**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**_______________________**

 

**FORM** **10-Q**

 

| **(Mark One)**                                                              |                                                                  |
|-----------------------------------------------------------------------------|-----------------------------------------------------------------------|
| **x**                                                                       | **QUARTERLY REPORT PURSUANT TO SECTION** **13 OR 15(d) OF THE**  |
|                                                                        | **SECURITIES EXCHANGE ACT OF 1934**                                   |
|                                                                        |
| **For the quarterly period ended September 30, 2007**                       |
|                                                                        |
| **OR**                                                                      |
|                                                                        |
| **o**                                                                       | **TRANSITION REPORT PURSUANT TO SECTION** **13 OR 15(d) OF THE** |
|                                                                        | **SECURITIES EXCHANGE ACT OF 1934**                                   |
|                                                                        |
| **For the transition period from** **__________ to** **________** |
|                                                                        |
| **Commission file number: 1-03562**                                         |

 

**_______________________**

 

**AQUILA,** **INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                             | **44-0541877**                    |
|------------------------------------------|-----------------------------------|
| (State or other jurisdiction of          | (IRS Employer Identification No.) |
| incorporation or organization)           |                              |
|                                     |                              |
| **20 West Ninth Street, Kansas City,**   | **64105**                         |
| **Missouri**                             | (Zip Code)                        |
| (Address of principal executive offices) |                              |

 

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 x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (see definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). 

|   | Large Accelerated filer x | Accelerated filer o | Non-accelerated filer o |
|--------|---------------------------|---------------------|-------------------------|

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

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

 

| **Class**                  | **Outstanding at November 2, 2007** |
|----------------------------|-------------------------------------|
| Common Stock, $1 par value | 375,912,718                         |

 

 

**PART** **I—FINANCIAL INFORMATION**

 

*ITEM* *1. FINANCIAL STATEMENTS*

 

Information regarding the consolidated financial statements is on pages 5 through 33.

 

*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 is on pages 33 through 52.

 

*ITEM* *3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK*

 

We are subject to market risk as described on pages 66 through 69 of our 2006 Annual Report on Form 10-K.  See discussion on page 52 of this document for changes in market risk since December 31, 2006.

 

*ITEM* *4. CONTROLS AND PROCEDURES*

 

Information regarding disclosure controls and procedures is on page 53.

 

**PART** **II—OTHER INFORMATION**

 

*ITEM* *1. LEGAL PROCEEDINGS*

 

Information regarding legal proceedings is on page 54.

 

*ITEM 1A. RISK FACTORS*

 

See pages 21 through 25 of our 2006 Annual Report on Form 10-K for a discussion of risk factors.

 

*ITEM* *2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS*

 

Not applicable.

 

*ITEM* *3. DEFAULTS UPON SENIOR SECURITIES*

 

Not applicable.

 

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

 

Information regarding submission of matters to a vote of security holders is on page 54.

 

*ITEM* *5. OTHER INFORMATION*

 

Information regarding other information is on page 54.

 

*ITEM* *6. EXHIBITS*

 

Exhibits are on page 55.

 

2

**Glossary of Terms and Abbreviations**

 

AFUDC – Allowance for Funds Used During Construction.

Aquila Merchant – Aquila Merchant Services, Inc., our wholly-owned merchant energy subsidiary.

Black Hills – Black Hills Corporation, a South Dakota corporation.

Crossroads plant – the Crossroads Energy Center, a 340 MW electric generation “peaking” facility located in Clarksdale, Mississippi which is contractually controlled by Aquila.

EBITDA – Earnings before interest, taxes, depreciation and amortization.

EITF – Emerging Issues Task Force, an organization that is designed to assist the FASB in improving financial reporting through the identification, discussion and resolution of financial issues within the framework of existing authoritative literature.

ERISA – Employee Retirement Income Security Act of 1974, as amended.

Exchange Act – Securities Exchange Act of 1934, as amended.

FAC – Fuel Adjustment Clause, a regulatory mechanism authorized by the Missouri Public Service Commission which allows for recovery of 95% of fuel costs in excess of those included in base rates.

FASB – Financial Accounting Standards Board, a rulemaking organization that establishes financial accounting and reporting standards in the United States of America.

FERC – Federal Energy Regulatory Commission, a governmental agency of the United States of America that, among other things, regulates interstate transmission and wholesale sales of electricity and gas and related matters.

FIN – FASB Interpretation intended to clarify accounting pronouncements previously issued by the FASB.

Fitch – Fitch Ratings, a leading global rating agency.

GAAP – Generally Accepted Accounting Principles in the United States of America.

Great Plains Energy – Great Plains Energy Incorporated, a Missouri corporation.

GWh – Gigawatt-hour.

IUB – Iowa Utilities Board, a governmental agency of the State of Iowa that, among other things, regulates the tariffs and service quality standards of our regulated utility operations in Iowa.

Kansas Commission – Kansas Corporation Commission, a governmental agency of the State of Kansas that, among other things, regulates the tariffs and service quality standards of our regulated utility operations in Kansas.

KCPL – Kansas City Power & Light Company, an electric utility company with operations in Missouri and Kansas that is wholly owned by Great Plains Energy.

LIBOR – London Inter-Bank Offering Rate.

Merger – the pending merger of Gregory Acquisition Corp., a wholly-owned subsidiary of Great Plains Energy, with and into Aquila.

Missouri Commission – Missouri Public Service Commission, a governmental agency of the State of Missouri that, among other things, regulates the tariffs and service quality standards of our regulated electric utility operations in Missouri.

Moody’s – Moody’s Investors Service, Inc., a leading global rating agency.

MW – Megawatt, which is one thousand kilowatts.

Nebraska Commission – Nebraska Public Service Commission, a governmental agency of the State of Nebraska that, among other things, regulates the tariffs and service quality standards of our regulated utility operations in Nebraska.

 

3

NYMEX – New York Mercantile Exchange.

OCI – Other Comprehensive Income (Loss) as defined by GAAP.

SAIFI – System Average Interruption Frequency Index.

S&P – Standard and Poor’s, a division of The McGraw-Hill Companies, Inc., a leading global rating agency.

SEC – Securities and Exchange Commission, a governmental agency of the United States of America.

SFAS – Statement of Financial Accounting Standards, the accounting and financial reporting rules issued by FASB.

Westar – Westar Energy, Inc., a Kansas utility company.

 

4

**Part** **I.  Financial Information**

**Item 1.  Financial Statements**

 

**Aquila,** **Inc.**

**Consolidated Statements of Income—Unaudited**

 

|                                                             | **Three Months Ended** |
|------------------------------------------------------------------|------------------------|
|                                                             | **September 30,**      |
| *In millions, except per share amounts*                          | **2007**               | **2006** |
| **Sales:**                                                       |                   |   |   |   |
| Electricity—regulated                                       | $                      | 282.1 | $ | 242.8 |
| Natural gas—regulated                                       |                   | 68.0 |   | 71.4 |
| Other—non-regulated                                         |                   | 7.6 |   | 2.4 |
| **Total sales**                                                  |                   | 357.7 |   | 316.6 |
| **Cost of sales:**                                               |                   |   |   |   |
| Electricity—regulated                                       |                   | 136.1 |   | 135.0 |
| Natural gas—regulated                                       |                   | 38.1 |   | 43.9 |
| Other—non-regulated                                         |                   | 4.6 |   | 2.9 |
| **Total cost of sales**                                          |                   | 178.8 |   | 181.8 |
| **Gross profit**                                                 |                   | 178.9 |   | 134.8 |
| **Operating expenses:**                                          |                   |   |   |   |
| Operation and maintenance expense                                |                   | 78.4 |   | 87.8 |
| Taxes other than income taxes                                    |                   | 8.5 |   | 8.5 |
| Restructuring charges                                            |                   | – |   | .6 |
| Net loss on sale of assets and other charges                     |                   | – |   | 5.5 |
| Depreciation and amortization expense                            |                   | 27.3 |   | 27.0 |
| **Total operating expenses**                                     |                   | 114.2 |   | 129.4 |
| **Operating income**                                             |                   | 64.7 |   | 5.4 |
| Other income (expense), net                                      |                   | 4.1 |   | 6.5 |
| Interest expense                                                 |                   | 31.5 |   | 42.7 |
| **Income (loss) from continuing operations before income taxes** |                   | 37.3 |   | (30.8) |
| **Income tax expense (benefit)**                                 |                   | 5.6 |   | (10.2) |
| **Income (loss) from continuing operations**                     |                   | 31.7 |   | (20.6) |
| **Earnings from discontinued operations, net of tax**            |                   | 8.8 |   | 136.3 |
| **Net income**                                                   | $                      | 40.5 | $ | 115.7 |
|  

**Basic and diluted earnings (loss) per common share:**  |                   |   |   |   |
| Continuing operations                                            | $                      | .09 | $ | (.05) |
| Discontinued operations                                          |                   | .02 |   | .36 |
| Net income (loss)                                                | $                      | .11 | $ | .31 |
|  

**Dividends per common share**                           | $                      | – | $ | – |

See accompanying notes to consolidated financial statements.

