     
     
 
       
Total natural gas customers
    285,927       280,421       273,154  
 
   
     
     
 
   
NATURAL GAS RESIDENTIAL SERVICE AVERAGES:
                       
     
Washington and Idaho
                       
       
Annual use per customer (therms)
    841       852       950  
       
Revenue per therm (in cents)
    93.05       89.24       57.82  
       
Annual revenue per customer
  $ 782.16     $ 760.02     $ 549.07  
     
Oregon and California
                       
       
Annual use per customer (therms)
    679       688       730  
       
Revenue per therm (in cents)
    90.00       93.44       66.83  
       
Annual revenue per customer
  $ 610.68     $ 643.31     $ 487.80  
   
NET SYSTEM MAXIMUM CAPABILITY (Thousands of Therms):
                       
     
Net system maximum demand (winter)
    2,253       2,236       2,347  
     
Net system maximum firm contractual capacity (winter)
    4,340       4,320       4,320  
   
HEATING DEGREE DAYS: (1)
                       
     
Spokane, WA
                       
       
Actual
    6,818       6,800       7,176  
       
30 year average
    6,842       6,842       6,842  
       
% of average
    100 %     99 %     105 %
     
Medford, OR
                       
       
Actual
    4,230       4,143       4,388  
       
30 year average
    4,611       4,611       4,611  
       
% of average
    92 %     90 %     95 %


(1)   Heating degree days are the measure of the coldness of weather experienced, based on the extent to which the average of high and low temperatures for a day falls below 65 degrees Fahrenheit (annual degree days below historic indicate warmer than average temperatures).

14


Table of Contents

AVISTA CORPORATION

Energy Trading and Marketing Line of Business

The Energy Trading and Marketing line of business includes Avista Energy and Avista Power, both wholly owned subsidiaries of Avista Capital.

Avista Energy

Avista Energy is an electricity and natural gas marketing and trading business, operating primarily within the WECC. Avista Energy focuses on asset-backed optimization of combustion turbines and hydroelectric assets owned by other entities, long-term electric supply contracts, natural gas storage, and electric and natural gas transmission and transportation arrangements. Avista Energy’s marketing efforts are driven by its base of knowledge and experience in the operation of both electric energy and natural gas physical systems in the WECC, as well as its relationship-focused approach with its customers. Avista Energy’s headquarters are in Spokane, Washington, and it also has an office in Vancouver, British Columbia, Canada.

Avista Energy accounted for energy commodity trading activity in compliance with Emerging Issues Task Force (EITF) Issue No. 98-10, “Accounting for Contracts Involved in Energy Trading and Risk Management Activities” through December 31, 2002 for contracts entered into on or prior to October 25, 2002. In October 2002, the EITF rescinded Issue No. 98-10. As such, Avista Energy is required to account for energy trading contracts that meet the definition of a derivative at market value in compliance with Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This applies to all existing contracts as of January 1, 2003 as well as to all new contracts entered into subsequent to October 25, 2002. The transition from EITF Issue No. 98-10 to accrual based accounting resulted in the adjustment of the contracts that are not considered derivatives from their market value to their cost basis. The changes are anticipated to primarily affect the timing of the recognition of income or loss in earnings, and not change the underlying economics or cash flows of transactions entered into by Avista Energy. The changes could result in a significant increase in the volatility of reported earnings on a quarter-to-quarter and year-to-year basis. See “ Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” and “Note 2 of the Notes to Consolidated Financial Statements” for further details.

Avista Energy trades electricity and natural gas, along with derivative commodity instruments including futures, options, swaps and other contractual arrangements. Most transactions are conducted on a largely unregulated “over-the-counter” basis, there being no central clearing mechanism (except in the case of specific instruments traded on the commodity exchanges). Avista Energy’s trading operations are affected by, among other things, volatility of prices within the electric energy and natural gas markets, the demand for and availability of energy, lower unit margins on new sales contracts, FERC-ordered price caps, deregulation of the electric utility industry, the creditworthiness of counterparties and the reduced liquidity in energy markets. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Business Risks” for further information.

The following table provides operating statistics for Avista Energy for the years ended December 31:

                             
        2002   2001   2000
       
 
 
Gross Realized Sales Transactions (dollars in thousands):
                       
 
Electric
  $ 1,417,499     $ 3,380,058     $ 4,721,291  
 
Natural Gas
    958,183       1,619,285       1,751,264  
 
Other
          1,612       58,996  
 
   
     
     
 
   
Total gross settled transactions
  $ 2,375,682     $ 5,000,955     $ 6,531,551  
 
   
     
     
 
Gross Realized Sales Volume:
                       
 
Electricity (thousands of MWhs)
    40,426       47,927       105,548  
 
Natural gas (thousands of dekatherms)
    225,983       248,193       273,448  
 
Coal (thousands of tons)
                3,514  

In April 1997, Avista Energy entered into a scheduling and marketing services agreement with Chelan County Public Utility District (PUD), located in Washington State. The agreement allows Avista Energy to market, on a “real-time” basis, a portion of the output from Chelan County PUD’s hydroelectric resources and to jointly market energy products and services to other utilities in the region.

In September 1999, Avista Energy began managing Avista Utilities’ natural gas storage assets, transportation contracts and natural gas purchasing operations. Under an Agency Agreement, Avista Energy serves as agent for

15


Table of Contents

AVISTA CORPORATION

Avista Utilities, managing its pipeline transportation rights and natural gas storage assets, as well as purchasing natural gas for Avista Utilities’ retail customers. The assets continue to be owned by Avista Utilities; however, they are fully integrated operationally into Avista Energy’s portfolio. The Natural Gas Benchmark Mechanism allows Avista Energy the opportunity to retain a portion of the benefits associated with asset optimization and the efficiencies gained in purchasing natural gas for Avista Utilities. The Natural Gas Benchmark Mechanism and related Agency Agreement expires in March 2005 in Idaho and Oregon. In January 2003, the WUTC approved the continuation of the Natural Gas Benchmark Mechanism and related Agency Agreement through January 2004. Hearings will be held before the WUTC during 2003 to determine whether or not the Natural Gas Benchmark Mechanism and related Agency Agreement will be extended beyond January 29, 2004.

Avista Energy is subject to the various risks inherent in commodity trading including, particularly, market risk, liquidity risk, commodity risk and credit risk, as well as possible new risks resulting from the imposition of market controls by federal and state regulatory agencies. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Power Market Issues and Future Outlook,” and “Notes 1, 2, 8 and 9 of Notes to Consolidated Financial Statements” for additional information regarding the market and credit risks inherent in the energy trading business, Avista Energy’s risk management policies and procedures, accounting practices, and positions held by Avista Energy as of December 31, 2002.

Avista Capital provides guarantees for Avista Energy’s credit agreement and, in the course of business, may provide guarantees to other parties with whom Avista Energy may be doing business. Avista Capital had $64.6 million of performance guarantees related to energy trading contracts outstanding as of December 31, 2002.

Avista Power

Avista Power was originally formed to develop and own generation assets. During 2001, the Company decided that Avista Power would no longer pursue the development of additional non-regulated generation projects due to changing market conditions and as part of Avista Corp.’s overall business strategy. Avista Power is a 49 percent owner of the Lancaster Project, which commenced commercial operation in September 2001. All of the output from the Lancaster Project is contracted to Avista Energy for 25 years. In addition, Avista Power and co-owner Mirant have substantially completed the construction of Coyote Springs 2. In January 2003, Avista Power’s 50 percent ownership interest in Coyote Springs 2 was transferred to Avista Corp. for inclusion in Avista Utilities’ power generation resource portfolio.

Information and Technology Line of Business

The Information and Technology line of business includes Avista Advantage and Avista Labs. Avista Advantage and Avista Labs are majority-owned and wholly-owned subsidiaries of Avista Capital, respectively.

Avista Advantage

Avista Advantage is a provider of internet-based facility intelligence, cost management, billing and information services to retail customers throughout North America. Avista Advantage’s solutions are designed to provide multi-site companies with critical and easy-to-access information that enables them to proactively manage and reduce their facility-related expenses.

Avista Advantage analyzes and presents consolidated bills on-line, and pays utility and other facility-related expenses for multi-site customers. Information gathered from invoices, providers and other customer-specific data allows Avista Advantage to provide its customers with in-depth analytical support, real-time reporting and consulting services with regard to facility-related energy, waste, repair and maintenance, and telecom expenses.

Avista Advantage has secured five patents on its two critical business systems, the Facility IQ system, which provides operational information drawn from facility bills, and the AviTrack database, which processes and reports on information gathered from service providers to ensure customers are receiving the most effective services at the proper price. Avista Advantage is not aware of any claimed or threatened infringement on any of its patents issued to date and will continue to expand and protect its existing patents, as well as file additional patent applications for new products, services and process enhancements.

As of December 31, 2002, Avista Advantage serviced 247 customers, having 98,251 billed sites throughout North America. This is an increase from 203 customers and 79,749 billed sites as of December 31, 2001. As of December

16


Table of Contents

AVISTA CORPORATION

31, 2000, Avista Advantage serviced 135 customers and 46,127 billed sites. During 2002, Avista Advantage processed $4.9 billion of bills, an increase from $4.3 billion in 2001 and $1.1 billion in 2000.

Avista Labs

Avista Labs is continuing to have discussions with selected companies in its search for a financial partner while moving forward with developing and selling its commercial fuel cell products. The Company has a goal of reducing its ownership interest in Avista Labs to less than 20 percent. Avista Labs has patented and developed a modular, air- cooled, self-hydrating Proton Exchange Membrane (PEM) fuel cell technology that provides reliable and clean distributed power solutions. Avista Labs also holds a 70 percent equity interest in H2fuel, LLC, a developer of fuel processors for the production of hydrogen. The remaining interest is owned by Unitel Fuels Technologies, LLC. H2fuel, LLC does not require any additional funding at this time.

In 2002, Avista Labs offered three PEM fuel cell products for commercial sale: a 100 watt system, a 500 watt system and a 1 kW system. Avista Labs is selling its fuel cell products directly and through selected market channels to industrial, commercial and government customers for premium and backup power. Avista Labs completed commercial transactions for the sale of 98 units during 2002. As of December 31, 2002, 174 units were installed in 42 locations throughout North and South America and Europe.

As of December 31, 2002, Avista Labs has been granted nine patents, with 805 issued claims recognizing and protecting the unique attributes of its fuel cell system, its modular approach to the design of fuel cell systems generally, the method used for rapidly energizing its hydrogen sensor, and its method for power conversion using ultracapacitors in tandem with fuel cells. In 2002, Avista Labs received a notice of allowance of an additional patent with 25 claims protecting its design for a hydrogen sensor circuit with a method for temperature and humidity compensation, and has 20 more patent applications pending or in process directed to its unique approach in fuel cells, power conversion and other components.

Alliances in bringing Avista Labs’ products to market include distribution agreements with Aperion Power Systems, LLC, Automated Railway Maintenance Systems, Inc., and SGS Futures, spa., and a joint marketing agreement with AirGas, Inc. Avista Labs continues to pursue additional partners for the distribution of its products. Avista Labs’ products are assembled primarily through outsourced manufacturing under contracts. In September 2002, Avista Labs entered into a strategic supply agreement with 3M Company for the purchase of membrane electrode assemblies (MEAs) for integration into its fuel cell products.

Other Line of Business

The Other line of business includes several subsidiaries, including Avista Ventures, Pentzer, Avista Development and Avista Services. The operations of Avista Capital that are not included through its subsidiaries are reported in this line of business. Prior to 1999, Pentzer was the parent company to the majority of Avista Corp.’s other subsidiary businesses, controlling interests in a broad range of middle market companies. Beginning in 2000, the focus of this line of business was changed to invest in business opportunities that have potential value to the Company’s energy-related businesses. The Company continues to limit its future investment in this line of business.

Discontinued Operations — Avista Communications

Avista Communications, formerly part of the Information and Technology line of business, provided local dial tone, data transport, internet services, voice messaging and other telecommunications services to several communities in the western United States. In September 2001, Avista Corp. decided that it would dispose of substantially all of the assets of Avista Communications. As such, these operations are reported as a discontinued operation. Avista Corp. began its divestiture of this business during the fourth quarter of 2001. The divestiture of operating assets was completed by the end of 2002. Certain liabilities of the operations remain to be settled.

17


Table of Contents

AVISTA CORPORATION

Item 2. Properties

Avista Utilities

Avista Utilities’ electric properties, located in the States of Washington, Idaho, Montana and Oregon, include the following:

Generation Properties (1)

                                 
                    Nameplate   Present
            No. of   Rating   Capability
            Units   (MW) (2)   (MW) (3)
           
 
 
Hydroelectric Generating Stations (River)
                       
   
Washington:
                       
       
Long Lake (Spokane)
    4       70.0       88.0  
       
Little Falls (Spokane)
    4       32.0       36.0  
       
Nine Mile (Spokane)
    4       26.4       24.5  
       
Upper Falls (Spokane)
    1       10.0       10.2  
       
Monroe Street (Spokane)
    1       14.8       15.0  
   
Idaho:
                       
       
Cabinet Gorge (Clark Fork)
    4       245.1       246.0  
       
Post Falls (Spokane)
    6       14.8       18.0  
   
Montana:
                       
       
Noxon Rapids (Clark Fork)
    5       466.2       527.0  
 
           
     
 
       
Total Hydroelectric
            879.3       964.7  
Thermal Generating Stations
                       
   
Washington:
                       
       
Kettle Falls
    1       50.7       50.0  
       
Kettle Falls CT
    1       6.9       6.9  
       
Northeast (Spokane) CT
    2       61.8       66.8  
       
Boulder Park
    6       24.6       24.6  
   
Idaho:
                       
       
Rathdrum CT (1)
    2       166.5       176.0  
   
Montana:
                       
       
Colstrip (Units 3 and 4) (4)
    2       233.4       222.0  
 
           
     
 
       
Total Thermal
            543.9       546.3  
   
Total Generation Properties
            1,423.2       1,511.0  
 
           
     
 

(1)   All generation properties are owned by the Company with the exception of the Rathdrum CT, which is leased from WP Funding LP. New accounting guidance was recently issued relating to the identification of, and accounting for, special-purpose entities such as WP Funding LP. See “Note 2 of the Notes to Consolidated Financial Statements” for further information. This interpretation will require the Company to begin consolidating WP Funding LP into its financial statements effective July 1, 2003.
 
(2)   Nameplate Rating, also referred to as “installed capacity”, is the manufacturer’s assigned power capability under specified conditions.
 
(3)   Present capability is the maximum capacity of the plant without exceeding approved limits of temperature, stress and environmental conditions.
 
(4)   Jointly owned; data refers to Avista Utilities’ 15 percent interest.

Generation Property under Development

In mid-2003, it is expected that the natural gas-fired Coyote Springs 2 will be placed into operation. Avista Utilities has a 50 percent ownership interest (140 MW) in Coyote Springs 2.

Electric Distribution and Transmission Plant

Avista Utilities operates approximately 12,200 miles of primary and secondary electric distribution lines and an electric transmission system of approximately 595 miles of 230 kV line and 1,528 miles of 115 kV line. Avista Utilities also owns a 10 percent interest in 495 miles of a 500 kV line between Colstrip, Montana and Townsend,

18


Table of Contents

AVISTA CORPORATION

Montana. The transmission and distribution system also includes numerous substations with transformers, switches, monitoring and metering devices, and other equipment related to its operation.

The 230 kV lines are used to transmit power from Avista Utilities’ Noxon Rapids and Cabinet Gorge hydroelectric generating stations to major load centers in its service area, as well as to transfer power between points of interconnection with adjoining electric transmission systems. These lines interconnect with the Bonneville Power Administration (BPA) at five locations and at one location each with PacifiCorp, NorthWestern Energy and Idaho Power Company. The BPA interconnections serve as points of delivery for power from the Colstrip generating station, as well as for the interchange of power with entities within and outside the Pacific Northwest. The interconnection with PacifiCorp is used to integrate Mid-Columbia hydroelectric generating facilities to Avista Utilities’ loads, as well as for the interchange of power with entities within and outside the Pacific Northwest.

The 115 kV lines provide for transmission of energy and the integration of the Spokane River hydroelectric and Kettle Falls wood-waste generating stations with service-area load centers. These lines interconnect with BPA at nine locations, Grant County PUD, Seattle City Light and Tacoma City Light at two locations each and one interconnection each with Chelan County PUD, PacifiCorp and NorthWestern Energy.

Avista Corp. is negotiating with nine other utilities in western United States in the possible formation of RTO West, a non-profit organization. Avista Corp. and two other utilities have also taken steps toward the formation of a for-profit Independent Transmission Company, TransConnect, which would be a member of RTO West, serve portions of five states and own or lease the high voltage transmission facilities of the participating utilities. See “Item 1. Business – Avista Utilities – Industry Restructuring” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Power Market Issues” for more information.

Natural Gas Plant

Avista Utilities has natural gas distribution mains of approximately 2,542 miles in Washington, 1,436 miles in Idaho, 1,699 miles in Oregon and 233 miles in California as of December 31, 2002. The natural gas distribution system includes numerous regulator stations, service distribution lines, monitoring and metering devices, and other equipment related to its operation.

Avista Utilities, Northwest Pipeline and Puget Sound Energy each own a one-third undivided interest in Jackson Prairie, which has a total peak day deliverability of 8.8 million therms, with a total working natural gas inventory of 190.3 million therms. Avista Utilities has contracted to release a total of approximately 37 percent of its Jackson Prairie capacity to two other utilities. One of these contracts requires two-years notice for termination and one contract is renewed on a year-to-year basis.

Item 3. Legal Proceedings

See “Note 28 of Notes to Consolidated Financial Statements” for additional information.

Item 4. Submission of Matters to a Vote of Security Holders

None.

19


Table of Contents

AVISTA CORPORATION

PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

Outstanding shares of Common Stock are listed on the New York and Pacific Stock Exchanges. As of February 28, 2003, there were approximately 17,131 registered shareholders of the Company’s no par value Common Stock.

The Board of Directors considers the level of dividends on the Company’s common stock on a regular basis, taking into account numerous factors including, without limitation, the Company’s results of operations, cash flows and financial condition, as well as the success of the Company’s strategies and general economic and competitive conditions. The Company’s net income available for dividends is derived primarily from the operations of Avista Utilities and Avista Energy.

Avista Energy holds a significant portion of the cash and cash equivalents reflected on the Consolidated Balance Sheet. Covenants in Avista Energy’s credit agreement restrict the amount of cash dividends that can be distributed to Avista Capital and ultimately to Avista Corp. During 2002, in accordance with the modified covenants of its credit agreement, Avista Energy paid $116.4 million in dividends to Avista Capital. In January 2003, Avista Energy paid $2.1 million in dividends to Avista Capital.

For additional information, refer to “Notes 1, 24 and 27 of Notes to Consolidated Financial Statements.” For high and low stock price information, refer to “Note 30 of Notes to Consolidated Financial Statements.”

20


Table of Contents

AVISTA CORPORATION

Item 6.  Selected Financial Data

                                             
(in thousands, except per share data and ratios)   Years Ended December 31,
       
        2002   2001   2000   1999   1998
Operating Revenues:
                                       
 
Avista Utilities
  $ 893,964     $ 1,230,847     $ 1,512,101     $ 1,115,647     $ 1,049,212  
 
Energy Trading and Marketing (net margin on trading activities)
    54,207       134,266       307,746       (17,942 )     48,624  
 
Information and Technology
    17,630       13,815       5,732       2,266       1,318  
 
Other
    14,645       16,385       32,937       122,303       231,483  
 
   
     
     
     
     
 
 
Total
  $ 980,446     $ 1,395,313     $ 1,858,516     $ 1,222,274     $ 1,330,637  
Income (Loss) from Operations (pre-tax):
                                       
 
Avista Utilities
  $ 149,180     $ 114,927     $ 3,177     $ 142,567     $ 143,153  
 
Energy Trading and Marketing
    29,211       94,669       250,196       (97,785 )     22,826  
 
Information and Technology
    (18,818 )     (29,872 )     (26,424 )     (8,966 )     (4,979 )
 
Other
    (14,886 )     (10,432 )     (9,861 )     (423 )     12,033  
 
   
     
     
     
     
 
 
Total
  $ 144,687     $ 169,292     $ 217,088     $ 35,393     $ 173,033  
Income (Loss) from Continuing Operations:
                                       
 
Avista Utilities
  $ 36,382     $ 24,164     $ (38,781 )   $ 59,573     $ 56,297  
 
Energy Trading and Marketing
    22,425       63,246       161,753       (60,739 )     14,116  
 
Information and Technology
    (12,117 )     (19,384 )     (19,032 )     (5,989 )     (3,221 )
 
Other
    (12,380 )     (8,421 )     (2,885 )     35,817       11,124  
 
   
     
     
     
     
 
 
Total
  $ 34,310     $ 59,605     $ 101,055     $ 28,662     $ 78,316  
Income (loss) from discontinued operations
    1,145       (47,449 )     (9,376 )     (2,631 )     (177 )
 
   
     
     
     
     
 
Net Income before cumulative effect of accounting change
  $ 35,455     $ 12,156     $ 91,679     $ 26,031     $ 78,139  
Cumulative effect of accounting change
    (4,148 )                        
 
   
     
     
     
     
 
Net income
  $ 31,307     $ 12,156     $ 91,679     $ 26,031     $ 78,139  
Preferred stock dividend requirements
    2,402       2,432       23,735       21,392       8,399  
 
   
     
     
     
     
 
Income available for common stock
  $ 28,905     $ 9,724     $ 67,944     $ 4,639     $ 69,740  
Average common shares outstanding, basic
    47,823       47,417       45,690       38,213       54,604  
Average common shares outstanding, diluted
    47,874       47,435       46,103       38,325       54,658  
Common shares outstanding at year-end
    48,044       47,633       47,209       35,648       40,454  
Earnings per Common Share:
                                       
 
Avista Utilities
  $ 0.71     $ 0.46     $ (1.37 )   $ 1.00     $ 0.88  
 
Energy Trading and Marketing
    0.47       1.33       3.51       (1.59 )     0.26  
 
Information and Technology
    (0.25 )     (0.41 )     (0.41 )     (0.16 )     (0.06 )
 
Other
    (0.26 )     (0.18 )     (0.06 )     0.94       0.20  
 
   
     
     
     
     
 
 
Earnings per common share from continuing operations, diluted
  $ 0.67     $ 1.20     $ 1.67     $ 0.19     $ 1.28  
 
Earnings (Loss) per common share from discontinued operations, diluted
    0.02       (1.00 )     (0.20 )     (0.07 )      
 
   
     
     
     
     
 
 
Earnings per common share before cumulative effect of accounting change, diluted
  $ 0.69     $ 0.20     $ 1.47     $ 0.12     $ 1.28  
 
Cumulative effect of accounting change, diluted
    (0.09 )                        
 
   
     
     
     
     
 
 
Total earnings per common share, diluted
  $ 0.60     $ 0.20     $ 1.47     $ 0.12     $ 1.28  
 
Total earnings per common share, basic
    0.60       0.21       1.49       0.12       1.28  
 
Dividends paid per common share
    0.48       0.48       0.48       0.48       1.05  
 
Book value per common share at year-end
  $ 14.84     $ 15.12     $ 15.34     $ 11.04     $ 12.07  
Total Assets at Year-End:
                                       
 
Avista Utilities
  $ 2,184,008     $ 2,396,317     $ 2,143,791     $ 1,976,716     $ 2,004,935  
 
Energy Trading and Marketing
    1,349,626       1,506,185       10,271,834       1,595,470       955,615  
 
Information and Technology
    37,528       26,891       14,429       6,312       2,492  
 
Other
    42,866       86,514       96,362       114,929       285,625  
 
Discontinued Operations
    105       21,316       50,665       20,067       4,969  
 
   
     
     
     
     
 
 
Total
  $ 3,614,133     $ 4,037,223     $ 12,577,081     $ 3,713,494     $ 3,253,636  
Long-Term Debt at Year-End
    902,635       1,175,715       679,806       714,904       730,022  
Company-Obligated Mandatorily
                                       
 
Redeemable Preferred Trust Securities
    100,000       100,000       100,000       110,000       110,000  
Preferred Stock Subject to Mandatory Redemption
    33,250       35,000       35,000       35,000       35,000  
Convertible Preferred Stock
                      263,309       269,227  
Common Equity
  $ 712,791     $ 720,063     $ 724,224     $ 393,499     $ 488,034  
Ratio of Earnings to Fixed Charges
    1.58       1.84       3.45       1.66       2.66  
Ratio of Earnings to Fixed Charges and Preferred Dividend Requirements
    1.52       1.78       2.19       1.11       2.26  

21


Table of Contents

AVISTA CORPORATION

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Safe Harbor for Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Avista Corporation (Avista Corp. or the Company) is including the following cautionary statement to make applicable, and to take advantage of, the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by, or on behalf of, the Company. Forward-looking statements include statements concerning plans, objectives, goals, strategies, projections of future events or performance, and underlying assumptions (many of which are based, in turn, upon further assumptions). Forward-looking statements are all statements other than statements of historical fact, including without limitation those that are identified by the use of words such as, but not limited to, “will,” “anticipates,” “seeks to,” “estimates,” “expects,” “intends,” “plans,” “predicts,” and similar expressions. From time to time, the Company may publish or otherwise make available forward-looking statements of this nature. All such subsequent forward-looking statements, whether written or oral and whether made by or on behalf of the Company, are also expressly qualified by these cautionary statements.

