Back to GetFilings.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

AQUILA, INC.
(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code    816-421-6600

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

        Information regarding the consolidated condensed financial statements is set forth on pages 3 through 24.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        Management's discussion and analysis of financial condition and results of operations can be found on pages 25 through 51.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        We are subject to market risk as described on pages 34 through 36 of our 2001 Annual Report to Shareholders. See discussion on pages 50 through 51 for changes in market risk since December 31, 2001.

ITEM 4. CONTROLS AND PROCEDURES

        Information regarding disclosure controls and procedures can be found on page 52.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

        Information regarding legal proceedings can be found on page 53.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

        Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

        Not applicable.

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

        Not applicable.

ITEM 5. OTHER INFORMATION

        Information regarding Corporate Governance and Management Restructuring can be found on page 53.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

        Exhibits and Reports on Form 8-K can be found on pages 54 through 55.

2

Part I.    Financial Information

Item 1.    Financial Statements

Aquila, Inc.

Consolidated Condensed Statements of Income—Unaudited

See accompanying notes to consolidated condensed financial statements.

3

Aquila, Inc.

Consolidated Condensed Statements of Income—Unaudited

See accompanying notes to consolidated condensed financial statements.

4

Aquila, Inc.

Consolidated Condensed Balance Sheets

See accompanying notes to consolidated condensed financial statements.

5

Aquila, Inc.

Consolidated Condensed Statements of Comprehensive Income—Unaudited

Consolidated Condensed Statements of Common Shareholders' Equity

See accompanying notes to consolidated condensed financial statements.

6

Aquila, Inc.

Consolidated Condensed Statements of Cash Flows—Unaudited

See accompanying notes to consolidated condensed financial statements.

7

AQUILA, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)

1. Summary of Significant Accounting Policies

1.1    Basis of Presentation    

        The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with the accounting policies described in the consolidated financial statements and related notes included in our 2001 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on August 14, 2002. We believe it is best to read our year-end consolidated financial statements in conjunction with this report. The accompanying Balance Sheet and Statement of Common Shareholders' Equity as of December 31, 2001, were derived from our audited financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States. In our opinion, the accompanying consolidated condensed financial statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair representation of our financial position and the results of our operations. Certain estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting periods shown have been made in preparing the consolidated condensed financial statements. Actual results could differ from these estimates.

        Certain prior year amounts in the consolidated condensed financial statements have been reclassified where necessary to conform to the 2002 presentation. In particular, sales and cost of sales have been reclassified to report energy trading gains and losses on a net basis pursuant to Emerging Issues Task Force Issue No. 02-3 (EITF 02-3) as discussed under the caption "Energy Trading Activities." Also, as discussed in Note 4, "Discontinued Operations," the assets to be sold and results of operations from those assets have been reclassified as discontinued operations in the accompanying balance sheets and statements of income for all periods presented.

        As a result of the reclassification associated with the discontinued operations and reclassification of sales and cost of sales discussed above, combined with our former auditor's, Arthur Andersen LLP, inability to attest to these adjustments due to their demise, we are required to have our financial statements for the years ended December 31, 2000 and 2001 re-audited by our newly engaged auditors. We do not anticipate any changes to our audited 2000 and 2001 financial statements filed with our Annual Report on Form 10-K/A on August 14, 2002, except the reclassifications necessary to reflect the discontinuation of certain operations and reclassification of sales and cost of sales under EITF No. 02-3. We expect the re-audits to be completed in early 2003.

1.2    Change in Accounting Principle    

        Effective January 1, 2002, we changed our method of accounting for our Merchant Services gas storage inventory (inventory used in daily trading activities) from the lower of cost or market method to a fair value method. This method facilitates a better matching of inventory value to the related revenues from future contract commitments that are also carried at fair value. This method consists of recording the fair value of this gas storage inventory using the gas daily index price from the last day of the reporting period for the applicable storage location. We had $71.3 million of gas storage inventory as of December 31, 2001, consisting of 27.4 Bcf at $2.61/mmbtu. In connection with the exit of our wholesale trading activities, we sold our entire gas storage inventory used in daily trading activities during the third quarter of 2002.