 

5

**Aquila,** **Inc.**

**Consolidated Statements of Income—Unaudited**

 

|                                                            | **Nine Months Ended** |
|-----------------------------------------------------------------|-----------------------|
|                                                            | **September 30,**     |
| *In millions, except per share amounts*                         | **2007**              | **2006** |
| **Sales:**                                                      |                  |   |   |   |
| Electricity—regulated                                      | $                     | 651.9 | $ | 601.0 |
| Natural gas—regulated                                      |                  | 435.4 |   | 413.3 |
| Other—non-regulated                                        |                  | 13.2 |   | 16.3 |
| **Total sales**                                                 |                  | 1,100.5 |   | 1,030.6 |
| **Cost of sales:**                                              |                  |   |   |   |
| Electricity—regulated                                      |                  | 354.2 |   | 327.7 |
| Natural gas—regulated                                      |                  | 310.8 |   | 300.2 |
| Other—non-regulated                                        |                  | 11.7 |   | 33.3 |
| **Total cost of sales**                                         |                  | 676.7 |   | 661.2 |
| **Gross profit**                                                |                  | 423.8 |   | 369.4 |
| **Operating expenses:**                                         |                  |   |   |   |
| Operation and maintenance expense                               |                  | 240.8 |   | 240.8 |
| Taxes other than income taxes                                   |                  | 21.9 |   | 22.6 |
| Restructuring charges                                           |                  | 1.6 |   | 5.5 |
| Net loss on sale of assets and other charges                    |                  | 1.3 |   | 246.9 |
| Depreciation and amortization expense                           |                  | 81.4 |   | 78.5 |
| **Total operating expenses**                                    |                  | 347.0 |   | 594.3 |
| **Operating income (loss)**                                     |                  | 76.8 |   | (224.9) |
| Other income (expense), net                                     |                  | 23.4 |   | 14.4 |
| Interest expense                                                |                  | 111.6 |   | 124.4 |
| **Loss from continuing operations before income taxes**         |                  | (11.4) |   | (334.9) |
| **Income tax benefit**                                          |                  | (.6) |   | (43.9) |
| **Loss from continuing operations**                             |                  | (10.8) |   | (291.0) |
| **Earnings from discontinued operations, net of tax**           |                  | 12.3 |   | 250.6 |
| **Net income (loss)**                                           | $                     | 1.5 | $ | (40.4) |
|  

**Basic and diluted earnings (loss) per common share:** |                  |   |   |   |
| Continuing operations                                           | $                     | (.03) | $ | (.78) |
| Discontinued operations                                         |                  | .03 |   | .67 |
| Net income (loss)                                               | $                     | – | $ | (.11) |
|  

**Dividends per common share**                          | $                     | – | $ | – |

See accompanying notes to consolidated financial statements.

 

6

**Aquila,** **Inc.**

**Consolidated Balance Sheets**

|                                                | **September 30,** | **December 31,** |
|-----------------------------------------------------|-------------------|------------------|
| *In millions*                                       | **2007**          | **2006**         |
|                                                |              | (Unaudited)      |   |   |
| **Assets**                                          |              |             |   |   |
| **Current assets:**                                 |              |             |   |   |
| Cash and cash equivalents                           | $                 | 92.5             | $ | 232.8 |
| Funds on deposit                                    |              | 50.5             |   | 107.9 |
| Accounts receivable, net                            |              | 219.9            |   | 257.0 |
| Inventories and supplies                            |              | 119.5            |   | 116.0 |
| Price risk management assets                        |              | 46.3             |   | 71.3 |
| Regulatory assets, current                          |              | 7.8              |   | 29.0 |
| Other current assets                                |              | 21.6             |   | 33.5 |
| Current assets of discontinued operations           |              | –           |   | 26.5 |
| **Total current assets**                            |              | 558.1            |   | 874.0 |
| Utility plant, net                                  |              | 1,917.4          |   | 1,825.1 |
| Non-utility plant, net                              |              | 123.1            |   | 130.2 |
| Price risk management assets                        |              | 18.3             |   | 43.4 |
| Goodwill, net                                       |              | 111.0            |   | 111.0 |
| Regulatory assets                                   |              | 128.4            |   | 149.0 |
| Deferred charges and other assets                   |              | 51.6             |   | 53.6 |
| Non-current assets of discontinued operations       |              | –           |   | 286.1 |
| **Total Assets**                                    | $                 | 2,907.9          | $ | 3,472.4 |
|                                                |              |             |   |   |
| **Liabilities and Shareholders’ Equity**       |              |             |   |   |
| **Current liabilities:**                            |              |             |   |   |
| Current maturities of long-term debt                | $                 | 2.3              | $ | 19.7 |
| Accounts payable                                    |              | 113.7            |   | 205.4 |
| Accrued interest                                    |              | 31.0             |   | 49.7 |
| Regulatory liabilities, current                     |              | 33.2             |   | 10.8 |
| Accrued compensation and benefits                   |              | 25.8             |   | 26.8 |
| Pension and post-retirement benefits, current       |              | 3.5              |   | 3.5 |
| Other accrued liabilities                           |              | 59.7             |   | 94.3 |
| Price risk management liabilities                   |              | 38.4             |   | 74.5 |
| Customer funds on deposit                           |              | 23.5             |   | 15.6 |
| Current liabilities of discontinued operations      |              | –           |   | 1.4 |
| **Total current liabilities**                       |              | 331.1            |   | 501.7 |
| **Long-term liabilities:**                          |              |             |   |   |
| Long-term debt, net                                 |              | 1,035.9          |   | 1,385.9 |
| Deferred income taxes and credits                   |              | –           |   | 19.3 |
| Price risk management liabilities                   |              | 7.3              |   | 27.1 |
| Pension and post-retirement benefits                |              | 73.4             |   | 72.5 |
| Regulatory liabilities                              |              | 73.0             |   | 72.4 |
| Deferred credits                                    |              | 52.1             |   | 51.5 |
| Non-current liabilities of discontinued operations  |              | –           |   | 35.9 |
| **Total long-term liabilities**                     |              | 1,241.7          |   | 1,664.6 |
|                                                |              |             |   |   |
| **Common shareholders’ equity**                |              | 1,335.1          |   | 1,306.1 |
|                                                |              |             |   |   |
| **Total Liabilities and Shareholders’ Equity** | $                 | 2,907.9          | $ | 3,472.4 |

 

See accompanying notes to consolidated financial statements.

 

7

**Aquila,** **Inc.**

**Consolidated Statements of Comprehensive Income—Unaudited**

 

| * *                                                                                                                                                                                                                                                                                                             | **Three Months Ended** | **Nine Months Ended** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------|-----------------------|
| * *                                                                                                                                                                                                                                                                                                             | **September 30,**      | **September 30,**     |
| *In millions***                                                                                                                                                                                                                                                                                                      | **2007**               | **2006**              | **2007** | **2006** |
| **Net income (loss)**                                                                                                                                                                                                                                                                                                | $                      | 40.5                  | $ | 115.7 | $ | 1.5 | $ | (40.4) |
| **Other comprehensive income (loss), net of related tax:**                                                                                                                                                                                                                                                           |                   |                  |   |   |   |   |   |   |
| Foreign currency adjustments:                                                                                                                                                                                                                                                                                        |                   |                  |   |   |   |   |   |   |
| Foreign currency translation adjustments, net of deferred tax expense (benefit) of $– million and $.1 million for the three months ended September 30, 2007 and 2006, respectively and $.5 million and $(.3) million for the nine months ended September 30, 2007 and 2006, respectively                        |                   | –                |   | .2 |   | .8 |   | (.4) |
| Reclassification of foreign currency (gains) losses to income, net of deferred tax (expense) benefit of $(.3) million and $– million for the three months ended September 30, 2007 and 2006, respectively and $(.6) million and $.3 million for the nine months ended September 30, 2007 and 2006, respectively |                   | (.4)                  |   | (.1) |   | (.9) |   | .5 |
| Total foreign currency adjustments                                                                                                                                                                                                                                                                                   |                   | (.4)                  |   | .1 |   | (.1) |   | .1 |
| Pension and post-retirement benefits costs amortized to income:                                                                                                                                                                                                                                                      |                   |                  |   |   |   |   |   |   |
| Prior service cost, net of deferred tax expense (benefit) of $.2 million and $.6 million for the three and nine months ended September 30, 2007, respectively                                                                                                                                                        |                   | .3                    |   | – |   | .9 |   | – |
| Net actuarial loss, net of deferred tax expense (benefit) of $.1 million and $.5 million for the three and nine months ended September 30, 2007, respectively                                                                                                                                                        |                   | .3                    |   | – |   | .7 |   | – |
| Accumulated regulatory loss adjustment, net of deferred tax expense (benefit) of $.6 million and $1.6 million for the three and nine months ended September 30, 2007, respectively                                                                                                                                   |                   | .8                    |   | – |   | 2.6 |   | – |
| Total pension and post-retirement benefit costs                                                                                                                                                                                                                                                                      |                   | 1.4                   |   | – |   | 4.2 |   | – |
| Other comprehensive income (loss)                                                                                                                                                                                                                                                                                    |                   | 1.0                   |   | .1 |   | 4.1 |   | .1 |
| **Total Comprehensive Income (Loss)**                                                                                                                                                                                                                                                                                | $                      | 41.5                  | $ | 115.8 | $ | 5.6 | $ | (40.3) |

 

See accompanying notes to consolidated financial statements.