Such statements are inherently subject to a variety of risks and uncertainties that could cause actual results to differ materially from those expressed. Most of these risks and uncertainties are beyond the Company’s control. Such risks and uncertainties include, among others:

  changes in the utility regulatory environment in the individual states in which the Company operates and the United States in general. This can impact allowed rates of return, financings, or industry and rate structures;
 
  the impact of regulatory and legislative decisions including Federal Energy Regulatory Commission (FERC) price controls, and including possible retroactive price caps and resulting refunds;
 
  the impact from the potential formation of a Regional Transmission Organization and/or an Independent Transmission Company;
 
  the impact from the implementation of the FERC’s proposed Standard Market Design;
 
  the availability and prices of purchased energy, volatility and illiquidity in wholesale energy markets;
 
  wholesale and retail competition (including but not limited to electric retail wheeling and transmission costs);
 
  future streamflow conditions that affect the availability of hydroelectric resources;
 
  outages at any company-owned generating facilities;
 
  unanticipated delays or changes in construction costs with respect to present or prospective generating facilities;
 
  changes in weather conditions that can affect customer demand, result in natural disasters and/or customer outages, and affect the availability of hydroelectric resources;
 
  changes in industrial, commercial and residential growth and demographic patterns in the Company’s service territory;
 
  the loss of significant customers and/or suppliers;
 
  failure to deliver on the part of any parties from which the Company purchases and/or sells capacity or energy;
 
  changes in the creditworthiness of customers and energy trading counterparties;
 
  the Company’s ability to obtain financing through the issuance of debt and/or equity securities, which can be affected by various factors including the Company’s credit ratings, interest rate fluctuations and other capital market conditions;
 
  changes in future economic conditions in the Company’s service territory and the United States in general, including inflation or deflation and monetary policy;
 
  the continuing impact of the September 11, 2001 terrorist attacks as well as the potential for future terrorist attacks, particularly with respect to utility plant assets;
 
  changes in tax rates and/or policies;
 
  research and development findings for the Information and Technology companies;
 
  changes in, and compliance with, environmental and endangered species laws, regulations, decisions and policies, including present and potential environmental remediation costs;
 
  the outcome of legal and regulatory proceedings concerning the Company or affecting directly or indirectly its operations;
 
  employee issues, including changes in collective bargaining unit agreements, strikes, work stoppages or the loss of any of the Company’s key executives;
 
  changes in actuarial assumptions and the return on assets with respect to the Company’s pension plan, which can impact future funding obligations, costs and pension plan liabilities;
 
  increasing health care costs and the resulting effect on health insurance premiums paid for employees and the

22


Table of Contents

AVISTA CORPORATION

    obligation to provide postretirement health care benefits;
 
  increasing costs of insurance and the ability to obtain insurance.

The Company’s expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis, including without limitation management’s examination of historical operating trends, data contained in the Company’s records and other data available from third parties. However, there can be no assurance that the Company’s expectations, beliefs or projections will be achieved or accomplished. Furthermore, any forward-looking statement speaks only as of the date on which such statement is made. The Company undertakes no obligation to update any forward-looking statement or statements to reflect events or circumstances that occur after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for management to predict all of such factors, nor can it assess the impact of each such factor on the Company’s business or the extent to which any such factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement.

The following discussion and analysis is provided for the consolidated financial condition and results of operations of Avista Corp., including its subsidiaries. This discussion focuses on significant factors concerning the Company’s financial condition and results of operations and should be read along with the consolidated financial statements.

Avista Corp. Lines of Business

Avista Corp. is an energy company engaged in the generation, transmission and distribution of energy as well as other energy-related businesses. The Company is organized into four lines of business – Avista Utilities, Energy Trading and Marketing, Information and Technology, and Other. Avista Utilities, an operating division of Avista Corp. and not a separate entity, represents the regulated utility operations. Avista Capital, a wholly owned subsidiary of Avista Corp., is the parent company of all of the subsidiary companies engaged in the non-utility lines of business. As of December 31, 2002, the Company had common equity investments of $457.6 million and $255.2 million in Avista Utilities and Avista Capital, respectively.

Avista Utilities generates, transmits and distributes electricity and distributes natural gas. Avista Utilities owns and operates eight hydroelectric projects, a wood-waste fueled generating station, a two-unit natural gas-fired combustion turbine (CT) generating facility and two small generating facilities. It also owns a 15 percent share in a two-unit coal-fired generating facility and leases and operates a two-unit natural gas-fired CT generating facility. At the end of 2002, Avista Utilities’ facilities had a total net capability of approximately 1,511 megawatts (MW), of which 64 percent was hydroelectric and 36 percent was thermal. In mid-2003, it is expected that the natural gas-fired Coyote Springs 2 Generation Project (Coyote Springs 2) will be placed into operation. Avista Utilities has a 50 percent ownership interest (140 MW) in Coyote Springs 2.

In addition to company owned resources, Avista Utilities has a number of long-term power purchase and exchange contracts that increase its available resources. Avista Utilities sells and purchases electric capacity and energy to and from utilities and other entities in the wholesale market under long-term contracts having terms of more than one year. In addition, Avista Utilities engages in an ongoing process of resource optimization which involves short-term purchases and sales in the wholesale market in pursuit of an economic selection of resources to serve retail and wholesale loads. Avista Utilities makes continuing projections of (1) future retail and wholesale loads based on, among other things, forward estimates of factors such as customer usage and weather as well as historical data and contract terms and (2) resource availability based on, among other things, estimates of streamflows, generating unit availability, historic and forward market information and experience. On the basis of these continuing projections, Avista Utilities makes purchases and sales of energy on an annual, quarterly, monthly, daily and hourly basis to match actual resources to actual energy requirements. This process includes hedging transactions.

The Energy Trading and Marketing line of business is comprised of Avista Energy, Inc. (Avista Energy) and Avista Power, LLC (Avista Power). Avista Energy is an electricity and natural gas marketing and trading business, operating primarily in the Western Electricity Coordinating Council (WECC) geographical area, which is comprised of eleven Western states. Avista Power was originally formed to develop and own generation assets. During 2001, the Company decided that Avista Power would no longer pursue the development of additional non-regulated generation projects.

The Information and Technology line of business is comprised of Avista Advantage, Inc. (Avista Advantage) and Avista Laboratories, Inc. (Avista Labs). Avista Advantage is a provider of internet-based facility intelligence, cost management, billing and information services to retail customers throughout North America. Its primary product lines include consolidated billing, resource accounting, energy analysis, load profiling and maintenance and repair

23


Table of Contents

AVISTA CORPORATION

billing services. Avista Labs has patented and developed a modular air-cooled, self-hydrating Proton Exchange Membrane (PEM) fuel cell that delivers reliable and clean distributed power solutions. In addition to developing its modular fuel cell products, Avista Labs is contracting with selected market channels to deliver system solutions to industrial, commercial and residential markets. Avista Labs holds a 70 percent equity interest in H2fuel, LLC, a developer of fuel processors for the production of hydrogen. Avista Corp. is currently seeking a financial partner for Avista Labs with the goal of reducing its ownership interest to less than 20 percent of this company.

The Other line of business includes several subsidiaries, including Avista Ventures, Inc. (Avista Ventures), Avista Capital (parent company only amounts), Pentzer Corporation (Pentzer), Avista Development and Avista Services. The Company continues to limit its future investment in this line of business.

Avista Communications, Inc. (Avista Communications), formerly part of the Information and Technology line of business, provided local dial tone, data transport, internet services, voice messaging and other telecommunications services to several communities in the western United States. In September 2001, Avista Corp. decided that it would dispose of substantially all of the assets of Avista Communications. As such, these operations are reported as a discontinued operation. Avista Corp. began its divestiture of this business during the fourth quarter of 2001, and the divestiture of operating assets was complete by the end of 2002. Certain liabilities of the operations remain to be settled.

Avista Utilities — Regulatory Matters

Beginning in the second quarter of 2000, the price of power in the wholesale markets of the western United States increased considerably and became much more volatile. While prices and volatility decreased during the second half of 2001, the effects of contracts entered into during the period of high wholesale prices continue to have an impact on Avista Corp.’s financial condition, results of operations and cash flows. In the second half of 2000 and continuing through 2001, Avista Utilities was required to purchase above-normal amounts of power in the wholesale market to meet its retail demand. This was primarily due to the reduced availability of hydroelectric resources as a result of low streamflow conditions. The combination of high wholesale market prices and increased amounts required to be purchased increased power supply costs to amounts far in excess of the amounts recovered from retail customers under rates in effect at the time.

The Company has had a power cost deferral mechanism in place in Washington as authorized by the Washington Utilities and Transportation Commission (WUTC) since the middle of 2000. The Company has had a power cost deferral mechanism in place in Idaho as authorized by the Idaho Public Utilities Commission (IPUC) since 1989. Avista Utilities defers the recognition in the income statement of certain power supply costs that are in excess of the level currently recovered from retail customers. A portion of power supply costs are recorded as a deferred charge on the balance sheet for future review and the opportunity for recovery through retail rates. The specific power costs deferred are a percentage of the difference between certain actual power supply costs incurred by Avista Utilities and the costs included in base retail rates. This difference is primarily related to changes in short-term wholesale market prices, changes in the level of hydroelectric generation and changes in the level of thermal generation (including changes in fuel prices). Avista Utilities accrues interest on deferred power costs in the Washington jurisdiction at a rate, which is adjusted semi-annually, of 8.9 percent as of December 31, 2002. Avista Utilities accrues interest on deferred power costs in the Idaho jurisdiction at a rate, which is adjusted annually, of 2 percent as of December 31, 2002. Avista Utilities anticipates making a filing with the IPUC requesting that the interest rate be modified to more closely approximate Avista Utilities’ costs of short-term borrowings until the current surcharge is eliminated.

In June 2002, the WUTC issued an order that became effective July 1, 2002 with respect to a general electric rate case filed by Avista Utilities in December 2001. The order provides for an overall rate of return of 9.72 percent and a return on equity of 11.16 percent. The order provided for no incremental rate increase to Avista Utilities’ Washington electric customers above the rates in effect at the time. Rate increases previously approved by the WUTC totaling 31.2 percent (a 25 percent temporary surcharge approved in September 2001 for the recovery of deferred power costs and a 6.2 percent increase approved in March 2002) were restructured. The general increase to base retail rates is 19.3 percent (or $45.7 million in expected annual revenues) and the remaining 11.9 percent represents the continued recovery of deferred power costs over a period currently projected to continue into 2009.

In the June 2002 rate order, the WUTC approved the establishment of an Energy Recovery Mechanism (ERM). The ERM replaced a series of temporary power cost deferral mechanisms that were in place in Washington since mid-2000. The ERM allows Avista Utilities to increase or decrease electric rates periodically with WUTC approval to reflect changes in power supply costs. The ERM provides for Avista Utilities to incur the cost of, or receive the benefit from, the first $9 million in annual power supply costs above or below the amount included in base retail

24


Table of Contents

AVISTA CORPORATION

rates. Under the ERM, 90 percent of the power supply costs exceeding or below the initial $9 million will be deferred for future surcharge or rebate to Avista Utilities’ customers. The remaining 10 percent will be an expense of, or benefit to, the Company. Because the ERM was implemented on July 1, 2002, the Company’s expense or benefit was limited to $4.5 million plus the remaining 10 percent of all costs above the amount included in base retail rates for 2002.

The Company expensed the initial $4.5 million in power supply costs above the amount included in base retail rates plus 10 percent of all costs exceeding the initial $4.5 million under the ERM during 2002. The Company currently expects to expense the first $9 million of power supply costs above the amount included in base retail rates under the ERM during the first quarter of 2003 as well as 10 percent of any costs exceeding the first $9 million for the year of 2003. The Company also expects to expense the first $9 million of power supply costs above the amount included in base retail rates in 2004 as well as 10 percent of any costs exceeding the first $9 million. The majority of these costs relate to fuel contracts entered during 2001 that expire in 2004 for the Company’s thermal generating units.

Avista Utilities has a power cost adjustment (PCA) mechanism in Idaho that allows it to modify electric rates periodically with IPUC approval to recover or rebate a portion of the difference between actual and allowed net power supply costs. The PCA mechanism allows for the deferral of 90 percent of the difference between certain actual net power supply expenses and the authorized level of net power supply expense approved in the last Idaho general rate case. In October 2002, the IPUC issued an order extending a 19.4 percent PCA surcharge for Idaho electric customers. In the order, the IPUC removed $0.9 million of costs associated with three small generation projects from the PCA. The Company will have the opportunity to address the recovery of these costs in a future rate proceeding. The IPUC also ordered that $0.6 million in fuel costs would receive additional review as part of the next PCA filing. The PCA surcharge will remain in effect until October 2003. The IPUC directed Avista Utilities to file a status report 60 days before the current PCA surcharge expires. If review of the status report and the actual balance of deferred power costs support continuation of the PCA surcharge, the IPUC has indicated that it anticipates the PCA surcharge will be extended for an additional period.

The following table shows activity in deferred power costs for Washington and Idaho during 2001 and 2002 (dollars in thousands):

                           
      Washington   Idaho   Total
     
 
 
Deferred power costs as of December 31, 2000
  $ 34,580     $ 2,693     $ 37,273  
Activity from January 1 – December 31, 2001:
                       
 
Power costs deferred
    167,196       73,677       240,873  
 
Unrealized loss on fuel contracts (1)
    8,232       4,077       12,309  
 
Interest and other net additions
    16,027       5,643       21,670  
 
Amortization of deferred credit
    (53,794 )     (6,927 )     (60,721 )
 
Recovery of deferred power costs through retail rates
    (10,223 )     (6,076 )     (16,299 )
 
Write-off deferred power costs
    (21,780 )           (21,780 )
 
   
     
     
 
Deferred power costs as of December 31, 2001
    140,238       73,087       213,325  
Activity from January 1 – December 31, 2002:
                       
 
Power costs deferred
    22,423       13,471       35,894  
 
Unrealized gain on fuel contracts (1)
    (7,068 )     (3,485 )     (10,553 )
 
Interest and other net additions
    6,726       888       7,614  
 
Amortization of deferred credit
          (27,711 )     (27,711 )
 
Recovery of deferred power costs through retail rates
    (38,570 )     (24,732 )     (63,302 )
 
   
     
     
 
Deferred power costs as of December 31, 2002
  $ 123,749     $ 31,518     $ 155,267  
 
   
     
     
 

(1)   Unrealized gains and losses on fuel contracts are not included in the ERM and PCA mechanism until the contracts are settled or realized.

During a year having normal streamflow conditions, Avista Utilities would expect to have generation from its hydroelectric resources (both owned and purchased under long-term hydroelectric contracts) of approximately 550 aMW. For 2002, streamflow conditions were 112 percent of normal and hydroelectric generation was 553 aMW (101 percent of normal). Hydroelectric generation for the year 2001 was 369 aMW (67 percent of normal), which was 181 aMW below normal and the lowest level in the 73 years in which records have been kept. Preliminary forecasts and snowpack conditions indicate streamflow conditions for 2003 are expected to be approximately 70 percent of normal. Avista Utilities currently estimates that hydroelectric generation will be 458 aMW (83 percent of normal) in 2003. Below normal hydroelectric generation will cause Avista Utilities to either increase its output from thermal generation resources or purchase energy in the wholesale market, or Avista Utilities will have less surplus

25


Table of Contents

AVISTA CORPORATION

energy available to sell in the wholesale market. The Company will choose the most appropriate cost-effective resources to meet its customer demand. Under the ERM and the PCA mechanism, 90 percent of any costs exceeding the first $9 million in Washington and 90 percent of any costs incurred above the amount included in base retail rates in Idaho will be deferred for future recovery. In each instance, the remaining 10 percent will be an expense to the Company. Based on current projections, total deferred power costs are expected to be approximately $166 million at the end of 2003.

Avista Utilities is currently planning to file a natural gas general rate case in Oregon during the first half of 2003. The Company regularly reviews the need for natural gas or electric rate changes in each state in which it provides service.

During the second half of 2002, Avista Utilities adjusted its natural gas rates in response to a decrease in current and projected natural gas costs. During the fourth quarter of 2002, natural gas rate decreases of 17.4 percent, 15.5 percent, 7.1 percent and 16.2 percent were approved and implemented in Washington, Idaho, Oregon and California, respectively. These natural gas rate decreases are designed to pass through changes in purchased natural gas costs to customers and reduce operating revenues and resource costs with no change in Avista Utilities’ gross margin or net income. Total deferred natural gas costs were $11.5 million and $52.7 million as of December 31, 2002 and 2001, respectively.

Power Market Issues

Avista Utilities and Avista Energy participate directly and indirectly in the power markets in the United States. Developments in these markets, particularly in the western part of the United States, have affected both Avista Utilities and Avista Energy. Federal and state officials including, but not limited to, the FERC and the California Public Utility Commission (CPUC), commenced reviews in 2000 to determine the causes of the changes in the wholesale energy markets to develop legal and regulatory remedies to address alleged market failures or abuses and large defaults by certain parties in the wholesale markets. The proceedings are continuing and their ultimate outcome and the resulting impact on the Company cannot be predicted at this time.

California Energy Crisis

In early 2001, California’s two largest utilities, Southern California Edison (SCE) and Pacific Gas & Electric Company (PG&E), defaulted on payment obligations owed to various energy sellers, including the California Power Exchange (CalPX), California Independent System Operator (CalISO), and Automated Power Exchange (APX). Consequently, CalPX, CalISO and APX defaulted on their payment obligations to Avista Energy. PG&E and CalPX filed voluntary petitions under chapter 11 of the bankruptcy code for protection from creditors. On March 1, 2002, SCE paid its past due obligations to the CalPX and various other creditors; however, these funds did not flow directly to Avista Energy. As of December 31, 2002, Avista Energy’s accounts receivable outstanding related to defaulting parties in California did not exceed its reserves for uncollected amounts, cost of collection, and refunds. Avista Energy is currently pursuing recovery of the defaulted obligations. Reserves for defaulted payments established in 2000 and 2001 accounted for the majority of the Company’s increase in the total allowance for doubtful accounts. The allowance for doubtful accounts was $46.9 million as of December 31, 2002 compared to $50.2 million as of December 31, 2001 and $14.4 million as of December 31, 2000.

In July 2001, the FERC issued an order to commence a fact-finding hearing to determine if refunds should be owed and, if so, the amounts of such refunds for sales during the period from October 2, 2000 to June 20, 2001 in the California spot market. The order provides that any refunds owed could be offset against unpaid energy debts due to the same party. However, the FERC announced that it is considering changing the method used to determine natural gas costs for calculating refunds in this proceeding, which could delay their findings. Furthermore, on November 20, 2002, the FERC issued a Discovery Order, which reopened the evidentiary record and allowed parties in the proceeding to conduct additional discovery for the period January 1, 2000 to June 20, 2001. The November 20, 2002 Discovery Order required that, by no later than March 3, 2003, the market participants provide relevant documents to support any proposed recommendations to the FERC. The Discovery Order also affords parties in this proceeding the opportunity to respond by March 20, 2003 to submissions made by March 3, 2003. On December 12, 2002, the FERC Administrative Law Judge issued a Certification of Proposed Findings on California Refund Liability detailing the proposed refund amounts, which was presented to the FERC for consideration.

Several parties filed documents with the FERC on March 3, 2003 presenting supplemental information regarding alleged improper market conduct and requests for refunds and other relief under the additional discovery procedures set forth in both the California and Pacific Northwest refund proceedings. The filing parties include the California Parties (a joint filing including the Attorney General of the State of California, the California Electricity Oversight

26


Table of Contents

AVISTA CORPORATION

Board, the CPUC, and PG&E), the City of Tacoma and Port of Seattle (jointly), the City of Seattle, and the Washington State Attorney General. The filing parties, with the exception of the Washington State Attorney General, have made specific allegations with regard to many companies, including Avista Corp. and Avista Energy.

