Days after the company announced it would officially exit the wholesale energy marketing and trading business by the end of the third quarter, Kansas City-based Aquila Inc. reported a loss of $5.69 per share for the second quarter, compared to earnings per share of $1.21 in the second quarter of 2001.

In taking the earnings hit, Aquila said it took its lumps on its Quanta Services investment, company restructuring and lower commodity trading volumes and prices. The troubled Quanta Services builds lines and infrastructure for telecommunication companies and utilities.

Excluding non-recurring charges of $966.4 million or $858.5 million after tax, the company posted second quarter operating earnings of 34 cents per share. For the first half of 2002, the company reported a loss of $5.49 per share, compared to earnings per share of $1.93 for the first half of 2001.

“This year’s second quarter was a very difficult one,” said CEO Robert K. Green. “The actions we have taken recently — such as exiting the wholesale energy trading business, reducing the dividend and writing down certain asset values — were painful, but necessary steps as we transition back to our roots as an operator of network and generation assets.”

Shortly after releasing its second quarter earnings, Aquila announced that it has signed an agreement to sell its Texas natural gas storage operations for $180 million in cash to PacifiCorp Power Marketing, Inc. (PPM), ScottishPower’s Oregon-based competitive U.S. energy business. The move is in line with its previously announced effort to strengthen its balance sheet and credit ratings through the sale of $1 billion in non-strategic assets.

Aquila’s Global Networks Group contributed the most in the non-recurring charges category, posting one-time charges of $735.9 million ($692.9 million of which is attributable to Aquila’s Quanta investment). Including those charges, second quarter results before interest and taxes (EBIT) for the group added up to a loss of $673.7 million, down $725.7 million compared to the second quarter of 2001. Excluding non-recurring items, Aquila said operating EBIT was up $10.2 million compared to a year earlier. The company allowed that the majority of this increase relates to the suspension of Aquila’s long-term incentive plan until Aquila’s credit ratings are improved.

Of the non-recurring item charges in the quarter, Aquila’s restructuring accounted for $71.8 million. The company said that in addition to the June 17 decision to scale back the wholesale energy trading business, Aquila recently restructured its domestic regulated utility business (see NGI, June 24). Of the $71.8 million, $19.9 million related to domestic networks and $51.9 million related to merchant services. Aquila said most of the costs related to employee separation costs and the write-off of office space improvements.

Closing down what was once the crown jewel and future of the company, Aquila said shuttering the trading business makes good on the company’s June promise to close its Merchant Services unit by the end of summer and fire nearly all of its 1,100-plus employees across the country and overseas. The segment laid off “hundreds” of employees earlier in the summer.

Over the last two months, Aquila had announced major cutbacks within its energy trading unit and lowered its 2002 earnings guidance by 30%. The company said its energy trading profits totaled $270 million in 2001 and were expected to drop to around $55 million for 2002.

Since announcing plans in mid-June to reduce its risk exposure and restructure the business, Aquila has eliminated all market-making activity and speculative trading, commonly referred to as “proprietary trading.” Aquila added that the elimination of this activity has resulted in an approximately 90% reduction in physical throughput.

As a part of the restructuring process, the company said it has worked with The Blackstone Group during the past several weeks to explore its strategic exit options.

“While we had explored the idea of securing a partner, we believe it is in the best interest of our shareholders to completely exit the wholesale energy marketing and trading business,” said Green. “Our focus now is to ensure a coordinated and seamless exit.”

Due to the shutdown, the company said Aquila Merchant Services’ North American and European workforce of approximately 500 will be significantly reduced. Since May, Aquila said about 550 positions have been eliminated across all merchant operations. However, as part of its exit strategy, Aquila said it has reached an agreement with Chicago-based Citadel Investment Group to provide potential career opportunities with the investment firm for those Aquila employees directly impacted.

A spokeswoman for the company said it is still unclear as to how many of the 500 remaining marketing and trading employees will be let go. “There will be an opportunity for some of those employees to come over” to Aquila’s Capacity Services segment, which manages Aquila’s non-utility assets, Aquila’s Mary Amundsen said. However, she added that “we do want to acknowledge that there will be significant reductions in that 500.”

Following the late September shutdown of the energy trading business, Aquila said Capacity Services will only market energy from the assets the company owns or controls.

“Our wholesale energy marketing and trading business is operated by some of the best talent in the industry, and they have created considerable value for Aquila in the past decade,” Green added. “Their skills and experience have played a major role in our growth. The process of taking this business from a top-five energy marketer to a complete exit of trading has required tremendous effort and that reflects well on the professionalism and commitment of Aquila’s people.”

In addition, the company said that an additional charge related to future severance, retention and lease termination costs is expected for the third quarter as a result of the Aug. 6 decision to exit the wholesale energy trading business completely.

Based on lower than expected power prices, higher interest costs and lower Quanta Services earnings, Aquila said it is reducing its full-year earnings guidance to $1 per share, down from previous guidance of $1.30-1.40. Green said the largest factor is the lower than expected power prices, reflecting reduced demand during the economic downturn, reduced liquidity in the energy market as players have exited and the current over-supply of electric generation capacity.

Aquila’s Merchant Services took a sizeable hit during the quarter. The segment’s second quarter loss before interest and taxes was down $440.5 million compared to the same period of 2001. About $99.2 million of the loss resulted mainly from less volatile and lower commodity prices in 2002, a change in the method of accounting for gas storage inventory, and the shorter period of full-scale operations resulting from the June 17 decision to cut back the wholesale energy marketing and trading business.

Capacity Services had operating EBIT of $25.6 million compared to $41.1 million a year earlier. Aquila said the main factors impacting the quarter were lower spark spreads when compared to levels experienced in 2001, lower power prices, and lower volumes and prices of natural gas liquids in the gas gathering and processing business.

Speaking on the Texas storage asset sale, Green said, “This announcement is part of our goal to sell $1 billion in non-strategic assets. While we are selling our Texas storage operations, we still remain committed to continuing the development of our western gas storage properties, which include Lodi in California and Red Lake in Arizona.”

The company’s Texas storage assets include the Katy storage facility near Houston, one of the largest operating storage facilities in the Southwest, two storage development opportunities and two other storage facilities in North Texas. The Katy facility has a working capacity of 21 Bcf and has connections with 13 different pipelines. Katy currently has 16 Bcf of the 21 Bcf of working gas capacity under firm contract.

In addition to the Texas deal, Aquila made numerous steps in its asset divestment plan over the last quarter. In July, the company announced the sale of its 16.58% interest in the Lockport Energy facility near Buffalo, NY for $37.5 million in cash (see NGI, July 8). On Wednesday, Aquila announced it is also starting a formal bid process to sell its 79.9% interest in Midlands Electricity in the United Kingdom.

Updating the situation of UnitedNetworks (see NGI, June 17), in which it owns a 55.5% stake, Aquila said that it has received bids from several interested buyers and named a short list of bidders that now are conducting due diligence. Bidders must have their final binding bids in by August, with a selection of the successful bidder targeted for the end of the month. UnitedNetworks is the largest electric and natural gas distribution utility in New Zealand.

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