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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the Fiscal Year Ended December 31, 2002

OR

For the Transition Period From              to             

Commission File Number 1-10290

DQE, Inc.

(Exact name of registrant as specified in its charter)

411 Seventh Avenue Pittsburgh, Pennsylvania 15219

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (412) 393-6000

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

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

Title of each class

Preferred Stock, Series A (Convertible)

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 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 is not contained herein, and will not be contained, to the best of the 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 voting common stock held by non-affiliates as of June 28, 2002 (the last business day of the registrant’s most recently completed second fiscal quarter) was $1,030,250,816, based on the New York Stock Exchange closing price of $14.00 per share on that date.

As of March 10, 2003, there were 74,569,747 shares of the registrant’s single class of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

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GLOSSARY OF TERMS

BACK-TO-BASICS—Our business strategy in 2002 featured a more concentrated focus on core electric utility operations and complementary businesses, such as energy services. The strategy included the divestiture of non-core businesses.

COMPETITIVE TRANSITION CHARGE (CTC)—During the electric utility restructuring from the traditional Pennsylvania regulatory framework to customer choice, electric utilities have the opportunity to recover transition costs from customers through this usage-based charge.

CUSTOMER CHOICE—The Pennsylvania Electricity Generation Customer Choice and Competition Act gives consumers the right to contract for electricity at market prices from PUC-approved electric generation suppliers.

FEDERAL ENERGY REGULATORY COMMISSION (FERC)—The FERC is an independent five-member commission within the United States Department of Energy. Among its many responsibilities, the FERC sets rates and charges for the wholesale transportation and sale of electricity.

PENNSYLVANIA PUBLIC UTILITY COMMISSION (PUC)—The governmental body that regulates all utilities (electric, gas, telephone, water, etc.) that do business in Pennsylvania.

PROVIDER OF LAST RESORT (POLR)—Under Customer Choice, the local distribution utility is required to provide electricity for customers who do not choose an alternative generation supplier, or whose supplier fails to deliver. (See “Rate Matters.”)

REGIONAL TRANSMISSION ORGANIZATION (RTO)—Organization formed by transmission-owning utilities to put transmission facilities within a region under common control.

REGULATORY ASSETS—Pennsylvania ratemaking practices grant regulated utilities exclusive geographic franchises in exchange for the obligation to serve all customers. Under this system, certain prudently incurred costs are approved by the PUC for deferral and future recovery, with a return from customers. These deferred costs are capitalized as regulatory assets by the regulated utility.

TRANSITION COSTS—Transition costs are the net present value of a utility’s known or measurable costs related to electric generation that are recoverable through the CTC.

TRANSMISSION AND DISTRIBUTION—Transmission is the flow of electricity from generating stations over high voltage lines to substations where voltage is reduced. Distribution is the flow of electricity over lower voltage facilities to the ultimate customer (businesses and homes).

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PART I

ITEM 1. BUSINESS.

CORPORATE STRUCTURE

Part I of this Annual Report on Form 10-K should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, set forth in Part II, Item 7, and with our audited consolidated financial statements, set forth in Part II, Item 8.

DQE, Inc. is an energy services holding company formed in 1989 to serve as the holding company for Duquesne Light and to engage in unregulated energy and related businesses. Our subsidiaries include those discussed below.

Continuing Operations

Duquesne Light Company, our largest subsidiary, is an electric utility engaged in the transmission and distribution of electric energy.

DQE Energy Services, LLC is an energy facilities management company that provides energy outsourcing solutions including development, operation and maintenance of energy and alternative fuel facilities.

DQE Communications, Inc. owns, operates and maintains a high-speed, fiber optic based transmission network, and leases dark fiber in this network to commercial, industrial and academic customers.

DQE Financial Corp. owns and operates landfill gas collection and processing systems, and is an investment and portfolio management organization focused on structured finance and alternative energy investments.

DQE Enterprises, Inc. manages our remaining electronic commerce and energy technologies investment portfolios.

Duquesne Power, Inc., formed to explore various alternative generation supply options, is currently inactive.

DQE Capital Corporation and Cherrington Insurance, Ltd. provide financing and insurance services for DQE and various affiliates.

Discontinued Operations

AquaSource, Inc. is a water resource management company. In 2002 we entered into agreements to sell substantially all of AquaSource’s assets. AquaSource is now reported as a discontinued operation. (See Note 13.)

We sold the propane distribution business of our subsidiary Pro Am, Inc. in December 2002. Pro Am is now reported as a discontinued operation. (See Note 13.)

Service Areas and Customer Concentrations

Continuing Operations

Duquesne Light’s electric utility operations provide service to approximately 587,000 direct customers in southwestern Pennsylvania (including in the City of Pittsburgh), a territory of approximately 800 square miles.

Our other business lines have operations and investments in several states and Canada. DQE Energy Services relies on a single alternative fuel facility customer for a significant portion of its revenues.

Discontinued Operations

AquaSource currently provides water utility service to more than 280,000 water and wastewater customer connections in 15 states.

Regulation

Continuing Operations

DQE and Duquesne Light are subject to the accounting and reporting requirements of the Securities and Exchange Commission (SEC). Duquesne Light’s electric delivery business is also subject to regulation by the Pennsylvania Public Utility Commission (PUC) and the Federal Energy Regulatory Commission (FERC) with respect to rates for delivery of electric power, accounting and other matters.

Discontinued Operations

AquaSource’s water utility operations are subject to regulation by various authorities within the states where they operate as to rates, accounting and other matters.

Business Segments

This information is set forth in Item 7 under “Results of Operations” and in Note 19 to our consolidated financial statements.

FORWARD-LOOKING STATEMENTS

We use forward-looking statements in this report. Statements that are not historical facts are forward-looking statements, and are based on beliefs and assumptions of our management, and on information currently available to management. Forward-looking statements include statements preceded by, followed by or using such words as “believe,” “expect,” “anticipate,” “plan,” “estimate” or similar expressions. Such statements speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events. Actual results may materially differ from those implied by forward-looking statements due to known and unknown risks and uncertainties, some of which are discussed below.

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EMPLOYEES

At December 31, 2002, DQE and its subsidiaries had 1,870 employees (including 473 at AquaSource). Duquesne Light is party to a labor contract with the International Brotherhood of Electrical Workers, which represents 943 of Duquesne Light’s 1,297 employees. The contract expires September 30, 2003.

ENVIRONMENTAL MATTERS

Continuing Operations

In 1992, the Pennsylvania Department of Environmental Protection (DEP) issued Residual Waste Management Regulations governing the generation and management of non-hazardous residual waste, such as coal ash. Following the generation asset divestiture, Duquesne Light retained certain facilities which remain subject to these regulations. We have assessed our residual waste management sites, and the DEP has approved our compliance strategies. We expect the costs of compliance to be approximately $7.4 million with respect to sites we will continue to own. These costs are being recovered in the CTC, and the corresponding liability has been recorded for current and future obligations.

Duquesne Light owns the closed Warwick Mine, located along the Monongahela River in Greene County, Pennsylvania. This property had been used in the electricity supply business segment. Duquesne Light has been selling unused portions of the property and will continue to do so. Duquesne Light’s current estimated liability for closing the Warwick Mine, including final site reclamation, mine water treatment and certain labor liabilities, is approximately $30 million. A liability for this amount is recorded on the consolidated balance sheets.

Discontinued Operations

AquaSource’s water and water-related operations are subject to the federal Safe Drinking Water Act, which provides for uniform minimum national water quality standards, as well as governmental authority to specify treatment processes to be used for drinking water. AquaSource’s operations are also subject to the federal Clean Water Act, which regulates the discharge of pollutants into waterways. AquaSource is aware of various compliance issues at its water and wastewater facilities, and is communicating and working closely with appropriate regulators to correct those issues in a timely manner. We do not believe that any of these compliance issues will have a material effect on DQE’s financial position, results of operations or cash flows.

AquaSource is a party to consent agreements regarding environmental compliance in three states. In Indiana, AquaSource has entered parallel agreements with the Indiana Department of Environmental Management and the Indiana Utility Regulatory Commission to establish a schedule for completing upgrades and resolving certain historical compliance issues at two wastewater facilities. AquaSource has completed the scheduled wastewater system upgrades, and continues to improve the systems’ infrastructure. Neither agreement imposed any compliance-related penalties or sanctions. AquaSource entered into a consent order with the Florida Department of Environmental Protection regarding historical compliance issues. AquaSource planned certain capital improvements in connection with its acquisition of five wastewater facilities. AquaSource has met its commitments under the consent order, except for completing its abandonment plan for retired facilities. The abandonment phase is expected to be completed during the first quarter of 2003. AquaSource and the Texas Commission on Environmental Quality (TCEQ) have entered into a consent agreement under which

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AquaSource will correct compliance issues at approximately 160 water and wastewater systems over a four-year period. In lieu of any fines, penalties or other sanctions, AquaSource agreed to make approximately $30 million in capital improvements to upgrade these systems, $18.1 million of which have already been completed. An additional $7 million has been budgeted for capital improvements to these systems in 2003. AquaSource is capitalizing all of these expenditures, and will seek recovery of the charges through future rates, if appropriate. We may also recover a portion of these charges through the sale of AquaSource. (See Note 13.)

The United States Environmental Protection Agency has established new arsenic standards for public water supplies, which must be met beginning in January 2006. AquaSource does not believe these new standards will have a material impact on its financial position.

OTHER

Recent Accounting Pronouncements

In June 2001 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Specifically, this standard requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. The entity is required to capitalize the cost by increasing the carrying amount of the related long-lived asset. The capitalized cost is then depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss. The standard is effective for fiscal years beginning after June 15, 2002. We do not believe that the adoption of SFAS No. 143 will have a significant impact on our financial statements.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, rather than at the time of the commitment to a disposal or exit plan. This statement also establishes that the initial measurement of the liability should be at fair market value. This statement is effective for exit or disposal activities initiated after December 31, 2002. Initial adoption of this statement should have no impact on our financial statements, but SFAS No. 146 may affect the accounting treatment of any future disposal or exit activities.