Avista Corp. and Avista Energy will file reply comments in response to the allegations of the parties by March 20, 2003. Based upon an initial review of the filings, there are no new allegations or information not known to and addressed by the FERC Trial Staff in a separate investigation of Avista Corp. and Avista Energy.

As explained at “Federal Energy Regulatory Commission Inquiry” in “Note 28 of the Notes to Consolidated Financial Statements” regarding the investigation of Avista Corp. and Avista Energy, the FERC Trial Staff concluded that: 1) There was no evidence that any executives or employees of Avista Utilities or Avista Energy knowingly engaged in or facilitated any improper trading strategy and 2) There was no evidence that Avista Utilities or Avista Energy engaged in any efforts to manipulate the western energy markets during 2000 and 2001. An agreement in resolution, including these findings, was filed with the FERC’s administrative law judge in January 2003. Avista Corp., Avista Energy and the FERC Staff have requested that the administrative law judge certify the agreement in resolution and forward it to the FERC for approval.

Pacific Northwest Refund Proceedings

The July 2001 FERC order also directed an evidentiary proceeding to explore wholesale power market issues in the Pacific Northwest to determine whether there were excessive charges for spot market sales in the Pacific Northwest during the period from December 25, 2000 to June 20, 2001. Based on their application of selected retroactive pricing methods, certain parties asserted claims for significant refunds from Avista Energy and lesser refunds from Avista Utilities. Avista Energy and Avista Utilities joined with numerous other wholesale market participants to oppose proposals by parties for retroactive price caps and refund claims. In September 2001, the FERC’s administrative law judge for this proceeding issued a recommendation that the FERC should not order refunds for the Pacific Northwest for the period in question and that the FERC should take no further action on these matters. On December 19, 2002, the FERC issued a Discovery Order that reopened the evidentiary record and allowed parties in the proceeding to conduct additional discovery for the period January 1, 2000 to June 20, 2001. The December 19, 2002 Discovery Order required that, by no later than March 3, 2003, the market participants provide relevant documents to support any proposed recommendations to the FERC. The Discovery Order also affords parties in this proceeding the opportunity to respond by March 20, 2003 to submissions made by March 3, 2003. The Company cannot predict when the FERC will issue a decision in the Pacific Northwest refund proceeding. If retroactive price caps or refunds are imposed, Avista Utilities and Avista Energy could assert offsetting claims in the Pacific Northwest refund proceeding.

See further information under “Federal Energy Regulatory Commission Inquiry,” “U.S. Commodity Futures Trading Commission (CFTC) Subpoena,” “California Energy Markets” and “Washington Consumer Class Action Lawsuit” in “Note 28 of the Notes to Consolidated Financial Statements.”

Regional Transmission Organizations

Avista Corp. is negotiating with nine other utilities in the western United States in the possible formation of a Regional Transmission Organization (RTO), RTO West, a non-profit organization. The potential formation of RTO West is in response to a FERC order requiring all utilities subject to FERC regulation to file a proposal to form a RTO, or a description of efforts to participate in a RTO, and any existing obstacles to RTO participation. RTO West filed its Stage 2 proposal with the FERC in March 2002 and received limited approval from the FERC of this initial plan in September 2002. The FERC’s goal with respect to the formation of RTOs is to promote efficiency in wholesale electricity markets and in the operation of transmission systems by way of standardized and independent operation of transmission systems.

Avista Corp. and two other western utilities have also taken steps toward the formation of a for-profit Independent Transmission Company, TransConnect, which would be a member of RTO West, serve portions of five states and own or lease the high voltage transmission facilities of the participating utilities. TransConnect filed its proposal with the FERC in November 2001 and received limited approval from the FERC in September 2002.

The final proposals must be approved by the FERC, the boards of directors of the filing companies and regulators in various states. The companies’ decision to move forward with the formation of TransConnect or RTO West will ultimately depend on the conditions related to the formation of the entities, as well as the economics and conditions imposed in the regulatory approval process. If TransConnect were formed, it could result in Avista Utilities divesting its electric transmission assets. The formation of RTO West or TransConnect could have an impact on the Company’s transmission costs.

27


Table of Contents

AVISTA CORPORATION

Standard Market Design

On July 31, 2002, the FERC issued a Notice of Proposed Rulemaking proposing a Standard Market Design (SMD) that would significantly alter the markets for wholesale electricity and transmission and ancillary services in the United States. The new SMD would establish a generation adequacy requirement for “load-serving entities” and a standard platform for the sale of electricity and transmission services. Under the new SMD, Independent Transmission Providers would administer spot markets for wholesale power, ancillary services and transmission congestion rights, and electric utilities, including Avista Utilities, would be required to transfer control over transmission facilities to the applicable Independent Transmission Provider. As the SMD proposal develops, the Company continues to assess the impact the SMD would have on its operations as well as how the SMD would impact the RTO West and TransConnect proposals. The Company is subject to state regulation in each of the states in which it operates. State regulatory agencies are actively involved in the SMD rulemaking process and there have been significant concerns at the state and regional level raised with the FERC with respect to the SMD, particularly in the western United States. In February 2003, Avista Utilities and several other western utilities filed comments with the FERC expressing their concerns with respect to the SMD proposal.

Results of Operations

Overall Operations

Diluted earnings (loss) per common share by business segments

The following table presents diluted earnings (loss) per common share by business segments for the years ended December 31:

                           
      2002   2001   2000
     
 
 
Avista Utilities
  $ 0.71     $ 0.46     $ (1.37 )
Energy Trading and Marketing
    0.47       1.33       3.51  
Information and Technology
    (0.25 )     (0.41 )     (0.41 )
Other
    (0.26 )     (0.18 )     (0.06 )
 
   
     
     
 
 
Earnings per common share from continuing operations
    0.67       1.20       1.67  
Earnings (loss) per common share from discontinued operations
    0.02       (1.00 )     (0.20 )
 
   
     
     
 
 
Earnings per common share before cumulative effect of accounting change
    0.69       0.20       1.47  
Loss per common share from cumulative effect of accounting change
    (0.09 )            
 
   
     
     
 
 
Total earnings per common share, diluted
  $ 0.60     $ 0.20     $ 1.47  
 
   
     
     
 

2002 compared to 2001

Income from continuing operations was $34.3 million for 2002 compared to $59.6 million for 2001. The decrease was primarily due to reduced net income recorded by the Energy Trading and Marketing line of business. Energy Trading and Marketing recorded net income of $22.4 million for 2002 compared to $63.2 million for 2001. The primary reason for the decrease in net income was a reduction in Avista Energy’s net margin. During the second half of 2001 and 2002, prices, trading volumes and volatility in wholesale energy markets in the western United States decreased relative to the first half of 2001, which reduced Avista Energy’s earnings potential. Net income recorded by Avista Utilities was $36.4 million for 2002, compared to $24.2 million for 2001. The increase for Avista Utilities is primarily due to an increase in gross margin (operating revenues less resource costs) primarily due to an electric rate increase in Washington, partially offset by an increase in other operating expenses.

The Information and Technology line of business incurred a net loss of $12.1 million for 2002 compared to $19.4 million for 2001. The decrease in the net loss was primarily due to a decrease in operating expenses.

The Other line of business incurred a net loss of $12.4 million for 2002 compared to $8.4 million for 2001. The increase in the net loss was primarily due to litigation costs and settlements.

The discontinued operations of Avista Communications recorded net income of $1.1 million for 2002 compared to a net loss of $47.4 million for 2001. Net income for 2002 was primarily due to the settlement of contracts and liabilities as well as the favorable settlement of a lawsuit. The significant loss for 2001 was primarily due to asset impairment charges of $58.4 million.

28


Table of Contents

AVISTA CORPORATION

Total revenues decreased $414.9 million for 2002 compared to 2001. Avista Utilities’ revenues decreased $336.9 million, or 27 percent, primarily due to decreased wholesale electric revenues, partially offset by increased retail electric revenues. Wholesale sales volumes decreased primarily due to the expiration of several wholesale electric sales contracts. The decrease in wholesale revenues also reflected a decrease in wholesale prices. The increase in retail electric revenues was primarily a result of higher rates approved by state regulatory commissions to recover deferred power costs as well as the general electric rate case order approved by the WUTC in June 2002. Revenues from Energy Trading and Marketing decreased $80.1 million, or 60 percent, primarily due to decreased energy commodity prices and trading volumes, as well as reduced market volatility. Revenues from the Information and Technology companies increased 28 percent to $17.6 million primarily as a result of customer growth at Avista Advantage. Revenues from the Other line of business decreased $1.7 million reflecting decreased activity in this line of business.

Total resource costs (all from Avista Utilities) decreased $396.5 million for 2002 compared to 2001 primarily due to reduced power purchase expenses, decreased cost of natural gas purchased to serve retail customers and decreased fuel for generation expenses. Power purchase expenses, natural gas purchased and fuel for generation decreased due to lower wholesale market prices, increased hydroelectric generation, reduced wholesale sales obligations and decreased thermal generation. The net amortization of deferred power and natural gas costs was $68.5 million for 2002, compared to net deferrals of $210.5 million for 2001.

Operations and maintenance expenses decreased $2.7 million primarily due to reduced expenses for Information and Technology. During 2002, Avista Advantage and Avista Labs focused on reducing operating expenses by improving efficiencies and reducing the workforce.

Administrative and general expenses decreased $0.5 million; however, there were significant fluctuations within each business segment. The net decrease was due to reduced expenses for Energy Trading and Marketing as well as Information and Technology, partially offset by increased expenses for Avista Utilities and Other. The decrease for Energy Trading and Marketing was primarily a result of reduced incentive compensation expenses resulting from decreased earnings as well as reduced professional fees. The decrease for Information and Technology was consistent with the decrease in operations and maintenance expenses. The increase for Avista Utilities was primarily due to initiatives implemented during the third quarter of 2001 designed to temporarily reduce certain operating expenses to improve liquidity and operating cash flows. These initiatives resulted in significantly reduced expenses for 2001. Cost reduction measures were not as restrictive during 2002 as the second half of 2001. The increase in administrative and general expenses for Avista Utilities was also due to increased pension, health care, legal and general insurance costs. Administrative and general expenses for the Other business segment increased due to litigation costs and settlements.

Depreciation and amortization increased $1.3 million due to an increase for Avista Utilities partially offset by decreases for each of the other business segments. The decreases for the other business segments were primarily due to the requirement of Statement of Financial Accounting Standards (SFAS) No. 142 “Goodwill and Other Intangible Assets” that goodwill no longer be amortized effective January 1, 2002.

Taxes other than income taxes increased $8.1 million primarily due to increased retail electric revenues and related taxes for Avista Utilities. The increase for Avista Utilities was partially offset by a decrease for Energy Trading and Marketing due to a decrease in the net margin on energy trading activities.

Interest expense decreased $1.1 million for 2002 compared to 2001. The average balance of debt outstanding was relatively consistent for 2001 and 2002 with increasing balances outstanding during 2001 and decreasing balances outstanding during 2002. The amount of debt outstanding increased substantially during 2001 with the issuance of $400.0 million of Unsecured Senior Notes in April 2001 and $150.0 million of First Mortgage Bonds in December 2001. During 2002, the Company repurchased $203.6 million of long-term debt. The Company expects interest expense to continue to decline in 2003 due to the effect of debt repurchases in 2002, expected debt repurchases in 2003 and scheduled debt maturities in 2003.

Capitalized interest decreased $3.0 million for 2002 compared to 2001 primarily due to the fact that the Company did not capitalize any interest related to Coyote Springs 2 subsequent to September 30, 2002 because the project was substantially completed. A decrease in capital expenditures for Avista Utilities also contributed to the decrease in capitalized interest.

Other income-net decreased $3.2 million primarily due to reduced interest income partially offset by impairment charges recorded during 2001.

29


Table of Contents

AVISTA CORPORATION

Income taxes decreased $4.4 million for 2002 compared to 2001, primarily due to decreased earnings before income taxes, partially offset by an increase in state income taxes. The effective tax rate was 46.6 percent for 2002 compared to 36.6 percent for 2001. The increase in the effective tax rate was due to increased state income tax expense as well as decreased earnings and the increased effect of permanent tax differences, such as accelerated tax depreciation, resulting from the Company’s previous transition to SFAS No. 109, “Accounting for Income Taxes.”

In April 2002, the Company completed its transitional test of goodwill related to the adoption of SFAS No. 142. Accordingly, the Company determined that $6.4 million of goodwill related to Advanced Manufacturing and Development, a subsidiary of Avista Ventures, was impaired. The Company recorded this impairment of $4.1 million, net of tax, as a cumulative effect of accounting change in the Consolidated Statement of Income and Comprehensive Income.

2001 compared to 2000

Income from continuing operations was $59.6 million for 2001 compared to $101.1 million for 2000. The decrease was primarily due to reduced net income recorded by the Energy Trading and Marketing line of business, partially offset by an increase in net income from Avista Utilities. Also contributing to the decline in income from continuing operations was an increase in interest expense and $21.8 million of deferred power costs written off during 2001. The Energy Trading and Marketing line of business recorded net income of $63.2 million in 2001 compared to $161.8 million in 2000. The primary reason for the decrease in net income was a reduction in the mark-to-market adjustment for the change in the fair value position of Avista Energy’s energy commodity portfolio. During the second half of 2001, volatility in wholesale energy markets in the western United States decreased, which reduced Avista Energy’s earnings potential. Net income recorded by Avista Utilities was $24.2 million in 2001, an increase from a net loss of $38.8 million in 2000. Avista Utilities’ net loss for 2000 was primarily due to unprecedented sustained peaks in electric energy prices compounded by a wholesale short position.

The Information and Technology line of business incurred a net loss of $19.4 million for 2001 compared to $19.0 million for 2000 as Avista Advantage and Avista Labs continued to grow their operations.

The Other line of business incurred a net loss of $8.4 million for 2001 compared to $2.9 million for 2000. The increase in the net loss from 2000 was primarily a result of increased interest expense on intercompany borrowings between Avista Capital and Avista Corp. that is eliminated in the consolidated financial statements.

The discontinued operations of Avista Communications incurred a net loss of $47.4 million for 2001 compared to a net loss of $9.4 million for 2000. The significant loss from Avista Communications was primarily due to pre-tax asset impairment charges of $58.4 million recorded during the third quarter of 2001.

Total revenues decreased $463.2 million in 2001 compared to 2000. Avista Utilities’ revenues decreased $281.3 million, or 19 percent, primarily due to decreased wholesale electric sales partially offset by increased retail revenues from both electric and natural gas sales. The increase in retail revenues is primarily a result of higher rates approved by state regulatory agencies to recover deferred power and natural gas costs. Revenues from the Energy Trading and Marketing line of business decreased $173.5 million, or 56 percent, due to a decrease in unrealized gains. Revenues from the Information and Technology companies increased 141 percent to $13.8 million primarily as a result of customer growth at Avista Advantage. Revenues from the Other line of business decreased $16.6 million, or 50 percent, reflecting decreased activity in this line of business.

Avista Utilities’ resource costs decreased $396.5 million in 2001 compared to 2000, or 32 percent, primarily due to reduced wholesale power purchases.

Administrative and general expenses decreased $15.7 million in 2001 compared to 2000 primarily due to reduced expenses for Avista Utilities and Energy Trading and Marketing. This was primarily a result of company-wide initiatives to reduce expenses. This was also due to decreased incentive compensation expense based on lower earnings by both Avista Energy and the Company.

Interest expense increased $38.2 million in 2001 compared to 2000, primarily due to higher levels of outstanding debt during the year. Long-term debt and short-term borrowings outstanding as of December 31, 2001 increased $320.2 million from December 31, 2000.

Capitalized interest increased $7.1 million from 2000 to 2001 primarily due to increased capitalized interest for Coyote Springs 2.

30


Table of Contents

AVISTA CORPORATION

Income taxes decreased $42.6 million in 2001 compared to 2000, primarily due to decreased earnings before income taxes. The effective tax rate was 36.6 percent for 2001 compared to 43.2 percent for 2000. The higher effective tax rate in 2000 was primarily due to higher state income taxes.

Preferred stock dividend requirements decreased from 2000 due to the conversion of all outstanding shares of Series L Preferred Stock into shares of common stock, which resulted in a one-time charge of $21.3 million for preferred stock dividend requirements in 2000.

Avista Utilities

2002 compared to 2001

Avista Utilities recorded net income of $36.4 million for 2002 compared to $24.2 million for 2001. Avista Utilities’ income from operations was $149.2 million for 2002 compared to $114.9 million for 2001. This increase was primarily due to an increase in gross margin (operating revenues less resource costs). Avista Utilities’ operating revenues decreased $336.9 million and resource costs decreased $396.5 million resulting in an increase of $59.6 million in gross margin for 2002 as compared to 2001. The increase in gross margin was partially offset by an increase in administrative and general expenses, depreciation and amortization and taxes other than income taxes. The general electric rate increase of 19.3 percent in Washington base retail rates effective July 1, 2002 contributed to the increase in gross margin.

Retail electric revenues increased $65.2 million for 2002 from 2001. This increase was primarily due to the electric surcharges implemented to recover deferred power costs and the June 2002 Washington electric rate increase, partially offset by decreased use per customer and total kWhs sold. The increase in retail electric revenues was also due to refunds to customers in January 2001 of the gain on the sale of Avista Utilities’ interest in the Centralia Power Plant (Centralia) that reduced revenues for 2001. During 2001 and 2002, Avista Utilities experienced decreased loads and decreased use per customer with respect to electric retail sales. The decrease in use per customer appears to be primarily due to a response to the increase in electric rates and the resulting conservation efforts of individual customers. The decrease in use per customer also appears to reflect milder weather in 2002 and 2001 as compared to 2000. The decrease in total kWhs sold primarily relates to industrial customers and appears to reflect a general downturn in the economy of eastern Washington and northern Idaho.

Wholesale electric revenues decreased $416.8 million, or 87 percent, reflecting wholesale sales volumes which decreased 65 percent from 2001 and average sales prices that were 62 percent lower than the prior year. Average wholesale prices decreased to $28.92 per MWh for 2002 from $76.80 per MWh for 2001 reflecting decreased electric prices in the western United States. Wholesale sales volumes decreased primarily due to the expiration of several wholesale electric sales contracts, including two 100 MW index-based sales contracts that expired in July 2001. The extent of future wholesale transactions will be based on the availability of resources owned or controlled by Avista Utilities and changes to loads of Avista Utilities’ customers and contractual obligations.

Other electric revenues increased $13.5 million primarily due to the sale of natural gas purchased for electric generation that was not used in generation. Avista Utilities operated less thermal generation in 2002 as compared to 2001 based on lower retail demand, increased hydroelectric generation and decreased wholesale market prices.

Natural gas revenues increased $1.2 million for 2002 from 2001 due to a slight increase in retail and transportation revenues, partially offset by a decrease in wholesale natural gas revenues. Retail rates were increased during 2001 to recover deferred natural gas costs. During the fourth quarter of 2002, retail rates for natural gas were reduced in response to a decrease in current and projected natural gas costs. During 2001 and 2002, Avista Utilities experienced decreased loads and decreased use per customer with respect to natural gas retail sales. The decrease in use per customer appears to be primarily due to a response to the increase in natural gas rates during 2001 and the resulting conservation efforts of individual customers. The decrease in use per customer also appears to reflect milder weather in 2002 and 2001 as compared to 2000. The decrease in total therms sold primarily relates to industrial customers and appears to reflect a general downturn in the economy of Avista Utilities’ service territory.

Power purchased for 2002 decreased $593.0 million, or 84 percent, compared to 2001 due to the decreased volume and price of power purchases. Average purchased power prices for 2002 were $24.64 per MWh or 68 percent lower than $77.40 per MWh for 2001 and volumes purchased decreased 49 percent compared to 2001. The decrease in the volume of purchased power was primarily the result of decreases in the volume of wholesale electric sales and increased hydroelectric resource availability to meet retail demand.

31


Table of Contents

AVISTA CORPORATION

Net amortization of deferred power costs was $26.3 million in 2002 compared to net deferrals of $202.8 million in 2001. During 2002, Avista Utilities recovered (collected as revenue) $38.6 million of previously deferred power costs in Washington and $24.7 million in Idaho. During 2002, Avista Utilities deferred $22.4 million of power costs in Washington and $13.5 million in Idaho. During 2002, $27.7 million of a deferred credit was offset against the Idaho share of deferred power costs. The deferred credit relates to funds received in December 1998 in which the Company assigned and transferred certain rights under a long-term power sales contract with Portland General Electric (PGE) to a funding trust. Total deferred power costs were $155.3 million as of December 31, 2002. See further description of issues related to deferred power costs in the section “Avista Utilities – Regulatory Matters.”

During 2002, Avista Utilities had $42.2 million of net amortization of deferred natural gas costs compared to net deferrals of $7.7 million in 2001. Total deferred natural gas costs were $11.5 million as of December 31, 2002.

The cost of fuel for generation for 2002 decreased $63.4 million from 2001 primarily due to a decrease in thermal generation as well as a decrease in the average cost of natural gas used for generation. Thermal generation decreased 43 percent primarily due to increased hydroelectric generation and wholesale market prices that were generally below the cost of operating the thermal generating units.

The expense for natural gas purchased for 2002 decreased $50.0 million compared to 2001 primarily due to the decreased average cost of natural gas.

Other fuel costs for 2002 increased $34.6 million compared to 2001. This was due to an increase in natural gas purchased as fuel for electric generation that was not used. This excess natural gas was sold with the associated revenues reflected as other electric revenues. Other fuel costs exceeded the revenues from selling the excess natural gas. This excess cost is accounted for under the ERM in Washington and the PCA in Idaho.

2001 compared to 2000

Avista Utilities recorded net income of $24.2 million in 2001 compared to a net loss of $38.8 million in 2000. Avista Utilities’ income from operations was $114.9 million for 2001 compared to $3.2 million for 2000. This increase was primarily due to an increase in gross margin (operating revenues less resource costs). Avista Utilities’ operating revenues decreased $281 million and resource costs decreased $396 million resulting in an increase of $115 million in gross margin for 2001 as compared to 2000.