 

8

**Aquila, Inc.**

**Consolidated Statements of Common Shareholders' Equity**

 

| *In millions*                                                                                                                                                                                                                                                                                                                                | **September 30,****2007** | **December 31,****2006** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------|--------------------------|
|                                                                                                                                                                                                                                                                                                                                         | (Unaudited)               |                     |   |
| Common stock: authorized 400 million shares at September 30, 2007 and December 31, 2006, par value $1 per share; 375,961,407 shares issued at September 30, 2007 and 374,611,194 shares issued at December 31, 2006; authorized 20 million shares of Class A common stock, par value $1 per share, none issued | $                         | 376.0                    | $ | 374.6 |
| Premium on capital stock                                                                                                                                                                                                                                                                                                                     |                      | 3,511.8                  |   | 3,509.2 |
| Retained deficit:                                                                                                                                                                                                                                                                                                                            |                      |                     |   |   |
| Beginning balance                                                                                                                                                                                                                                                                                                                            |                      | (2,546.7)                |   | (2,570.6) |
| Net income                                                                                                                                                                                                                                                                                                                                   |                      | 1.5                      |   | 23.9 |
| Cumulative effect of change in accounting                                                                                                                                                                                                                                                                                                    |                      | 19.3                     |   | – |
| Other                                                                                                                                                                                                                                                                                                                                        |                      | (.1)                     |   | – |
| Ending balance                                                                                                                                                                                                                                                                                                                               |                      | (2,526.0)                |   | (2,546.7) |
| Treasury stock, at cost 71,663 shares at September 30, 2007 (90,063 shares at December 31, 2006)                                                                                                                                                                                                                                             |                      | (.3)                     |   | (.4) |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                                                                         |                      | (26.4)                   |   | (30.6) |
| **Total Common Shareholders’ Equity**                                                                                                                                                                                                                                                                                                   | $                         | 1,335.1                  | $ | 1,306.1 |

 

See accompanying notes to consolidated financial statements.

 

9

**Aquila, Inc.**

**Consolidated Statements of Cash Flows—Unaudited**

 

|                                                                                                                                                | **Nine Months Ended** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------|
|                                                                                                                                                | **September 30,**     |
| *In millions*                                                                                                                                       | **2007**              | **2006** |
|                                                                                                                                                |                  |   |   |   |
| **Cash Flows From Operating Activities:**                                                                                                           |                  |   |   |   |
| Net income (loss)                                                                                                                                   | $                     | 1.5 | $ | (40.4) |
| Adjustments to reconcile net income (loss) to net cash provided from operating activities:                                                          |                  |   |   |   |
| Depreciation and amortization expense                                                                                                               |                  | 81.4 |   | 79.5 |
| Restructuring charges                                                                                                                               |                  | 1.6 |   | 7.5 |
| Cash paid for restructuring and other charges                                                                                                       |                  | (2.4) |   | (222.2) |
| Net (gain) on sale of assets and other charges                                                                                                      |                  | (1.7) |   | (24.0) |
| Net changes in price risk management assets and liabilities                                                                                         |                  | (5.9) |   | 67.3 |
| Deferred income taxes and investment tax credits                                                                                                    |                  | – |   | 33.0 |
| Changes in certain assets and liabilities, net of effects of divestitures:                                                                          |                  |   |   |   |
| Funds on deposit                                                                                                                                    |                  | 57.4 |   | 148.3 |
| Accounts receivable/payable, net                                                                                                                    |                  | (55.6) |   | 29.4 |
| Inventories and supplies                                                                                                                            |                  | (4.2) |   | 18.0 |
| Other current assets                                                                                                                                |                  | 31.5 |   | 32.1 |
| Deferred charges and other assets                                                                                                                   |                  | 22.1 |   | (4.4) |
| Accrued interest and other accrued liabilities                                                                                                      |                  | (22.3) |   | (69.7) |
| Customer funds on deposit                                                                                                                           |                  | 7.9 |   | (60.1) |
| Deferred credits                                                                                                                                    |                  | 1.4 |   | (4.7) |
| Other                                                                                                                                               |                  | (.3) |   | (.5) |
| **Cash provided from (used for) operating activities**                                                                                              |                  | 112.4 |   | (10.9) |
| **Cash Flows From Investing Activities:**                                                                                                           |                  |   |   |   |
| Utilities capital expenditures                                                                                                                      |                  | (169.2) |   | (115.0) |
| Cash proceeds received on sale of assets                                                                                                            |                  | 294.1 |   | 1,003.0 |
| Purchases of short-term investments                                                                                                                 |                  | – |   | (42.5) |
| Other                                                                                                                                               |                  | (1.1) |   | (14.8) |
| **Cash provided from investing activities**                                                                                                         |                  | 123.8 |   | 830.7 |
| **Cash Flows From Financing Activities:**                                                                                                           |                  |   |   |   |
| Premium on the retirement of long-term debt                                                                                                         |                  | (1.3) |   | (28.2) |
| Retirement of long-term debt                                                                                                                        |                  | (364.7) |   | (572.8) |
| Short-term debt repayments, net                                                                                                                     |                  | – |   | (12.0) |
| Cash paid on long-term gas contracts                                                                                                                |                  | (11.7) |   | (11.7) |
| Other                                                                                                                                               |                  | 1.2 |   | 2.4 |
| **Cash used for financing activities**                                                                                                              |                  | (376.5) |   | (622.3) |
| **Increase (decrease) in cash and cash equivalents**                                                                                                |                  | (140.3) |   | 197.5 |
| **Cash and cash equivalents at beginning of period**  (includes $4.8 million of cash included in current assets of discontinued operations in 2006) |                  | 232.8 |   | 19.0 |
| **Cash and cash equivalents at end of period**                                                                                                      | $                     | 92.5 | $ | 216.5 |

 

See accompanying notes to consolidated financial statements.

 

10

**AQUILA,** **INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.  Summary of Significant Accounting Policies**

 

**Basis of Presentation**

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with the accounting policies described in the consolidated financial statements and related notes included in our 2006 Annual Report on Form 10-K filed with the SEC on March 1, 2007.  You should read our 2006 Form 10-K in conjunction with this report.  The accompanying Consolidated Balance Sheets and Consolidated Statements of Common Shareholders’ Equity as of December 31, 2006, 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 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. Certainestimates and assumptions have been made in preparing the consolidated financial statements 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.  Actual results could differ from these estimates.

 

Certain prior period amounts in the consolidated financial statements have been reclassified where necessary to conform to the 2007 presentation.  

 

Our consolidated financial statements include all of our operating divisions and majority-owned subsidiaries for which we maintain controlling interests, including Aquila Merchant.

 

**Pending Merger**

 

We have entered into a merger agreement with Great Plains Energy.  We discuss our pending merger in more detail in Note 12.

 

***Seasonal Variations of Business***

 

Our electric and gas utility businesses are weather-sensitive. We have both summer- and winter-peaking network assets to reduce dependence on a single peak season. The table below shows normal utility peak seasons. 

 

| **Operations**     | **Peak**               |
|--------------------|------------------------|
| Gas Utilities      | November through March |
| Electric Utilities | July and August        |

 

**New Accounting Standards**

 

**Fair Value Measurements**

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is effective for our financial statements as of January 1, 2008. We are currently evaluating the impact SFAS 157 may have on our financial condition or results of operations. 

 

11

**Accounting for Planned Major Maintenance**

 

In September 2006, the FASB issued FSP AUG AIR-1, “Accounting for Planned Major Maintenance Activities”.  FSP AUG AIR-1 amends the guidance on the accounting for planned major maintenance activities; specifically, it precludes the use of the previously acceptable “accrue-in-advance” method, which we followed as allowed by regulatory authorities.  FSP AUG AIR-1 was effective for our financial statements as of January 1, 2007, and was applied retrospectively. Before considering the effect of our regulatory “accrue-in-advance” method, we adopted the direct expense method under FSP AUG AIR-1. We believe, however, it is probable that the cost of planned major maintenance will continue to be recovered through customer rates charged by our rate-regulated utility operations in advance of such maintenance being performed consistent with our historical rate recovery ofthese costs.  Therefore, a regulatory liability was recorded.  Upon adoption as of January 1, 2007, our accrued liability for planned major maintenance in our continuing operations of $4.7 million was reclassified as a regulatory liability.  