In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45), which requires that upon issuance of certain types of guarantees, the guarantor must recognize and account for the fair value of the guarantee as a liability. FIN 45 contains exclusions to this requirement, including the exclusion of a parent’s guarantee of its subsidiaries’ debt to a third party.

In the normal course of business, we and certain of our subsidiaries enter into various agreements providing financial or performance assurance to third parties on behalf of certain subsidiaries. Such agreements include, for example, guarantees, stand-by letters of credit and surety bonds. These agreements are entered into primarily to support or enhance the creditworthiness otherwise attributed to a subsidiary on a stand-alone basis, thereby facilitating the extension of sufficient credit to accomplish the subsidiaries’ intended business purposes.

In addition, we have guaranteed a minimum defined yield to third-party investors, as part of our investment portfolio in seven affordable housing funds that afford favorable tax treatment. The guarantees will expire by 2015, and in the event the underlying properties do not generate the necessary minimum yield, we will make cash payments necessary to achieve that minimum yield. (See Note 12.)

FIN 45 is effective on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure provisions are effective for financial statements of interim and annual periods ending after December 15, 2002.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46), which addresses the consolidation of variable interest entities (VIE’s) by business enterprises that are the primary beneficiaries. A VIE is an entity that does not have sufficient equity investment at risk to permit it to finance its activities without additional subordinated financial support, or whose equity investors lack the characteristics of a controlling financial interest. The primary beneficiary of a VIE is the enterprise with the majority of the risks or rewards associated with the VIE. FIN 46 applies immediately to VIE’s created after January 31, 2003 and to VIE’s in which an enterprise obtains an interest after January 31, 2003. For VIE’s created earlier, the consolidation requirements apply in the first fiscal year or interim period beginning after June 15, 2003. Certain disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the VIE was established. Several of our subsidiaries are investors in entities, such as affordable housing partnerships, service agreements and structured lease transactions, which may be considered VIE’s. We do not believe that the adoption of FIN 46 will have a material impact on our consolidated financial position, earnings or cash flows.

Pending Litigation

Information regarding pending litigation is set forth in Item 3, “Legal Proceedings.”

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Non-Audit Services

Our independent public accountants provide non-audit, tax-related services, as approved by our Audit Committee.

Available Information

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these reports are available free of charge through our website (www.dqe.com) when they become available on the SEC website.

EXECUTIVE OFFICERS OF THE REGISTRANT

Set forth below are the names, ages as of March 10, 2003, and positions during the past five years of our executive officers.

Morgan K. O’Brien, age 43. President and Chief Executive Officer since September 2001. Chief Operating Officer from August 2000 to September 2001. Executive Vice President—Corporate Development from January 2000 to August 2000. Vice President—Corporate Development from July 1999 to January 2000. Treasurer from November 1998 to July 1999. Vice President from October 1997 to July 1999. Controller from October 1995 to July 1999.

Frank A. Hoffmann, age 51. Executive Vice President since October 2001. President and Treasurer of AquaSource since July 2000. Vice President—Operations of DQE Systems from January 2000 to July 2000. Vice President of DQE Systems from May 1999 to January 2000. General Manager, Marketing and Sales of Duquesne Light from 1995 to May 1999.

Victor A. Roque, age 56. Executive Vice President since November 1998. General Counsel from November 1994 to October 2001. Secretary from May 2000 to October 2001. Vice President from April 1995 to November 1998. President of Duquesne Light since October 2001.

Philip J. Damiani, age 52. Senior Vice President—Unregulated Businesses since December 2002. At DQE Energy Services, Inc.: President since October 2001; Senior Vice President from December 2000 to October 2001; Vice President from March 1998 to December 2000. Also President of DQE Communications, Inc. since December 2002.

Maureen L. Hogel, age 42. Senior Vice President and Chief Administrative Officer since December 2002. At Duquesne Light: Senior Vice President and Chief Administrative Officer since December 2002. Senior Vice President—Human Resources and Administration from October 2001 through November 2002; Vice President—Development, Legal and Administrative Affairs from January 2001 through October 2001; Vice President—Legal from September 1999 through December 2000 and Assistant General Counsel from February 1996 to September 1999.

Joseph G. Belechak, age 43. Vice President—Operations and Customer Service since December 2002. At Duquesne Light: Senior Vice President—Operations and Customer Service since October 2001. Vice President, Asset Management & Operations from August 2000 to October 2001; General Manager, Asset Management—1999-2000; Best in Class Change Program Leader—1999-2000 and Manager, Substations & Telecommunications—1996-99.

William F. Fields, age 52. Vice President and Treasurer since December 2002. At DQE Financial Corp.: President since April 2000; Vice President and Treasurer from August 1999 to March 2000; Treasurer from December 1997 to June 2001. At Duquesne Light: Vice President and Treasurer since December 2002; Assistant Treasurer from June 1991 to November 1998.

Stevan R. Schott, age 40. Vice President and Controller since October 2001. Vice President of Duquesne Light from August 1999 to October 2001. Controller of DQE Financial from September 1998 to August 1999. Senior Manager, Public Utilities Specialist at Deloitte & Touche LLP from September 1993 to September 1998.

James E. Wilson, age 37. Vice President—Corporate Development and Rates since December 2002. Vice President—Corporate Development from October 2001 to December 2002. Vice President and Controller from March 2000 to October 2001. Controller from July 1999 to March 2000. Assistant Controller from 1996 to July 1999.

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ITEM 2. PROPERTIES.

Continuing Operations

Our principal properties consist of Duquesne Light’s electric transmission and distribution facilities and supplemental properties and appurtenances, located substantially in Allegheny and Beaver counties in southwestern Pennsylvania. Substantially all of the electric utility properties are subject to a lien under the Indenture of Mortgage and Deed of Trust dated as of April 1, 1992.

In April 2000, Duquesne Light sold its generation assets. Duquesne Light owns 9 transmission substations and 561 distribution substations (367 of which are located on customer-owned land and are used to service only that customer). Duquesne Light has 592 circuit-miles of transmission lines, comprised of 345,000, 138,000 and 69,000 volt lines. Street lighting and distribution circuits of 23,000 volts and less include approximately 16,420 circuit-miles of lines and cable. These properties are used in the electricity delivery business segment.

Our total investment in property, plant and equipment (PP&E) and the related accumulated depreciation balances for major classes of property at December 31, 2002 and 2001 are as follows:

PP&E and Related Accumulated Depreciation

Electric delivery PP&E includes: (1) distribution poles and equipment; (2) lower voltage distribution wires used in delivering electricity to customers; (3) substations and transformers; (4) high voltage transmission wires used in delivering electricity from generating stations to substations; (5) internal telecommunication equipment, vehicles and office equipment; and (6) meters and automated meter reading assets, all used in our electricity delivery business segment. The other PP&E is comprised of energy facilities used in our Energy Services business segment, telecommunications facilities and property related to our DQE Communications business (reported in the “all other” category), and landfill gas recovery equipment used in our Financial business segment.

Discontinued Operations

AquaSource owns and operates over 450 investor-owned water and wastewater systems and performs contract services for over 130 additional systems. These systems are comprised of distribution and collection lines, pump stations, treatment plants, storage tanks, reservoirs and related facilities. Properties are adequately maintained and units of property are replaced as and when necessary. AquaSource owns a substantial acreage of land, the greater part of which is located in watershed areas and used for the discharge of treated effluent, with the balance being principally sites of pumping and treatment plants, storage reservoirs, tanks and standpipes. These properties are used in our water distribution business. The net investment as of December 31, 2002, and 2001 was $154.6 million, and $216.4 million. These amounts are not included in the above table.

ITEM 3. LEGAL PROCEEDINGS.

Shareholder Class Action. In October and November 2001, a number of putative class action lawsuits were filed by purported shareholders of DQE against DQE and David Marshall, DQE’s former chairman, chief executive officer and president, in the United States District Court for the Western District of Pennsylvania. These cases were consolidated under the caption In re DQE, Inc. Securities Litigation, Master File No. 01-1851 (W.D. Pa.), and the plaintiffs filed a second consolidated amended complaint on April 15, 2002. The complaint alleges violations of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder, and Section 12(a)(2) of the Securities Act of 1933 (the “Securities Act”). The complaint alleges controlling person liability under Section 20(a) of the Exchange act and Section 15 of the Securities Act. The complaint alleges that between December 6, 2000, and April 30, 2001, the defendants issued a number of materially false and misleading statements concerning investments made by our subsidiary, DQE Enterprises, and the impact that these investments would have on our current and future financial results.

More particularly, the complaint alleges that DQE and Marshall stated their expectation that certain companies in which DQE Enterprises had invested would undertake initial public offerings of their shares, with the result that our earnings would be positively impacted by the public market valuation of DQE Enterprises’ interests in these companies, but failed to disclose allegedly adverse facts that made the possibility of successful public offerings of the securities of these companies unlikely. The complaint seeks an award of

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unspecified compensatory damages, and an order permitting class members who purchased DQE shares through a dividend reinvestment plan to rescind those purchases, pre- and post-judgment interest, attorneys’ fees and expenses of litigation and unspecified equitable and injunctive relief.

On December 12, 2002, the lead plaintiffs asked the court to certify the class action. We filed our opposition to this motion on March 10, 2003. The motion is scheduled to be argued before the court on April 7, 2003. Since December 2002, we and the plaintiffs have been in pre-trial discovery. The court has directed that this phase be concluded by September 30, 2003, followed by an expert discovery period through December 31, 2003.

No trial date has yet been scheduled, and we would not anticipate one to be set before the first quarter of 2004.

Although we cannot predict the ultimate outcome of this case or estimate the range of any potential loss that may be incurred in the litigation, we believe that the lawsuit is without merit, strenuously deny all of the plaintiffs’ allegations of wrongdoing and believe we have meritorious defenses to the plaintiffs’ claims. We are vigorously defending this lawsuit.