Based on views of streamflows, historic wholesale market prices and energy availability in the second quarter of 2000, Avista Utilities entered into contracts and sold call options for fixed-price power for delivery without making matching purchases at the same time. Avista Utilities also made certain short-term sales at fixed prices that were offset by purchases at prices indexed to the market price at the time of delivery. Certain of these wholesale trading positions were outside normal operating guidelines. Avista Utilities was required to buy additional power not only to meet its obligations to its retail and long-term wholesale customers, but also to cover its wholesale trading positions. An orderly process to complete the necessary power purchases was impeded by the rapid escalation of market prices and lack of liquidity in the power markets during the second quarter of 2000. These purchases were made at fixed prices significantly higher than the related selling prices and at index, which settled at unprecedented levels in June 2000. The pricing of these purchases caused the majority of Avista Utilities’ net loss for 2000.

Avista Utilities’ short position was compounded by the May 2000 sale of its interest in Centralia to TransAlta, which reduced its system capacity by 200 megawatts. Based on historical trends and Avista Utilities’ views on power prices and availability of power for May and June 2000, Avista Utilities did not seek to replace Centralia generation for those two months with firm commitments. Avista Utilities entered into a three-and-one-half-year contract to purchase 200 megawatts from TransAlta beginning in July 2000.

Retail electric revenues increased $4.0 million for 2001 from 2000. This increase was primarily due to the electric surcharges implemented in Washington and Idaho to recover deferred power costs, partially offset by decreased use per customer and kWh sold. Wholesale electric revenues decreased $383.9 million, or 44 percent, while wholesale sales volumes decreased 60 percent from 2000, reflecting average sales prices that were 40 percent higher than the prior year. Wholesale sales volumes decreased due to management’s decision in 2000 to reduce power imbalance volume limits (the difference between projected load obligations and projected resource availability). This decision was based on the emergent market price volatility, and Avista Utilities’ strategy to focus primarily on energy transactions necessary to efficiently manage power resources to meet retail customer loads and wholesale obligations.

32


Table of Contents

AVISTA CORPORATION

Natural gas revenues increased $83.8 million for 2001 from 2000 due to increased prices approved by state commissions to recover increased natural gas costs partially offset by decreased therm sales, primarily due to both decreased retail and transportation customer volumes.

Power purchased during 2001 decreased $364.2 million, or 34 percent compared to 2000 primarily due to the decreased volume of power purchases, partially offset by higher average prices. Average purchased power prices for 2001 were 28 percent higher than for 2000; however, volumes purchased decreased 48 percent. The decrease in the volume of purchased power was primarily the result of decreases in the volume of wholesale electric sales.

During 2001 Avista Utilities deferred $145.4 million (net of the $21.8 million write-off) in power costs in Washington and $73.7 million in Idaho. The total balance of deferred power costs was $140.2 million for Washington and $73.1 million for Idaho as of December 31, 2001. In September 2001, the WUTC approved a temporary electric surcharge of 25 percent. In 2001, revenue collected under the Washington surcharge was $10.2 million, and $53.8 million of a deferred credit on the Company’s balance sheet relating to funds received from a power sales contract with PGE in 1998 was offset against deferred power costs. In October 2001, the IPUC approved a PCA surcharge and the extension of a previously approved PCA surcharge for a total of 19.4 percent. In 2001, revenue collected under the Idaho PCA surcharges was $6.1 million, and $6.9 million of a deferred credit on the Company’s balance sheet relating to funds received from a power sales contract with PGE in 1998 was offset against deferred power costs. In March 2002, the WUTC issued an order approving the prudence and recoverability of 90 percent of deferred power supply costs incurred during the period from July 1, 2000 through December 31, 2001. This resulted in the Company recording an additional expense for $21.8 million (representing the 10 percent of costs not recoverable) of power supply costs previously deferred through 2001. Additionally, the order also provided that one-fifth of the 25 percent electric surcharge will be applied to offset the Company’s general operating costs and the remainder will continue to be applied as a recovery of deferred power costs. The WUTC order also approved a 6.2 percent (or $14.7 million in annual revenues) increase in base retail rates. See further description of issues related to deferred power costs in the section “Avista Utilities – Regulatory Matters.”

Avista Utilities deferred, net of amortization, $7.7 million of purchased natural gas costs during 2001 and total deferred natural gas costs were $52.7 million as of December 31, 2001. In July 2001, the Company filed requests for purchased gas cost adjustments (PGA) with the WUTC and the IPUC in order to recover certain deferred natural gas costs related to Washington and Idaho natural gas purchases. The Washington PGA increase of 12.2 percent approved by the WUTC and the Idaho PGA increase of 11.5 percent approved by the IPUC became effective in August 2001.

The cost of fuel for generation for 2001 increased $12.9 million from 2000 primarily due to an increase in natural gas-fired combustion turbine plant generation and partially due to the increased cost of natural gas. Natural gas costs were relatively high compared to historical prices during the first half of 2001 before declining in the second half of 2001.

The expense for natural gas purchased for resale for 2001 increased $50.8 million compared to 2000 due to the increased cost of natural gas partially offset by a decrease in total therms sold. Consistent with changes in fuel for generation, natural gas costs declined during the second half of 2001 as compared to the first half of the year.

As part of the strategy to mitigate the decline in electric resources caused by poor hydroelectric conditions and volatile energy markets, Avista Utilities had several buy-back and rebate programs for residential, commercial and industrial customers during 2001. The programs were designed to encourage conservation and decrease average customer usage.

Energy Trading and Marketing

Energy Trading and Marketing includes the results of Avista Energy and Avista Power.

Avista Energy is an electricity and natural gas marketing and trading business, operating primarily within the WECC. Avista Energy focuses on asset-backed optimization of combustion turbines and hydroelectric assets owned by other entities, long-term electric supply contracts, natural gas storage, and electric and natural gas transmission and transportation arrangements. Avista Energy’s marketing efforts are driven by its base of knowledge and experience in the operation of both electric energy and natural gas physical systems in the WECC, as well as its relationship-focused approach with its customers.

33


Table of Contents

AVISTA CORPORATION

In June 2002, the Emerging Issues Task Force (EITF) reached a partial consensus on Issue No. 02-3 regarding the accounting for contracts involved in energy trading and risk management activities. The partial consensus required that all gains and losses arising from energy trading contracts (whether realized or unrealized) accounted for under EITF Issue No. 98-10 “Accounting for Contracts Involved in Energy Trading and Risk Management Activities” were to be presented on a net basis in the income statement beginning in the third quarter of 2002. Reclassification of all historical comparable periods was required. Avista Energy historically presented unrealized gains and losses on energy trading contracts on a net basis. However, realized contracts were presented on a gross basis for both operating revenues and resource costs. The implementation of EITF Issue 02-3 resulted in reduced operating revenues and resource costs as compared to historical periods with no impact on the Company’s net income or financial condition.

Avista Energy accounted for energy commodity trading activity in compliance with EITF Issue No. 98-10 through December 31, 2002 for contracts entered into on or prior to October 25, 2002. Under EITF 98-10, Avista Energy recognized revenue based on the change in the market value of outstanding derivative commodity sales contracts, net of future servicing costs and reserves, in addition to revenue related to settled contracts. In October 2002, the EITF rescinded Issue No. 98-10. As such, Avista Energy is required to account for energy trading contracts that meet the definition of a derivative at market value in compliance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This applies to all existing contracts as of January 1, 2003 as well as to all new contracts entered into subsequent to October 25, 2002. Contracts not meeting the definition of a derivative are no longer accounted for at market value and include Avista Energy’s Agency Agreement with Avista Utilities, natural gas storage contracts, tolling agreements and natural gas transportation agreements. The transition from EITF Issue No. 98-10 to accrual based accounting resulted in the adjustment of the contracts that are not considered derivatives from their market value to their cost basis. Any gain or loss on contracts that are not considered derivatives will not be recognized until the contract is settled or realized. The Company anticipates that the changes will primarily affect the timing of the recognition of income or loss in earnings, and not change the underlying economics or cash flows of transactions entered into by Avista Energy. The changes could result in a significant increase in the volatility of reported earnings on a quarter-to-quarter and year-to-year basis. On January 1, 2003, Avista Energy recorded as a cumulative effect of accounting change a charge of approximately $1.2 million (net of tax) related to the transition from EITF 98-10 to SFAS No. 133. See “Critical Accounting Policies” and “Note 2 of the Notes to Consolidated Financial Statements” for further details.

Derivative commodity instruments in the energy trading portfolio are marked to estimated fair market value on a daily basis (mark-to-market accounting), which causes earnings variability. Market prices are utilized in determining the value of electric, natural gas and related derivative commodity instruments. For natural gas commodity instruments, these market prices are generally available through three years. For electric commodity instruments, these market prices are generally available through two years. For longer-term positions and certain short-term positions for which market prices are not available, models based on forward price curves are utilized. These models incorporate a variety of estimates and assumptions, the ultimate outcomes of which are beyond Avista Energy’s control including, among others, estimates and assumptions as to demand growth, fuel price escalation, availability of existing generation and costs of new generation. Actual experience can vary significantly from these estimates and assumptions.

Avista Energy trades electricity and natural gas, along with derivative commodity instruments including futures, options, swaps and other contractual arrangements. Most transactions are conducted on a largely unregulated “over-the-counter” basis, there being no central clearing mechanism (except in the case of specific instruments traded on the commodity exchanges). Avista Energy’s trading operations are affected by, among other things, volatility of prices within the electric energy and natural gas markets, the demand for and availability of energy, lower unit margins on new sales contracts, FERC-ordered price caps, deregulation of the electric utility industry, the creditworthiness of counterparties and the reduced liquidity in energy markets. See “Business Risk” for further information.

2002 compared to 2001

Energy Trading and Marketing’s net income was $22.4 million for 2002, compared to $63.2 million for 2001. The primary reason for the decrease in net income was a decrease in the net margin on energy trading activities. Net margin on energy trading activities, which is reported as operating revenues, was $54.2 million for 2002 compared to $134.3 million for 2001.

Realized gains decreased to $141.6 million for 2002 from $164.5 million for 2001. Realized gains represent the net gain on contracts that have settled. The decrease was primarily due to a decrease in the underlying commodity

34


Table of Contents

AVISTA CORPORATION

values that settled and a decrease in the volume of transactions. The decrease in the volume of transactions was primarily due to reduced liquidity in wholesale markets, fewer creditworthy counterparties participating in the wholesale markets and a decrease in the volatility of prices in the wholesale markets. The total mark-to-market adjustment for Energy Trading and Marketing was an unrealized loss of $87.4 million for 2002 compared to an unrealized loss of $30.2 million for 2001. The increase in the unrealized loss is primarily due to the settlement of contracts and the realization of previously unrealized gains and decreased volatility in the wholesale energy markets. During 2002, the change in the total unrealized gain attributable to market prices and other market changes was $49.7 million, a decrease from $120.6 million in 2001.

Administrative and general expenses decreased $11.7 million, or 35 percent, from 2001 primarily due to reduced incentive compensation expense based on lower earnings in 2002. Reduced professional fees also contributed to the decrease in administrative and general expenses. Professional fees were high during 2001 due to expenses associated with the California energy crisis (see “Power Market Issues”) and a CFTC investigation that was resolved in 2001 related to certain trades in 1998.

Energy Trading and Marketing’s total assets decreased $156.6 million from December 31, 2001 to December 31, 2002 primarily due to a decrease in total current and non-current energy commodity assets. This decrease in commodity assets reflects the settlement of contracts and a decrease in commodity prices during 2002.

2001 compared to 2000

Energy Trading and Marketing’s net income was $63.2 million for 2001, compared to $161.8 million for 2000. The primary reason for the decrease in net income was a decrease in the mark-to-market adjustment for the change in the fair value position of Avista Energy’s energy commodity portfolio. The mark-to-market adjustment was an unrealized loss of $30.2 million for 2001 compared to an unrealized gain of $176.8 million for 2000. The decrease is primarily due to a significant amount of contracts settled during 2001 and the realization of previous unrealized gains. Volatility in energy markets and increased commodity prices during 2000 resulted in significant unrealized gains during 2000. These unrealized gains were partially realized during 2001. Realized gains increased to $164.5 million in 2001 from $130.9 million in 2000.

Administrative and general expenses decreased $7.8 million or 19 percent from 2000 primarily due to reduced incentive compensation expense based on lower earnings in 2001.

Expenses associated with the exit of Avista Energy’s operations in Houston and Boston during the first half of 2000 totaled $7.9 million in 2000.

During 2001 the Company recorded an impairment charge of $8.2 million related to three turbines owned by Avista Power which is reflected in the line item other income-net in the Consolidated Statements of Income and Comprehensive Income. The Company originally planned to use these turbines in a non-regulated generation project. During 2001, the Company decided that it would no longer pursue the development of additional non-regulated generation projects. As such, the Company wrote down the carrying value of the turbines to estimated fair value less selling costs.

Energy Trading and Marketing’s total assets decreased $8.8 billion from December 31, 2000 to December 31, 2001 primarily due to a decrease in total current and non-current energy commodity assets. This decrease in commodity assets primarily reflected the settlement of a significant amount of contracts during 2001 and a decrease in the forward price and estimated value of natural gas and electricity from December 31, 2000 to December 31, 2001.

35


Table of Contents

AVISTA CORPORATION

Energy trading activities and positions

The following summarizes information with respect to Avista Energy’s trading activities during 2002 (dollars in thousands):

                         
    Natural Gas   Electric   Total
    Assets net of   Assets net of   Unrealized
    Liabilities   Liabilities   Gain (Loss) (4)
 
 
 
 
Fair value of contracts as of December 31, 2001
  $ 38,392     $ 148,325     $ 186,717  
Less contracts settled during 2002 (1)
    (33,334 )     (108,276 )     (141,610 )
Fair value of new contracts when entered into during 2002 (2)
                 
Change in fair value due to changes in valuation techniques (3)
                 
Change in fair value attributable to market prices and other market changes
    29,662       20,032       49,694  
 
   
     
     
 
Fair value of contracts as of December 31, 2002
  $ 34,720     $ 60,081     $ 94,801  
 
   
     
     
 

(1)   Contracts settled during 2002 include those contracts that were open in 2001 but settled during 2002 as well as new contracts entered into and settled during 2002. Amount represents realized gains associated with these settled transactions.
 
(2)   Avista Energy has not entered into any origination transactions during 2002 in which dealer profit or mark-to-market gain or loss was recorded at inception.
 
(3)   During 2002, Avista Energy did not experience a change in fair value as a result of changes in valuation techniques.
 
(4)   Change in unrealized gain (loss) does not reconcile to totals for the Energy Trading and Marketing segment due to an intercompany elimination between Avista Energy and Avista Power related to Avista Energy’s contract for the output from the Lancaster Project that is 49 percent owned by Avista Power.

The following discloses summarized information with respect to valuation techniques and contractual maturities of Avista Energy’s energy commodity contracts outstanding as of December 31, 2002 (dollars in thousands):

                                           
              Greater   Greater                
              than one   than three   Greater        
      Less than   and less than   and less than   than        
      one year   three years   five years   five years   Total
     
 
 
 
 
Natural gas assets (liabilities), net (1)
                                       
 
Prices from other external sources (2)
  $ 25,622     $ 2,144     $     $     $ 27,766  
 
Fair value based on valuation models (3)
    6,345       (1,351 )     1,184       776       6,954  
 
   
     
     
     
     
 
 
Total natural gas assets (liabilities), net
  $ 31,967     $ 793     $ 1,184     $ 776     $ 34,720  
 
   
     
     
     
     
 
Electric assets (liabilities), net (1)
                                       
 
Prices from other external sources (2)
  $ 30,659     $ 21,688     $     $     $ 52,347  
 
Fair value based on valuation models (4)
    (1,929 )     5,415       9,304       (5,056 )     7,734  
 
   
     
     
     
     
 
 
Total electric assets (liabilities), net
  $ 28,730     $ 27,103     $ 9,304     $ (5,056 )   $ 60,081  
 
   
     
     
     
     
 

(1)   Reflects commodity contracts outstanding and accounted for under EITF 98-10 as of December 31, 2002 with the exception of contracts entered into subsequent to October 25, 2002. The table does not reflect any adjustment for the transition to SFAS No. 133 for contracts not meeting the definition of a derivative. Effective January 1, 2003, contracts that were entered into on or prior to October 25, 2002 and not meeting the definition of a derivative are accounted for on an accrual basis. Contracts not meeting the definition of a derivative include Avista Energy’s Agency Agreement with Avista Utilities, natural gas storage contracts, tolling agreements and natural gas transportation agreements.
 
(2)   Fair value is determined based upon actively traded, “over-the-counter” market quotes received from third party brokers. For natural gas assets and liabilities, these market quotes are generally available through three years. For electric assets and liabilities, these market quotes are generally available through two years.
 
(3)   Represents contracts for delivery at basis locations not actively traded in the “over-the-counter” markets. In addition, this includes all contracts with a delivery period greater than three years, for which active quotes are not available. These internally developed market curves are based upon published New York Mercantile Exchange prices through seven years, as well as basis spreads using historical and broker estimates. After seven years, an escalation is used to estimate the valuation.
 
(4)   Represents contracts for delivery at basis locations not actively traded in the “over-the-counter” markets. In addition, this includes all contracts with a delivery period greater than two years, for which active quotes are not available. These internally developed market curves are determined using a production cost model with

36


Table of Contents

    AVISTA CORPORATION
 
    inputs for assumptions related to power prices (including, without limitation, natural gas prices, generation on line, transmission constraints, future demand and weather).

Avista Energy conducts frequent stress tests on the valuation of its portfolio. By changing the input assumptions to the internally developed market curves, these stress tests attempt to capture Avista Energy’s sensitivity to changes in portfolio valuation. These stress tests indicate that, for the portfolio valued under internally developed market curves, the valuations can be reasonably certain to be within a 20 percent range, upwards or downwards, of the reported values listed above.

Avista Power

Avista Power is a 49 percent owner of a 270 MW natural gas-fired combustion turbine plant in northern Idaho (Lancaster Project), which commenced commercial operation in September 2001. All of the output from the Lancaster Project is contracted to Avista Energy for 25 years. In addition, Avista Power and its co-owner, an affiliate of Mirant Americas Development, Inc. (Mirant), have substantially completed the construction of Coyote Springs 2. In January 2003, Avista Power’s 50 percent ownership interest in Coyote Springs 2 was transferred to Avista Corp. for inclusion in Avista Utilities’ power generation resource portfolio. See “New Generation Resource – Avista Utilities” for further information.

Information and Technology

The Information and Technology line of business includes the results of Avista Advantage and Avista Labs (including its 70 percent equity interest in H2fuel, LLC). Avista Advantage remains focused on growing revenue, improving margins, reducing fixed and variable costs and improving client satisfaction. Avista Corp. continues discussions with selected companies in its search for a financial partner for Avista Labs with the goal of reducing its ownership interest in Avista Labs to less than 20 percent.

2002 compared to 2001

Information and Technology’s net loss was $12.1 million for 2002 compared to $19.4 million for 2001. Operating revenues for this line of business increased $3.8 million and operating expenses decreased $7.2 million, as compared to 2001. Avista Advantage accounted for the increase in revenues primarily due to the expansion of its customer base. The decrease in operating expenses reflects reduced expenses for Avista Advantage and Avista Labs due to improved efficiencies, a reduction in the number of employees and a focus on reducing operating expenses. Certain non-recurring items in both periods also contributed to the decrease in operating expenses.

2001 compared to 2000

Information and Technology’s net loss was $19.4 million for 2001 compared to $19.0 million for 2000. Operating revenues and expenses in 2001 for this line of business increased $8.1 million and $11.5 million, respectively, as compared to 2000. Avista Advantage accounted for the increase in revenues primarily due to the expansion of its customer base. The increase in operating expenses reflected expansion of operations for Avista Advantage and further fuel cell development by Avista Labs.

Other

The Other line of business includes several subsidiaries, including Avista Ventures, Pentzer, Avista Development and Avista Services. The operations of Avista Capital that are not included through its subsidiaries are reported in this line of business.

2002 compared to 2001

The net loss before cumulative effect of accounting change from this line of business was $12.4 million for 2002, compared to $8.4 million for 2001. The increase in the net loss was primarily due to a decrease in income from operations and partially due to an increase in interest expense as well as a reduction in gains on the disposition of assets. Operating revenues from this line of business decreased $1.7 million and operating expenses increased $2.7 million, respectively, for 2002 as compared to 2001. The decrease in income from operations was primarily due to an increase in litigation costs and settlements as well as an increase in the loss from Advanced Manufacturing and Development, a subsidiary of Avista Ventures, from $4.5 million in 2001 to $5.1 million in 2002.

37


Table of Contents

AVISTA CORPORATION

2001 compared to 2000

The net loss from this line of business was $8.4 million for 2001, compared to $2.9 million for 2000. The increase in the net loss from 2000 was primarily a result of increased interest expense on intercompany borrowings between Avista Capital and Avista Corp. that is eliminated in the consolidated financial statements. Operating revenues and expenses from this line of business decreased $16.6 million and $16.0 million, respectively, during 2001 as compared to 2000, reflecting reduced activities in this line of business.

Discontinued Operations

In September 2001, the Company reached a decision that it would dispose of substantially all of the assets of Avista Communications. The divestiture of operating assets was complete by the end of 2002. Certain liabilities of the operations remain to be settled. In October 2001, minority shareholders of Avista Communications acquired ownership of its Montana and Wyoming operations as well as its dial-up internet access operations in Spokane, Washington and Coeur d’Alene, Idaho. In December 2001, Avista Communications completed the sale of the assets and customer accounts of its Yakima and Bellingham, Washington operations to Advanced Telcom Group, Inc. In April 2002, Avista Communications completed the transfer of voice and integrated services customer accounts in Spokane, Washington and Lewiston and Coeur d’Alene, Idaho to certain subsidiaries of XO Communications, Inc. In December 2002, the Company completed the sale of substantially all of the remaining assets of Avista Communications to FiberLink LLC.

2002 compared to 2001

Net income for 2002 was $1.1 million, compared to a net loss of $47.4 million for 2001. Net income for 2002 was primarily due to the settlement of contracts and liabilities during the period as well as the favorable settlement of a lawsuit during the period. The significant net loss for 2001 was due to asset impairment charges of $58.4 million recorded during the third quarter of 2001.

2001 compared to 2000

The net loss for 2001 was $47.4 million, compared to a net loss of $9.4 million for 2000. The significant net loss for 2001 was due to asset impairment charges. The loss from operations for Avista Communications was $21.1 million for 2001 compared to $15.4 million for 2000.

