Aquila shares plummeted 35% last Thursday to $2.16/share and fell another 3% Friday to $2.09 by mid afternoon after the company suspended its dividend and announced a loss of $332 million, or $1.85 per share, for the 2002 third quarter, compared to diluted earnings of $69 million, or $0.58/share, in the third quarter of 2001.

Wall Street analysts had been expecting earnings of 14 cents/share for the quarter. For the nine months ended Sept. 30, the company reported a massive $1.1 billion loss, $7.17 per share, compared to earnings of $286 million, $2.50/share, for the same period in 2001. CEO Richard Green called 2002 a “real disaster” compared to 2001, “the best year in Aquila’s history.”

The company’s financials in the third quarter were “truly bad,” said analyst Ronald Barone at UBS Warburg. Barone sharply lowered his earnings forecast for the company and cut his stock price target by 250% to only $2.

“Historically we have priced ILA shares based on the sum-of-the-parts methodology. However the company’s complex/murky financial structure and a lack of information has made this analysis virtually impossible,” said Barone. “As a result we are pricing ILA shares based on a simple forward P/E approach. We apply a 10x multiple to our very preliminary 2003 [earnings per share] estimated at 20 cents.”

Excluding non-recurring charges of $155.8 million after tax and a loss from discontinued operations of $151.0 million after tax, the third quarter operating loss was $0.14 per fully diluted common share.

“We’re naturally disappointed by Fitch’s decision,” said Green, “but we’ve already been operating more than two months with a prior non-investment grade rating. We’re well prepared to meet any additional cash requirements that may result from this latest credit action.”

Green said the company plans to “do more than simply survive. Aquila’s liquidity is sufficient to ensure that Aquila can continue to operate safe and reliable utility networks and maintain quality customer service. This remains a healthy core business.” Aquila said the decision to cut its dividend was part of its strategy to strengthen its credit profile.

While core domestic and international networks contributed strong earnings, the company continued to bear the costs of exiting the troubled energy trading sector.

“The third quarter and the year as a whole have been a disaster for Aquila as well as for our industry,” said Green. “Exiting the wholesale energy trading business, writing down assets, reducing the workforce by approximately 1,600 employees, cutting and then suspending the dividend all have caused our shareholders and employees a great deal of pain.

“The aggressive restructuring we began six months ago is designed to position Aquila for the future. With the exit from the trading business largely behind us,” he said, “we can now focus on the next critical phase of our transition — the restructuring or termination of our tolling contracts on terms mutually acceptable to us and our counterparties.”

He said Aquila expects to record significant charges during this year’s fourth quarter related to renegotiation of contracts, the continued exit from wholesale commodity positions, additional severance costs and possible additional asset impairments. “The largest factor affecting operating earnings going forward is low power prices resulting from lower demand during the economic downturn and the current oversupply of generating capacity,” Green said.

Merchant Services had a third quarter loss before interest and taxes of $282.1 million, compared to earnings before interest and taxes of $36.6 million in the 2001 quarter. Approximately $215.8 million of the variance related to non-recurring charges. The rest of the decrease, $102.9 million, was from the company’s exit from wholesale energy trading operations.

Capacity Services had a loss before interest and taxes of $40.8 million for the quarter compared to EBIT of $13.3 million a year earlier. One-time charges accounted for $34.9 million of the variance. The other main factors impacting the quarter were lower power prices and spark spreads and higher capacity payments for tolls and synthetic leases that allow Aquila to generate power at plants owned by others.

Currently the company has obligations to pay $118.2 million annually under long-term, fixed capacity contracts or leases. With relatively low prices for power and high prices for natural gas expected to continue through 2003, the current economics make it unlikely that Aquila can sell power to recover these capacity payments. For the foreseeable future, Aquila does not expect this business unit to be profitable and the company will have to renegotiate the structure of certain contracts, including its tolling agreements.

Third quarter earnings before interest and taxes (EBIT) for Aquila’s Global Networks was $92.8 million, compared to $93.9 million in 3Q2001. International Networks provided EBIT of $60.8 million compared to $48.9 million. Domestic utility operations posted EBIT of $32 million, compared to $45 million in the 2001 quarter.

The company reported $226 million in total non-recurring charges in the third quarter related to impairments resulting from asset sales, losses in connection with winding down the wholesale trading book, and the exit from wholesale energy trading businesses. There were no non-recurring charges in the 2001 third quarter.

Aquila has targeted the sale of $1 billion in non-strategic assets, $796.6 million of which have already been sold. The assets include its New Zealand utility, gas pipeline and processing assets, Quanta stock, New York power project, UK gas storage assets, the cost of a development loan and the pending sale of its Texas gas storage business. Aquila also is in the process of carrying out a formal bid process to sell its 79.9% interest in Midlands Electricity.

Aquila said that as a result of its operating performance, the winding down of merchant energy businesses and the asset sales program, it is not going to be in compliance with an interest coverage requirement contained in certain financial arrangements until at least Dec. 31, 2003. As a result, it has obtained a waiver from this requirement, which will expire on April 12, 2003, in exchange for certain payments to financial institutions, the dividend cut, lower borrowing capacity, and possibly pledging its domestic regulated assets as collateral. Aquila must renegotiate its bank financing arrangements prior to the waiver’s expiration.

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