Fresh Kills. GSF Energy, L.L.C., a DQE Financial subsidiary, has a 20 year concession agreement for the gas rights to New York City’s Fresh Kills landfill. GSF also maintains an investment in a gas processing facility at the landfill and was constructing additional processing capacity when the World Trade Center tragedy occurred. The debris from the World Trade Center was transported to the Fresh Kills landfill and currently rests on top of the landfill’s largest hill. During 2002, GSF suffered reductions in available gas due to the continued effects of the World Trade Center debris as well as other actions taken by the New York City Department of Sanitation resulting in further damage to its gas collection system. On January 16, 2003, GSF initiated litigation against the City of New York acting by and through its Department of Sanitation in the United States District Court for the Southern District of New York. Concurrently, GSF tendered notice of its intent to surrender the concession agreement in 180 days as permitted by the concession agreement.

The complaint seeks rescission of the concession agreement and related relief and seeks an injunction to prevent the Department of Sanitation from taking any action to declare an event of default under the concession agreement, accelerate payment under a promissory note or draw on letters of credit supporting GSF’s obligations thereunder. On that same date, GSF filed a notice of claim with the New York City Comptroller seeking monetary relief as an alternative to its rescission and other claims set forth in the complaint. The 180-day surrender period has been extended until September 13, 2003 on a consent as part of the parties’ effort to determine whether the litigation can be settled.

Other. In the fourth quarter of 2002, we settled the AquaSource minority shareholder litigation discussed in Note 13. We are involved in various other legal proceedings and environmental matters. We believe that the resolution of such proceedings and matters, in total, will not have a materially adverse effect on our financial position, results of operations or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.

Information relating to the market for our common stock and other matters related to our holders is set forth in Note 5 and in Note 20 hereto, and incorporated here by reference.

Our board declared quarterly dividends on our common stock totaling $1.34 per share in 2002. (See “Dividends” discussion at Item 7.) At March 10, 2003, there were approximately 53,225 holders of record of our common stock. Our common stock is listed and traded on the New York, Philadelphia and Chicago Stock Exchanges.

On October 7, 2002, we issued 60,000 shares of our Preferred Stock, Series A (Convertible), having an aggregate liquidation value of $6 million, in connection with the settlement of the AquaSource minority shareholder litigation discussed in Note 13. Each recipient of preferred stock also received an option to sell all the shares to us on the earlier to occur of (i) our sale of all or substantially all the stock or assets of AquaSource or (ii) October 7, 2004. The purchase price will be the $100 per share liquidation value, payable in cash or common stock at our election. These shares were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.

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ITEM 6. SELECTED FINANCIAL DATA

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF

   OPERATIONS.

RESULTS OF OPERATIONS

OVERALL PERFORMANCE

In 2002, we made considerable progress in implementing our Back-to-Basics business strategy, which features a more concentrated focus on our electric utility operations and its complementary businesses. Key initiatives targeted for 2002 included strengthening our balance sheet, conserving cash through a new dividend policy, divesting non-core businesses and assets, and enhancing our long-term earnings stream from our core electric business.

Narrowing our focus through the Back-to-Basics strategy led to the disposition of non-core investments and continued restructuring of our administrative operations. As a result, impairment and other charges were recorded in 2002, which are detailed in the financial results that follow.

Twelve Months Ended December 31,

Our earnings from continuing operations available for common shareholders were $26.1 million or $0.40 per share in 2002, compared to a loss attributable to common shareholders of $45.0 million or $0.80 per share in 2001. Excluding the impairment and other charges in both years, earnings from continuing operations available for common shareholders were $78.3 million, or $1.19 per share, in 2002, as compared to earnings of $55.3 million, or $0.99 per share, in 2001, an increase of $23.0 million. The average shares outstanding increased by 17.4% from 55.9 million shares in 2001 to 65.6 million shares in 2002, principally due to our June 2002 common stock offering. (See Note 5.)

In addition, as a result of the agreements reached to sell substantially all of AquaSource’s assets, and the sale of the propane distribution business of our subsidiary Pro Am in December 2002, the results of these two subsidiaries are now reported as discontinued operations.

2002 COMPARED TO 2001

Our loss attributable to common shareholders was $215.2 million or $3.28 per share in 2002, compared to a loss attributable to common shareholders of $153.9 million, or $2.75 per share, in 2001. The following table has been provided to highlight the effects of the significant impairment and other charges that occurred in both 2002 and 2001. Each of the items shown in the table will be discussed in detail, however the focus of this discussion will be on the income from continuing operations available for common shareholders, excluding the impairment and other charges.

The increase in earnings from continuing operations, excluding impairment and other charges, is due to a number of factors, including:

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The following factors partially offset these contributions to earnings from continuing operations, excluding impairment and other charges:

In addition to the above items, our continued focus on cost reductions, including cost savings from our fourth quarter 2001 and 2002 corporate restructurings, contributed positively to net income in 2002.

2002 Impairments and Other Charges

DQE Financial (the Financial business segment) recorded a fourth quarter $19.7 million after-tax asset impairment charge relating to the Fresh Kills landfill gas site. See Item 3, “Legal Proceedings” for discussion of reduced gas flows and legal action taken by our subsidiary, GSF. Based on reduced gas flows experienced at the site and the actions taken to abandon the gas rights, management has determined that the Fresh Kills investment is now fully impaired, and has recognized a charge to write its investment in the gas rights and long-lived assets to zero as of December 31, 2002. (See Note 3.)

DQE Financial maintains a limited partnership investment in a waste-to-energy facility. During 2002, the credit rating of the general partner’s parent was downgraded, which led to an event of default under the partnership’s service agreement to operate the underlying waste-to-energy facility for a local authority. The general partner, its parent and the partnership filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. The local authority issued a notice to terminate the service agreement; however, the termination has been suspended under the automatic stay protection afforded the partnership by the bankruptcy filing. The partnership group, including DQE Financial, is negotiating with the local authority to restructure the service agreement. The local authority’s restructuring proposal, made in December 2002, would not allow DQE Financial to recover its investment in this project. Based on this, management determined that the investment has been fully impaired and recorded an after-tax charge of $10.1 million in 2002, to write its investment in the waste-to-energy facility to zero as of December 31, 2002. (See Note 3.)

During the fourth quarter of 2002, as a part of our continuing Back-to-Basics strategy, we initiated a restructuring plan that focused primarily on the executive levels of management to reduce expenses and improve efficiency. In the fourth quarter of 2002, we recorded an after-tax restructuring charge of $3.1 million, consisting of $2.3 million at Duquesne Light (the electricity delivery business segment) and $0.8 million at DQE (the “all other” category). (See Note 4.)

During the second and fourth quarters of 2002, DQE Enterprises (the Enterprises business segment) recorded after-tax investment impairment charges totaling $18.1 million to write down three investments in publicly traded businesses from our cost to their fair market values due to an other-than-temporary decline in the market value of these businesses, and to write off five privately held investments that have either recently filed for protection under Chapter 7 of the U.S. Bankruptcy Code, or have been determined to be impaired based on our analysis. (See Note 3.) As of December 31, 2002, the remaining investments held by DQE Enterprises totaled $2.4 million.

The other charges of $1.2 million after-tax shown in the table above were recorded in the all other category and reflect the write-off of costs associated with the previously proposed generating station.

The 2001 impairment and other charges detailed in the table above are described in more detail in the 2001 compared to 2000 discussion that follows.

The loss from discontinued operations in 2002 was $127.6 million, compared to a loss of $108.9 million from discontinued operations in 2001. After-tax impairment charges relating to the AquaSource discontinued operations totaling $100.9 million were recorded in the second quarter of 2002. In late June 2002, we received indications of interest for this business, and ultimately determined that the likely outcome would be a sale of this business. Based on the information received at that time, an indication of impairment of long-lived assets existed. The estimated proceeds to be received from a sale were compared to the carrying amount of the long-lived assets. This comparison indicated that the carrying amount of the investor-owned water utilities to be sold significantly exceeded the expected proceeds to be received. As a result, an impairment charge of $100.9 million was recorded which reduced the amount of property, plant and equipment and other long-lived assets. On July 29, 2002

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a sale agreement was entered into for substantially all of this business. A $21.2 million loss on disposal relating to Pro Am was recorded in the fourth quarter of 2002, as a result of the sale of the propane business on December 13, 2002 (See Note 13.)

After-tax impairment charges of $99.7 million related to AquaSource were recorded in the second quarter of 2001. See the 2001 compared to 2000 discussion for a description of these charges.

A charge of $113.7 million was recorded effective as of January 1, 2002 related to the cumulative effect of a change in accounting principle for the impairment of goodwill related to these discontinued operations resulting from the adoption of SFAS No. 142. (See Note 1.)

2001 COMPARED TO 2000

Our loss attributable to common shareholders was $153.9 million or $2.75 per share in 2001, compared to earnings available for common shareholders of $154.4 million or $2.44 per share in 2000. As discussed above, the results of AquaSource and Pro Am are now reported as discontinued operations, and all prior periods presented have been restated to conform.

Our loss from continuing operations attributable to common shareholders was $45.0 million, or $0.80 per share, in 2001, compared to earnings available to common shareholders of $146.1 million, or $2.30 per share, in 2000. Impairment and other charges totaling $82.5 million after-tax were recorded in 2001 relating to the impairment of investments and long-lived assets. In addition, restructuring charges of $17.8 million after-tax were recorded in 2001 as discussed below.

Excluding the impairment and other charges in 2001, which are described below, earnings from continuing operations available for common shareholders were $55.3 million, or $0.99 per share, in 2001, as compared to earnings of $146.1 million, or $2.30 per share, in 2000, a decrease of $90.8 million.

The principle reason for this decline in earnings from continuing operations available for common shareholders was due to the recognition in 2000 of a gain on the sale of DQE Energy Services’ alternative fuel facilities.

In addition, the CTC business segment earned $33.3 million less in 2001 due to the decline in the average CTC balance. The lower balance caused a corresponding decrease in the return earned in 2001.

2001 Impairments and Other Charges

DQE Financial recorded a fourth quarter 2001 $43.7 million after-tax impairment charge relating to Fresh Kills and three other landfill gas sites. During 2001, the excess weight from the World Trade Center debris caused damage to the gas collection system and reduced gas flows at the Fresh Kills site. Additional security at the site caused construction delays. As a result, management determined that the Fresh Kills investment was partially impaired. (See Note 3.)

The remaining impairment charges recorded in 2001 were $36.1 million after-tax relating to energy technology investments. During 2001, having formalized plans to monetize DQE Enterprises, we sold two investments and recognized an impairment charge to write off all or parts of eleven other investments. (See Note 3.)