        The cumulative effect of this change at January 1, 2002, was a reduction in income before income taxes of $643,000 and net income of $386,000, or less than one cent per share. The effect of this change is included in Natural gas – non-regulated sales and is not separately identified in our

8

Statement of Income. However, had this change been in effect for the three- and nine-month periods ended September 30, 2001, net income and diluted earnings per share would have been affected as follows:

        In October 2002, the EITF reached a consensus to rescind EITF Issue 98-10, "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." All new contracts that would otherwise have been accounted for under Issue 98-10, and that do not fall within the scope of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," (SFAS 133), should no longer be marked-to-market through earnings beginning on October 25, 2002. This rescission would have resulted in a change from carrying these inventories at market to carrying these inventories at cost, however, as we have sold our inventory as of September 30, 2002, there will be no impact on our results of operations or financial position.

1.3    New Accounting Pronouncements    

1.3.1    Goodwill and Other Intangible Assets    

        On January 1, 2002, we were required to adopt Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). SFAS 142 requires that goodwill no longer be amortized to expense. Rather, this statement requires that goodwill be tested for impairment at least annually and, if impaired, be written off against earnings at that time. We completed an initial assessment of the realizability of our goodwill and determined that as of January 1, 2002, no goodwill impairments existed.

        Amortization expense for the three- and nine-month periods ended September 30, 2001 totaled $5.2 million and $17.5 million, respectively. In addition, our earnings from equity method investments included $4.4 million and $13.1 million of amortization expense, for the three- and nine-months ended September 30, 2001, respectively.

        As discussed in Note 6, $218.7 million of goodwill was recorded in the repurchase of Aquila Merchant Services, Inc. on January 7, 2002. We allocated $175.0 million of this goodwill to our Wholesale Services segment and $43.7 million to our Capacity Services segment based upon future expected cash flows. As a result of our second quarter decision to exit the wholesale energy trading business, we determined that all of the goodwill in our Wholesale Services business was impaired. Therefore, we recorded an impairment charge of $178.6 million in the second quarter of 2002. In addition, as further discussed in Note 3, we recorded a total impairment charge related to our investment in Quanta Services, Inc. of $692.9 million, which included a $328.0 million goodwill impairment charge related to this investment.

        In connection with the sale of our interest in Lockport Energy and our plan to sell Aquila Gas Pipeline, allocated goodwill of $14.0 million and $19.0 million, respectively, was included in the basis used in determining the Impairment Charges and Net Loss on Sale of Assets in the third quarter of 2002. Also, approximately $26.7 million of goodwill related to Katy Storage and $73.3 million of goodwill in investments in unconsolidated subsidiaries related to our investment in the Oasis Pipe Line Company has been reclassified to "Non-current Assets of Discontinued Operations" in the Consolidated Condensed Balance Sheet. See Note 4 for further discussion.

9

        Our goodwill allocated to each segment at September 30, 2002 and December 31, 2001 is as follows:

        Following are disclosures of net income and earnings per share for the three- and nine-month periods ended September 30, 2001, had SFAS 142 been in effect at the beginning of those periods:

1.3.2    Asset Retirement Obligations    

        In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). SFAS 143 requires companies to record the fair value of a liability for an asset retirement obligation in the period in which the liability is incurred. When the liability is initially recorded, we will include the fair value of the estimated cost of removal as an addition to the asset purchase cost, with an offsetting liability related to the estimated cost of removal. The liability will be increased to the nominal value over time. Upon settlement of the liability, we will record a gain or loss for the difference between the settled liability and the recorded amount. This standard will become effective for us on January 1, 2003, and will be recorded as a cumulative effect of an accounting change. We are in the process of identifying our assets that are subject to a retirement obligation and assessing the impact that the adoption of this standard will have on our financial position and results of operations.

1.3.3    Energy Trading Activities    

        In June 2002, the EITF reached a consensus on a topic discussed in EITF No. 02-3, "Recognition and Reporting of Gains and Losses on Energy Trading Contracts under EITF No. 98-10, 'Accounting for Contracts Involved in Energy Trading Risk Management Activities."' EITF No. 02-3 requires that gains and losses on energy trading contracts be shown net on the income statement whether or not they are settled physically. The adoption of this standard requires the reclassification of all prior period sales

10

and cost of sales to reflect the net gains and losses on energy trading contracts. This new standard became effective beginning in the third quarter of 2002. The adoption of this requirement had no impact on our gross profit, but it did result in a reduction of sales and cost of sales.

        In October 2002, the EITF met again regarding EITF No. 02-3 and reached a consensus to rescind EITF No. 98-10 and require that all new contracts that would otherwise have been accounted for under EITF 98-10 and that do not fall within the scope of SFAS 133, no longer be marked-to-market through earnings beginning on October 25, 2002. This provision is effective for the first fiscal quarter beginning after December 15, 2002. Accordingly, a cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20 will be recorded in the first quarter of 2003 for all of those contracts affected as of October 25, 2002. The adoption of this requirement would reduce net income by approximately $13.9 million if adopted as of September 30, 2002.