Earnings Outlook

The Company expects to report consolidated earnings in the range of $0.80 to $1.00 per diluted share in 2003. This expectation is for earnings before the cumulative effect of changes in accounting principles. This estimate includes earnings ranging from $0.60 to $0.80 for Avista Utilities and $0.20 to $0.30 for Energy Trading and Marketing and a loss ranging from $0.10 to $0.15 for Information and Technology. The 2003 projection includes uncertainties surrounding reduced activity in the wholesale energy markets and increased expenses, such as pension, health care and insurance costs. The projection for 2003 anticipates that the Company will expense the first $9 million plus 10 percent of any additional power supply costs above the amount allowed in base retail electric rates for Washington customers. The Company anticipates that the change in accounting for Avista Energy’s energy trading activities from EITF Issue No. 98-10 to SFAS No. 133 could result in a significant increase in the volatility of reported earnings on a quarter-to-quarter and year-to-year basis. These projections are subject to a variety of risks and uncertainties that could cause actual results to differ from this estimate, including those described above and listed under “Safe Harbor for Forward-Looking Statements” and “Future Outlook-Business Risks.” See “Liquidity and Capital Resources” for additional information.

New Generation Resource – Avista Utilities

Construction has been substantially completed on the 280 MW combined cycle natural gas-fired turbine power plant at Coyote Springs 2 located near Boardman, Oregon which was 50 percent owned by Avista Power and 50 percent owned by Mirant and was included in the Energy Trading and Marketing line of business as of December 31, 2002. The Company’s ownership interest in the plant was transferred from Avista Power to Avista Corp. in January 2003 to be operated as an asset of Avista Utilities. Avista Corp. and Mirant are both current with respect to their obligations to share equally in the costs of construction of the plant. Avista Corp. and Mirant will share equally in the costs of operation and output from Coyote Springs 2. In May 2002, a transformer at the site failed and caught fire resulting in the release of an estimated 17,000 gallons of coolant oil. The Company worked closely with the

38


Table of Contents

AVISTA CORPORATION

appropriate environmental agencies to complete a satisfactory cleanup of the oil. While the cause of the failure is still being investigated, the Company anticipates the cost of the cleanup as well as the cost of replacing the damaged transformer will be considered covered losses under the relevant insurance policies. Additionally, the Company continues to evaluate the merits of possible claims against those parties that may be responsible for the transformer failure. In December 2002, the replacement transformer was received in a damaged condition. The problems with the transformer have delayed the scheduled completion of the project from the third quarter of 2002 to the middle of 2003. As of December 31, 2002, the Company had invested $109.0 million in Coyote Springs 2, including capitalized interest.

New Accounting Standards

See “Note 2 of the Notes to Consolidated Financial Statements.”

Critical Accounting Policies

Use of estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements. Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the consolidated financial statements and thus actual results could differ from the amounts reported and disclosed herein.

Regulatory Accounting

The Company prepares its consolidated financial statements in accordance with the provisions of SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation.” The Company prepares its financial statements in accordance with SFAS No. 71 because (i) the Company’s rates for regulated services are established by or subject to approval by an independent third-party regulator, (ii) the regulated rates are designed to recover the Company’s cost of providing the regulated services and (iii) in view of demand for the regulated services and the level of competition, it is reasonable to assume that rates can be charged to and collected from customers at levels that will recover the Company’s costs. SFAS No. 71 requires the Company to reflect the impact of regulatory decisions in its financial statements. SFAS No. 71 requires that certain costs and/or obligations (such as incurred power and natural gas costs not currently recovered through rates, but expected to be recovered in the future) are reflected as deferred charges on the balance sheet. These costs and/or obligations are not reflected in the statement of income until the period during which matching revenues are recognized. If at some point in the future the Company determines that it no longer meets the criteria for continued application of SFAS No. 71 with respect to all or a portion of the Company’s regulated operations, the Company could be required to write off its regulatory assets. The Company could also be precluded from the future deferral of costs not recovered through rates at the time such costs were incurred, even if such costs were expected to be recovered in the future.

In accordance with SFAS No. 71, profits recognized by Avista Energy on natural gas sales to Avista Utilities, including gains and losses on natural gas contracts, are not eliminated in the consolidated financial statements. This is due to the fact that costs incurred by Avista Utilities for natural gas purchases to serve retail customers and for fuel for electric generation are expected to be recovered through future retail rates.

The Company’s primary regulatory assets include power and natural gas deferrals, investment in exchange power, regulatory assets for deferred income taxes, unamortized debt expense, regulatory asset offsetting energy commodity derivative liabilities (see “Utility Energy Commodity Derivative Assets and Liabilitiesfor further information), demand side management programs, conservation programs and the provision for postretirement benefits. Deferred credits include regulatory liabilities created when Centralia was sold and the gain on the general office building sale/leaseback, which is being amortized over the life of the lease.

Avista Utilities Energy Commodity Derivative Assets and Liabilities

SFAS No. 133 as amended by SFAS No. 138, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires the recording of all derivatives as either assets or liabilities in the balance sheet measured at estimated fair value and the recognition of the unrealized gains and losses. In certain defined conditions, a derivative may be specifically designated as a hedge for a particular exposure. The accounting for derivatives depends on the intended use of the derivatives and the resulting designation.

39


Table of Contents

AVISTA CORPORATION

Avista Utilities enters into forward contracts to purchase or sell energy. Under forward contracts, Avista Utilities commits to purchase or sell a specified amount of energy at a specified time, or during a specified period, in the future. Certain of these forward contracts are considered derivative instruments. Avista Utilities also records derivative commodity assets and liabilities for over-the-counter and exchange-traded derivative instruments as well as certain long-term contracts. In conjunction with the issuance of SFAS No. 133, the WUTC and the IPUC issued accounting orders requiring Avista Utilities to offset any derivative assets or liabilities with a regulatory asset or liability. This accounting treatment is intended to defer the recognition of mark-to-market gains and losses on energy commodity transactions until the period of settlement. The order provides for Avista Utilities to not recognize the unrealized gain or loss on utility derivative commodity instruments in the Consolidated Statements of Income and Comprehensive Income. Such realized gains or losses are recognized in the period of settlement subject to current or future recovery in retail rates.

Avista Utilities believes that substantially all of its purchases and sales contracts for both capacity and energy qualify as normal purchases and sales under SFAS No. 133 and are not required to be recorded as derivative commodity assets and liabilities. Contracts that are not considered derivatives under SFAS No. 133 are generally accounted for at cost until they are settled unless there is a decline in the fair value of the contract that is determined to be other than temporary.

Interpretations that may be issued by the Derivatives Implementation Group, a task force created to assist the Financial Accounting Standards Board (FASB) in answering questions that companies have in implementing SFAS No. 133, may change the conclusions that the Company has reached regarding accounting for energy contracts. As a result, the accounting treatment and financial statement impact could change in future periods.

Avista Energy Trading Activities

Avista Energy accounted for energy commodity trading activity in compliance with EITF Issue No. 98-10 through December 31, 2002 for contracts entered into on or prior to October 25, 2002. Under EITF 98-10, Avista Energy recognized revenue based on the change in the market value of outstanding derivative commodity sales contracts, net of future servicing costs and reserves, in addition to revenue related to settled contracts. In October 2002, the EITF rescinded Issue No. 98-10. As such, Avista Energy is required to account for energy trading contracts that meet the definition of a derivative at market value in compliance with SFAS No. 133. This applies to all existing contracts as of January 1, 2003 as well as to all new contracts entered into subsequent to October 25, 2002. Contracts not meeting the definition of a derivative are no longer accounted for at market value and include Avista Energy’s Agency Agreement with Avista Utilities, natural gas storage contracts, tolling agreements and natural gas transportation agreements. The transition from EITF Issue No. 98-10 to accrual based accounting resulted in the adjustment of the contracts that are not considered derivatives from their market value to their cost basis. Any gain or loss on contracts that are not considered derivatives will not be recognized until the contract is settled or realized. The Company anticipates that the changes will primarily affect the timing of the recognition of income or loss in earnings, and not change the underlying economics or cash flows of transactions entered into by Avista Energy. The changes could result in a significant increase in the volatility of reported earnings on a quarter-to-quarter and year-to-year basis. On January 1, 2003, Avista Energy recorded as a cumulative effect of accounting change a charge of approximately $1.2 million (net of tax) related to the transition from EITF 98-10 to SFAS No. 133.

Market prices are utilized in determining the value of the electric, natural gas and related derivative commodity instruments. For natural gas commodity instruments, these market prices are generally available through three years. For electric commodity instruments, these market prices are generally available through two years. For longer-term positions and certain short-term positions for which market prices are not available, a model to estimate forward price curves is utilized. These models incorporate a variety of estimates and assumptions, the ultimate outcomes of which are beyond Avista Energy’s control including, among others, estimates and assumptions as to demand growth, fuel price escalation, availability of existing generation and costs of new generation. Actual experience can vary significantly from these estimates and assumptions. Gains and losses on electric, natural gas and related derivative commodity instruments utilized for trading are recognized as income on a current basis (the mark-to-market method) and are included in the Consolidated Statements of Income and Comprehensive Income in operating revenues on a net basis, and in the Consolidated Balance Sheets as current or non-current energy commodity assets or liabilities. Contracts in a receivable position, as well as the options held, are reported as assets. Similarly, contracts in a payable position, as well as options written, are reported as liabilities. Net cash flows are recognized in the period of settlement.

40


Table of Contents

AVISTA CORPORATION

Pension Plans and Other Postretirement Benefit Plans

The Company has a defined benefit pension plan covering substantially all of its regular full-time employees. Certain of the Company’s subsidiaries also participate in this plan. Individual benefits under this plan are based upon years of service and the employee’s average compensation as specified in the plan. The Company’s funding policy is to contribute amounts that are not less than the minimum amounts required to be funded under the Employee Retirement Income Security Act, nor more than the maximum amounts which are currently deductible for income tax purposes. The Company made $12 million in cash contributions to the pension plan in 2002 and did not make any cash contributions to the pension plan in 2001. The Company expects to contribute approximately $12 million to the pension plan in 2003. Pension fund assets are invested primarily in marketable debt and equity securities. The Company’s pension plan currently has assets with a fair value that is less than the present value of the accumulated benefit obligation under the plan. In 2002, the Company recorded an additional minimum liability for the unfunded accumulated benefit obligation of $33.4 million and an intangible asset of $6.4 million (representing the amount of unrecognized prior service cost) related to the pension plan. This resulted in a charge to other comprehensive income of $17.6 million, net of taxes.

The Company’s pension costs (including the Supplemental Executive Retirement Plan (SERP)) were $10.3 million, $4.8 million and $2.1 million for 2002, 2001 and 2000, respectively. Of these pension costs, approximately 70 percent are expensed and approximately 30 percent are capitalized. The Company’s costs for the pension plan are determined in part by actuarial formulas and are dependent upon numerous factors resulting from actual plan experience and assumptions of future experience. Pension costs are affected by actual employee demographics (including age, compensation and the length of service by employees), the amount of cash contributions the Company makes to the pension plan and the return on pension plan assets. Changes made to the provisions of the pension plan may also impact current and future pension costs. Pension plan costs may also be significantly affected by changes in key actuarial assumptions, including the expected return on pension plan assets, the discount rate used in determining the projected benefit obligation and pension costs as well as the assumed rate of increase in employee compensation. The change in pension plan obligations associated with these factors may not be immediately recognized as pension costs in the Consolidated Statement of Income and Comprehensive Income, but generally are recognized in future years over the remaining average service period of pension plan participants. As such, significant portions of pension costs recorded in any period may not reflect the actual level of cash benefits provided to pension plan participants.

The Company has not made any changes to pension plan provisions in 2002, 2001 and 2000 that have had any significant effect on recorded pension plan amounts. The Company has revised the key assumptions of expected return on pension plan assets and the discount rate in 2002 as compared to 2001 and 2000. Such changes had an effect on reported pension costs in 2002 and will have an impact on future years given the cost recognition approach described above. However, in determining pension obligation and costs amounts, these assumptions can change from period to period, and such changes could result in material changes to future pension costs and funding requirements.

The following chart reflects the sensitivities associated with a change in certain actuarial assumptions by the indicated percentage (dollars in thousands):

                                 
Actuarial   Change in   Impact on Projected   Impact on   Impact on
Assumption   Assumption   Benefit Obligation   Pension Liability   Pension Cost

 
 
 
 
Expected long-term return on plan assets
    -0.5 %   $     $ —*     $ 769  
Expected long-term return on plan assets
    +0.5 %           —*       (770 )
Discount rate
    -0.5 %     17,184       11,450       1,598  
Discount rate
    +0.5 %     (15,396 )     (15,396 )     (1,411 )

* As the Company has already recorded an additional minimum liability for the unfunded accumulated benefit obligation during 2002, changes in the expected return on plan assets would not have an impact on the total pension liability.

In selecting a discount rate, the Company considers yield rates for highly rated corporate bond portfolios with maturities similar to that of the expected term of pension benefits. The Company reduced the discount rate in 2002 from 7.25 percent to 6.75 percent.

In selecting an assumed long-term rate of return on plan assets, the Company considered past performance and economic forecasts for the types of investments held by the plan. The market value of the Company’s plan assets has been affected by a decline in equity markets beginning in 2000. For the past three years the fair value of plan assets

41


Table of Contents

AVISTA CORPORATION

has decreased $16.7 million, $9.3 million and $1.0 million in 2002, 2001 and 2000, respectively. In its 2002 actuarial valuation, the Company decreased the expected long-term rate of return on plan assets from 9 percent to 8 percent as a result of continued declines in general equity and bond market returns. Reported pension costs are expected to increase in 2003 and future years as the result of this changed assumption. The projected increased pension costs and contributions have been incorporated in the earnings outlook for 2003.

The Company also has a SERP that provides additional pension benefits to executive officers of the Company. The SERP is intended to provide benefits to executive officers whose benefits under the pension plan are reduced due to the application of Section 415 of the Internal Revenue Code of 1986 and the deferral of salary under deferred compensation plans. In 2002, the Company recorded an additional minimum liability for the unfunded accumulated benefit obligation of $0.7 million related to the SERP. In 2001, the Company recorded an additional minimum liability for the unfunded accumulated benefit obligation of $1.1 million related to the SERP. This resulted in a charge to other comprehensive income of $0.5 million and $0.7 million, net of taxes, for 2002 and 2001, respectively.

The Company provides certain health care and life insurance benefits for substantially all of its retired employees. The Company accrues the estimated cost of postretirement benefit obligations during the years that employees provide services. The Company elected to amortize the transition obligation of $34.5 million over a period of twenty years, beginning in 1993.

Assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement plans. A one-percentage-point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of December 31, 2002 by $2.0 million and the service and interest cost by $0.2 million. A one-percentage-point decrease in the assumed health care cost trend rate for each year would decrease the accumulated postretirement benefit obligation as of December 31, 2002 by $1.7 million and the service and interest cost by $0.2 million.

42


Table of Contents

AVISTA CORPORATION

Liquidity and Capital Resources

Review of Cash Flow Statement

Continuing Operating Activities Net cash provided by continuing operating activities was $331.3 million for 2002 compared to net cash used in continuing operating activities of $76.1 million for 2001. The primary reason for the increase in net cash provided by continuing operating activities was power and natural gas cost amortization, net of deferrals and interest, of $68.5 million for 2002 compared to net deferrals of $210.5 million for 2001. This was primarily due to increased retail rates approved by the respective utility commissions to recover increased deferred power and natural gas costs incurred during 2000 and 2001. Net power and natural gas cost amortizations and deferrals are non-cash items that are added back or deducted from net income to determine net cash flows from operating activities using the indirect method. Net cash provided by working capital components was $110.0 million for 2002, compared to $108.3 million of net cash used for 2001. The increase in other current liabilities is primarily due to an increase in deposits held from other parties from $15.7 million as of December 31, 2001 to $92.7 million as of December 31, 2002. Significant changes in non-cash items also included a $57.2 million change in energy commodity assets and liabilities, representing the increase in the unrealized loss on energy trading activities for Energy Trading and Marketing from $30.2 million in 2001 to $87.4 million in 2002. The $119.4 million change in the provision for deferred income taxes was primarily due to changes in deferred power and natural gas cost amortizations and deferrals described above.

Continuing Investing Activities Net cash used in continuing investing activities was $48.3 million for 2002, a decrease compared to $218.4 million for 2001. This was due to a decrease in other capital expenditures and utility property construction expenditures, partially offset by a decrease in the proceeds from property sales and sales of subsidiary investments. Other capital expenditures during 2001 were primarily for the construction of Coyote Springs 2 and the purchase of four turbines by Avista Power that were planned to be used in a non-regulated generation project. In 2001, proceeds from property sales and sale of subsidiary investments were $76.0 million, primarily related to the sale of the 50 percent interest in Coyote Springs 2 and three of Avista Power’s turbines. Utility property construction expenditures decreased to $64.2 million for 2002 compared to $119.9 million for 2001.

Continuing Financing Activities Net cash used in continuing financing activities was $284.7 million for 2002 compared to net cash provided of $285.7 million for 2001. During 2002, short-term borrowings decreased $45.1 million and the Company repurchased $203.6 million of long-term debt scheduled to mature in future years. The Company paid net premiums of $9.5 million to repurchase long-term debt in 2002. The decrease in short-term borrowings reflects a decrease in the amount outstanding under Avista Corp.’s line of credit as well as the repayment of a short-term note at Avista Capital. The overall decrease in borrowings during 2002 reflects increased cash flows from operations primarily related to the recovery of deferred power and natural gas costs as well as a general rate increase for Washington electric customers that was partially used to repurchase long-term debt. Cash dividends from Avista Energy were also a significant source of funds used by Avista Corp. to repurchase long-term debt during 2002.

In 2001, the Company issued $550.0 million of long-term debt. During 2001, short-term borrowings decreased $88.1 million, $89.0 million of Medium-Term Notes matured and the Company also legally defeased $50.0 million of Medium-Term Notes scheduled to mature in 2002. The overall increase in borrowings during 2001 was due to increased cash needs to fund capital expenditures and increased power and natural gas costs.

Discontinued Operations Net cash provided by discontinued operations was $16.8 million for 2002 compared to $17.2 million of net cash used in discontinued operations for 2001. The change was primarily due to a decrease in operating costs and capital expenditures by Avista Communications as the Company decided to dispose of the operations. Net cash provided by discontinued operations in 2002 primarily represented the disposal of assets and the settlement of deferred tax assets.

Overall Liquidity

During 2002, the Company’s overall liquidity improved compared to 2001. The general electric rate case order issued by the WUTC in June 2002 should allow the Company to continue to improve its liquidity. The general electric rate case order provided for the restructuring and continuation of previously approved rate increases totaling 31.2 percent (a 25 percent temporary surcharge approved in September 2001 and a 6.2 percent increase approved in March 2002). The general increase to base retail rates is 19.3 percent (or $45.7 million in annual revenues) and the remaining 11.9 percent represents the continued recovery of deferred power costs over a period currently projected to extend into 2009. Additionally, the Company has a PCA surcharge of 19.4 percent in place in Idaho. See further details in the section “Avista Utilities - Regulatory Matters.”

43


Table of Contents

AVISTA CORPORATION

In addition to rate surcharges and increases, the Company has taken other steps to improve its liquidity. The Company completed the sale of 50 percent of its interest in the Coyote Springs 2 project to Mirant during the fourth quarter of 2001. The Company received $53.6 million in proceeds from Mirant. In addition, Mirant provided the majority of the remaining funds to complete the project. The Company also sold three turbines owned by Avista Power with $22.7 million of proceeds received during the fourth quarter of 2001 and $22.7 million of proceeds received during 2002. Additionally, 2002 operating budgets were designed to control costs and the Company significantly reduced capital expenditures from the amount originally budgeted. The Company’s disposal of Avista Communications reduces future cash investments in the Information and Technology line of business. The Company continues discussions with selected companies in its search for a financial partner for Avista Labs with the goal of reducing its ownership interest to less than 20 percent.

Covenants in Avista Energy’s credit agreement restrict the amount of cash dividends that can be distributed to Avista Capital and ultimately to Avista Corp. During 2002, in accordance with the modified covenants of its credit agreement, Avista Energy paid $116.4 million in dividends to Avista Capital.

These measures are largely related to the Company’s efforts to improve its liquidity and cash flows and should provide the Company the ability to maintain access to adequate levels of credit with its banks.

During the second half of 2000 and the year 2001, the Company’s cash outlays for purchased power exceeded the related amounts paid to the Company by its retail customers. This condition was primarily due to the reduced availability of hydroelectric resources compared to historical periods, increased prices in the wholesale market and increased volumes purchased to meet retail customer demand. In addition to operating expenses, the Company has continuing commitments for capital expenditures for construction, improvement and maintenance of facilities. In 2001, the Company incurred substantial levels of indebtedness, both short and long-term, to finance these requirements and to otherwise maintain adequate levels of working capital. Debt service is another significant cash requirement.

If Avista Utilities’ power and natural gas costs were to significantly exceed the levels currently recovered from retail customers, its cash flows would be negatively affected. Factors that could cause purchased power costs to exceed the levels currently recovered from customers include, but are not limited to, a return to high prices in wholesale markets combined with an increased need to purchase power in the wholesale markets. Current FERC imposed price caps limit wholesale market prices to $250 per MWh. Factors beyond the Company’s control that could result in an increased need to purchase power in the wholesale markets include, but are not limited to, increases in demand (either due to weather or customer growth), low availability of hydroelectric resources, outages at generating facilities and failure of third parties to deliver on energy or capacity contracts.

Capital Resources

The Company incurred significant indebtedness to support capital expenditures, to fund power and natural gas costs that were in excess of the amount recovered currently through rates and to maintain working capital through the end of 2001. However, as of December 31, 2002, the Company’s total debt outstanding was $1,004.5 million, a decrease of $248.1 million from $1,252.6 million as of December 31, 2001. The decrease was primarily due to the repurchase of long-term debt and partially due to a decrease in short-term borrowings. This was made possible by improved operating cash flows from both Avista Utilities and Avista Energy. The Company needs to finance capital expenditures and obtain additional working capital from time to time. The cash requirements to service the indebtedness, both short-term and long-term, reduces the amount of cash flow available to fund working capital, purchased power and natural gas costs, capital expenditures, dividends and other corporate requirements.

The Company generally funds capital expenditures with a combination of internally generated cash and external financing. The level of cash generated internally and the amount that is available for capital expenditures fluctuates depending on a variety of factors. Cash provided by utility operating activities and cash generated by Avista Energy are expected to be the Company’s primary source of funds for operating needs, dividends and capital expenditures for 2003. Cash flows from operations have improved primarily from the recovery of deferred power and natural gas costs and from the electric rate increase in Washington and the continuation of the PCA surcharge in Idaho. This should allow the Company to continue to reduce total debt outstanding. Capital expenditures are expected to be funded either with cash flows from operations or on an interim basis with short-term borrowings.