During the fourth quarter of 2001, as part of our Back-to-Basics strategy, we initiated a restructuring plan to improve operational effectiveness and efficiency, and to reduce operational expenses on a company-wide basis. Through the restructuring plan, we reorganized to focus on our core regulated utility businesses and opportunities related to those investments. In the fourth quarter of 2001, we recorded an after-tax restructuring charge of $17.8 million, consisting of $11.1 million in the all other category, and $6.7 million in the electricity delivery business segment. (See Note 4.)

The loss from discontinued operations in 2001 was $108.9 million, compared to a loss of $7.2 million in 2000. After-tax impairment charges relating to the discontinued operations totaling $99.7 million were recorded in 2001. During 2001, management evaluated AquaSource’s future direction and the capabilities of its operating platforms. This evaluation determined that the company’s potential future performance would result in lower returns than originally anticipated. As a result, impairment charges were recorded to write down various aspects of this business, primarily related to contract operations and construction. (See Note 13.)

The 2000 results were favorably impacted by the $15.5 million cumulative effect of a change in accounting principle relating to unbilled revenues.

RESULTS OF OPERATIONS BY BUSINESS SEGMENT

We report the results of our business segments, determined by products, services and regulatory environment as follows: (1) Duquesne Light’s transmission and distribution of electricity (electricity delivery business segment), (2) Duquesne Light’s supply of electricity (electricity supply business segment), (3) Duquesne Light’s collection of transition costs (CTC business segment), (4) DQE Energy Services’ development, operation and maintenance of energy and alternative fuel facilities (Energy Services business segment), (5) DQE Financial’s collection and processing of landfill gas and the management of structured finance and alternative energy investments (Financial business segment), and (6) DQE Enterprises’ management of electronic commerce and energy technologies investment portfolios (Enterprises business segment).

With the completion of our generation asset sale in April 2000, the electricity supply business segment is now comprised solely of provider-of- last-resort (POLR) service. We also report an “all other” category to include our other subsidiaries below the quantitative threshold for disclosure,

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and corporate administrative functions, financing, and insurance services for our various affiliates.

Because AquaSource and Pro Am are reported as discontinued operations, we no longer report a water distribution business segment, or include propane distribution in the all other category. (See Note 13.)

We have restated prior periods, where appropriate, to present segment information consistent with the manner that is currently used by management. Note 19 shows the financial results of each principal business segment in tabular form. Following is a discussion of these results.

2002 COMPARED TO 2001

Electricity Delivery Business Segment. The electricity delivery business segment reported $55.3 million of income in 2002, consisting of $57.6 million before an after-tax restructuring charge of $2.3 million, as previously discussed. This is compared to $37.7 million in net income in 2001, consisting of $44.4 million before an after-tax restructuring charge of $6.7 million. Excluding the restructuring charges in both years, income from the electricity delivery business segment was $13.2 million, or 29.7%, higher in 2002, due to the hotter than normal summer weather in 2002 and lower interest and operating costs, as discussed below.

Operating revenues for this business segment are primarily derived from the delivery of electricity, including related gross receipts taxes. Sales to residential and commercial customers are primarily influenced by weather conditions. Warmer summer and colder winter seasons lead to increased customer use of electricity for cooling and heating. Commercial sales also are affected by regional development. Sales to industrial customers are influenced by national and global economic and competitive conditions.

Operating revenues increased by $30.4 million, or 9.5%, compared to 2001. The increase can be primarily attributed to a $15.9 million increase in 2002 in gross receipts taxes that are collected through revenue. The largest component increase was in the Pennsylvania revenue neutral reconciliation (RNR) tax rate, which became effective January 1, 2002. Electric distribution companies such as Duquesne Light are permitted to recover this cost from consumers on a current basis. In addition, there was a 5.1% increase in megawatt-hour (MWh) sales to customers as compared to 2001, which caused a $9.6 million increase in revenues.

The hotter than normal summer temperatures in the Pittsburgh region contributed to residential and commercial sales increasing 9.5% and 4.6%, compared to 2001, in response to higher cooling demands. Industrial sales, which are less sensitive to weather, also increased by 1.4%, due to higher sales to industrial customers in the primary metals sector. The following table sets forth MWh delivered to electric utility customers.

MWh Delivered

Operating expenses for the electricity delivery business segment are primarily made up of costs to operate and maintain the transmission and distribution system; meter reading, billing and collection costs; customer service; administrative expenses; and non-income taxes, such as gross receipts, property and payroll taxes. Operating expenses increased by $8.2 million, or 5.5%, compared to 2001, primarily due to the increase in gross receipts tax expense of approximately $14.3 million from the increased RNR in 2002. This increase was partially offset by the cost savings from corporate restructurings that occurred in the fourth quarters of both 2001 and 2002 and other cost reduction initiatives, which continue to generate incremental cost savings.

Other income decreased $7.5 million, or 18.9%, compared to 2001, primarily due to lower interest rates in 2002.

Interest and other charges include interest on long-term debt, other interest and preferred stock dividends of Duquesne Light. In 2002, there was $6.0 million, or 7.7%, less interest and other charges primarily due to debt retirements during August 2002 totaling $110 million, which reduced interest expense by $3.4 million. In addition, there were lower interest rates on the variable rate, tax-exempt debt in 2002.

Electricity Supply Business Segment. In 2002, the electricity supply business segment reported income of $13.9 million, compared with income of zero in 2001. For the period April 28, 2000 through December 31, 2001, this segment’s financial results reflected our initial POLR arrangement (POLR I), which was designed to be income neutral to Duquesne Light. During the first quarter of 2002, Duquesne Light began operating under POLR II, which extends the POLR service (and the PUC-approved rates for the supply of electricity) beyond the final CTC collection through December 31, 2004. POLR II also permits Duquesne Light, following CTC collection for each rate class, an average margin per MWh supplied. The actual margin earned during 2002 averaged $4.77 per MWh based on the mix of rate classes, and number of customers, participating in POLR II.

Operating revenues for this business segment are derived primarily from the supply of electricity for delivery to retail customers and the supply of electricity to wholesale customers. Retail energy requirements fluctuate as the number of customers participating in customer choice changes. Energy requirements for residential and

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commercial customers are also influenced by weather conditions; temperature extremes lead to increased customer use of electricity for cooling and heating. Commercial energy requirements are also affected by regional development. Energy requirements for industrial customers are primarily influenced by national and global economic conditions.

Short-term sales to other utilities are made at market rates. Fluctuations result primarily from excess daily energy deliveries to Duquesne Light’s electricity delivery system.

Operating revenues increased $41.9 million, or 9.7%, compared to 2001. The increase is due to an increase in the average generation rate charged to customers, partially offset by a decrease in the percentage of customers who received electricity through our POLR arrangements.

The following table sets forth MWh supplied for POLR customers.

MWh Supplied

Operating expenses for the electricity supply business segment consist of costs to obtain energy for our POLR service and gross receipts tax, both of which fluctuate in direct relation to operating revenues. Operating expenses increased $18.3 million, or 4.3%, compared to 2001, despite a decrease in the MWh supplied. The increase in expense is due to the higher rate charged by our supplier under the POLR II arrangement.

CTC Business Segment. In its final restructuring order issued in the second quarter of 1998, the PUC determined that Duquesne Light should recover most of the above-market costs of its generation assets, including plant and regulatory assets, through the collection of the competitive transition charge (CTC) from electric utility customers. On January 18, 2001, the PUC issued an order approving our final accounting for the proceeds of our April 2000 generation asset sale, including the net recovery of sale-related transaction costs.

For the CTC business segment, operating revenues are derived by billing electric delivery customers for generation-related transition costs. Duquesne Light is allowed to earn an 11% pre-tax return on the net of tax CTC balance. As revenues are billed to customers on a monthly basis, we amortize the CTC balance. The resulting decrease in the CTC balance causes a decline in the return earned by Duquesne Light.

In 2002, the CTC business segment reported income of $2.9 million compared to income of $12.3 million in 2001, a decrease of $9.4 million, or 76.4%.

Operating revenues decreased $181.3 million, or 59.7%, due to the full collection of the allocated CTC balance as of December 31, 2002 for most of our customers as well as scheduled decreases in the average CTC rate charged to customers from 2001 to 2002. As of December 31, 2002, the CTC balance has been fully collected for approximately 95% of Duquesne Light’s customers, representing approximately 87% of the MWh sales for the year.

Operating expenses consist solely of gross receipts tax, which fluctuates in direct relation to operating revenues. Operating expenses decreased $8.1 million, or 60%, compared to 2001.

Depreciation and amortization expense consists of the amortization of transition costs. There was a decrease of $158.7 million, or 58.5%, compared to 2001, primarily due to the full collection of the allocated CTC balance for most customers, as described above.

Energy Services Business Segment. The Energy Services business segment reported income of $17.1 million in 2002, compared to income of $6.3 million in 2001, an increase of $10.8 million, or 171.4%. This increase resulted primarily from a full year’s income from alternative fuel service contracts that were entered into during 2001 and new contracts entered into in 2002.

Operating revenues are primarily derived from the facility management services for industrial, airport and alternative fuel customers. Operating revenues increased $23.4 million or 74.8% compared to 2001. This increase is primarily due to the increased facility management revenue of $17.4 million from the additional alternative fuel service contracts.

Operating expenses consist of the operating and maintenance costs to manage the facilities, as well as general corporate overhead. Operating expenses increased $1.6 million, or 5.8%, compared to 2001. An increase of $8.6 million resulted from the additional alternative fuel facility management service contracts, and was partially offset by decreased overhead costs.

Other income consists of income from early completion bonuses, construction management fee income and gains recognized on the sale of assets. Other income decreased $5.5 million, or 59.8%, compared to 2001 due primarily to gains recognized on sales of alternative fuel property of $2.6 million and recognition of an early completion bonus and construction management fee of $2.6 million on a new alternative fuel facility in 2001.