 

**Offsetting of Amounts Related to Certain Contracts**

 

In April 2007, the FASB issued FSP FIN 39-1, “Amendment of FASB Interpretation No. 39.” FSP FIN 39-1 replaces certain terms in FIN No. 39 with “derivative instruments” (as defined in SFAS No. 133) and permits the offsetting of fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement.  FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007.  We are currently evaluating the impact of applying the guidance in this FSP.

 

**2.  Restructuring Charges**

 

We recorded the following restructuring charges:

 

|                                | **Three Months Ended** | **Nine Months Ended** |
|-------------------------------------|------------------------|-----------------------|
|                                | **September 30,**      | **September 30,**     |
| *In millions*                       | **2007**               | **2006**              | **2007** | **2006** |
| Corporate and Other severance costs | $                      | –                | $ | .6 | $ | 1.6 | $ | 5.5 |
| Total restructuring charges         | $                      | –                | $ | .6 | $ | 1.6 | $ | 5.5 |

 

**Severance Costs**

 

During the first quarter of 2006 our management adopted and communicated to employees a plan to reduce corporate and central services costs, which included the elimination of approximately 220 positions through attrition and employee terminations.  The 83 employees who were involuntarily terminated received severance and other one-time termination benefits.  The total cost of one-time termination benefits for these terminated employees was approximately $5.7 million, which was recognized in 2006 over the remaining service period of terminated employees and will be paid out over time.  We recognized $.6 million and $5.5 million for termination benefits in the three and nine months ended September 30, 2006, respectively.

 

In addition, upon closing of the sale of Everest Connections in June 2006, its employees received retention payments of approximately $2.0 million, which were recognized in the nine months ended September 30, 2006.  These charges were included in discontinued operations.  

 

Finally, we recorded $1.6 million of one-time termination benefits in first quarter of 2007 related to the departure of our Chief Operating Officer.  These benefits will be paid over a two-year period beginning April 28, 2007.

 

12

**Restructuring Reserve Activity**

 

The following table summarizes activity in accrued restructuring charges for our continuing and discontinued operations for the nine months ended September 30, 2007:

 

| *In millions*                                    |   |   |
|--------------------------------------------------|--------|--------|
| Severance Costs:                                 |   |   |
| Accrued severance costs as of December 31, 2006  | $      | 2.3    |
| Additional expense during the period             |   | 1.6    |
| Cash payments during the period                  |   | (2.4)  |
| Accrued severance costs as of September 30, 2007 | $      | 1.5    |

 

**3.  Net Loss on Sale of Assets and Other Charges**

 

We have sold the assets and terminated the contracts in the table below and recorded the following pretax net losses on sale of assets and other charges:

 

|                                                 | **Three Months Ended** | **Nine Months Ended** |
|------------------------------------------------------|------------------------|-----------------------|
|                                                 | **September 30,**      | **September 30,**     |
| *In millions*                                        | **2007**               | **2006**              | **2007** | **2006** |
| Merchant Services:                                   |                   |                  |   |   |   |   |   |   |
| Elwood tolling contract                              | $                      | –                | $ | – | $ | – | $ | 218.0 |
| Other                                                |                   | –                |   | – |   | – |   | .7 |
| Total Merchant Services                              |                   | –                |   | – |   | – |   | 218.7 |
| Corporate and Other:                                 |                   |                  |   |   |   |   |   |   |
| Early retirement of debt                             |                   | –                |   | 5.5 |   | 1.3 |   | 28.2 |
| Total Corporate and Other                            |                   | –                |   | 5.5 |   | 1.3 |   | 28.2 |
| Total net loss on sale of assets and other 

charges | $                      | –                | $ | 5.5 | $ | 1.3 | $ | 246.9 |

 

After-tax losses discussed below are reported after giving consideration to the effect of capital loss carryback and carryforward limitations.  As a result, the net tax effect may differ substantially from our expected statutory tax rates.  

 

**Elwood Tolling Contract**

 

In June 2006, we paid $218 million to a third party to assume our rights and obligations under the Elwood tolling contract. This transaction resulted in a pretax and after-tax loss of $218 million, and terminated approximately $405 million of our fixed capacity payments through August 2017.  For income tax purposes, we treated the $218 million payment as an ordinary loss on our 2006 income tax return.  However, because we did not conclude that it was probable that the IRS will agree with this treatment, we increased our reserve for uncertain tax positions by $84.6 million, thereby fully offsetting the tax benefit of the loss in the second quarter of 2006.  In the first quarter of 2007, we evaluated the impact of FIN 48 on our financial statements and concluded that it was more likely than not that the tax benefit would be realized.  We recognized this tax benefit through a reduction of ourreserve for uncertain tax positions when we adopted FIN 48 in the first quarter of 2007.

 

**Early Retirement of Debt**

 

As discussed in more detail in Note 7, we retired $344 million of callable debt in June 2007.  We recorded a pretax early retirement loss of $1.3 million, or $.8 million after tax, in connection with this transaction.

 

In June 2006, we completed a cash tender offer that resulted in the early retirement of approximately $350 million of outstanding senior notes.  We recorded a pretax early retirement loss 

 

13

of $22.7 million, or $14.0 million after tax, in connection with this transaction.  We also incurred fees of $5.5 million, or $3.3 million after tax, primarily on the prepayment of the remaining $210 million outstanding on our five-year term loan, as discussed in Note 7.

 

**4.  Discontinued Operations**

 

As part of a strategic repositioning of our company, we have sold or wound-down a number of operations since 2002 to generate cash to be used to reduce debt and eliminate other long-term obligations.  We have sold the assets discussed below, which are considered discontinued operations in accordance with SFAS 144.  

 

After-tax losses discussed below are reported after giving consideration to the effect of capital loss carryback and carryforward limitations. As a result, the net tax effect may differ substantially from our expected statutory tax rates. 

 

**Electric and Gas Utilities**

 

In September 2005, we entered into agreements to sell our Kansas electric distribution business and our Michigan, Minnesota and Missouri natural gas distribution businesses.  We completed these asset sales in 2006, except for the Kansas electric sale, which was completed on April 1, 2007.  The sale of these utility assets resulted in pretax and after tax gains.  The Michigan, Minnesota and Missouri gas and Kansas electric sales also resulted in gains for tax purposes.  The classification of the tax gains between ordinary income and capital gain depends upon the final allocation of the purchase price based upon the terms of the respective asset purchase agreements.  Ordinary income has been offset by current year net operating losses and/or net operating loss carryforwards.  Capital gains have been offset by capital loss carryforwards.  To the extent capital loss carryforwardswere utilized, the valuation allowance against the tax benefit of the capital loss carryforwards have been reversed for 2006 sales and will be reversed for the Kansas sale when the estimated tax allocation is completed.  The tax gains have been adjusted for the 2006 sales based upon the final allocations included in our 2006 income tax return.  The tax gain on the sale of the Kansas electric properties will be adjusted when the final determination is made and as the 2007 income tax return is filed in 2008.

 

On April 1, 2006, we closed the sale of our Michigan gas operations and received gross cash proceeds of $314.9 million, including the base purchase price of $269.5 million plus preliminary working capital and other adjustments of $45.4 million.  During the third quarter of 2006, we received $25.0 million as part of the working capital and other adjustments “true up.”  We settled with the buyer regarding the gas in storage issue and other matters and paid the buyer $1.8 million in March 2007.  In 2007, the Michigan Commission issued an order disallowing $.3 million in gas costs.  A reserve of $2.1 million had been previously established for this purpose.  In connection with this sale we have recorded a pretax gain of approximately $92.2 million after transaction fees and expenses.  The estimated after-tax gain previously was approximately $99.5 million, including an estimate of$44.0 million for the valuation allowance reversal related to the estimated capital gain amount discussed above.  The final after-tax gain is $103.7 million, including the final valuation allowance reversal related to capital gains realized on our 2006 income tax return.

 

On June 1, 2006, we closed the sale of our Missouri gas operations and received gross cash proceeds of $102.1 million, including the base purchase price of $85.0 million plus preliminary working capital and other adjustments of $17.1 million.  The working capital and other adjustments were “trued up” in the fourth quarter of 2006 through a final payment of $.2 million to the buyer.  In connection with this sale we recorded a pretax gain of approximately $30.7 million after transaction fees and expenses.  The estimated after-tax gain previously was approximately $31.1 million, including an estimate of $11.7 million for the valuation allowance reversal related to the estimated capital gain amount discussed above.  In 2007, final adjustments related to pensions and other items reduced the pretax gain $.6 million, or $.4 million after tax.  The final after-tax gain is $34.1 million,including the final valuation reversal related to capital gains realized in our 2006 income tax return.