On May 21, 2002, the Company entered into a committed line of credit with various banks in the total amount of $225.0 million. The committed line of credit, which expires on May 20, 2003, replaced the $220.0 million committed

44


Table of Contents

AVISTA CORPORATION

line of credit that expired on May 29, 2002. As of December 31, 2002, the Company had borrowed $30.0 million under this committed line of credit. Under this committed line of credit, the Company may have up to $50.0 million in letters of credit outstanding. As of December 31, 2002, there was $14.3 million of letters of credit outstanding. The Company’s obligation under the committed line of credit is secured with First Mortgage Bonds in the amount of the commitment. The Company is currently in discussions with its banks and believes that the committed line of credit will be renewed for an additional year by the May 20, 2003 expiration date.

The committed line of credit agreement contains customary covenants and default provisions, including covenants not to permit the ratio of “consolidated total debt” to “consolidated total capitalization” of Avista Corp. to be, at the end of any fiscal quarter, greater than 65 percent. As of December 31, 2002, the Company was in compliance with this covenant with a ratio of 54.3 percent. The committed line of credit also has a covenant requiring the ratio of “earnings before interest, taxes, depreciation and amortization” to “interest expense” of Avista Utilities for the year ending December 31, 2002 to be greater than 1.6 to 1. As of December 31, 2002, the Company was in compliance with this covenant with a ratio of 2.04 to 1.

Any default on its committed line of credit or other financing arrangements could result in cross-defaults to other agreements and could induce vendors and other counterparties to demand collateral. In the event of default, it would be difficult for the Company to obtain financing on any reasonable terms to pay creditors or fund operations, and the Company would likely be prohibited from paying dividends on its common stock. As of December 31, 2002, Avista Corp. was in compliance with the covenants of all of its financing agreements.

During 2002, the Company repurchased $133.8 million of Medium-Term Notes scheduled to mature in 2003, $59.8 million of Unsecured Senior Notes scheduled to mature in 2008 and $10.0 million of Medium-Term Notes scheduled to mature in 2028. In accordance with regulatory accounting practices under SFAS No. 71, total net premiums paid to repurchase debt were $9.5 million and are being amortized over the average remaining maturity of outstanding debt.

The Mortgage and Deed of Trust securing the Company’s First Mortgage Bonds contains limitations on the amount of First Mortgage Bonds which may be issued based on, among other things, a 70 percent debt-to-collateral ratio and a 2.00 to 1 net earnings to First Mortgage Bond interest ratio. Under various financing agreements, the Company is also restricted as to the amount of additional First Mortgage Bonds that it can issue. As of December 31, 2002, the Company could issue $109.4 million of additional First Mortgage Bonds under the most restrictive of these financing agreements.

If market conditions warrant during 2003, the Company may issue long-term debt and repurchase outstanding long-term debt to reduce its overall debt service costs.

The Company is restricted under various agreements and its Restated Articles of Incorporation as to the additional preferred stock it can issue. As of December 31, 2002, approximately $267.1 million of additional preferred stock could be issued at an assumed dividend rate of 6.95 percent with a maturity date later than June 1, 2008.

In July 2001, the Company filed a registration statement on Form S-3 with the Securities and Exchange Commission for the purpose of issuing up to 3.7 million shares of common stock. No common stock has been issued and the Company currently does not have any plans to issue common stock under this registration statement.

Inter-Company Debt; Subordination

As part of its on-going cash management practices and operations, Avista Corp. from time to time makes unsecured short-term loans to, and borrowings from, Avista Capital. In turn, Avista Capital from time to time makes unsecured short-term loans to, and borrowings from, its subsidiaries. As of December 31, 2002, Avista Corp. held short-term notes of Avista Capital in the principal amount of $137.3 million; and Avista Capital held, among other notes, $109.0 million in principal amount of short-term notes of Avista Power, issued primarily for the construction of Coyote Springs 2. The inter-company borrowings associated with Coyote Springs 2 were satisfied with the transfer of the interest in the plant from Avista Power to Avista Corp. in January 2003.

In addition, Avista Capital from time to time guarantees the indebtedness and other obligations of its subsidiaries. See “Energy Trading and Marketing Operations” and “Contractual Obligations” for further information.

The credit arrangements of Avista Capital’s subsidiaries generally provide that any indebtedness owed by such entity to its corporate parent will be subordinated to the indebtedness outstanding under such credit arrangements.

45


Table of Contents

AVISTA CORPORATION

The right of Avista Corp., as a shareholder, to receive assets of any of its direct or indirect subsidiaries upon the subsidiary’s liquidation or reorganization (and the consequent right of the holders of debt securities and other creditors of Avista Corp. to participate in those assets) is junior to the claims against such assets of that subsidiary’s creditors. As a result, the obligations of Avista Corp. to its debt securityholders and other unrelated creditors are effectively subordinated in right of payment to all indebtedness and other liabilities and commitments (including trade payables and lease obligations) of Avista Corp.’s direct and indirect subsidiaries. Similarly, the obligations of Avista Capital to its creditors are effectively subordinated in right of payment to all indebtedness and other liabilities and commitments of its direct and indirect subsidiaries.

Pension Plan

As of December 31, 2002, the Company’s pension plan had assets with a fair value that was less than the present value of the accumulated benefit obligation under the plan. In 2002, the Company recorded an additional minimum liability for the unfunded accumulated benefit obligation of $33.4 million and an intangible asset of $6.4 million (representing the amount of unrecognized prior service cost) related to the pension plan. This resulted in a charge to other comprehensive income of $17.6 million, net of taxes. The Company does not expect the current pension plan funding deficit to have a material adverse impact on its financial condition, results of operations or cash flows. The Company’s funding policy is to contribute amounts that are not less than the minimum amounts required to be funded under the Employee Retirement Income Security Act. The Company made $12 million in cash contributions to the pension plan in 2002 and did not make any cash contributions to the pension plan in 2001. The Company expects to contribute approximately $12 million to the pension plan in 2003. The Company is funding the pension plan at what it believes to be an adequate level. The increased funding and pension costs have been factored into the Company’s earnings outlook for 2003.

Off-Balance Sheet Arrangements

Avista Receivables Corp. (ARC), formerly known as WWP Receivables Corp., is a wholly owned, bankruptcy-remote subsidiary of the Company formed in 1997 for the purpose of acquiring or purchasing interests in certain accounts receivable, both billed and unbilled, of the Company. On May 29, 2002, ARC, the Company and a third-party financial institution entered into a three-year agreement whereby ARC can sell without recourse, on a revolving basis, up to $100.0 million of those receivables. ARC is obligated to pay fees that approximate the purchaser’s cost of issuing commercial paper equal in value to the interests in receivables sold. As of December 31, 2002, $65.0 million in receivables were sold pursuant to the agreement. ARC will not be consolidated in accordance with a recently issued FASB interpretation related to special-purpose entities.

WP Funding LP is an entity that was formed for the purpose of acquiring the natural gas-fired combustion turbine generating facility in Rathdrum, Idaho (Rathdrum CT). WP Funding LP purchased the Rathdrum CT from the Company with funds provided by unrelated investors of which 97 percent represented debt and 3 percent represented equity. The Company operates the Rathdrum CT and leases it from WP Funding LP and currently makes lease payments of $4.5 million per year. The total amount of WP Funding LP debt outstanding that is not included on the Company’s balance sheet was $54.5 million as of December 31, 2002. The lease term expires in February 2020; however, the current debt matures in October 2005 and will need to be refinanced at that time. The FASB has issued an interpretation relating to the identification of, and accounting for, special-purpose entities such as WP Funding LP. See “Note 2 of the Notes to Consolidated Financial Statements” for further information. This interpretation will require the Company to begin consolidating WP Funding LP into its financial statements effective July 1, 2003, whereby the $54.5 million of debt will be included in the Company’s capitalization and the book value of the Rathdrum CT will be included in utility plant. The equity investment of the unrelated investors will be reported as a minority interest. Based on current information, the difference between the book value of the debt and equity of WP Funding LP and the book value of the Rathdrum CT is approximately $15.5 million ($10.1 million, net of taxes). The Company intends to request regulatory accounting orders to record this amount as a regulatory asset upon the consolidation of WP Funding LP.

Total Company Capitalization

The Company’s consolidated capital structure, including the current portion of long-term debt and short-term borrowings was 54.3 percent debt, 5.4 percent preferred trust securities, 1.8 percent preferred stock and 38.5 percent common equity as of December 31, 2002, compared to 59.4 percent debt, 4.7 percent preferred trust securities, 1.7 percent preferred stock and 34.2 percent common equity as of December 31, 2001. The Company’s consolidated debt decreased by $248 million due to both the repurchase of long-term debt and a decrease in short-term borrowings. The Company’s consolidated common equity decreased $7.3 million during 2002 to $712.8 million as of December 31,

46


Table of Contents

AVISTA CORPORATION

2002.     This decrease is primarily due to dividends and other comprehensive loss, partially offset by net income and the issuance of common stock through the Dividend Reinvestment Plan and employee benefit plans. The significant other comprehensive loss of $20.3 million for 2002 was primarily related to the recording of an unfunded accumulated benefit obligation for the pension plan. The Company has a target capital structure of 50 percent total debt and 50 percent preferred trust securities, preferred stock and common equity. The Company plans to achieve this capital structure primarily with the reduction of total debt and the retention of net earnings.

Credit Ratings

The Company’s credit ratings were downgraded during the fourth quarter of 2001 resulting in an overall corporate credit rating that is below investment grade. The downgrade was due to liquidity concerns primarily related to the significant amount of purchased power and natural gas costs incurred and the resulting increase in debt levels and debt service costs. The following table summarizes the Company’s current credit ratings:

                           
      Standard & Poor’s   Moody’s   Fitch, Inc.
     
 
 
Avista Corporation
                       
 
Corporate/Issuer rating
  BB+   Ba1   BB+
 
Senior secured debt
  BBB-   Baa3   BBB-
 
Senior unsecured debt
  BB+   Ba1   BB+
 
Preferred stock
  BB-   Ba3   BB
Avista Capital I*
                       
 
Preferred Trust Securities
  BB-   Ba2   BB+
Avista Capital II*
 
 
Preferred Trust Securities
  BB-   Ba2   BB
Rating outlook
  Stable**   Negative   Stable

*   Only assets are subordinated debentures of Avista Corporation
 
**   Changed to stable from negative on December 18, 2002

These security ratings are not recommendations to buy, sell or hold securities. The ratings are subject to change or withdrawal at any time by the respective credit rating agencies. Each credit rating should be evaluated independently of any other rating.

Avista Utilities Operations

Capital expenditures for Avista Utilities were $282.8 million for the 2000-2002 period. This excludes Coyote Springs 2, which was included in Energy Trading and Marketing. During the 2003-2005 period, utility capital expenditures are expected to be in the range of $90 to $110 million per year and long-term debt maturities and preferred stock sinking fund requirements total $137 million. During this period, internally generated funds and short-term borrowing arrangements are expected to be sufficient to fund the Company’s capital expenditures, maturing long-term debt and preferred stock sinking fund requirements. These estimates of capital expenditures are subject to continuing review and adjustment. Actual capital expenditures may vary from these estimates due to factors such as changes in business conditions, construction schedules and environmental requirements.

Avista Utilities’ planned capital expenditures include an expansion and enhancement of its 230 kV transmission system at an estimated total cost of $85 to $100 million that is expected to be completed by the end of 2006. To the extent that Avista Utilities chooses to or is required to divest of its transmission assets, it would expect to recover these costs.

Avista Utilities held cash deposits from other parties in the amount of $17.5 million as of December 31, 2002, which is included in cash and cash equivalents with a corresponding amount in other current liabilities in the Consolidated Balance Sheet. These amounts are subject to return if conditions warrant because of continuing portfolio value fluctuations with those parties or substitution of collateral.

As of December 31, 2002, Avista Utilities had $37.0 million in cash and temporary investments, including the $17.5 million of cash deposits from other parties.

See “Notes 6, 15, 16, 17, 20, 21, 22, 23 and 24 of Notes to Consolidated Financial Statements” for additional details related to financing activities.

47


Table of Contents

AVISTA CORPORATION

Energy Trading and Marketing Operations

Avista Energy funds its ongoing operations with a combination of internally generated cash and a bank line of credit. On June 28, 2002 Avista Energy and its subsidiary, Avista Energy Canada, Ltd., as co-borrowers, renewed their credit agreement with a group of banks in the aggregate amount of $110.0 million expiring June 30, 2003. This credit agreement may be terminated by the banks at any time and all extensions of credit under the agreement are payable upon demand, in either case at the lenders’ sole discretion. This agreement also provides, on an uncommitted basis, for the issuance of letters of credit to secure contractual obligations to counterparties. This facility is guaranteed by Avista Capital and secured by Avista Energy’s assets. The maximum amount of credit extended by the banks for the issuance of letters of credit is the subscribed amount of the facility less the amount of outstanding cash advances, if any. The maximum amount of credit extended by the banks for cash advances is $30.0 million. As of December 31, 2002, there were no cash advances (demand notes payable) outstanding and letters of credit outstanding under the facility totaled $17.4 million.

The Avista Energy credit agreement contains customary covenants and default provisions, including covenants to maintain “minimum net working capital” and “minimum net worth” as well as a covenant limiting the amount of indebtedness which the co-borrowers may incur. Avista Energy was in compliance with the covenants of its credit agreement as of December 31, 2002.

Avista Energy believes that it will have access to credit facilities beyond the June 30, 2003 expiration date of its current uncommitted credit agreement.

Avista Capital provides guarantees for Avista Energy’s credit agreement and, in the course of business, may provide guarantees to other parties with whom Avista Energy may be doing business. Avista Capital had $64.6 million of performance guarantees related to energy trading contracts outstanding as of December 31, 2002.

Periodically, Avista Capital may lend funds to Avista Energy to support its short-term cash and collateral needs. Avista Energy’s obligations to repay loans to Avista Capital are subordinate to any obligations of Avista Energy to the banks under the credit agreements. As of December 31, 2002, there were no loans between Avista Capital and Avista Energy outstanding.

Avista Energy manages collateral requirements with counterparties by providing letters of credit, providing guarantees from Avista Capital, cash deposited with counterparties and offsetting transactions with counterparties. Cash deposited with counterparties totaled $35.7 million as of December 31, 2002, and is included in prepayments and other current assets in the Consolidated Balance Sheet. Avista Energy held cash deposits from other parties in the amount of $75.2 million as of December 31, 2002, which is included in cash and cash equivalents with a corresponding amount in other current liabilities in the Consolidated Balance Sheet. These amounts are subject to return if conditions warrant because of continuing portfolio value fluctuations with those parties or substitution of collateral.

As of December 31, 2002, Avista Energy had $148.9 million in cash, including the $75.2 million of cash deposits from other parties. Covenants in Avista Energy’s credit agreement restrict the amount of cash dividends that can be distributed to Avista Capital and ultimately to Avista Corp. During 2002, in accordance with the modified covenants of its credit agreement, Avista Energy paid $116.4 million in dividends to Avista Capital. In January 2003, Avista Energy paid $2.1 million in dividends to Avista Capital.

Capital expenditures for the Energy Trading and Marketing companies were $239.6 million for the 2000-2002 period, primarily due to Avista Power’s investment in Coyote Springs 2 as well as the purchase of turbines during 2001. Capital expenditures are expected to be less than $1.0 million per year in this line of business during the 2003-2005 period.

Information and Technology Operations

Capital expenditures for the Information and Technology line of business were $14.7 million for the 2000-2002 period. The 2003-2005 capital expenditures are expected to be between $3.0 and $4.0 million per year. Avista Advantage and Avista Labs expect to support these capital requirements through a combination of funding from Avista Corp. and third party equity investment. Two venture capital firms made minority interest investments totaling $3.4 million in Avista Advantage during the fourth quarter of 2000. As of December 31, 2002, the Information and Technology companies had $0.1 million in cash and cash equivalents and $0.6 million in debt outstanding. The Company continues discussions with selected companies in its search for a financial partner for Avista Labs with the goal of reducing its ownership interest in Avista Labs to less than 20 percent.

48


Table of Contents

AVISTA CORPORATION

Other Operations

Capital expenditures for these companies were $1.8 million for the 2000-2002 period. The 2003-2005 capital expenditures are not expected to be material. As of December 31, 2002, this line of business had $0.4 million in cash and cash equivalents and temporary investments, with $0.2 million in debt outstanding. In October 2001, Avista Capital entered into a one-year $20 million promissory note collateralized by certain receivables. The note was extended in October 2002 and paid off in December 2002.

Contractual Obligations

The following table provides a summary of the Company’s future contractual obligations as of December 31, 2002 (dollars in millions):

                                                     
        2003   2004   2005   2006   2007   Thereafter
       
 
 
 
 
 
Avista Utilities:
                                               
 
Long-term debt maturities
  $ 71     $ 30     $ 30     $ 38     $ 26     $ 780  
 
Short-term debt (1)
    95                                
 
Preferred stock redemptions
    2       2       2       2       25        
 
Preferred trust securities
                                  100  
 
Energy purchase contracts (2)
    390       290       148       113       115       892  
 
Public Utility District contracts (2)
    4       3       3       3       3       22  
 
Operating lease obligations (3)
    12       10       7       7       7       65  
 
Capital lease obligations (3)
                                   
 
Other obligations (4)
    10       12       12       12       12       185  
Avista Capital (consolidated):
                                               
 
Long-term debt maturities
    1                                
 
Physical energy contracts (5)
    936       324       206       188       126       393  
 
Financial energy contracts (5)
    961       89       3       12              
 
Operating lease obligations (3)
    3       3       2       1             1  
 
Capital lease obligations (3)
    1                                
         
     
     
     
     
     
 
Total cash requirements
  $ 2,486     $ 763     $ 413     $ 376     $ 314     $ 2,438  
         
     
     
     
     
     
 

(1)   Represents $30 million outstanding under a $225 million line of credit and $65 million outstanding under a $100 million accounts receivable financing facility.
 
(2)   All of the energy purchase contracts were entered into as part of Avista Utilities’ obligation to serve its retail natural gas and electric customers’ energy requirements. As a result, these costs are generally recovered either through base retail rates or adjustments to retail rates as part of the power and natural gas cost adjustment mechanisms.
 
(3)   Includes the interest component of the lease obligation.
 
(4)   Represents operational agreements, settlements and other contractual obligations with respect to generation, transmission and distribution facilities.
 
(5)   Represents Avista Energy’s contractual commitments under energy contracts in future periods. Avista Energy also has sales commitments related to energy commodities in future periods.

As of December 31, 2002, Avista Corp. did not have any commitments outstanding with equity triggers. When the Company’s corporate credit rating was reduced to below investment grade in October 2001, additional collateral requirements due to rating triggers were met and further requirements are not currently anticipated. The Company does not expect any material impact from rating triggers; remaining triggers primarily relate to changes in pricing under certain financing agreements.

Additional Financial Data

As of December 31, 2002, the total long-term debt of the Company and its consolidated subsidiaries, as shown in the Company’s consolidated financial statements, was $902.6 million. Of such amount, $605.3 million represents long-term unsecured and unsubordinated indebtedness of the Company, and $298.5 million represents secured indebtedness of the Company. The unamortized debt discount was $2.2 million. Other long-term debt was $1.0 million. Consolidated long-term debt does not include the Company’s subordinated indebtedness held by the issuers of Company-obligated preferred trust securities. In addition to long-term secured indebtedness, $30.0 million of the

49


Table of Contents

AVISTA CORPORATION

Company’s short-term debt outstanding under or backed by its $225.0 million committed line of credit is secured indebtedness. The current portion of long-term debt was $71.9 million as of December 31, 2002, of which $15.0 million was secured indebtedness.

Future Outlook

Business Strategy

Avista Corp. intends to continue to focus on its core energy-related businesses. Avista Corp. intends to focus on improving cash flows and earnings, controlling costs and reducing debt while working to restore an investment grade credit rating. Avista Utilities seeks to maintain a strong, low-cost and efficient electric and natural gas utility business focused on providing reliable, high quality service to its customers. The utility business is expected to grow modestly, consistent with historical trends. Expansion is expected to result primarily from economic growth in its service territory. It is Avista Utilities’ strategy to own or control a sufficient amount of resources to meet its retail and wholesale energy requirements on an average annual basis. Avista Energy works primarily within the WECC and focuses on asset-backed optimization of combustion turbines and hydroelectric assets owned by other entities, long-term electric supply contracts, natural gas storage, and electric and natural gas transmission and transportation arrangements. Avista Energy’s marketing efforts are driven by its base of knowledge and experience in the operation of both electric energy and natural gas physical systems in the WECC, as well as its relationship-focused approach with its customers. Avista Advantage remains focused on growing revenue, improving margins, reducing fixed and variable costs and improving client satisfaction. Avista Corp. continues discussions with selected companies in its search for a financial partner for Avista Labs with the goal of owning less than 20 percent of this company. Avista Labs continues to move forward with developing and selling its commercial fuel cell products. The Company plans to dispose of assets and phase out of operations in the Other business segment that are not related to its energy operations.

Competition

Avista Utilities competes to provide service to new retail electric customers with various rural electric cooperatives and public utility districts in and adjacent to its service territories. Alternate providers of power may also compete for sales to existing customers, including new market entrants as a result of deregulation. Competition for available electric resources can be critical to utilities as surplus power resources are absorbed by load growth. Avista Utilities’ natural gas distribution operations compete with other energy sources; however, natural gas continues to maintain a price advantage compared to heating oil, propane and other fuels, provided that the natural gas distribution system is proximate to prospective customers.

The Energy Policy Act of 1992 (Energy Act) amended provisions of the Public Utility Holding Company Act of 1935 (PUHCA) and the Federal Power Act to remove certain barriers to a competitive wholesale market. The Energy Act expanded the authority of the FERC to issue orders requiring electric utilities to transmit power and energy to or for wholesale purchasers and sellers, and to require electric utilities to enlarge or construct additional transmission capacity for the purpose of providing these services. It also created “exempt wholesale generators,” a new class of independent power plant owners that are able to sell generation only at the wholesale level. This permits public utilities and other entities to participate through subsidiaries in the development of independent electric generating plants for sales to wholesale customers without being required to register under the PUHCA.