Financial Business Segment. The Financial business segment reported a loss of $8.0 million in 2002, consisting of

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income of $21.8 million before after-tax impairment charges of $29.8 million. This is compared to a loss of $2.6 million in 2001, which consisted of income of $41.1 million before after-tax impairment charges of $43.7 million. Absent these impairment charges, income decreased $19.3 million, or 47.0%. The decrease resulted primarily from less income due to the sale of most of the affordable housing portfolio in 2001, lower landfill gas production and lower gas sales prices.

Operating revenues in this business segment are primarily derived from the sale of landfill gas. Operating revenues decreased $7.3 million, or 32.2%, compared to 2001. This decrease is primarily due to lower landfill gas production and lower landfill gas sales prices which reduced revenues by $3.0 million and $2.0 million.

Operating expenses consist of various costs to operate and maintain the landfill gas sites, as well as expenses related to alternative fuel investments. Operating expenses increased $2.8 million, or 6.6%, compared to 2001 due to increased expenses related to increased production at alternative fuel investments.

Depreciation and amortization expense consists of the depreciation of landfill gas equipment and gas rights. There was an increase of $3.5 million, or 94.6%, compared to 2001. This increase resulted from additional depreciation on portions of the Fresh Kills landfill gas investment.

Other income consists of income from the structured lease and affordable housing investments, tax credits generated from the investments in landfill gas, natural gas and alternative fuel, and gains recognized on the sale of investments. Other income decreased $12.8 million, or 18.5%, as compared to 2001, due to reduced tax credits of $8.5 million as a result of the sale of most of the affordable housing portfolio, and lower structured lease income of $5.2 million, partially offset by increased alternative fuel tax credits.

Interest and other charges include interest on long-term debt and other interest. There was a decrease of $4.3 million, or 71.7%, as compared to 2001 due to the retirement of $85.0 million of notes in 2001.

Enterprises Business Segment. The Enterprises business segment reported a $19.0 million loss in 2002, compared to a $25.3 million loss in 2001. Included in the 2002 loss is an $18.1 million after-tax charge for the impairment of eight investments. A $36.1 million after-tax impairment charge for the sale of two investments and impairment of 11 other investments was included in the 2001 results. (See Note 3.)

All Other. The all other category reported a loss of $32.9 million in 2002, consisting of a loss of $31.5 million before after-tax restructuring charges of $0.8 million and preferred dividends of $0.6 million. This is compared to a loss of $71.3 million in 2001, which consisted of a loss of $59.7 million before after-tax restructuring charges of $11.1 million and preferred dividends of $0.5 million. Absent the restructuring charges and the preferred dividends, this improvement of $28.2 million was primarily due to lower interest expense in 2002 and the loss on the sale of the bottled water business recognized in 2001.

Operating revenues are comprised of revenues from our telecommunications business line and, until its sale in 2001, revenues from our bottled water business. Operating revenues decreased $16.2 million, or 74.0%, compared to 2001, due to decreased revenues of $8.1 million from the sale of our bottled water business and $8.1 million due to sales-type leases recognized in 2001 by DQE Communications.

Operating expenses consist of expenses to operate and maintain our fiber optic based transmission network and, until its sale, expenses to operate our bottled water business. In 2002, operating expenses decreased $8.9 million, or 26.4%, as compared to 2001. This decrease was primarily due to an $8.4 million decrease in expenses following the sale of the bottled water business and a decrease in expenses from the cost savings associated with the 2001 restructuring. Offsetting this was a $5.5 million increase in expenses in 2002 due to the write-off of a receivable from a telecommunications customer who filed for bankruptcy and a $1.9 million increase in expenses associated with the write-off of the costs associated with the previously proposed generating station.

Other income increased $18.9 million compared to 2001. This increase is primarily due to the loss on the sale of the bottled water business in 2001.

Interest and other charges include interest on long-term debt, other interest and preferred dividends of our other business lines. Interest expense decreased $18.4 million, or 38.2%, in 2002 compared to 2001. This decrease was primarily due to lower interest rates, lower short-term borrowing levels and the retirement of $150.0 million of floating rate notes in January 2002.

Discontinued Operations. The loss from discontinued operations in 2002 was $127.6 million, which was comprised of $8.3 million of income from operations and a $135.9 million loss on disposal. In 2001, the loss from discontinued operations was $108.9 million. (See Note 13.)

AquaSource’s loss in 2002 was $105.7 million, which was comprised of $9.0 million of income from operations and $114.7 million of an estimated loss on disposal. The loss resulted primarily from the $100.9 million after-tax charge related to the impairment of long-lived assets taken in the second quarter of 2002. In 2001, AquaSource’s loss from operations was $110.5 million. This loss resulted primarily from a $99.7 million after-tax charge related to the impairment of the contract operations and construction businesses.

Pro Am’s 2002 loss was $21.9 million and was comprised of a loss of $0.7 million from operations and an estimated

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$21.2 million loss on disposal. In 2001, Pro Am realized income of $1.6 million from its operations.

2001 COMPARED TO 2000

Electricity Delivery Business Segment. The electricity delivery business segment reported $37.7 million of income in 2001, consisting of $44.4 million before an after-tax restructuring charge of $6.7 million, as previously discussed. This is compared to $36.1 million in 2000, which excludes $7.3 million of after-tax income related to the cumulative effect of a change in accounting principle for unbilled revenues. Excluding the restructuring charge in 2001, income from the electricity delivery business segment was $8.3 million higher in 2001, primarily due to lower operating expenses resulting from the cost reduction initiatives that were begun in 2000.

Operating revenues increased by $3.5 million, or 1.1%, compared to 2000. Residential sales increased 2.1%, primarily due to warmer summer weather in 2001. Commercial sales increased 1.3%, due to an increase in the number of commercial customers, while industrial sales decreased 8.3%, due to decreased consumption by steel manufacturers, including one major customer who filed for protection under Chapter 11 of the U.S. Bankruptcy Code. The following table sets forth MWh delivered to electric utility customers.

MWh Delivered

Operating expenses decreased by $19.6 million, or 11.7%, compared to 2000, due to cost reduction initiatives that were begun in 2000, as well as a reduction to our employee pension costs. (See Note 14.)

Depreciation and amortization expense includes the depreciation of electricity delivery-related plant and equipment. There was an increase in depreciation and amortization expense of $3.3 million, or 5.9%, compared to 2000 due primarily to net additions to property, plant and equipment during 2001.

Other income increased $2.4 million, or 6.4%, compared to 2000, primarily due to increased interest income on a higher cash balance in 2001.

In 2001, there was $8.9 million, or 12.8%, more interest and other charges allocated to the electricity business segment compared to 2000. Although Duquesne Light used the generation asset sale proceeds to retire debt, thus reducing its overall level of interest expense, all Duquesne Light financing costs after recapitalization are borne by the electricity delivery business segment.

Electricity Supply Business Segment. In 2001, the electricity supply business segment reported income of zero, compared with a loss of $8.0 million in 2000, which excludes $8.2 million of after-tax income related to the cumulative effect of a change in accounting principle for unbilled revenues. For all of 2001, and for the period from April 29 through December 31, 2000, this segment’s financial results reflect POLR I, which is designed to be income neutral to Duquesne Light.

Short-term sales to other utilities are made at market rates. Prior to the April 2000 generation asset divestiture, fluctuations in such sales were related to customer energy requirements, the energy market and transmission conditions, and the availability of generating stations. Following the divestiture, fluctuations result primarily from excess daily energy deliveries to Duquesne Light’s electricity delivery system.

Operating revenues increased $4.9 million, or 1.2%, compared to 2000. The increase is due to an increase in the average generation rate charged to customers, as well as an increase in the percentage of customers who received electricity through our POLR arrangement.

The following table sets forth MWh supplied for customers who had not chosen an alternative generation supplier.

MWh Supplied

Operating expenses for the electricity supply business segment from April 29, 2000, through 2001 consist of costs to obtain energy under our POLR I arrangement and gross receipts tax, both of which fluctuate in direct relation to operating revenues. Prior to April 29, 2000, such operating expenses included energy costs; costs to operate and maintain the power stations; administrative expenses; and non-income taxes, such as gross receipts, property and payroll taxes.

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Fluctuations in energy costs in 2001 resulted from total MWh supplied through our POLR I arrangement. Fluctuations in energy costs in 2000 generally resulted from changes in the total MWh supplied, the mix between coal generated power and purchased power, the cost of fuel, and generating station availability.

Operating expenses increased $10.4 million, or 2.5%, from 2000 as a result of an increase in the MWh supplied. This increase resulted from higher purchased power costs (related to POLR I) following the generation asset sale, as opposed to the cost of power generated by our previously owned power stations. The cost under POLR I averaged $4.00 per MWh across all rate classes.

Other income decreased $3.0 million from 2000, because no other income has been allocated to this business segment since the generation asset sale.

In 2001, no interest expense was allocated to this business segment; in 2000, there was $21.2 million of allocated interest expense. All remaining financing costs following the generation asset sale are borne by the electricity delivery business segment.

CTC Business Segment. In 2001, the CTC business segment reported income of $12.3 million compared to $45.6 million in 2000, a decrease of $33.3 million, or 73.0%. Operating revenues decreased $30.7 million, or 9.2%, due to scheduled decreases in the average CTC rate charged to customers from 2000 to 2001.

Operating expenses consist solely of gross receipts tax, which fluctuates in direct relation to operating revenues.

As a result of the lower average CTC balance, there was less return earned in 2001. Accordingly, there was an increase in depreciation and amortization expense of $21.7 million, or 8.7%, compared to 2000.

Energy Services Business Segment. In 2001, this business segment reported income of $6.3 million, compared to income of $98.2 million in 2000. Income was $91.9 million higher in 2000, primarily due to the gain on the sale of DQE Energy Services’ alternative fuel facilities.

Operating revenues increased $11.5 million, or 58.1%, compared to 2000. The increase is due to increased facility management revenues from three new alternative fuel service contracts.

Operating expenses increased $5.8 million, or 26.5%, from 2000, primarily due to the additional service contracts.

Depreciation and amortization expense consists of depreciation on energy facilities. Depreciation and amortization expense decreased $3.2 million, or 62.7%, in 2001, due to the lack of depreciation on the alternative fuel facilities that were sold in 2000.

Other income and income taxes were $154.6 million and $54.0 million higher in 2000, due primarily to the gain recognized on the sale of the alternative fuel facilities in 2000.