        The following table reconciles gross sales and cost of sales to sales and cost of sales reported after the effects of EITF 02-3 and the reclassification of discontinued operations discussed in Note 4:

1.3.4    Impairment or Disposal of Long-Lived Assets    

        In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144). SFAS 144 addresses how and when to measure impairment on long-lived assets and how to account for long-lived assets that an entity plans to dispose of either through sale, abandonment, exchange, or distribution to owners. Additionally, this statement expands the scope of discontinued operations and requires expected future operating losses from discontinued operations to be recorded in the period in which the losses are incurred rather than the measurement date. SFAS 144 also requires that the respective income statements for current and prior periods for components of an entity that have been disposed of, or that are carried as held for sale, be shown as the results from discontinued operations, less applicable income taxes, as a separate component of income in the Consolidated Condensed Income Statement. In addition, assets held for sale shall be presented separately in the Consolidated Condensed Balance Sheet. This standard became effective for us on January 1, 2002. See Footnote 4, "Discontinued Operations," for additional information.

1.3.5    Costs Associated with Exit or Disposal Activities    

        On July 30, 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS 146). The primary effect of applying SFAS 146 will be on the timing of recognizing costs associated with exit or disposal activities. This standard requires companies to recognize certain costs associated with exit or disposal costs when they are incurred rather than at the

11

date of a commitment to an exit or disposal plan. SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002.

2.    Restructuring Charges

        During the second and third quarters of 2002, we restructured our Domestic Networks Group to more closely align itself with its regulatory service areas and exited our wholesale energy trading business. The reductions in employees that resulted from the restructuring, including employees transferred with the sale of businesses, consisted of approximately 1,120 Merchant Services employees, 80 Corporate employees, and 430 Domestic Networks employees.

        Because of these decisions, we recorded severance costs of $13.4 million in the third quarter of 2002 and $54.1 million in the nine months of 2002. Certain employees of the wholesale energy trading operations had retention agreements to ensure an orderly exit of the business. During the third quarter, we paid approximately $28.9 million of retention payments to these employees.

        As a result of these actions, we recorded restructuring charges of $116.2 million and $188.0 million, respectively, for the three- and nine-month periods ended September 30, 2002 that consisted of the following:

        Severance costs were accrued and charged to expense, but will be paid bi-weekly over the term of the severance benefit. The amount of severance costs paid for the three and nine months ended September 30, 2002, was $14.0 million and $15.4 million, respectively. The remaining liability for severance costs as of September 30, 2002, was $38.7 million.

        During the second and third quarters, we also wrote-down certain leasehold improvements and equipment in our wholesale energy trading business that were no longer realizable based on management's best estimate of their fair value. The disposition of the corporate aircraft primarily included the termination of applicable lease agreements and losses associated with the sale of our corporate aircraft. We also have operating leases for various office facilities used in the wholesale energy trading operations with future lease commitments including estimated maintenance and building restoration costs of $86.7 million. During the third quarter, we determined that $36.7 million of these leases would no longer be used and therefore recorded a restructuring charge for the estimated future net lease cost after estimated sublease recoveries. Approximately $3.1 million of these excess lease costs were paid in the third quarter.

        We continue to evaluate our staffing levels and expect to incur additional severance and retention costs as we reduce staff by approximately 200 positions in the fourth quarter of 2002.

12

3.    Impairment Charges and Net Loss on Sale of Assets

        We recorded the following impairment charges and net loss on sale of assets for the three and nine months ended September 30, 2002:

        We also incurred a $236.6 million loss on the sale of Aquila Gas Pipeline that is reflected in discontinued operations. See Footnote 4, "Discontinued Operations," for further discussion.

3.1    Quanta Services    

        At June 30, 2002, our cost basis in our 38% equity investment in Quanta of approximately $26.69 per share was significantly above the trading price of Quanta's stock. On July 1, 2002, Quanta announced that it had reduced its earnings forecast due to a continued decline in the telecommunications industry, reduced utility construction spending, and the financial difficulties of Quanta's two largest customers. Quanta's share price had dropped to approximately $3.00 per share after this announcement. Because of these factors, and the termination of our proxy contest for control of Quanta in May 2002, we concluded that there was an other than temporary decline in the fair value of this investment. Accordingly, in the second quarter of 2002, we wrote the investment down by $692.9 million to its estimated fair value of $3.00 a share, or $87.7 million in total.