 

14

 

On July 1, 2006, we closed the sale of our Minnesota gas operations and received gross cash proceeds of $333.3 million, including the base purchase price of $288.0 million plus preliminary working capital and other adjustments of $45.3 million.  We paid $16.9 million as part of the working capital and other adjustments “true up.”  In connection with this sale we recorded a pretax gain of approximately $120.5 million after transaction fees and expenses, subject to the final determination of pension assets transferred to the buyer as discussed below.  The estimated after-tax gain previously was approximately $127.5 million, including an estimate of $56.9 million for the valuation allowance reversal related to the estimated capital gain amount discussed above.  In 2007, final adjustments related to pensions increased the pretax gain $1.0 million, or $.6 million after tax.  The finalafter-tax gain is $126.5 million, including the final valuation allowance reversal related to capital gains realized in our 2006 income tax return.

 

On April 1, 2007, we closed the sale of our Kansas electric operations and transferred our 8% leased interest in the Jeffrey Energy Center and received gross cash proceeds of $291.8 million, including the base purchase price of $249.7 million plus preliminary working capital and other adjustments of $42.1 million.  We received a working capital and other adjustments “true up” payment of $.4 million in the third quarter of 2007.  We expect to resolve certain minor disputed items in the fourth quarter of 2007.  In connection with this sale we recorded a pretax gain of approximately $.9 million in the second quarter of 2007 after transaction fees and expenses, subject to the final determination of pension assets transferred to the buyer as discussed below.  The estimated after-tax gain was approximately $.5 million, subject to the determination of the capital gain amount discussed above.

 

The operating results of the utility divisions sold include the direct operating costs associated with those businesses but do not include the allocated operating costs of central services and corporate overhead in accordance with EITF Consensus 87-24, “Allocation of Interest to Discontinued Operations” (EITF 87-24).  We provide corporate and centralized support services to all of our utility divisions, including customer care, billing, collections, information technology, accounting, tax and treasury services, regulatory services, gas supply services, human resources, safety and other services.  The operating costs related to these functions are allocated to the utility divisions based on various cost drivers.  Effective January 1, 2006, we ceased allocating costs to our held-for-sale utilities.  These allocated costs were not included in the reclassification to earnings fromdiscontinued operations because these support services were necessary to maintain ongoing operations until the sales are final and cannot be eliminated immediately upon closing of the asset sales.  We eliminated a majority of these costs when we completed the sale of our Michigan, Minnesota and Missouri gas operations.  

 

The discontinued utility operations participated in our qualified pension plan, non-qualified Supplemental Executive Retirement Plan (SERP) and other post-retirement benefit plans.  Under the asset purchase agreements, the buyers assumed upon closing the accrued pension obligations owed to the current and former employees of the operations they acquired.  After closing, benefit plan assets were or will be transferred to comparable plans established by the buyers in accordance with the terms of the asset purchase agreements and the applicable ERISA requirements.  These benefit plan asset transfers resulted in plan curtailments.  In connection with the sale of our Michigan, Minnesota and Missouri gas operations we included $13.0 million of net prepaid pension assets and pension and post-retirement benefit obligations, including the effect of plan curtailment and settlement losses, in thedetermination of the pretax gains on these sales.  The plan curtailment and settlement losses related to the sale of our Kansas electric operations are estimated to be approximately $5.2 million.  The effect of the plan curtailments related to the Michigan, Missouri and Minnesota sales have been finalized. The effect of the plan curtailment related to the Kansas sale will depend on the final determination of the asset transfer, which will not be completed until late 2007. 

 

15

**Other Asset Sales**

 

In March 2006, we sold two merchant “peaking” power plants located in Illinois for gross proceeds of $175 million.  In June 2006, we sold our telecommunications business (Everest Connections) for net proceeds of approximately $78 million.

 

**Interest Allocation to Discontinued Operations**

 

The buyers of the assets in discontinued operations did not assume any of our long-term debt.  The direct debt and related interest of Everest Connections was included in discontinued operations.  We allocated a portion of consolidated interest expense to discontinued operations based on the ratio of net assets of discontinued operations to consolidated net assets plus consolidated debt in accordance with EITF 87-24.  As we completed each asset sale the allocation of interest to discontinued operations ceased, thereby increasing interest expense in continuing operations, without impacting total interest expense, until the sales proceeds were used to reduce debt.

 

**Summary**

 

We have reported the results of operations from these assets in discontinued operations for the three and nine months ended September 30, 2007 and 2006 in the Consolidated Statements of Income. 

 

Operating results from our discontinued operations are as follows:

 

| * *                                                                        | **Three Months Ended** | **Nine Months Ended** |
|---------------------------------------------------------------------------------|------------------------|-----------------------|
| * *                                                                        | **September 30,**      | **September 30,**     |
| *In millions*                                                                   | **2007**               | **2006**              | **2007** | **2006** |
| * *                                                                        |                   |                  |   |   |   |   |   |   |
| Sales                                                                           | $                      | .3                    | $ | 61.8 | $ | 46.0 | $ | 479.3 |
| Cost of sales                                                                   |                   | –                |   | 30.5 |   | 23.4 |   | 322.6 |
| Gross profit                                                                    |                   | .3                    |   | 31.3 |   | 22.6 |   | 156.7 |
| Operating expenses:                                                             |                   |                  |   |   |   |   |   |   |
| Operation and maintenance expense                                               |                   | .1                    |   | 11.0 |   | 11.3 |   | 61.0 |
| Taxes other than income taxes                                                   |                   | –                |   | 1.4 |   | 2.0 |   | 9.8 |
| Restructuring charges                                                           |                   | –                |   | – |   | – |   | 2.0 |
| Net (gain) on sale of assets and other      charges    |                   | (2.7)                 |   | (122.2) |   | (3.0) |   | (270.8) |
| Depreciation and amortization expense                                           |                   | –                |   | – |   | – |   | .9 |
| Total operating expenses                                                        |                   | (2.6)                 |   | (109.8) |   | 10.3 |   | (197.1) |
| Operating income                                                                |                   | 2.9                   |   | 141.1 |   | 12.3 |   | 353.8 |
| Other income (expense)                                                          |                   | –                |   | (.4) |   | .2 |   | .1 |
| Interest expense                                                                |                   | –                |   | 4.5 |   | 4.1 |   | 30.7 |
| Income before income taxes                                                      |                   | 2.9                   |   | 136.2 |   | 8.4 |   | 323.2 |
| Income tax expense (benefit)                                                    |                   | (5.9)                 |   | (.1) |   | (3.9) |   | 72.6 |
| Earnings from discontinued operations, net      of tax | $                      | 8.8                   | $ | 136.3 | $ | 12.3 | $ | 250.6 |

 

 

16

      The related assets and liabilities included in the sale of these businesses, as detailed below, have been reclassified as current and non-current assets and liabilities of discontinued operations on the September 30, 2007 and December 31, 2006 Consolidated Balance Sheets as follows:

 

|                                                     | **September 30,** | **December 31,** |
|----------------------------------------------------------|-------------------|------------------|
| *In millions***                                          | **2007**          | **2006**         |
| Current assets of discontinued operations:               |              |             |   |   |
| Accounts receivable, net                                 | $                 | –           | $ | 13.0 |
| Inventories and supplies                                 |              | –           |   | 5.7 |
| Other current assets                                     |              | –           |   | 7.8 |
| Total current assets of discontinued operations          | $                 | –           | $ | 26.5 |
| Non-current assets of discontinued operations:           |              |             |   |   |
| Utility plant, net                                       | $                 | –           | $ | 236.6 |
| Regulatory assets                                        |              | –           |   | 28.9 |
| Other non-current assets                                 |              | –           |   | 20.6 |
| Total non-current assets of discontinued operations      | $                 | –           | $ | 286.1 |
| Current liabilities of discontinued operations:          |              |             |   |   |
| Other current liabilities                                | $                 | –           | $ | 1.4 |
| Total current liabilities of discontinued operations     | $                 | –           | $ | 1.4 |
| Non-current liabilities of discontinued operations:      |              |             |   |   |
| Pension and post-retirement benefits                     | $                 | –           | $ | 17.7 |
| Deferred credits                                         |              | –           |   | 18.2 |
| Total non-current liabilities of discontinued operations | $                 | –           | $ | 35.9 |

 

**5.  Earnings (Loss) per Common Share**

 

The table below shows how we calculated basic and diluted earnings (loss) per share.  Basic earnings (loss) per share and basic weighted average shares are the starting point in calculating the dilutive measures.  To calculate basic earnings (loss) per share, divide our loss available for common shares for the period by our weighted average shares outstanding, without adjusting for dilutive items.  Diluted earnings (loss) per share is calculated by dividing our net loss, after assumed conversion of dilutive securities, by our weighted average shares outstanding, adjusted for the effect of dilutive securities.  However, as a result of the loss from continuing operations in the three months ended September 30, 2006 and the nine months ended September 30, 2007 and 2006, the potential issuances of common stock for dilutive securities of 564,968, 259,056 and 501,680, respectively, wereconsidered anti-dilutive in those periods and were therefore not included in the calculation of diluted earnings (loss) per share.