Financial Business Segment. The Financial business segment reported a loss of $2.6 million in 2001, consisting of $41.1 million of income prior to after-tax impairment charges of $43.7 million, as previously discussed. This is compared to income of $36.8 million in 2000. Excluding the impairment charges in 2001, income from the Financial business segment was $4.3 million higher in 2001, primarily due to increased landfill gas production and higher landfill gas sales prices.

Operating revenues increased $1.9 million, or 9.1%, compared to 2000. The increase in revenue is due to an increase in landfill gas production and higher landfill gas sales prices.

Operating expenses increased $2.8 million, or 7.0%, from 2000, due to the increased operating costs at its landfill gas sites, caused primarily by higher gas production.

Interest and other charges decreased $3.9 million, or 39.4%, as compared to 2000 due to the retirement of $85.0 million of notes in 2001, as well as a full year’s effect of debt retirements that occurred in 2000.

Enterprises Segment. The Enterprises segment had a $25.3 million loss in 2001, consisting of $10.8 million of income before after-tax impairment charges of $36.1 million, as previously discussed. This is compared to $5.7 million of income in 2000. Absent the impairment charges, income from the Enterprises segment was $5.1 million, or 89.5%, higher in 2001, primarily due to the $8.4 million after-tax gain on the sale of the Pittsburgh Airport energy facility in July 2001. This sale resulted in a decrease in operating revenues of $5.8 million and operating expenses of $6.3 million.

Operating revenues for this segment are derived from energy sales and rent payments from real estate investments. Operating revenues decreased $7.8 million, or 34.5%, compared to 2000. This decrease is primarily due to the energy facility sale.

Operating expenses for the Enterprises segment are primarily made up of costs to maintain the rental properties and the energy facility, administrative expenses and non-income taxes, such as property and payroll taxes. Operating expenses decreased $6.6 million, or 33.0%, compared to 2000. The decrease was mainly attributable to the energy facility sale.

Other income increased $8.3 million or 88.3% compared to 2000, primarily due to the gain on the energy facility sale.

All Other. The all other category had a $71.3 million loss in 2001, consisting of a $59.7 million loss before an after-tax restructuring charge of $11.1 million, as previously discussed, and preferred dividends of $0.5 million. This is compared to a $68.1 million loss in 2000, consisting of a $68.9 million loss and preferred dividends of $(0.8). Absent the restructuring charge and preferred dividends, this is an improvement of $9.2 million, or 13.4%.

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Operating revenues decreased $13.8 million, or 38.7%, compared to 2000. The decrease is primarily comprised of a $14.0 million decrease related to the sale of our bottled water business in May 2001.

In 2001, operating expenses decreased $28.8 million, or 46.1%, due primarily to the sale of our bottled water business in May 2001 and administrative cost reductions.

Interest expense increased $8.0 million, or 19.9%, primarily as a result of increased borrowing used largely to fund subsidiary cash requirements (excluding Duquesne Light).

Discontinued Operations. The loss from discontinued operations in 2001 was $108.9 million, as compared to a loss from discontinued operations in 2000 of $7.2 million. (See Note 13.)

AquaSource’s loss in 2001 was $110.5 million. This loss resulted primarily from a $99.7 million after-tax charge related to the impairment of the contract operations and construction businesses. In 2000, AquaSource had a loss from operations of $7.3 million.

Pro Am’s income was $1.6 million in 2001 and $0.1 million in 2000.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions with respect to values and conditions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the financial statements. The reported amounts of revenues and expenses during the reporting period also may be affected by the estimates and assumptions we are required to make. We evaluate these estimates on an ongoing basis, using historical experience, consultation with experts and other methods we consider reasonable in the particular circumstances. Nevertheless, actual results may differ significantly from our estimates.

In preparing our financial statements and related disclosures, we have adopted the following accounting policies which management believes are particularly important to the financial statements and that require the use of estimates and assumptions in the financial preparation process.

Accounting for the Effects of Regulation. Our subsidiary, Duquesne Light, prepares its financial statements in accordance with the provisions of SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation,” which differs in certain respects from the application of accounting principles generally accepted in the United States of America by non-regulated businesses. In general, SFAS No. 71 recognizes that accounting for rate-regulated enterprises should reflect the economic effects of regulation. As a result, a regulated utility is required to defer the recognition of costs (a regulatory asset) if it is probable that, through the rate-making process, there will be a corresponding increase in future rates. Accordingly, we defer certain costs, which will be amortized over future periods. To the extent that collection of such costs is no longer probable as a result of changes in regulation or our competitive position, the associated regulatory assets are charged to expense.

Unbilled Energy Revenues. We record revenues related to the sale of energy when delivery is made to our customers. However, the determination of such sales to individual customers is based on the reading of their meters, which we read on a systematic basis throughout the month. At the end of each month, we estimate the amounts delivered to customers since the date of the last meter reading and record the corresponding unbilled revenue. We estimate this unbilled revenue each month based on daily volumes, estimated customer usage by class, delivery losses and applicable customer rates based on regression analyses reflecting significant historical trends and experience. Customer accounts receivable as of December 31, 2002, and 2001, include unbilled revenues of $31.9 million and $36.9 million.

Impairment of Long-Lived Assets and Investments. We evaluate long-lived assets (including other intangibles and related goodwill) of identifiable business activities and investments for impairment when events or changes in circumstances indicate, in management’s judgment, that the carrying value of such assets may not be recoverable. In addition to those long-lived assets and investments for which impairment charges were recorded (see Note 3), others were reviewed for which no impairment was required. For long-lived assets to be held and used, these computations used judgments and assumptions inherent in management’s estimate of undiscounted future cash flows to determine recoverability of the assets. It is possible that a computation under a “held for sale” situation for certain of these long-lived assets could result in a significantly different assessment because of market conditions, specific transaction terms or a buyer’s different viewpoint of future cash flows. For investments, we considered our investee’s cash on-hand, fundraising abilities, customers, contracts and overall ability to continue as a going concern.

Pension and Other Postretirement Benefit Plan Assumptions. We provide pension benefit plans covering substantially all of our full-time employees. We also provide postretirement benefits for some retired employees. The post-retiree medical benefits terminate when retirees reach age 65. We account for these benefits in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” and SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” We record amounts related

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to our pension and other postretirement benefit plans based on actuarial valuations. Inherent in those valuations are key assumptions including discount rates, expected returns on plan assets, compensation increases, and health care cost trend rates. These actuarial assumptions are reviewed annually and modified as appropriate. Changes in these assumptions could have a significant effect on our noncash pension income or expense or on our postretirement benefit costs. The effect of changes in these assumptions is generally recorded or amortized over future periods.

We discounted our future pension and other postretirement plan obligations using a rate of 6.75% as of December 31, 2002, compared to 7.25% as of December 31, 2001. We determine the discount rate by considering the yield rates on corporate high-grade bonds, including relative year-over-year changes. Both the pension and other postretirement plan obligations and related expense increase as the discount rate is reduced.

The assumed rate of return on plan assets in the pension plans is the weighted average of long-term returns forecast for the type of investments held by the plans. As the expected rate of return on plan assets decreases, the pension plan expense increases, however the postretirement plan expense is unaffected as this plan has no assets. The health care trend assumption used in the development of the fiscal 2002 postretirement benefit plan expense was 11.0% for fiscal year 2002, decreasing to an ultimate rate of 5.75% in 2013. Assumed health care cost trend rates have a significant effect on the liabilities for the postretirement plans.

We believe the assumptions used in recording obligations under the plans are reasonable based on our prior experience, market conditions, and the advice of plan actuaries. See Note 14 for information about these assumptions, actual performance, amortization of investment and other actuarial gains and losses and calculated plan costs for 2002, 2001 and 2000. As of December 31, 2002, the projected benefit obligations for our retirement plans exceeded the fair value of the plan assets in the trusts.

Primarily because of the amortization of previous years’ net investment gains, our pension expense for 2002, 2001 and 2000 was negative, resulting in an increase in net income in each year. Our expense or (credit) for actual pension benefits in future periods will depend upon actual returns on plan assets and the key assumptions we use for future periods. Our current estimate for 2003 is a reduction, compared to 2002, in the pension benefits net credit of $14.3 million pre-tax. This reduction reflects, among other factors, actual losses on the pension fund assets of $43.8 million in 2002 and $35.1 million in 2001, as compared with an expected annual asset return assumption of 7.5% in each of the years. Absent a substantial recovery in the equity markets, pension costs and cash funding requirements could substantially increase in future years. Pursuant to the actuarial valuations that were performed, we were not required to make cash contributions to our pension plans in 2002, nor will we be required to do so in 2003. However, Duquesne Light has an obligation to contribute approximately $32.1 million to the pension plans over future years. (See Note 14.)

Income Taxes. In accordance with SFAS No. 109, “Accounting for Income Taxes,” we use the liability method in computing deferred taxes on all differences between book and tax bases of assets and liabilities. These book/tax differences occur when events and transactions recognized for financial reporting purposes are not recognized in the same period for tax purposes. The deferred tax liability or asset is also adjusted in the period of enactment for the effect of changes in tax laws or rates.

We file a consolidated U.S. federal income tax return with our subsidiaries, all of whom participate in an intercompany tax sharing agreement which generally provides that taxable income for each subsidiary be calculated as if it filed a separate return.

For the electricity delivery business segment, we recognize a regulatory asset for deferred tax liabilities that are expected to be recovered through rates. The difference in the provision for deferred income taxes related to depreciation of electric plant in service and the amount that otherwise would be recorded under generally accepted accounting principles is deferred and included in regulatory assets on the consolidated balance sheets. (See Note 1.)

Contingent Liabilities. We establish reserves for estimated loss contingencies when it is management’s assessment that a loss is probable and the amount can be reasonably estimated. Revisions to contingent liabilities are reflected in income in the period in which different facts or information become known, or circumstances change, that affect the previous assumptions with respect to the likelihood or amount of loss. Reserves for contingent liabilities are based upon management’s assumptions and estimates, advice of legal counsel, or other third parties regarding the probable outcomes of the matter. Should the ultimate outcome differ from the assumptions and estimates, revisions to the estimated reserves for contingent liabilities would be recognized. Such contingent liabilities for DQE include, but are not limited to, restructuring liabilities (see Note 4), income tax matters (see Note 10), and other commitments and contingencies (see Note 12).