        In the third quarter of 2002, we sold approximately 8.4 million shares of Quanta stock at an average price of $2.38 per share for an additional loss of $5.2 million, reducing our ownership percentage from 38% to approximately 27%. In October 2002, we sold an additional 8.0 million Quanta shares at a price of $3.00 per share. After this sale, our ownership percentage is approximately 14%. As a result, we will account for this asset as a cost method investment in future periods. We continue to evaluate our remaining holdings of 12.8 million Quanta shares and expect to dispose of these shares prior to December 31, 2002.

3.2    Wholesale Services    

        In connection with our decision to exit our wholesale energy trading operations, we assessed our ability to realize the goodwill associated with our Wholesale Services business. This assessment was based on our best estimate of the value of this business in a liquidation, which we determined was less than the carrying value of its net assets. Because future earnings or sufficient sales proceeds could no longer support this asset, we wrote off the entire unamortized goodwill balance in the second quarter of 2002.

3.3    Communications Technology Investments    

        During the quarter ended June 30, 2002, we determined that certain cost and equity method investments in our communications technology-related businesses were impaired based on continuing losses in these businesses, their continued failure to achieve operational goals, the inability of these

13

businesses to obtain additional capital, and our assessment of the long-term prospects of these businesses. Accordingly, we wrote off $23.1 million of these investments.

        In addition, we are in the process of reviewing the strategic initiatives for Everest Connections. If we decide not to continue to fund or otherwise support Everest Connections, and it is unable to obtain separate third party debt or equity funding, our current investment of approximately $210 million would be impaired in part or in its entirety.

3.4    Lodi Gas Storage    

        On October 31, 2002, we announced that we had exited our investment in the Lodi gas storage project in California due to our exit from the wholesale energy trading business. We owned 50% of WHP Acquisition Company LLC, a company jointly established with an affiliate of ArcLight Energy Partners Fund I, L.P. in 2001 to purchase Western Hub Properties LLC, the developer of the Lodi gas storage project. Under the settlement, WHP Acquisition Company LLC redeemed Aquila's ownership interest for cash payments totaling $5 million over a five-year period. We were also released from all of our guarantee obligations relating to this transaction. We recorded a $21.9 million pre-tax and after-tax loss on this transaction.

3.5    Cogentrix Transaction Termination    

        On August 2, 2002, we agreed to terminate our purchase agreement signed in April 2002 to acquire Cogentrix Energy, Inc., a leading independent power producer. We agreed with Cogentrix that due to the current uncertainty of the electric power market, the deterioration of the creditworthiness of some of Cogentrix's customers and our exit from the wholesale energy trading business, proceeding with the transaction was impractical and not in either company's interest. In connection with the termination of this transaction we expensed legal, consulting and termination fees of $12.2 million.

3.6    Notes Receivable and Royalty Interests    

        We are in the process of evaluating the best way to monetize our investment in notes receivable and associated royalty interests in our Aquila Energy Capital Corporation portfolio of loans to energy-related businesses. As part of this evaluation, we will determine if a loan-by-loan sale or sale of the entire portfolio maximizes value and liquidity to us. If we decide to execute a sale of the entire portfolio, we would expect to incur substantial losses on its disposition.

4.    Discontinued Operations

        Consistent with our announced intention to sell $1 billion of assets, we have announced the sale of the following assets from our Capacity Services segment which were considered discontinued operations in accordance with SFAS 144.

4.1    Sale of Katy Storage    

        On August 8, 2002, we signed an agreement to sell our Texas natural gas storage facility for approximately $180 million. This transaction is expected to close in the fourth quarter of 2002.

4.2    Sale of Aquila Gas Pipeline    

        On August 19, 2002, we signed an agreement to sell our Texas and Mid-Continent natural gas pipeline systems, including our natural gas and natural gas liquids processing assets, and our ownership percentage in Oasis Pipe Line Company, for $265 million. The transaction closed on October 1, 2002. In connection with this sale, we recorded an estimated pre-tax loss of $236.6 million, or $156.0 million after tax, to reduce the carrying value of the assets to be sold to their fair value less estimated selling costs.

14

        In connection with our plan to sell these assets, we have reported the results of operations of Katy Storage and Aquila Gas Pipeline in discontinued operations for the three- and nine-month periods ended September 30, 2002 and 2001 in the Consolidated Condensed Statements of Income. The related assets held for sale have been reclassified as assets of discontinued operations on the September 30, 2002 and December 31, 2001 Consolidated Condensed Balance Sheets. The Non-current Assets of Discontinued Operations at September 30, 2002 were made up of property, plant and equipment of $285.7 million, investments in unconsolidated subsidiaries of $100.2 million and goodwill of $26.7 million.