Participants in the wholesale market include other utilities, federal marketing agencies and energy trading and marketing companies. The wholesale market has changed significantly over the last few years with respect to market participants involved, level of activity, variability in market prices, liquidity, FERC imposed price caps and counterparty credit issues. During 2000 and the first half of 2001, the electric wholesale market in the WECC region was more turbulent than previously experienced and marked by significant volatility, service disruptions and defaults by certain participants. During the second half of 2001 and 2002 wholesale market prices decreased to levels similar to those experienced before 2000. Many energy companies are facing liquidity issues, and counterparty credit exposure is of concern to all market participants. During 2002, electric and natural gas trading volumes have decreased, the energy markets are less volatile and fewer creditworthy counterparties are currently participating in the energy markets. Avista Corp. is actively monitoring energy industry developments with a focus on liquidity, volatility of energy trading markets and counterparty credit exposure.

The Avista Capital subsidiaries, particularly the Information and Technology companies, are subject to competition as they develop products and services and enter new markets. Competition from other companies in these emerging industries may mean challenges for a company to be the first to market a new product or service to gain the advantage

50


Table of Contents

AVISTA CORPORATION

in market share. In order for these new businesses to grow as planned, one significant challenge will be the availability of funding and resources to meet the capital needs. Other challenges will be rapidly advancing technologies, possibly making some of the current technology quickly obsolete, and requiring continual research and development for product advancement. In order for some of these subsidiaries to succeed, they will need to reduce costs of these emerging technologies to make them affordable to future customers.

Business Risk

The Company’s operations are exposed to risks including, but not limited to, the price and supply of purchased power, fuel and natural gas, recoverability of power and natural gas costs, streamflow and weather conditions, the effects of changes in legislative and governmental regulations, availability of generation facilities, competition, technology and availability of funding. Also, like other utilities, the Company’s facilities and operations may be exposed to terrorism risks. See further reference to risks and uncertainties under “Safe Harbor for Forward-Looking Statements.”

As described under “Avista Corp. Lines of Business,” hydroelectric conditions in 2001 were significantly below normal, leading to greater than normal reliance on purchased power. Hydroelectric generation was slightly above normal in 2002 and current forecasts indicate that hydroelectric generation will be approximately 83 percent of normal in 2003. The earnings impact of these factors is mitigated by regulatory mechanisms that are intended to defer increased power supply costs for recovery in future periods. Avista Utilities is not able to fully predict how the combination of energy resources, energy loads, prices, rate recovery and other factors will ultimately drive deferred power costs and the timing of recovery of these costs in future periods. Current estimates and projections by the Company indicate that deferred power costs will be recovered by 2009. See further information at “Avista Utilities - - Regulatory Matters.”

Challenges facing Avista Utilities’ electric operations include, among other things, the timing of the recovery of deferred power and natural gas costs, changes in the availability of and volatility in the prices of power and fuel, generating unit availability, legislative and governmental regulations, potential tax law changes, customer response to price increases and surcharges, streamflows and weather conditions.

Natural gas commodity prices increased dramatically during 2000 and remained at relatively high levels during the first half of 2001 before declining in the second half of the year. Natural gas commodity prices during 2002 were generally lower than during 2000 and the first half of 2001. Natural gas commodity prices have increased towards the end of 2002 and into 2003. Market prices for natural gas continue to be competitive compared to alternative fuel sources for residential, commercial and industrial customers. Avista Utilities believes that natural gas should sustain its market advantage based on the levels of existing reserves and the potential for natural gas development in the future. Growth has occurred in the natural gas business in recent years due to increased demand for natural gas in new construction, as well as conversions from electric space, oil space and electric water heating to natural gas. Challenges facing Avista Utilities’ natural gas operations include, among other things, volatility in the price of natural gas, changes in the availability of natural gas, legislative and governmental regulations, weather conditions and the timing of recovery for increased commodity costs. Avista Utilities’ natural gas business also faces the potential for large natural gas customers to by-pass its natural gas system. To reduce the potential for such by-pass, Avista Utilities prices its natural gas services, including transportation contracts, competitively and has varying degrees of flexibility to price its transportation and delivery rates by means of individual contracts, subject to state regulatory review and approval. Avista Utilities has long-term transportation contracts with seven of its largest industrial customers, which reduces the risk of these customers by-passing the system in the foreseeable future.

Avista Energy trades electricity and natural gas, along with derivative commodity instruments, including futures, options, swaps and other contractual arrangements. As a result of these trading activities, Avista Energy is subject to various risks, including commodity price risk and credit risk, as well as possible new risks resulting from the recent imposition of market controls by federal and state agencies. The FERC is conducting separate proceedings related to market controls within California and within the Pacific Northwest that include proposals by certain parties to retroactively impose price caps. As a result, certain parties have asserted claims for significant refunds from Avista Energy and lesser refunds from Avista Utilities which could result in liabilities for refunding revenues recognized in prior periods. Avista Energy and Avista Utilities have joined other parties in opposing these proposals. The California proceedings provide that any refunds owed could be offset against unpaid energy debts due to the same party. Avista Energy has fully reserved for all defaulted obligations from California parties and believes that any refunds imposed would not exceed its uncollected receivables. If retroactive price caps or refunds were imposed in the Pacific Northwest, Avista Energy and Avista Utilities could assert offsetting claims for certain transactions. See “Power Market Issues” for further information with respect to the FERC refund proceedings.

51


Table of Contents

AVISTA CORPORATION

In connection with matching loads and resources, Avista Utilities engages in wholesale sales and purchases of electric capacity and energy and, accordingly, is also subject to commodity price risk, credit risk and other risks associated with these activities.

Commodity Price Risk. Both Avista Utilities and Avista Energy are subject to energy commodity price risk. The price of power in wholesale markets is affected primarily by production costs and by other factors including streamflows, the availability of hydroelectric and thermal generation and transmission capacity, weather and the resulting retail loads, and the price of coal, natural gas and oil to operate thermal generating units. Any combination of these factors that results in a shortage of energy generally causes the market price of power to move upward. Additionally, the FERC imposed a price mitigation plan in the western United States in June 2001.

Price risk is, in general, the risk of fluctuation in the market price of the commodity needed, held or traded. In the case of electricity, prices can be affected by the adequacy of generating reserve margins, scheduled and unscheduled outages of generating facilities, availability of streamflows for hydroelectric generation, the price of thermal generating plant fuel, and disruptions or constraints to transmission facilities. Demand changes (caused by variations in the weather and other factors) can also affect market prices. Price risk also includes the risk of fluctuation in the market price of associated derivative commodity instruments (such as options and forward contracts). Price risk may also be influenced to the extent that the performance or non-performance by market participants of their contractual obligations and commitments affect the supply of, or demand for, the commodity. Wholesale market prices for power and natural gas in the western United States and western Canada were significantly higher in 2000 and the first half of 2001 than at any time in history, with unprecedented levels of volatility. Prices and volatility decreased considerably during the second half of 2001 and 2002 relative to 2000 and the first half of 2001.

Credit Risk. Credit risk relates to the risk of loss that Avista Utilities and/or Avista Energy would incur as a result of non-performance by counterparties of their contractual obligations to deliver energy and make financial settlements. Credit risk includes not only the risk that a counterparty may default due to circumstances relating directly to it, but also the risk that a counterparty may default due to circumstances that relate to other market participants that have a direct or indirect relationship with such counterparty. Avista Utilities and Avista Energy seek to mitigate credit risk by applying specific eligibility criteria to existing and prospective counterparties and by actively monitoring current credit exposures. These policies include an evaluation of the financial condition and credit ratings of counterparties, collateral requirements or other credit enhancements, such as letters of credit or parent company guarantees, and the use of standardized agreements that allow for the netting or offsetting of positive and negative exposures associated with a single counterparty. However, despite mitigation efforts, defaults by counterparties periodically occur. Avista Energy experienced payment receipt defaults from certain parties impacted by the California energy crisis. Avista Energy and Avista Corp. (through the Avista Utilities division) have engaged in physical and financial transactions with Enron Corporation (Enron) and certain of its affiliates and experienced disruptions to forward contract commitments as a result of Enron’s December 2001 bankruptcy. The Enron bankruptcy and other changes, uncertainties and regulatory proceedings have resulted in reduced liquidity in the energy markets. See “Enron Corporation” in “Note 28 of Notes to Consolidated Financial Statements” for more information.

A trend of declining credit quality was evident during 2002, particularly in the energy industry. Rating agencies have downgraded the credit ratings of several of the counterparties of Avista Energy and Avista Utilities. Avista Energy and Avista Utilities regularly evaluate counterparties’ credit exposure for future settlements and delivery obligations. Avista Energy and Avista Utilities have taken a conservative position by reducing or eliminating open (unsecured) credit limits for parties perceived to have increased default risk. Counterparty collateral is used to offset the Company’s credit risk where unsettled net positions and future obligations by counterparties to pay Avista Utilities and/or Avista Energy or deliver to Avista Utilities and/or Avista Energy warrant.

Avista Energy has concentrations of suppliers and customers in the electric and natural gas industries including electric utilities, natural gas distribution companies, and other energy marketing and trading companies. In addition, Avista Energy has concentrations of credit risk related to geographic location as Avista Energy operates in the western United States and western Canada. These concentrations of counterparties and concentrations of geographic location may impact Avista Energy’s overall exposure to credit risk, either positively or negatively, in that the counterparties may be similarly affected by changes in economic, regulatory or other conditions.

Credit risk also involves the exposure that counterparties perceive related to performance by Avista Utilities and Avista Energy to perform deliveries and settlement of energy transactions. These counterparties may seek assurance of performance in the form of letters of credit, prepayment or cash deposits, and, in the case of Avista Energy, parent company performance guarantees. In periods of price volatility, the level of exposure can change significantly, with the result that sudden and significant demands may be made against the Company’s capital resource reserves (credit

52


Table of Contents

AVISTA CORPORATION

facilities and cash). Avista Utilities and Avista Energy actively monitor the exposure to possible collateral calls and take steps to minimize capital requirements.

In conjunction with the valuation of their commodity derivative instruments and accounts receivable, Avista Utilities and Avista Energy maintain credit reserves that are based on management’s evaluation of the credit risk of the overall portfolio. Based on these policies, exposures and credit reserves, the Company does not anticipate a materially adverse effect on its financial condition or results of operations as a result of counterparty nonperformance.

Other Operating Risks. In addition to commodity price risk, Avista Utilities’ commodity positions are subject to operational and event risks including, among others, increases in load demand, transmission or transport disruptions, fuel quality specifications, forced outages at generating plants and disruptions to information systems and other administrative tools required for normal operations. Avista Utilities also has exposure to weather conditions and natural disasters that can cause physical damage to property, requiring immediate repairs to restore utility service.

The emergence of terrorism threats, both domestic and foreign, is a risk to the entire utility industry, including Avista Utilities. Potential disruptions to operations or destruction of facilities from terrorism are not readily determinable. The Company has taken various steps to mitigate terrorism risks and to prepare contingency plans in case its facilities are targeted.

Interest Rate Risk. The Company is subject to the risk of fluctuating interest rates in the normal course of business. The Company manages interest rate risk by taking advantage of market conditions when timing the issuance of long-term financings and optional debt redemptions and through the use of fixed rate long-term debt with varying maturities. The interest rate on $40 million of Company-Obligated Mandatorily Redeemable Preferred Trust Securities — Series B is adjusted quarterly, reflecting current market conditions. In order to lower interest payments during a period of declining interest rates, Avista Corp. entered into an interest rate swap agreement, effective July 17, 2002, that terminates on June 1, 2008. This interest rate swap agreement effectively changes the interest rate on $25 million of Unsecured Senior Notes from a fixed rate of 9.75 percent to a variable rate based on LIBOR. Additionally, amounts borrowed under the Company’s $225.0 million line of credit have a variable interest rate.

The Company’s credit ratings were downgraded during the fourth quarter of 2001 resulting in an overall corporate credit rating that is below investment grade. These downgrades increased the cost of debt and other securities going forward and may affect the Company’s ability to issue debt and equity securities at reasonable interest rates and prices. The downgrades also required the Company to provide letters of credit and/or collateral to certain parties.

Foreign Currency Risk. The Company has investments in Canadian companies through Avista Energy Canada, Ltd. and its subsidiary, Copac Management, Inc. The Company’s exposure to foreign currency risk and other foreign operations risk was immaterial to the Company’s consolidated results of operations and financial position during 2002 and is not expected to change materially in the near future.

Risk Management

Risk Policies and Oversight. Avista Utilities and Avista Energy use a variety of techniques to manage risks. The Company has risk management oversight for these risks for each area of the Company’s energy-related businesses. The Company has a Risk Management Committee, separate from the units that create such risk exposure and that is overseen by the Audit Committee of the Company’s Board of Directors, to monitor compliance with the Company’s risk management policies and procedures. Avista Utilities and Avista Energy have policies and procedures in place to manage the risks, both quantitative and qualitative, inherent in their businesses. The Company’s Risk Management Committee reviews the status of risk exposures through regular reports and meetings and it monitors compliance with the Company’s risk management policies and procedures on a regular basis. Nonetheless, adverse changes in commodity prices, generating capacity, customer loads, regulation and other factors may result in losses in earnings, cash flows and/or fair values.

Quantitative Risk Measurements.Avista Utilities has volume limits for its imbalance between projected loads and resources. Normal operations result in seasonal mismatches between power loads and available resources. Avista Utilities is able to vary the operation of its generating resources to help match hourly, daily and weekly load fluctuations. Avista Utilities uses the wholesale power markets to sell projected resource surpluses and obtain resources when deficits are projected in the 18-month forward planning horizon. Any imbalance is required to remain within limits, or management action or decisions are triggered to address larger imbalance situations. Volume limits for forward periods are based on monthly and quarterly averages that may vary materially from the actual load and resource variations within any given month or operating day. Future projections of resources are updated as

53


Table of Contents

AVISTA CORPORATION

forecasted streamflows and other factors differ from prior estimates. Forward power markets may be illiquid, and market products available may not match Avista Utilities’ desired transaction size and shape. Therefore, open imbalance positions exist at any given time.

Avista Energy measures the risk in its power and natural gas portfolio daily utilizing a Value-at-Risk (VAR) model, monitoring its risk in comparison to established thresholds. VAR measures the expected portfolio loss under hypothetical adverse price movements, over a given time interval within a given confidence level. Avista Energy also measures its open positions in terms of volumes at each delivery location for each forward time period. The extent of open positions is included in the risk management policy and is measured with stress tests and VAR modeling.

The VAR computations are based on a historical simulation, utilizing price movements over a specified period to simulate forward price curves in the energy markets to estimate the potential unfavorable impact of price movement in the portfolio of transactions scheduled to settle within the following eight calendar quarters. The quantification of market risk using VAR provides a consistent measure of risk across Avista Energy’s continually changing portfolio. VAR represents an estimate of reasonably possible net losses in earnings that would be recognized on its portfolio assuming hypothetical movements in future market rates and is not necessarily indicative of actual results that may occur.

Avista Energy’s VAR computations utilize several key assumptions, including a 95 percent confidence level for the resultant price movement and holding periods of one and three days. The calculation includes derivative commodity instruments held for trading purposes and excludes the effects of embedded physical options in the trading portfolio.

As of December 31, 2002, Avista Energy’s estimated potential one-day unfavorable impact on net margin was $0.7 million, as measured by VAR, related to its commodity trading and marketing business, compared to $0.4 million as of December 31, 2001. The average daily VAR for 2002 was $0.6 million. Avista Energy was in compliance with its one-day VAR limits during 2002. Changes in markets inconsistent with historical trends or assumptions used could cause actual results to exceed predicted limits. Market risks associated with derivative commodity instruments held for purposes other than trading were not material as of December 31, 2002.

For forward transactions that settle beyond the next eight calendar quarters, Avista Energy applies other risk measurement techniques, including price sensitivity stress tests, to assess the future market risk. Volatility in longer-dated forward markets tends to be significantly less than near-term markets.

Economic and Load Growth

Avista Utilities, along with others in the service area, is continuing its efforts to facilitate expansion of existing businesses and to attract new businesses to the Inland Northwest. Agriculture, mining and lumber were the primary industries for many years; today health care, education, financial, electronic and other manufacturing, tourism and the service sectors have become important industries that operate in Avista Utilities’ service area. Avista Utilities also anticipates moderate economic growth to continue in its Oregon service area.

Avista Utilities anticipates residential and commercial electric load growth to average between 2.5 and 3.5 percent annually for the next four years, primarily due to increases in both population and the number of businesses in its service territory. The number of electric customers is expected to increase and the average annual usage by residential customers is expected to remain steady.

Avista Utilities anticipates natural gas load growth to average between 3.0 and 4.0 percent annually for the next four years. The anticipated natural gas load growth is primarily due to expected conversions from electric space, oil space and electric water heating to natural gas, and increases in both population and the number of businesses in its service territory.

During 2001 and 2002, Avista Utilities experienced decreased loads and decreased use per customer with respect to both electric and natural gas retail sales. The decrease in use per customer appears to be primarily due to a response to the increase in rates and the resulting conservation efforts of individual customers. The decrease in use per customer in 2002 and 2001 as compared to 2000 also appears to reflect milder weather in 2002 and 2001 as compared to 2000. The decrease in total kWhs and therms sold primarily relates to industrial customers and appears to reflect a general downturn in the economy of the Company’s service territory. However, as described above, based on economic forecasts, publicly available studies and internal analysis of company-specific data, the Company does not expect the trend of declining loads to continue over the next four years.

54


Table of Contents

AVISTA CORPORATION

The forward-looking projections set forth above regarding retail sales growth are based, in part, upon purchased economic forecasts and publicly available population and demographic studies. The expectations regarding retail sales growth are also based upon various assumptions including, without limitation, assumptions relating to weather and economic and competitive conditions, internal analysis of company-specific data, such as energy consumption patterns and internal business plans, and an assumption that Avista Utilities will incur no material loss of retail customers due to self-generation or retail wheeling. Changes in the underlying assumptions can cause actual experience to vary significantly from forward-looking projections.

Information Services Contract

Electronic Data Systems (EDS) has performed certain information services for the Company since 1992. The Company’s current contract with EDS expires in August 2005. In order to increase flexibility and increase efficiencies, the Company is currently negotiating to extend and restructure its contract with EDS. The Company believes that any changes to the contract with EDS will not have any material impact on its financial condition or results of operations and will not result in any disruption to its business operations.

Environmental Issues

Since December 1991, a number of species of fish in the Northwest, including the Snake River sockeye salmon and fall chinook salmon, the Kootenai River white sturgeon, the upper Columbia River steelhead, the upper Columbia River spring chinook salmon and the bull trout, have been listed as threatened or endangered under the Federal Endangered Species Act. Thus far, measures that were adopted and implemented to save the Snake River sockeye salmon and fall chinook salmon have not directly impacted generation levels at any of Avista Utilities’ hydroelectric dams. Avista Utilities does, however, purchase power from four projects on the Columbia River that are directly impacted by ongoing mitigation measures for salmon and steelhead. The reduction in generation at these projects is relatively minor, resulting in minimal economic impact on Avista Utilities at this time. It is currently not possible to accurately predict the likely economic costs to the Company resulting from all future actions.

The Company received a new FERC operating license for the Cabinet Gorge and Noxon Rapids hydroelectric projects in March 2001 that incorporates a comprehensive settlement agreement. The restoration of native salmonid fish, in particular bull trout, is a principal focus of the agreement. The result is a collaborative bull trout recovery program with the U.S. Fish and Wildlife Service, Native American tribes and the states of Idaho and Montana on the lower Clark Fork River, consistent with requirements of the FERC license.

The issue of high levels of dissolved gas which exceed Idaho and federal water quality standards downstream of the Cabinet Gorge Hydroelectric Generating Project (Cabinet Gorge) during spill periods continues to be studied, as agreed to in the Clark Fork Settlement Agreement and incorporated into the recently renewed FERC license. To date, intensive biological studies in the lower Clark Fork River and Lake Pend Oreille have documented minimal biological effects of high dissolved gas levels on free ranging fish. Under the terms of the Clark Fork Settlement Agreement, the Company developed an abatement and mitigation strategy during 2002 with the other signatories to the agreement. In December 2002, the Company submitted its plan for review and approval by the other signatories as well as the FERC. The structural alternative proposed in the plan provides for the modification of the two existing diversion tunnels built when Cabinet Gorge was originally constructed. The costs of modifications to the first tunnel are currently estimated to be $37 million (including AFUDC and inflation) and would be incurred between 2004 and 2009. The second tunnel would be modified only after evaluation of the performance of the first tunnel and such modifications would commence no later than 10 years following the completion of the first tunnel. It is currently estimated that the costs to modify the second tunnel would be $23 million (including AFUDC and inflation). As part of the plan, the Company will also provide $0.5 million annually commencing as early as 2004, as mitigation for aquatic resources that might be adversely affected by high dissolved gas levels. Mitigation funds will continue until the modification of the second tunnel commences or if the second tunnel is not modified to an agreed upon point in time commensurate with the biological effects of high dissolved gas levels. The Company will seek regulatory recovery of the costs for the modification of Cabinet Gorge and the mitigation payments.

See “Note 28 of Notes to Consolidated Financial Statements” for additional information.

Dividends

The Board of Directors considers the level of dividends on the Company’s common stock on a regular basis, taking into account numerous factors including, without limitation, the Company’s results of operations, cash flows and financial condition, as well as the success of the Company’s strategies and general economic and competitive

55


Table of Contents

AVISTA CORPORATION

conditions. The Company’s net income available for dividends is derived primarily from the operations of Avista Utilities and Avista Energy.

Avista Energy holds a significant portion of cash and cash equivalents reflected on the Consolidated Balance Sheet. Covenants in Avista Energy’s credit agreement restrict the amount of cash dividends that can be distributed to Avista Capital and ultimately to Avista Corp. During 2002, in accordance with the modified covenants of its credit agreement, Avista Energy paid $116.4 million in dividends to Avista Capital. In January 2003, Avista Energy paid $2.1 million in dividends to Avista Capital.

Item 7a. Quantitative and Qualitative Disclosures About Market Risk

See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations: Future Outlook: Business Risk and Risk Management.”

Item 8. Financial Statements and Supplementary Data

The Independent Auditor’s Report and Financial Statements begin on the next page.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

56


Table of Contents

INDEPENDENT AUDITORS’ REPORT

Avista Corporation
Spokane, Washington

We have audited the accompanying consolidated balance sheets and statements of capitalization of Avista Corporation and subsidiaries (the Company) as of December 31, 2002 and 2001, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows, which include the schedule of information by business segments, for each of the three years in the period ended December 31, 2002. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.