DIVIDENDS

Once all dividends on our Preferred Stock, Series A (Convertible), $100 liquidation preference per share (DQE preferred stock), have been paid, dividends may be paid on our common stock as permitted by law and as declared by the board of directors. Since we are a holding company, substantially all of the assets shown on our consolidated balance sheets are held by our subsidiaries. Accordingly, our earnings and cash flow, and our ability to meet our

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obligations, are largely dependent upon the earnings and cash flows of such subsidiaries and the distribution or other payment of such earnings to us in the form of dividends, loans or advances, and repayment of loans and advances from us. Our subsidiaries are separate and distinct legal entities and have no obligation to pay any amounts due on our securities or to make any funds available for such payments. Our subsidiaries’ ability to make dividend payments or other distributions to us may be restricted by their obligations to holders of their outstanding debt and preferred securities and to their creditors, the availability of earnings and the needs of their businesses.

As discussed above, Duquesne Light Company is our largest subsidiary. If Duquesne Light cannot pay common dividends, we may not be able to pay dividends on our common stock or DQE preferred stock. Payments of dividends on Duquesne Light’s common stock may be restricted by Duquesne Light’s obligations to holders of preferred and preference stock pursuant to Duquesne Light’s articles of incorporation and by obligations of a Duquesne Light subsidiary to holders of its securities. (See Note 16.) No dividends or distributions may be made on Duquesne Light’s common stock if Duquesne Light has not paid dividends or sinking fund obligations on its preferred or preference stock. Dividends on Duquesne Light stock may also be effectively limited by the terms of certain financing agreements. Further, the aggregate amount of Duquesne Light’s common stock dividend payments or distributions may not exceed certain percentages of net income if the ratio of total common shareholder’s equity to total capitalization is less than specified percentages.

We have continuously paid dividends on common stock since 1953. Our annual dividends per share, paid quarterly, were $1.51, $1.68 and $1.60 for the years 2002, 2001 and 2000, respectively. Most recently, in the first quarter of 2003 the board of directors declared a quarterly dividend of $0.25 per share (payable on April 1, 2003 to holders of record on March 10, 2003). The board regularly evaluates our dividend policy and sets the amount each quarter. The level of dividends will continue to be influenced by many factors such as, among other things, our earnings, financial condition and cash flows from subsidiaries, as well as general economic and competitive conditions. (See “Rate Matters.”)

LIQUIDITY AND CAPITAL RESOURCES

Except for the affordable housing investment guarantees discussed in Note 12, we have no material off-balance sheet arrangements. We are not involved in any commodity contract trading activities.

CAPITAL EXPENDITURES

Continuing Operations. In 2002, 2001 and 2000, we spent approximately $72.5 million, $59.1 million and $89.8 million for electric utility construction, and approximately $11.3 million, $61.3 million and $15.2 million on capital expenditures relating to our other business lines and other investments. We estimate that during 2003, 2004 and 2005 we will spend, excluding the allowance for funds used during construction, approximately $70 million for electric utility construction in each year, and $5 million, $3 million and $3 million for construction by our other businesses.

Discontinued Operations. In 2002, 2001 and 2000, we spent approximately $39.9 million, $39.5 million and $44.8 million for water utility construction. We estimate that during 2003 we will spend up to $45 million for water utility construction, which depends, in part, on the timing of the sale to Philadelphia Suburban Corporation (PSC).

ASSET DISPOSITIONS

Continuing Operations. On February 20, 2003, DQE Financial sold its limited partnership investment in one of the natural gas operating partnerships. Proceeds from the sale totaled $18.5 million, and resulted in an after-tax gain of $7.0 million.

In 2002 we sold a significant portion of our remaining affordable housing portfolio, receiving proceeds of approximately $17 million, which approximated book value. We received $1.3 million from the sale of securities and recognized an after-tax gain of $0.8 million. We received $1.3 million from the sale of a building and recognized an after-tax gain of $0.3 million. We also received $2.3 million for the sale of an electronic commerce investment, which approximated book value.

In the fourth quarter of 2001, we sold a portion of our affordable housing portfolio, receiving proceeds of approximately $34 million, which approximated book value. We also sold an office building, receiving proceeds of $18.5 million, which approximated book value.

In July 2001, the Allegheny County Airport Authority purchased the Pittsburgh International Airport energy facility from a DQE Enterprises subsidiary, and entered into a 15-year operations and maintenance agreement regarding the facility with DQE Energy Services. The transaction resulted in an after-tax gain of $8.4 million.

We sold our bottled water assets in May 2001. The sale resulted in an after-tax loss of approximately $15 million, of which $10.0 million had been recorded in December 2000. We also received $4.3 million for the sale of other non-strategic assets.

In 2000, Duquesne Light completed the sale of its generation assets for approximately $1.7 billion. We used approximately $665 million of these proceeds to repurchase approximately 16 million shares of common stock and 248,000 shares of preferred stock. We also received $262.8 million of proceeds from the sale of various non-strategic investments, including affordable housing and DQE Energy Services’ alternative fuel facilities. The alternative fuel transaction included a seven-year contract to operate several

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of the facilities. Also in 2000, Duquesne Light purchased the automated electronic meter-reading system, which had previously been leased.

Discontinued Operations.

On March 14, 2003, AquaSource entered into an agreement to sell its water and wastewater utility construction business to a related party for approximately $7 million before consideration of an earn-out provision. Of the total purchase price, $4 million is in the form of a personally guaranteed promissory note that bears interest at 3.5% per annum and shall be paid in full, including accrued but unpaid interest, on the second anniversary of the closing date. The balance of the purchase price is in the form of cash due at the closing date. Closing of the transaction is anticipated to take place on or near April 1, 2003 and is contingent on the buyer meeting certain obligations. The estimated worth of the earn-out provision is in the range from $0 to $1 million.

We sold various assets in 2002, including several wastewater facilities and real property and received proceeds of approximately $6 million which approximated book value. In addition, we entered into agreements to sell substantially all of AquaSource’s assets, as well as all of Pro Am’s propane distribution business. (See our more detailed discussion of these sales in Note 13.)

In 2001, we sold 50,000 shares of AquaSource Class A Common Stock to a third party in exchange for approximately $4 million of services. We also sold real property, receiving proceeds of $0.1 million, and acquired four water companies for approximately $0.9 million.

In 2000, AquaSource acquired 13 water and water-related companies for approximately $11.1 million. We also sold a water utility system, receiving proceeds of $23.9 million.

FINANCING

In September 2002, Duquesne Light converted approximately $98 million of variable rate debt to fixed rate with maturities in 2011 and 2013, resulting in a weighted average interest rate of 4.20%.

On August 5, 2002, we redeemed the following: (i) $10 million aggregate principal amount of Duquesne Light’s 8.20% first mortgage bonds due 2022 at a redemption price of 104.51% of the principal amount thereof, and (ii) $100 million aggregate principal amount of Duquesne Light’s 7 5/8% first mortgage bonds due 2023 at a redemption price of 103.9458% of the principal amount thereof.

On June 26, 2002 we issued 17,250,000 shares of common stock at $13.50 per share in an underwritten public offering. This issuance was made under our April 5, 2002, shelf registration statement for up to $500.0 million of various debt and equity securities. We received net proceeds, after payment of underwriters discounts and commissions and other expenses, of $223.4 million. We have used net proceeds to reduce approximately $171 million principal amount of outstanding long-term debt (as discussed above) and short-term debt, and have targeted the remaining net proceeds for general corporate purposes, including payment of a deposit to the IRS toward any adjustments in connection with the income tax matter discussed in Note 10.

On April 15, 2002, Duquesne Light issued $200 million of 6.7% first mortgage bonds due 2012. On April 30, 2002, Duquesne Light issued $100 million of 6.7% first mortgage bonds due 2032. In each case it used the proceeds to call and refund existing debt, including debt scheduled to mature in 2003 and 2004.

In January 2002, we refinanced $150 million of matured DQE Capital floating rate notes through the issuance of commercial paper, primarily at Duquesne Light, which loaned the proceeds to DQE. Cash generated from operations and equity offering proceeds was used to repay and retire this debt in full, leaving no outstanding balance at December 31, 2002.

LIQUIDITY

At December 31, 2002, we had a cash balance of $93.9 million.

In the first quarter of 2002, Moody’s Investor Service, Standard & Poor’s, and Fitch Ratings assessed our short and long-term credit profiles. The ratings reflect the agencies’ opinion of our overall financial strength. Ratings impact our ability to access capital markets for investment and capital requirements, as well as the relative costs related to such liquidity capability. In general, the agencies reduced our long-term credit ratings, although staying within the range considered to be investment grade. The agencies maintained the existing credit ratings for Duquesne Light’s short-term debt. However Moody’s and Fitch reduced DQE Capital’s short-term debt rating by one level, thereby restricting DQE Capital from accessing the commercial paper market. This ratings downgrade does not limit our ability to access our revolving credit facilities; it does, however, impact the cost of maintaining the credit facilities and the cost of any new debt. These ratings are not a recommendation to buy, sell or hold any securities of DQE or our subsidiaries, may be subject to revisions or withdrawal by the agencies at any time, and should be evaluated independently of each other and any other rating that may be assigned to our securities.

We maintain two 364-day revolving credit agreements, one for $150 million at Duquesne Light and one for $140 million at DQE Capital. Both expire in October 2003. We guarantee DQE Capital’s revolving credit agreement obligations. At December 31, 2002, no borrowings were outstanding; however, we had $90.1 million in standby letters of credit, $66.3 million of which are backed by the revolving credit agreements, leaving $223.7 million available. These letters of credit relate primarily to DQE Financial.

Decreases in our credit ratings will result in an inverse change in the fees and interest rates charged under the facilities. Both revolving credit agreements are subject to cross-default if Duquesne Light defaults on any payment due under any indebtedness exceeding $50 million. In addition, the $140 million revolver is subject to cross-default if DQE Capital defaults on any payments due under any of its indebtedness exceeding $10 million.