 

17

|                                                                                | **Three Months Ended** | **Nine Months Ended** |
|-------------------------------------------------------------------------------------|------------------------|-----------------------|
|                                                                                | **September 30,**      | **September 30,**     |
| *In millions, except per share amounts***                                           | **2007**               | **2006**              | **2007** | **2006** |
|                                                                                |                   |                  |   |   |   |   |   |   |
| Income (loss) from continuing operations                                            | $                      | 31.7                  | $ | (20.6) | $ | (10.8) | $ | (291.0) |
| Earnings from discontinued operations                                               |                   | 8.8                   |   | 136.3 |   | 12.3 |   | 250.6 |
| Net income (loss) as reported                                                       |                   | 40.5                  |   | 115.7 |   | 1.5 |   | (40.4) |
| Interest and debt amortization costs associated with the PIES                       |                   | –                |   | – |   | .1 |   | .1 |
| Income (loss) available for common shares                                           | $                      | 40.5                  | $ | 115.7 | $ | 1.6 | $ | (40.3) |
|                                                                                |                   |                  |   |   |   |   |   |   |
| Basic and diluted earnings (loss) per share:                                        |                   |                  |   |   |   |   |   |   |
| Income (loss) from continuing operations                                            | $                      | .09                   | $ | (.05) | $ | (.03) | $ | (.78) |
| Earnings from discontinued operations                                               |                   | .02                   |   | .36 |   | .03 |   | .67 |
| Net income (loss)                                                                   | $                      | .11                   | $ | .31 | $ | – | $ | (.11) |
| Weighted average number of common shares used in basic earnings (loss) per share    |                   | 375.9                 |   | 375.2 |   | 375.7 |   | 375.0 |
| Effect of dilutive stock options, convertible debentures and restricted stock units |                   | .2                    |   | – |   | – |   | – |
| Weighted average number of common shares used in dilutive earnings (loss) per share |                   | 376.1                 |   | 375.2 |   | 375.7 |   | 375.0 |

 

**6.  Reportable Segment Reconciliation**

 

We manage our business in three business segments:  Electric Utilities, Gas Utilities and Merchant Services.  Our Electric and Gas Utilities currently consist of our regulated electric utility operations in two states and our natural gas utility operations in four states.  We manage our electric and gas utility divisions by state.  However, as each of our electric utility divisions and each of our gas utility divisions have similar economic characteristics, we aggregate our electric utility divisions into the Electric Utilities reporting segment and our gas utility divisions into the Gas Utilities reporting segment.  The operating results of our Kansas electric division, which was sold April 1, 2007, and our Michigan, Missouri and Minnesota gas divisions, which were sold on April 1, 2006, June 1, 2006 and July 1, 2006, respectively, have been reclassified to discontinued operations.Merchant Services includes the residual operations of Aquila Merchant Services, Inc.  These operations include its commitments under long-term gas contracts and the remaining contracts from its wholesale energy trading operations.  Also, included in Merchant Services is our investment in the Crossroads plant, which is an investment of Aquila, Inc. and is not an asset of Aquila Merchant Services, Inc.  The operating results of our former two Illinois power plants, which were sold on March 31, 2006, have been reclassified to discontinued operations.  The operating results of Everest Connections, which was sold on June 30, 2006, have been reclassified to discontinued operations.  All other operations are included in Corporate and Other, including the costs not allocated to our operating businesses.  

 

Each segment is managed based on operating results, expressed as earnings before interest, taxes, depreciation and amortization. Generally, decisions on finance, dividends and taxes are made at the Corporate level.  The current and non-current assets of our discontinued operations were included in the segments referenced above.

 

Our reportable segment reconciliation is shown below:

 

 

18

 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | **Three Months Ended** | **Nine Months Ended** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------|-----------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | **September 30,**      | **September 30,**     |
| *In millions***                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | **2007**               | **2006**              | **2007** | **2006** |
| Sales: *(a)*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |                   |                  |   |   |   |   |   |   |
| Utilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                   |                  |   |   |   |   |   |   |
| Electric Utilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | $                      | 282.3                 | $ | 243.0 | $ | 652.5 | $ | 601.5 |
| Gas Utilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |                   | 77.1                  |   | 78.0 |   | 457.2 |   | 436.3 |
| Total Utilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                   | 359.4                 |   | 321.0 |   | 1,109.7 |   | 1,037.8 |
| Merchant Services                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                   | (1.6)                 |   | (4.4) |   | (9.1) |   | (7.3) |
| Corporate and Other                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                   | (.1)                  |   | – |   | (.1) |   | .1 |
| Total sales                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | $                      | 357.7                 | $ | 316.6 | $ | 1,100.5 | $ | 1,030.6 |
| *(a)*         *For the three months ended September 30, 2007 and 2006, and nine months ended September 30, 2007 and 2006, respectively, the following sales (in millions) have been reclassified to discontinued operations and are not included in the above amounts: Electric Utilities of $*–*, $61.8, $42.4 and $147.8; Gas Utilities of $.3, $*–*, $3.6 and $304.2; Merchant Services sales of $–, $*–*, $– and $2.2; and Corporate and Other sales related to Everest Connections of $–, $*–*, $– and$25.1.*

  |
| Earnings (Loss) Before Interest, Taxes, Depreciation and Amortization (EBITDA): *(a)*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                   |                  |   |   |   |   |   |   |
| Utilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                   |                  |   |   |   |   |   |   |
| Electric Utilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | $                      | 94.9                  | $ | 58.0 | $ | 149.3 | $ | 120.5 |
| Gas Utilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |                   | 5.2                   |   | 1.6 |   | 41.7 |   | 29.3 |
| Total Utilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                   | 100.1                 |   | 59.6 |   | 191.0 |   | 149.8 |
| Merchant Services                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                   | (1.3)                 |   | (17.0) |   | (1.9) |   | (249.0) |
| Corporate and Other                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                   | (2.7)                 |   | (3.7) |   | (7.5) |   | (32.8) |
| Total EBITDA                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |                   | 96.1                  |   | 38.9 |   | 181.6 |   | (132.0) |
| Depreciation and amortization expense                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                   | 27.3                  |   | 27.0 |   | 81.4 |   | 78.5 |
| Interest expense                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                   | 31.5                  |   | 42.7 |   | 111.6 |   | 124.4 |
| Income (loss) from continuing operations     before income taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | $                      | 37.3                  | $ | (30.8) | $ | (11.4) | $ | (334.9) |
| *(a)*         *For the three months ended September 30, 2007 and 2006, and nine months ended September 30, 2007 and 2006, respectively, the following EBITDA (in millions) have been reclassified to discontinued operations and are not included in the above amounts: Electric Utilities of $(.1), $20.4, $6.8 and $39.4; Gas Utilities of $1.3, $121.4, $4.0 and $286.0; Merchant Services of $1.7, $*–*, $1.7 and $(.8); and Corporate and Other related to Everest Connections of $–, $(1.1), $– and $30.2.*

* *                         |
| Depreciation and Amortization:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |                   |                  |   |   |   |   |   |   |
| Utilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                   |                  |   |   |   |   |   |   |
| Electric Utilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | $                      | 18.0                  | $ | 18.4 | $ | 54.6 | $ | 52.1 |
| Gas Utilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |                   | 8.4                   |   | 7.7 |   | 23.8 |   | 24.6 |
| Total Utilities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                   | 26.4                  |   | 26.1 |   | 78.4 |   | 76.7 |
| Merchant Services                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                   | 1.0                   |   | 1.0 |   | 3.0 |   | 3.1 |
| Corporate and Other                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                   | (.1)                  |   | (.1) |   | – |   | (1.3) |
| Total depreciation and amortization                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | $                      | 27.3                  | $ | 27.0 | $ | 81.4 | $ | 78.5 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

 

 

19

| *In millions***                                                                                                                                                 | **September 30,****2007** | **December 31,****2006** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------|--------------------------|
| Assets: *(a)*                                                                                                                                                   |                      |                     |   |   |
| Utilities:                                                                                                                                                      |                      |                     |   |   |
| Electric Utilities                                                                                                                                              | $                         | 1,979.4                  | $ | 2,169.5 |
| Gas Utilities                                                                                                                                                   |                      | 550.6                    |   | 689.5 |
| Total Utilities                                                                                                                                                 |                      | 2,530.0                  |   | 2,859.0 |
| Merchant Services                                                                                                                                               |                      | 236.7                    |   | 316.2 |
| Corporate and Other                                                                                                                                             |                      | 141.2                    |   | 297.2 |
| Total assets                                                                                                                                                    | $                         | 2,907.9                  | $ | 3,472.4 |
| *(a)*  *Included in total assets as of December 31, 2006 are total assets of discontinued operations as follows:  Electric Utilities $312.6 million.* |

 

**7.  Financings**

 

**Five-Year Unsecured Revolving Credit Facility**

 

In September 2004, we completed a $110 million 364-day unsecured revolving credit facility.  This facility automatically extended to September 2009 when we received extension approval from the FERC and various state public utility commissions (the Five-Year Unsecured Revolving Credit Facility). There were no borrowings outstanding on this facility as of September 30, 2007.  The Five-Year Unsecured Revolving Credit Facility bears interest at the LIBOR plus 5.75%, subject to reduction if our credit rating improves.  Among other restrictions, the Five-Year Unsecured Revolving Credit Facility contains financial covenants similar to, but less restrictive than, those contained in the Iatan Facility described below.  We were in compliance with these covenants as of September 30, 2007.