        Unaudited operating results of Katy Storage and Aquila Gas Pipeline for the three- and nine-month periods ended September 30, 2002 and 2001 are as follows:

5.    Earnings (Loss) per Common Share

        The following table shows the amounts used in computing basic and diluted earnings (loss) per common share and the effect on income and weighted average number of shares of dilutive securities for the three- and nine-month periods ended September 30, 2002 and 2001. As a result of the net loss

15

for the three-month and nine-month periods ended September 30, 2002, the potential issuances of common stock were anti-dilutive and therefore not included in those periods.

6.    Financings, Mergers, Acquisitions and Divestitures

6.1    Exchange Offer    

        On January 7, 2002, we completed an offer to acquire all of the outstanding publicly held shares of Aquila Merchant Services, Inc. (Aquila Merchant) in exchange for shares of Aquila common stock. The public shareholders of Aquila Merchant received .6896 shares of Aquila common stock in a tax-free exchange for each outstanding share of Aquila Merchant Class A common stock. Approximately 76% of the outstanding public shares of Aquila Merchant were tendered in the offer. Aquila Merchant shareholders holding approximately 1.8 million shares of Aquila Merchant Class A shares exercised dissenters' rights with respect to the merger.

        We accounted for this transaction as a purchase. The total purchase price of $369.7 million was determined based upon the market price of the approximately 12.6 million Aquila common shares issued in the tender offer and merger, an estimated liability to dissenting shareholders at the same market price and transaction costs. The purchase price was in excess of our proportionate interest in the fair value of the net assets of Aquila Merchant acquired by approximately $218.7 million. This excess was classified as goodwill and allocated as $175.0 million to our Wholesale Services segment and $43.7 million to our Capacity Services segment based on future expected cash flows. Due to our decision to exit the wholesale energy trading operations, we subsequently wrote off the goodwill that was allocated to the Wholesale Services segment based upon the lack of expected future cash flows.

6.2    Equity and Senior Notes Offerings    

        On January 30, 2002, we sold 12.5 million shares of our common stock to the public at a price of $23 per share, which raised approximately $277.7 million in net proceeds. Net proceeds from the sale were used to reduce short-term debt and for general corporate purposes.

16

        On February 28, 2002, we issued $287.5 million of 7.875% senior notes due in February 2032. These bonds are callable by us at par after February 28, 2007. Net proceeds from the sale were used to replace liquidity of $220 million previously provided under Aquila Merchant's accounts receivable sales program and to retire short-term debt incurred for general corporate purposes.

        On July 3, 2002, we completed our concurrent offerings of 37.5 million shares of our common stock to the public at a price of $7.50 per share and $500 million of 11.875% senior unsecured notes due in July 2012, raising total proceeds of approximately $764 million. We used the proceeds from these offerings to repay $417 million of borrowings under the revolving credit facility, to retire $100 million of current maturities of company-obligated preferred securities and to increase liquidity. On September 2, 2002, Moody's lowered our credit rating from Baa3 to Ba2. As a result, the interest rate on these senior notes has increased to 13.125%.

6.3    Pipeline Operations    

        In January 2002, we completed the sale of an intrastate pipeline for our net book value of approximately $65.9 million, including a $5 million deposit received in 2001.

6.4    Midlands Electricity Acquisition    

        On May 8, 2002, we completed our purchase of a 79.9% economic interest in Midlands Electricity plc (Midlands), a United Kingdom electricity network, from FirstEnergy Corp. The gross price of this acquisition was approximately $262 million. The purchase price consists of an initial payment of $155 million, which was financed through a short-term acquisition facility, transaction costs of $19 million, and a promissory note to be paid in six equal annual payments of $19 million each (with an initial present value of approximately $88 million). Midlands is the fourth-largest regional electricity company in the United Kingdom, serving approximately 2.3 million customers through a 38,000-mile distribution network. Midlands also owns 886 megawatts of net generating capacity in the U.K., Turkey and Pakistan. Pursuant to an operating services agreement, we provide management and operating services to Midlands in exchange for a management fee.