Under our credit facilities, we are subject to financial covenants requiring each of DQE and Duquesne Light to maintain a maximum debt-to-capitalization ratio of 65.0%. In addition, DQE is required to maintain a minimum cash coverage ratio of 2-to-1. At December 31, 2002, we were in compliance with these covenants, having debt-to-total-capitalization ratios of approximately 61% at DQE and approximately 57% at Duquesne Light, and a cash coverage ratio of 2.3-to-1 at DQE.

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None of our long-term debt is scheduled to mature before 2008.

We expect to make deposits of at least $80 million with the IRS in connection with the income tax matter discussed in Note 10. We expect to have sufficient liquidity to make these deposits using funds from such possible sources as cash on hand, AquaSource sale proceeds or our revolving credit agreements.

At December 31, 2002, we had no commercial paper borrowings outstanding, and $1.0 million of current debt maturities. During 2002, the maximum amount of bank loans and commercial paper borrowings outstanding at any date was $155 million, the amount of average daily borrowings was $45.8 million, and the weighted average daily interest rate was 2.34%.

At December 31, 2001, we had $151.0 million of current debt maturities and no commercial paper borrowings outstanding. During 2001, the maximum amount of bank loans and commercial paper borrowings outstanding at any date was $55.0 million, the amount of average daily borrowings was $22.7 million, and the weighted average daily interest rate was 4.79%.

At December 31, 2000, we had $88.5 million of current debt maturities and no commercial paper borrowings outstanding. During 2000, the maximum amount of bank loans and commercial paper borrowings outstanding at any date was $373.3 million, the amount of average daily borrowings was $34.4 million, and the weighted average daily interest rate was 6.1%.

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CONTRACTUAL OBLIGATIONS

As of December 31, 2002, we have certain contractual obligations and commitments that extend beyond 2003, the principal amounts of which are set forth in the following tables:

Payments Due By Period

Other Commitments

RATE MATTERS

COMPETITIVE TRANSITION CHARGE

Under Customer Choice, customers must choose to receive their electric energy from an alternative generation supplier or through our POLR arrangements. Customers who select an alternative generation supplier pay for generation charges set competitively by that supplier, and pay Duquesne Light transmission and distribution charges and the CTC (unless the CTC has already been collected for a customer’s rate class).

Duquesne Light has completed the CTC collection from most of its customers. As of December 31, 2002, the CTC balance has been fully collected for approximately 95% of customers, representing approximately 87% of the MWh sales for 2002. The transition costs, as reflected on the consolidated balance sheets, are being amortized over the same period that the CTC revenues are being recognized. For regulatory purposes, the unrecovered balance of transition costs was approximately $25 million ($15 million net of tax) at December 31, 2002, and approximately $142 million ($87 million net of tax) at December 31, 2001. Duquesne Light is allowed to earn an 11.0% pre-tax return on the net of tax CTC balance. A lower amount is shown on the consolidated balance sheets due to the accounting for unbilled revenues.

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PROVIDER OF LAST RESORT

Orion Power Midwest (a subsidiary of Reliant Resources, Inc.) is Duquesne Light’s supplier under POLR I and POLR II. As discussed in “Results of Operations” above, POLR II extends through December 31, 2004, and permits Duquesne Light a margin per MWh supplied based on the mix of rate classes, and number of customers, participating in POLR II. For 2002, the average margin was $4.77 per MWh. Except for this margin, POLR I and POLR II, in general, effectively transfer to Orion the financial risks and rewards associated with Duquesne Light’s provider-of-last-resort obligations. As of December 31, 2002, approximately 77% of Duquesne Light’s customers measured on a MWh basis received electricity through POLR I or POLR II. The number of POLR customers will fluctuate depending on market prices and the number of alternative generation suppliers in the retail supply business.

There are certain safeguards in POLR I and POLR II designed to mitigate losses in the event that Orion defaults on its performance under the arrangement. Contractually, Duquesne Light has various credit enhancements to address market exposure if Orion failed to deliver the required POLR supply. Duquesne Light holds an irrevocable $10 million letter of credit (that can be increased based on Orion’s investment ratings and net worth). Duquesne Light also remits the POLR customer payments 35 days after billing the customer. Duquesne Light has the right not to remit these payments in the event of an Orion default.

If Orion were to fail to deliver, Duquesne Light would be required to procure its POLR supply requirements in the energy markets. If market prices for energy were higher than the POLR rate at the time of default, Duquesne Light could potentially be acquiring energy for sale to POLR customers at a loss. If that were to happen and the contractual provisions with Orion were not sufficient to cover any loss, Duquesne Light would seek regulatory recovery of any additional loss. While the Customer Choice Act provides generally for POLR supply costs to be borne by customers, recent litigation suggests that it may not be clear whether Duquesne Light could pass any costs in excess of the existing PUC-approved POLR prices on to its customers. Additionally, Orion’s parent was downgraded by the rating agencies in 2002. To date, the downgrade has not affected Orion’s performance.

Duquesne Light is preparing POLR III, a rate plan and related generation supply plan intended to cover the period beginning in 2005. For our larger commercial and industrial customers (fewer than 1,000 customers but approximately 50% of the electricity consumption) the rate plan proposal is likely to include a market-based pilot program comprised of a choice between auction-based, fixed-price service and variable, real-time hourly price service. For our residential and small business customers, the proposal is likely to include a multi-year, fixed-price service option to offer protection from market volatility. We are evaluating, among other options, a contracting strategy for long-term POLR supply. Duquesne Light is actively engaged in discussions with potential suppliers in an effort to structure an arrangement with appropriate protections in the event of supplier default. Once the supply plan is finalized, Duquesne Light will submit POLR III for PUC approval. We expect to make the filing in mid-2003.

Duquesne Light retains the risk that customers will not pay for the POLR generation supply. However, a component of Duquesne Light’s delivery rate is designed to cover the cost of a normal level of uncollectible accounts. Duquesne Light’s goal is to mitigate such risks associated with POLR III and to enhance shareholder value through a continuing earnings stream from the core electric business.

RATE FREEZE

In connection with POLR II, Duquesne Light negotiated a rate freeze for generation, transmission and distribution rates. The rate freeze fixed generation rates for retail POLR II customers, and continues the transmission and distribution rates for all customers at current levels through 2003. Under certain circumstances, affected interests may file a complaint alleging that, under these frozen rates, Duquesne Light has exceeded reasonable earnings, in which case the PUC could make adjustments to rectify such earnings.

REGIONAL TRANSMISSION ORGANIZATION

FERC Order No. 2000, as amended, calls on transmission-owning utilities such as Duquesne Light to join regional transmission organizations by September 2004. Duquesne Light is committed to ensuring a stable, plentiful supply of electricity for its customers. Toward that end, Duquesne Light anticipates joining a regional transmission organization as part of its pending POLR III proposal.

PUC PROCEEDINGS

On October 25, 2002, Duquesne Light petitioned the PUC to issue a declaratory order regarding a provision in its retail tariff that affected its largest industrial customer. Orion and Duquesne Light had interpreted the tariff differently. On February 6, 2003 the PUC issued an order, to be effective prospectively, affirming Orion’s interpretation. The effect of this order could increase the customer’s annual billings significantly. The ultimate impact will be influenced by operational changes the customer may make to reduce its energy costs. Duquesne Light is responsible for paying Orion the amount billed, and retains the risk of recovering any increased billings from the customer. This risk is not included in the “normal level” of uncollectible accounts described above.

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DISCONTINUED OPERATIONS

In June 2000, AquaSource filed consolidated, statewide water and sewer rate change applications with the TCEQ and 17 municipalities. As previously reported, four municipalities denied or altered the rate increase, AquaSource appealed, and the parties have entered into a settlement agreement. The TCEQ entered its final order on September 17, 2002 approving the settlement agreement reached by all parties.

In March 2001, AquaSource also filed a rate increase petition with the Indiana Utility Regulatory Commission (IURC) to increase water and sewer rates for Utility Center, Inc., AquaSource’s largest regulated subsidiary. In the fourth quarter of 2002, the IURC issued a new rate order approving an 8% increase; however, AquaSource believes various technical amendments must be made before the order becomes effective. AquaSource remains engaged in discussions with the IURC regarding the technical amendments. Final resolution is anticipated in the second quarter of 2003.

In December 2002, AquaSource filed a rate increase petition in Sarasota County, Florida. No order is anticipated before the fourth quarter of 2003. The final rate outcomes in Indiana and Florida will cause purchase price adjustments under the sale agreement with PSC. (See Note 13.)

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Market risk represents the risk of financial loss that may impact our consolidated financial position, results of operations or cash flows due to adverse changes in market prices and rates.

We manage our interest rate risk by balancing our exposure between fixed and variable rates, while attempting to minimize our interest costs. Currently, our variable interest rate debt is approximately $320.1 million, or 29.6%, of long-term debt. This variable rate debt is low-cost, tax-exempt debt. We also manage our interest rate risk by retiring and issuing debt from time to time and by maintaining a balance of short-term, medium-term and long-term debt. A 10% increase in interest rates would have affected our variable rate debt obligations by increasing interest expense by approximately $0.4 million, $1.1 million and $3.1 million for the years ended December 31, 2002, 2001 and 2000. A 10% reduction in interest rates would have increased the market value of our fixed-rate debt by approximately $49.7 million and $40.6 million as of December 31, 2002 and 2001. Such changes would not have had a significant near-term effect on our future earnings or cash flows.

See our Provider of Last Resort discussion in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations for discussion of market risk associated with our POLR obligation.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

INDEPENDENT AUDITORS’ REPORT

To the Directors and Shareholders of DQE, Inc.:

We have audited the accompanying consolidated balance sheets of DQE, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, comprehensive income, retained earnings, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of DQE, Inc.’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule 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 DQE, Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their 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. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, effective January 1, 2002, DQE, Inc. changed its method of accounting for goodwill and other intangible assets. Also, as discussed in Note 1 to the consolidated financial statements, effective January 1, 2000, DQE, Inc. changed its method of accounting for unbilled revenues.

/s/ Deloitte & Touche LLP

Pittsburgh, Pennsylvania

January 30, 2003

(March 14, 2003 as to Note 21)

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Consolidated Statements of Income