 

The Five-Year Unsecured Revolving Credit Facility contains a $40 million “cross default” provision, as well as covenants that restrict certain activities including, among others, limitations on additional indebtedness, restrictions on acquisitions, sale transactions and investments. In addition, we are prohibited from paying dividends and from making certain other payments if our senior unsecured debt is not rated at least Ba2 by Moody's and BB by S&P, or if such a payment would cause a default under the facility. 

 

**$180 Million Unsecured Revolving Credit and Letter of Credit Facility**

 

On April 13, 2005, we entered into a five-year credit agreement with a commercial lender.  Subject to the satisfaction of certain conditions, the facility provides for up to $180 million of cash advances and letters of credit for working capital purposes.  Cash advances must be repaid within 364 days unless we obtain the necessary regulatory approvals to incur long-term indebtedness under the facility.  As of September 30, 2007, we had $150.0 million of uncollateralized capacity at an average cost of 3.65% under this agreement, which contains a $40 million “cross default” provision.  As of September 30, 2007, $121.9 million of the available capacity had been utilized for letters of credit under this facility.

 

**Four-Year Secured Revolving Credit Facility**

 

On April 22, 2005, we executed a four-year $150 million secured revolving credit facility (the AR Facility).  Proceeds from this facility may be used for working capital and other general corporate purposes.  Borrowings under this facility are secured by the accounts receivable generated by our regulated utility operations in Colorado, Iowa, Kansas, Missouri and Nebraska.  Borrowings under the AR Facility bear interest at LIBOR plus 1.375%, subject to reduction if our credit ratings improve.  Borrowings must be repaid within 364 days unless we obtain the necessary regulatory approvals to incur long-term indebtedness under the facility.  Among other restrictions, we are required under the AR Facility to maintain the same debt-to-total capital and EBITDA-to-interest 

 

20

expense ratios as those contained in the Five-Year Unsecured Revolving Credit Facility discussed above.  The credit agreement also contains a $40 million “cross default” provision.  No borrowings were outstanding under this facility as of September 30, 2007.

 

**$50 Million Revolving Credit and Letter of Credit Facility**

 

On January 13,2006, we closed on a $50 million short-term letter of credit facility with a commercial lender, which was originally scheduled to terminate on December 20, 2006, that allows us to either issue letters of credit or make cash drawings under the facility. This facility, which initially included a 2.50% advance rate on letters of credit, is nearly fully utilized through letter of credit issuances.  The credit agreement also contains a $40 million “cross default” provision.  In November 2006, we entered into amendments to extend the maturity date to December 19, 2007 and lower the advance rate to 1.07%.  There were $27.4 million of letters of credit outstanding under this facility as of September 30, 2007.

 

**Iatan Construction Financing**

 

On August 31, 2005, we entered into a $300 million credit agreement with a commercial lender and a syndicate of other lenders (the Iatan Facility). The credit agreement allows us to obtain loans and issue letters of credit (limited to $175 million of letters of credit) in support of our participation in the construction of the Iatan 2 facility being developed by KCPL near Weston, Missouri (Iatan 2), and our obligation to fund pollution controls being installed at an adjacent facility. Extensions of credit under the facility will be due and payable on August 31, 2010. Loans bear interest at LIBOR plus a margin determined by our credit ratings.  A fee based on our credit ratings will be paid on the amount of letters of credit outstanding. Obligations under the credit agreement are secured by the assets of our Missouri Public Service electric operations.  There were no borrowings or letters ofcredit outstanding under this facility at September 30, 2007.  Among other restrictions, the Iatan Facility contains the following financial covenants with which we were in compliance as of September 30, 2007: 

 

|   | (1) | We are required to maintain a ratio of total debt to total capital (expressed as a percentage) of not more than 75% through September 30, 2008; 70% from October 1, 2008 through September 30, 2009; and 65% thereafter. |
|--------|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | (2) | We must maintain a trailing 12-month ratio of EBITDA, as defined in the agreement, to interest expense of no less than 1.3 to 1.0 from October 1, 2006 through September 30, 2007; 1.4 to 1.0 from October 1, 2007 through September 30, 2008; 1.6 to 1.0 from October 1, 2008 through September 30, 2009; and 1.8 to 1.0 thereafter. |
|--------|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | (3) | We must maintain a trailing 12-month ratio of debt outstanding to EBITDA of no more than 7.5 to 1.0 from October 1, 2006 through September 30, 2007; 6.0 to 1.0 from October 1, 2007 through September 30, 2008; 5.5 to 1.0 from October 1, 2008 through September 30, 2009; and 5.0 to 1.0 thereafter. |
|--------|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | (4) | We must maintain a ratio of mortgaged property to extensions of credit (borrowings plus outstanding letters of credit) of no less than 2.0 to 1.0 as of the last day of each fiscal quarter. |
|--------|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The Iatan Facility contains a $40 million “cross default” provision, as well as covenants that restrict certain activities including, among others, limitations on additional indebtedness, restrictions on acquisitions, sale transactions and investments. In addition, we are prohibited from paying dividends and from making certain other payments if our senior unsecured debt is not rated at least Ba2 by Moody's and BB by S&P, or if such a payment would cause a default under the facility.

 

21

**Early Retirement of Debt**

 

In May 2007, we announced that call notices had been issued for the redemption of certain of our outstanding senior notes.  In June 2007, we completed the redemption, which resulted in the early retirement of $344 million of aggregate debt principal. We recorded a pretax early retirement loss of $1.3 million, or $.8 million after tax, in connection with the transaction in the second quarter of 2007.  The table below provides the detail on the notes retired:

| **Title of Security**     |   | **Principal Amount Retired (in millions)** |
|---------------------------|--------|--------------------------------------------|
| 7.875% Notes due 3/1/2032 |   | $                                          | 287.5 |
| 8.0% Notes due 3/1/2023   |   |                                       | 51.5 |
| 9.0% Notes due 11/15/2021 |   |                                       | 5.0 |
| Total                     |   | $                                          | 344.0 |

 

In May 2006, we announced a cash tender offer for the early retirement of certain of our outstanding senior notes.  Under the offer, the total consideration paid in exchange for the notes was based either on a fixed spread over the yield to maturity of a U.S. Treasury reference security or on a fixed price basis. Noteholders that accepted the tender received the accrued interest from the last interest payment date, and those that properly tendered their notes before the early tender time date were also entitled to receive an additional early tender premium of two percent of the debt tendered.  

 

In June 2006, we completed the cash tender offer, which resulted in the early retirement of $350 million of aggregate debt principal. We recorded a pretax early retirement loss of $22.7 million, or $14.0 million after tax, in connection with the transaction in the second quarter of 2006.  The table below provides the detail on the notes retired:

| **Title of Security**       |   | **Principal Amount Retired (in millions)** |
|-----------------------------|--------|--------------------------------------------|
| 6.7% Notes due 10/15/2006   |   | $                                          | 84.5 |
| 8.2% Notes due 1/15/2007    |   |                                       | 22.3 |
| 7.625% Notes due 11/15/2009 |   |                                       | 130.5 |
| 9.95% Notes due 2/01/2011   |   |                                       | 112.7 |
| Total                       |   | $                                          | 350.0 |

 

In September 2006, we elected to prepay the remaining $210 million outstanding under our five-year term loan plus a 2.5% prepayment fee.  Primarily as a result of this prepayment we incurred an additional $5.5 million loss on early debt retirement in the third quarter of 2006.

 

**PIES Conversion**

 

In September 2007, the $2.6 million of outstanding PIES units were converted at their scheduled maturity for 835,640 shares of common stock.

 

**Other**

 

We had an additional $.8 million of letters of credit outstanding under various arrangements as of September 30, 2007.