        In connection with the acquisition, FirstEnergy retained substantive participating and protective rights as the minority partner. We and FirstEnergy each have 50% voting power and an equal number of representatives on the Midlands board of directors. Although we have the majority economic interest, FirstEnergy's participation in the ordinary course of making business decisions is significant; including approval of senior management compensation, additional capital contributions, distributions other than as provided in the agreement, budgets and financial plans and the dissolution of the company. As such, we are required to account for this acquisition using the equity method of accounting. FirstEnergy has the right to sell its interest in Midlands to us at fair market value if, at any time during the 30-day period prior to May 8, 2008, the fair value of FirstEnergy's holdings is less than $72.8 million.

        The continuation of recognizing equity earnings from our Midlands investment is dependent on an assumption that the investment will be realized in cash dividends or cash proceeds from the possible sale of the investment. Although the current forecast supports the recognition of equity earnings, we may be precluded from recognizing equity earnings if we conclude that those earnings cannot be realized in cash. Additionally, if Midlands' credit rating is downgraded below investment grade, Midlands may be prohibited from paying dividends or may require additional cash funding to stabilize its financial condition. Midlands is committed to maintaining its investment grade rating and has taken such steps as reducing the level of dividends paid and eliminating discretionary cash expenditures. However, we may not be in a financial position to provide such support to Midlands, if required, which may eliminate our ability to recognize equity earnings and potentially impair a portion of our investment.

17

        A summary income statement for Midlands for the year ended December 31, 2001, is as follows:

        On August 7, 2002, we initiated a bid process for the sale of our interest in Midlands. We expect to receive binding offers in late November and will make a determination regarding the acceptance of any of the offers in December.

6.5    New Zealand    

        On October 11, 2002, 100% of the outstanding shares of UnitedNetworks Limited (UNL), in which we had a 70.2% indirect interest, were acquired by VECTOR Limited for a purchase price of NZ$9.90 per share. The sale resulted in $362 million of net cash proceeds to us which will be utilized to retire debt. Prior to closing this transaction, we repurchased our minority partner's 14.7% stake in UNL for approximately $38.5 million. We expect to record a $120 million pre-tax gain, or $28 million after-tax gain, in the fourth quarter of 2002 as a result of this sale.

6.6    Pulse Energy    

        On July 2, 2002, we announced that United Energy and Multinet Gas had reached an agreement to sell their combined 50% interest in Pulse Energy, a retail electric and gas company. Through our 34% ownership in United Energy and our 25.5% ownership in Multinet Gas, we had an approximate 15% ownership in Pulse. United Energy also announced the sale of its interests in EdgeCap, a marketing and trading business, and Utili-Mode, a provider of back office support services for United Energy and others. The sales of these three businesses closed in the third quarter and resulted in a $3.0 million pre-tax and after-tax gain.

6.7    Power Plant Lease    

        In February of 2002, we entered into an agreement to lease from a special purpose entity a $235 million, 510-megawatt power plant which is being constructed in Piatt County, Illinois. We expect construction to be completed in June 2003. Under the lease, which is a five-year operating lease that begins after construction is completed, we guarantee up to 89.99% of the construction costs prior to completion. We also guarantee that the residual value at the end of the lease will equal at least 83% of construction costs. As of September 30, 2002, $178.0 million of construction costs had been funded. We are required to cash collateralize all future construction costs in excess of the $178.0 million spent to date. We have deposited $45.3 million of cash collateral as of September 30, 2002. See Footnote 9, "Credit Facilities—Debt Covenants," for further discussion.

18

6.8    Hole House    

        On October 15, 2002, we sold our Hole House natural gas storage assets in the United Kingdom for $34.9 million. In connection with this sale, we recorded an estimated pre-tax and after-tax loss on disposal of $1.8 million to reduce the carrying value of the assets to their fair value less estimated selling costs.

6.9    Lockport Energy    

        On September 30, 2002, we completed the sale of our 16.58% interest in the Lockport Energy facility for $37.5 million that was comprised of $27.0 million in cash and a $10.5 million note due in November 2002. We recorded a minimal pre-tax gain and a $5.3 million after-tax loss on this sale.

        See Footnote 3, "Impairments and Net Loss on Sale of Assets," and Footnote 4, "Discontinued Operations," for discussion of other asset sales.

7.    Finance Subsidiaries' Securities

        Aquila Networks Canada Finance Corporation and UtiliCorp Capital Trust I are wholly-owned consolidated finance subsidiaries of Aquila. We have fully and unconditionally guaranteed the $200 million of long-term debt and $250 million of company-obligated preferred securities issued by these subsidiaries, respectively.

19

8.    Reportable Segment Reconciliation