Kansas City, MO-based Aquila Inc. responded to last Thursday’s 52% drop in its share price by restating its confidence in its liquidity position, credit standing and its preparedness for any sudden collateral requirements in the event of a credit ratings downgrade to junk status. Aquila currently is rated only one notch above junk status by Moody’s Investors Service and Fitch Ratings and two notches above junk by Standard and Poor’s.

“We would like to reiterate that our current liquidity position of $754 million, as disclosed in our second-quarter Form10-Q, has not changed. Our liquidity position as of today is comprised of $492 million in domestic cash, $80 million in highly liquid commodity inventory, and $182 million of availability on a $650 million revolving line of credit (50% of which expires April 2003 and the other 50% in 2005).”

Investors apparently were concerned on Thursday that Aquila’s liquidity was rapidly drying up and that a rating downgrade was forthcoming when rumors surfaced during the week that the company was drawing down its available credit line. On Wednesday, Aquila converted $400 million of its revolving credit facility to cash to replenish its cash balance from $92 million to a normalized level of $250 million in order to repay scheduled debt maturities coming due later in the year and for general corporate purposes. “We expect that a portion of the draw will be repaid upon consummation of the recently announced and future asset sales,” Aquila officials said in a statement on Friday.

In its second-quarter 10-Q, management also updated investors on its best estimate of collateral requirements in the event of a credit rating downgrade. The company said in its statement Friday that only $135 million would be required. However, in its 10-Q, it stated that there could be additional collateral requirements, including $177 million to repurchased bonds issued by its Australian subsidiaries, $172 million to cover requirements of its tolling agreements and $62 million required under its margining agreements in the event that its credit rating falls below investment grade.

Adding further uncertainty to its financial position is the legal battle with Chubb Insurance Group, the issuer of surety bonds that support Aquila’s performance under certain long-term gas supply contracts. Chubb demanded that it be released from its up to $561 million surety obligation or, alternatively, that Aquila post collateral to secure its obligation. On Feb. 19, Aquila filed a lawsuit against Chubb. “We do not believe that Chubb is entitled to be released from its surety obligations or that we are obligated to post collateral to secure its obligations unless it is likely we will default on the contracts,” Aquila told the SEC in its 10-Q. “Chubb has not alleged that we are likely to default on the contracts. If Chubb were to prevail, it would have a material adverse impact on our liquidity and financial position.”

However, Aquila evidently believes it can avoid these dire circumstances. “We believe that our liquidity position should be sufficient to meet short-term demands in the event of a downgrade by one or all three agencies as stated in the August 14 Form 10-Q.

“We believe that recent actions taken by the company improve our credit standing and demonstrate considerable progress toward achieving our goal of maintaining a strong investment grade credit rating profile for the company. We are in the process of completely exiting the wholesale energy trading business and are currently liquidating most of our remaining trading positions. In early July, we completed equity and debt offerings totaling $764 million in net proceeds. We have executed contracts for asset sales totaling $218 million to date, and we are making progress with the remainder of our $1 billion asset sale program. We are currently in the process of completing several additional bid processes, including the publicly announced sale for our New Zealand and United Kingdom investments. We reduced our dividend by 42% to provide additional financial flexibility and to more appropriately match earnings and fixed charges. We have made considerable progress in our cost-savings initiatives, identifying and implementing $100 million in cost reductions on an annualized basis already this year.”

Also spooking investors last week, was Aquila’s decision to file an amended Form 10-K to reclassify $110.8 million cash flows from operations for last year into cash flow from investing activities. The company’s new auditor suggested the change because the gain was from the initial public offering of the Aquila Merchant Services unit last April. Although it had been completely disclosed in its Form 10-K filings, it had been classified as cash from operations rather than investing. Despite the reclassification, total cash flow for the year did not change.

Aquila operates electricity and natural gas distribution networks serving more than six million customers in seven states and in Canada, the United Kingdom, New Zealand and Australia. As of June 30, Aquila had total assets of $11.9 billion.

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