As described in Note 2 to the consolidated financial statements, during 2002, the Company changed its method of accounting for goodwill to conform to Statement of Financial Accounting Standards No. 142, also, as described in Note 2 to the consolidated financial statements, the Company changed its presentation of energy trading activities in accordance with Emerging Issues Task Force Issue No. 02-3.

/s/ Deloitte & Touche LLP

Seattle, Washington
February 7, 2003
(March 3, 2003, as to Note 28)

57


Table of Contents

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Avista Corporation

For the Years Ended December 31
Dollars in thousands, except per share amounts

                             
        2002   2001   2000
       
 
 
OPERATING REVENUES
  $ 980,446     $ 1,395,313     $ 1,858,516  
 
   
     
     
 
OPERATING EXPENSES:
                       
 
Resource costs
    453,525       849,996       1,246,459  
 
Operations and maintenance
    122,920       125,656       129,708  
 
Administrative and general
    118,766       119,216       134,912  
 
Depreciation and amortization
    73,275       71,981       65,936  
 
Taxes other than income taxes
    67,273       59,172       54,608  
 
Restructuring and exit costs
                9,805  
 
   
     
     
 
   
Total operating expenses
    835,759       1,226,021       1,641,428  
 
   
     
     
 
INCOME FROM OPERATIONS
    144,687       169,292       217,088  
 
   
     
     
 
OTHER INCOME (EXPENSE):
                       
 
Interest expense
    (105,336 )     (106,480 )     (68,255 )
 
Capitalized interest
    7,486       10,498       3,359  
 
   
     
     
 
   
Net interest expense
    (97,850 )     (95,982 )     (64,896 )
 
Other income-net
    17,467       20,681       25,861  
 
   
     
     
 
   
Total other income (expense)-net
    (80,383 )     (75,301 )     (39,035 )
 
   
     
     
 
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
    64,304       93,991       178,053  
INCOME TAXES
    29,994       34,386       76,998  
 
   
     
     
 
INCOME FROM CONTINUING OPERATIONS
    34,310       59,605       101,055  
 
   
     
     
 
DISCONTINUED OPERATIONS (Note 3):
                       
 
Income (loss) before asset impairment charges, minority interest and income taxes
    2,499       (21,130 )     (15,367 )
 
Asset impairment charges
          (58,417 )      
 
Minority interest
          4,319       2,454  
 
Income tax benefit (expense)
    (1,354 )     27,779       3,537  
 
   
     
     
 
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
    1,145       (47,449 )     (9,376 )
 
   
     
     
 
NET INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
    35,455       12,156       91,679  
CUMULATIVE EFFECT OF ACCOUNTING CHANGE (net of tax) (Note 2)
    (4,148 )            
 
   
     
     
 
NET INCOME
    31,307       12,156       91,679  
DEDUCT-Preferred stock dividend requirements
    2,402       2,432       23,735  
 
   
     
     
 
INCOME AVAILABLE FOR COMMON STOCK
  $ 28,905     $ 9,724     $ 67,944  
 
   
     
     
 
Weighted-average common shares outstanding (thousands), Basic
    47,823       47,417       45,690  
EARNINGS PER COMMON SHARE, BASIC (Note 25):
                       
 
Earnings per common share from continuing operations
  $ 0.67     $ 1.21     $ 1.69  
 
Earnings (loss) per common share from discontinued operations
    0.02       (1.00 )     (0.20 )
 
   
     
     
 
 
Earnings per common share before cumulative effect of accounting change
    0.69       0.21       1.49  
 
Loss per common share from cumulative effect of accounting change
    (0.09 )            
 
   
     
     
 
   
Total earnings per common share, basic
  $ 0.60     $ 0.21     $ 1.49  
 
   
     
     
 
Weighted-average common shares outstanding (thousands), Diluted
    47,874       47,435       46,103  
EARNINGS PER COMMON SHARE, DILUTED (Note 25):
                       
 
Earnings per common share from continuing operations
  $ 0.67     $ 1.20     $ 1.67  
 
Earnings (loss) per common share from discontinued operations
    0.02       (1.00 )     (0.20 )
 
   
     
     
 
 
Earnings per common share before cumulative effect of accounting change
    0.69       0.20       1.47  
 
Loss per common share from cumulative effect of accounting change
    (0.09 )            
 
   
     
     
 
   
Total earnings per common share, diluted
  $ 0.60     $ 0.20     $ 1.47  
 
   
     
     
 
Dividends paid per common share
  $ 0.48     $ 0.48     $ 0.48  
 
   
     
     
 
NET INCOME
  $ 31,307     $ 12,156     $ 91,679  
 
   
     
     
 
OTHER COMPREHENSIVE INCOME (LOSS):
                       
 
Foreign currency translation adjustment
    8       (221 )     (82 )
 
Unfunded accumulated benefit obligation - net of tax
    (18,081 )     (740 )      
 
Unrealized loss on interest rate swap agreements - net of tax
    (1,258 )            
 
Unrealized investments gains (losses) - net of tax
    (934 )     1,585       (475 )
 
   
     
     
 
TOTAL OTHER COMPREHENSIVE INCOME (LOSS)
    (20,265 )     624       (557 )
 
   
     
     
 
COMPREHENSIVE INCOME
  $ 11,042     $ 12,780     $ 91,122  
 
   
     
     
 

The Accompanying Notes are an Integral Part of These Statements.

58


Table of Contents

CONSOLIDATED BALANCE SHEETS
Avista Corporation


As of December 31
Dollars in thousands

                       
          2002   2001
         
 
ASSETS:
               
CURRENT ASSETS:
               
 
Cash and cash equivalents
  $ 186,369     $ 171,221  
 
Temporary investments
          1,872  
 
Accounts and notes receivable-less allowances of $46,909 and $50,211, respectively
    321,091       388,083  
 
Energy commodity assets
    365,477       477,037  
 
Materials and supplies, fuel stock and natural gas stored
    22,047       21,776  
 
Taxes receivable
          32,348  
 
Prepayments and other current assets
    73,633       19,364  
 
Assets held for sale from discontinued operations
    105       21,316  
 
   
     
 
   
Total current assets
    968,722       1,133,017  
 
   
     
 
NET UTILITY PROPERTY:
               
 
Utility plant in service
    2,370,811       2,277,779  
 
Construction work in progress
    17,581       54,964  
 
   
     
 
   
Total
    2,388,392       2,332,743  
 
Less: Accumulated depreciation and amortization
    824,688       767,101  
 
   
     
 
   
Total net utility property
    1,563,704       1,565,642  
 
   
     
 
OTHER PROPERTY AND INVESTMENTS:
               
 
Investment in exchange power-net
    40,833       43,314  
 
Non-utility properties and investments-net
    204,522       230,800  
 
Non-current energy commodity assets
    348,309       383,497  
 
Other property and investments-net
    12,702       13,620  
 
   
     
 
   
Total other property and investments
    606,366       671,231  
 
   
     
 
DEFERRED CHARGES:
               
 
Regulatory assets for deferred income tax
    139,138       149,033  
 
Other regulatory assets
    29,735       192,760  
 
Utility energy commodity derivative assets
    60,322       1,889  
 
Power and natural gas deferrals
    166,782       265,063  
 
Unamortized debt expense
    51,128       41,222  
 
Other deferred charges
    28,236       17,366  
 
   
     
 
   
Total deferred charges
    475,341       667,333  
 
   
     
 
     
TOTAL ASSETS
  $ 3,614,133     $ 4,037,223  
 
   
     
 
LIABILITIES AND CAPITALIZATION:
               
CURRENT LIABILITIES:
               
 
Accounts payable
  $ 340,651     $ 367,899  
 
Energy commodity liabilities
    304,781       373,837  
 
Current portion of long-term debt
    71,901       1,827  
 
Short-term borrowings
    30,000       75,099  
 
Interest accrued
    20,307       18,583  
 
Other current liabilities
    172,138       84,587  
 
Liabilities of discontinued operations
    1,052       6,642  
 
   
     
 
   
Total current liabilities
    940,830       928,474  
 
   
     
 
NON-CURRENT LIABILITIES AND DEFERRED CREDITS:
               
 
Deferred revenue
    672       35,824  
 
Non-current energy commodity liabilities
    314,204       299,980  
 
Utility energy commodity derivative liabilities
    50,058       159,418  
 
Deferred income taxes
    454,147       517,428  
 
Other non-current liabilities and deferred credits
    105,546       65,321  
 
   
     
 
   
Total non-current liabilities and deferred credits
    924,627       1,077,971  
 
   
     
 
CAPITALIZATION (See Consolidated Statements of Capitalization)
    1,748,676       2,030,778  
 
   
     
 
COMMITMENTS AND CONTINGENCIES (See Notes to Consolidated Financial Statements)
               
     
TOTAL LIABILITIES AND CAPITALIZATION
  $ 3,614,133     $ 4,037,223  
 
   
     
 

The Accompanying Notes are an Integral Part of These Statements.

59


Table of Contents

CONSOLIDATED STATEMENTS OF CAPITALIZATION
Avista Corporation

As of December 31
Dollars in thousands, except per share amounts

                       
          2002   2001
         
 
LONG-TERM DEBT:
               
 
First Mortgage Bonds:
               
   
Secured Medium-Term Notes:
               
     
Series A - 6.25% to 7.90% due 2003 through 2023
  $ 89,500     $ 104,500  
     
Series B - 6.50% to 7.89% due 2005 through 2010
    59,000       59,000  
 
   
     
 
     
Total secured medium-term notes
    148,500       163,500  
   
First Mortgage Bonds - 7.75% due 2007
    150,000       150,000  
 
   
     
 
     
Total first mortgage bonds
    298,500       313,500  
 
   
     
 
 
Unsecured Pollution Control Bonds:
               
   
Colstrip 1999A, due 2032
    66,700       66,700  
   
Colstrip 1999B, due 2034
    17,000       17,000  
   
6% Series due 2023
    4,100       4,100  
 
   
     
 
     
Total unsecured pollution control bonds
    87,800       87,800  
 
   
     
 
 
Unsecured Notes:
               
   
Unsecured Medium-Term Notes:
               
     
Series A - 7.94% to 8.99% due 2003 through 2007
    3,000       13,000  
     
Series B - 6.75% to 8.23% due 2003 through 2023
    74,000       79,000  
     
Series C - 5.99% to 8.02% due 2007 through 2028
    99,000       109,000  
     
Series D - 9.125% due 2003
          175,000  
 
   
     
 
     
Total unsecured medium-term notes
    176,000       376,000  
   
Unsecured 9.75% Senior Notes due 2008
    341,529       400,000  
 
   
     
 
     
Total unsecured notes
    517,529       776,000  
 
   
     
 
 
Other long-term debt
    967       962  
 
   
     
 
 
Unamortized debt discount
    (2,161 )     (2,547 )
 
   
     
 
   
Total long-term debt
    902,635       1,175,715  
 
   
     
 
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED TRUST SECURITIES:
               
   
7.875%, Series A, due 2037
    60,000       60,000  
   
Floating Rate, Series B, due 2037
    40,000       40,000  
 
   
     
 
     
Total company-obligated mandatorily redeemable preferred trust securities
    100,000       100,000  
 
   
     
 
PREFERRED STOCK-CUMULATIVE:
               
 
10,000,000 shares authorized:
               
 
Subject to mandatory redemption:
               
 
   
     
 
   
$6.95 Series K; 332,500 and 350,000 shares outstanding ($100 stated value)
    33,250       35,000  
 
   
     
 
COMMON EQUITY:
               
 
Common stock, no par value; 200,000,000 shares authorized; 48,044,208 and 47,632,678 shares outstanding
    623,092       617,737  
 
Note receivable from employee stock ownership plan
    (4,146 )     (5,679 )
 
Capital stock expense and other paid in capital
    (11,928 )     (11,924 )
 
Accumulated other comprehensive loss
    (20,364 )     (99 )
 
Retained earnings
    126,137       120,028  
 
   
     
 
   
Total common equity
    712,791       720,063  
 
   
     
 
TOTAL CAPITALIZATION
  $ 1,748,676     $ 2,030,778  
 
   
     
 

The Accompanying Notes are an Integral Part of These Statements.

60


Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
Avista Corporation

For the Years Ended December 31
Dollars in thousands

                         
    2002   2001   2000
   
 
 
CONTINUING OPERATING ACTIVITIES:
                       
Net income
  $ 31,307     $ 12,156     $ 91,679  
Loss (income) from discontinued operations
    (1,145 )     47,449       9,376  
Cumulative effect of accounting change
    4,148              
Non-cash items included in net income:
                       
Depreciation and amortization
    73,275       71,981       65,936  
Provision for deferred income taxes
    (40,287 )     79,141       79,274  
Power and natural gas cost amortizations (deferrals), net
    68,481       (210,540 )     (70,250 )
Amortization of debt expense
    8,861       5,639       3,409  
Impairment of non-operating assets
          8,240        
Energy commodity assets and liabilities
    87,403       30,238       (174,680 )
Other
    (10,763 )     (12,096 )     (32,470 )
Changes in working capital components:
                       
Sale of customer accounts receivable-net
    (10,000 )     (5,000 )     35,000  
Accounts and notes receivable
    80,203       457,924       (338,512 )
Materials and supplies, fuel stock and natural gas stored
    (271 )     (853 )     7,037  
Other current assets
    (21,921 )     15,058       (45,271 )
Accounts payable
    (27,248 )     (518,369 )     363,790  
Other current liabilities
    89,275       (57,038 )     89,772  
 
   
     
     
 
NET CASH PROVIDED BY (USED IN) CONTINUING OPERATING ACTIVITIES
    331,318       (76,070 )     84,090  
 
   
     
     
 
CONTINUING INVESTING ACTIVITIES:
                       
Utility property construction expenditures (excluding AFUDC)
    (64,207 )     (119,905 )     (98,680 )
Other capital expenditures
    (19,390 )     (162,279 )     (73,515 )
Changes in other property and investments
    1,438       10,163       2,106  
Repayments received on notes receivable
    33,752       1,000       1,297  
Proceeds from property sales and sale of subsidiary investments
    586       75,953       105,228  
Assets acquired and investments in subsidiaries
    (461 )     (23,321 )     (1,496 )
 
   
     
     
 
NET CASH USED IN CONTINUING INVESTING ACTIVITIES
    (48,282 )     (218,389 )     (65,060 )
 
   
     
     
 
CONTINUING FINANCING ACTIVITIES:
                       
Increase (decrease) in short-term borrowings
    (45,099 )     (88,061 )     42,126  
Redemption of preferred trust securities
                (10,000 )
Proceeds from issuance of long-term debt
    621       550,457       224,000  
Redemption and maturity of long-term debt
    (204,014 )     (140,208 )     (54,283 )
Redemption of preferred stock
    (1,750 )            
Issuance of common stock
    7,035       8,267       4,532  
Repurchase of common stock
                (1,907 )
Cash dividends paid
    (25,456 )     (25,110 )     (28,304 )
Premiums paid for the redemption of long-term debt
    (9,456 )            
Long-term debt and short-term borrowing issuance costs
    (6,534 )     (19,693 )     (850 )
 
   
     
     
 
NET CASH PROVIDED BY (USED IN) CONTINUING FINANCING ACTIVITIES
    (284,653 )     285,652       175,314  
 
   
     
     
 
NET CASH PROVIDED BY (USED IN) CONTINUING OPERATIONS
    (1,617 )     (8,807 )     194,344  
NET CASH PROVIDED BY (USED IN) DISCONTINUED OPERATIONS
    16,765       (17,210 )     (37,094 )
 
   
     
     
 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    15,148       (26,017 )     157,250  
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    171,221       197,238       39,988  
 
   
     
     
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 186,369     $ 171,221     $ 197,238  
 
   
     
     
 
SUPPLEMENTAL CASH FLOW INFORMATION:
                       
Cash paid (received) during the period:
                       
Interest
  $ 95,801     $ 98,571     $ 61,774  
Income taxes
    7,428       (35,874 )     (6,855 )
Non-cash financing and investing activities:
                       
Accounts receivable from sale of non-operating assets
          22,665        
Series L preferred stock converted to common stock
                271,286  
Unrealized loss on interest rate swap agreements
    (1,936 )            
Unrealized investment gains (losses)
    (1,436 )     2,437       (475 )
Intangible asset related to pension plan
    6,366              
Unfunded accumulated benefit obligation
    (34,164 )     (1,139 )     3,500  

The Accompanying Notes are an Integral Part of These Statements.

61


Table of Contents

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Avista Corporation

For the Years Ended December 31
Dollars in thousands

                                                 
    Preferred Stock   Convertible Preferred Stock,                
    Series K   Series L   Common Stock
   
 
 
    Shares   Amount   Shares   Amount   Shares   Amount
   
 
 
 
 
 
Balance as of December 31, 1999
    350,000     $ 35,000       1,508,210     $ 263,309       35,648,239     $ 318,731  
 
   
     
     
     
     
     
 
Net income
                                               
Conversion of convertible preferred stock into common stock
                    (1,508,210 )     (263,309 )     11,410,047       289,118  
Repurchase of common stock
                                    (45,975 )     (1,488 )
Stock issued under compensatory plans
                                    70,742       1,192  
Employee Investment Plan (401-K)
                                    97,478       2,614  
Dividend Reinvestment Plan
                                    28,158       574  
Repayments of note receivable
                                               
Foreign currency translation adjustment
                                               
Unrealized investment loss-net
                                               
Cash dividends paid (common stock)
                                               
Cash dividends paid (preferred stock)
                                               
ESOP dividend tax savings
                                               
 
   
     
     
     
     
     
 
Balance as of December 31, 2000
    350,000     $ 35,000           $       47,208,689     $ 610,741  
 
   
     
     
     
     
     
 
Net income
                                               
Stock issued under compensatory plans
                                    91,128       1,763  
Employee Investment Plan (401-K)
                                    172,681       2,823  
Dividend Reinvestment Plan
                                    160,180       2,410  
Repayments of note receivable
                                               
Foreign currency translation adjustment
                                               
Unfunded accumulated benefit obligation
                                               
Unrealized investment gain-net
                                               
Cash dividends paid (common stock)
                                               
Cash dividends paid (preferred stock)
                                               
ESOP dividend tax savings
                                               
 
   
     
     
     
     
     
 
Balance as of December 31, 2001
    350,000     $ 35,000           $       47,632,678     $ 617,737  
 
   
     
     
     
     
     
 
Net income
                                               
Stock issued under compensatory plans
                                    2,730       74  
Employee Investment Plan (401-K)
                                    227,585       3,046  
Dividend Reinvestment Plan
                                    181,215       2,235  
Redemption of preferred stock
    (17,500 )     (1,750 )                                
Repayments of note receivable
                                               
Foreign currency translation adjustment
                                               
Unfunded accumulated benefit obligation
                                               
Unrealized investment gain-net
                                               
Unrealized loss on interest rate swap
                                               
Cash dividends paid (common stock)
                                               
Cash dividends paid (preferred stock)
                                               
ESOP dividend tax savings
                                               
 
   
     
     
     
     
     
 
Balance as of December 31, 2002
    332,500     $ 33,250           $       48,044,208     $ 623,092  
 
   
     
     
     
     
     
 

[Additional columns below]

[Continued from above table, first column(s) repeated]

For the Years Ended December 31
Dollars in thousands

                                         
    Note                                
    Receivable   Capital   Accumulated                
    from Employee   Stock Expense   Other                
    Stock   and Other   Comprehensive   Retained        
    Ownership Plan   Paid-in Capital   Income (Loss)   Earnings   Total
   
 
 
 
 
Balance as of December 31, 1999
  $ (8,240 )   $ (4,347 )   $ (166 )   $ 87,521     $ 691,808  
 
   
     
     
     
     
 
Net income
                            91,679       91,679  
Conversion of convertible preferred stock into common stock
            (8,009 )             (17,868 )     (68 )
Repurchase of common stock
                            (419 )     (1,907 )
Stock issued under compensatory plans
            689               101       1,982  
Employee Investment Plan (401-K)
            (29 )                     2,585  
Dividend Reinvestment Plan
                                    574  
Repayments of note receivable
    1,200                               1,200  
Foreign currency translation adjustment
                    (82 )             (82 )
Unrealized investment loss-net
                    (475 )             (475 )
Cash dividends paid (common stock)
                            (22,616 )     (22,616 )
Cash dividends paid (preferred stock)
                            (5,600 )     (5,600 )
ESOP dividend tax savings
                            144       144  
 
   
     
     
     
     
 
Balance as of December 31, 2000
  $ (7,040 )   $ (11,696 )   $ (723 )   $ 132,942     $ 759,224  
 
   
     
     
     
     
 
Net income
                            12,156       12,156  
Stock issued under compensatory plans
            (228 )             (14 )     1,521  
Employee Investment Plan (401-K)
                                    2,823  
Dividend Reinvestment Plan
                                    2,410  
Repayments of note receivable
    1,361                               1,361  
Foreign currency translation adjustment
                    (221 )             (221 )
Unfunded accumulated benefit obligation
                    (740 )             (740 )
Unrealized investment gain-net
                    1,585               1,585  
Cash dividends paid (common stock)
                            (22,765 )     (22,765 )
Cash dividends paid (preferred stock)
                            (2,432 )     (2,432 )
ESOP dividend tax savings
                            141       141  
 
   
     
     
     
     
 
Balance as of December 31, 2001
  $ (5,679 )   $ (11,924 )   $ (99 )   $ 120,028     $ 755,063  
 
   
     
     
     
     
 
Net income
                            31,307       31,307  
Stock issued under compensatory plans
            (4 )                     70  
Employee Investment Plan (401-K)
                                    3,046  
Dividend Reinvestment Plan
                                    2,235  
Redemption of preferred stock
                                    (1,750 )
Repayments of note receivable
    1,533                               1,533  
Foreign currency translation adjustment
                    8               8  
Unfunded accumulated benefit obligation
                    (18,081 )             (18,081 )
Unrealized investment gain-net
                    (934 )             (934 )
Unrealized loss on interest rate swap
                    (1,258 )             (1,258 )
Cash dividends paid (common stock)
                            (22,955 )     (22,955 )
Cash dividends paid (preferred stock)
                            (2,402 )     (2,402 )
ESOP dividend tax savings
                            159       159  
 
   
     
     
     
     
 
Balance as of December 31, 2002
  $ (4,146 )   $ (11,928 )   $ (20,364 )   $ 126,137     $ 746,041  
 
   
     
     
     
     
 

The Accompanying Notes are an Integral Part of These Statements.

62


Table of Contents

SCHEDULE OF INFORMATION BY BUSINESS SEGMENTS
Avista Corporation

For the Years Ended December 31
Dollars in thousands

                             
                         
        2002