 

22

**8.  Employee Benefits**

 

|   | The following table shows the components of net periodic benefit costs: |
|--------|-------------------------------------------------------------------------|

 

| * *                                                                  | **Pension Benefits**                 | **Other****Post-retirement****Benefits** |
|---------------------------------------------------------------------------|--------------------------------------|------------------------------------------|
| * *                                                                  | **Three Months Ended September 30,** |
| *In millions***                                                           | **2007**                             | **2006**                                 | **2007** | **2006** |
| **Components of Net Periodic Benefit Cost:**                              |                                 |                                     |   |   |   |   |   |   |
| Service cost                                                              | $                                    | 2.2                                      | $ | 2.2 | $ | .3 | $ | .2 |
| Interest cost                                                             |                                 | 4.8                                      |   | 4.9 |   | .6 |   | .9 |
| Expected return on plan assets                                            |                                 | (5.8)                                    |   | (6.3) |   | (.3) |   | (.1) |
| Amortization of transition amount                                         |                                 | –                                   |   | (.2) |   | .2 |   | .3 |
| Amortization of prior service cost                                        |                                 | 1.1                                      |   | 1.2 |   | .5 |   | .5 |
| Recognized net actuarial (gain)/loss                                      |                                 | .6                                       |   | .8 |   | (.1) |   | – |
| Net periodic benefit cost before regulatory expense adjustments           |                                 | 2.9                                      |   | 2.6 |   | 1.2 |   | 1.8 |
| Regulatory (gain)/loss adjustment                                         |                                 | 1.4                                      |   | 1.1 |   | .1 |   | .2 |
| SFAS 71 regulatory adjustment                                             |                                 | (.3)                                     |   | .2 |   | – |   | – |
| Net periodic benefit cost after regulatory expense adjustments            |                                 | 4.0                                      |   | 3.9 |   | 1.3 |   | 2.0 |
| Effect of curtailments and settlements included in gain on sale of assets |                                 | –                                   |   | .9 |   | – |   | (1.3) |
| **Total periodic benefit costs**                                          | $                                    | 4.0                                      | $ | 4.8 | $ | 1.3 | $ | .7 |
| * *                                                                  |                                 |                                     |
| * *                                                                  | **Pension Benefits**                 | **Other****Post-retirement****Benefits** |
| * *                                                                  | **Nine Months Ended September 30,**  |
| *In millions***                                                           | **2007**                             | **2006**                                 | **2007** | **2006** |
| **Components of Net Periodic Benefit Cost:**                              |                                 |                                     |   |   |   |   |   |   |
| Service cost                                                              | $                                    | 6.8                                      | $ | 7.2 | $ | .9 | $ | .6 |
| Interest cost                                                             |                                 | 15.0                                     |   | 16.0 |   | 2.1 |   | 3.1 |
| Expected return on plan assets                                            |                                 | (18.0)                                   |   | (20.5) |   | (.9) |   | (.5) |
| Amortization of transition amount                                         |                                 | –                                   |   | (.6) |   | .8 |   | 1.0 |
| Amortization of prior service cost                                        |                                 | 3.4                                      |   | 3.9 |   | 1.5 |   | 1.8 |
| Recognized net actuarial (gain)/loss                                      |                                 | 2.0                                      |   | 2.8 |   | (.3) |   | – |
| Net periodic benefit cost before regulatory expense adjustments           |                                 | 9.2                                      |   | 8.8 |   | 4.1 |   | 6.0 |
| Regulatory (gain)/loss adjustment                                         |                                 | 4.2                                      |   | 3.7 |   | .3 |   | .6 |
| SFAS 71 regulatory adjustment                                             |                                 | (.7)                                     |   | .5 |   | – |   | – |
| Net periodic benefit cost after regulatory expense adjustments            |                                 | 12.7                                     |   | 13.0 |   | 4.4 |   | 6.6 |
| Effect of curtailments and settlements included in gain on sale of assets |                                 | 10.0                                     |   | 14.7 |   | (4.8) |   | (.7) |
| **Total periodic benefit costs**                                          | $                                    | 22.7                                     | $ | 27.7 | $ | (.4) | $ | 5.9 |

 

In connection with the sale of our Michigan, Minnesota and Missouri gas operations in 2006 and our Kansas electric operations in 2007, we included the effects of curtailments and settlements in the determination of the gains on sales of these operations by considering the prepaid pension asset and pension and post-retirement benefit obligations in the net asset basis sold.

 

The unrecognized net periodic benefit costs amortized to income from the regulatory asset and accumulated other comprehensive income accounts are as follows:

 

23

 

 

| * *                                                           | **Pension Benefits**                      | **Other****Post-retirement****Benefits** |
|--------------------------------------------------------------------|-------------------------------------------|------------------------------------------|
| * *                                                           | **Three Months Ended September 30, 2007** |
| *In millions***                                                    | **Regulatory Asset**                      | **Other Comprehensive Income**           | **Regulatory Asset** | **Other Comprehensive Income** |
| **Components of Net Periodic Benefit Cost Amortized to Income:**   |                                      |                                     |   |   |   |   |   |   |
| Transition amount                                                  | $                                         | –                                   | $ | – | $ | .2 | $ | – |
| Prior service cost                                                 |                                      | .5                                       |   | .6 |   | .5 |   | – |
| Recognized net actuarial (gain)/loss                               |                                      | .3                                       |   | .3 |   | (.1) |   | – |
| Regulatory (gain)/loss adjustment                                  |                                      | –                                   |   | 1.4 |   | .1 |   | – |
| **Total pension and post-retirement benefit**

**costs amortized** | $                                         | .8                                       | $ | 2.3 | $ | .7 | $ | – |
| * *                                                           | **Pension Benefits**                      | **Other****Post-retirement****Benefits** |
| * *                                                           | **Nine Months Ended September 30, 2007**  |
| *In millions***                                                    | **Regulatory Asset**                      | **Other Comprehensive Income**           | **Regulatory Asset** | **Other Comprehensive Income** |
| **Components of Net Periodic Benefit Cost Amortized to Income:**   |                                      |                                     |   |   |   |   |   |   |
| Transition amount                                                  | $                                         | –                                   | $ | – | $ | .8 | $ | – |
| Prior service cost                                                 |                                      | 1.7                                      |   | 1.7 |   | 1.5 |   | – |
| Recognized net actuarial (gain)/loss                               |                                      | 1.0                                      |   | 1.0 |   | (.3) |   | – |
| Regulatory (gain)/loss adjustment                                  |                                      | –                                   |   | 4.2 |   | .3 |   | – |
| **Total pension and post-retirement benefit**

**costs amortized** | $                                         | 2.7                                      | $ | 6.9 | $ | 2.3 | $ | – |

We previously disclosed in our financial statements for the year ended December 31, 2006, that we expected to contribute $.7 million and $2.9 million to our defined benefit pension plans and other post-retirement benefit plan, respectively, in 2007.  Our qualified pension plan is funded in compliance with income tax regulations and federal funding requirements.  We expect to fund no less than the IRS minimum funding amount and no more than the IRS maximum tax deductible amount.  To comply with a regulatory condition related to the closing of the sale of our Kansas electric operations, we contributed $3.4 million to our qualified defined benefit pension plan and $1.1 million to our other post-retirement benefit plan in April 2007.  As a result of the transfer of pension plan assets and pension benefits obligations in accordance with ERISA requirements to the buyers of our utility assets asdiscussed in Note 4, we expect to make an additional voluntary contribution of approximately $10 million to our defined benefit plan upon completion of the final plan asset transfers to maintain the funded status of our pension plan.  

 

As disclosed in Note 4, our former Kansas electric operations and our former Michigan, Minnesota and Missouri gas operations have been reclassified as discontinued operations.  The components of net periodic benefit cost presented in the tables above disclose information for the plans in total.  For the three and nine months ended September 30, 2007 and 2006, the net periodic pension benefit cost charged to discontinued operations was $**–** million, $.3 million, $.5 million and $2.0 million, respectively.  In addition, for the three and nine months ended September 30, 2007 and 2006, the net periodic other post-retirement benefits cost charged to discontinued operations was $**–** million, $.3 million, $.4 million and $1.6 million, respectively.

 

24

**9.  Legal******

 

**Price Reporting Litigation**

 

In response to complaints of manipulation of the California energy market, in 2002 the FERC issued an order requiring net sellers of power in the California markets from October 2, 2000 through June 20, 2001 at prices above a FERC determined competitive market clearing price to make refunds to net purchasers of power in the California market during that time period.  Because Aquila Merchant was a net purchaser of power during the refund period it has received approximately $7.6 million in refunds.  However, various parties appealed the FERC order to the United States Court of Appeals for the Ninth Circuit seeking review of a number of issues, including changing the refund period to include periods prior to October 2, 2000.  On August 2, 2006, the U.S. Court of Appeals for the Ninth Circuit issued an order finding, among other things, that FERC did not provide a sufficientjustification for refusing to exercise its remedial authority under the Federal Power Act to determine whether market participants violated FERC-approved tariffs during the period prior to October 2, 2000, and imposing a remedy for any such violations.  The court remanded the matter to FERC to determine whether tariff violations occurred and, if so, the appropriate remedy. A finding by FERC that tariff violations occurred during this period could result in Aquila Merchant being required to make substantial refunds and have a material adverse effect on its financial condition, results of operations and cash flows.

 

On October 6, 2006, the Missouri Commission filed suit in the Circuit Court of Jackson County, Missouri against 18 companies, including Aquila and Aquila Merchant, alleging that the companies manipulated natural gas prices through the misreporting of natural gas trade data and, therefore, violated Missouri antitrust laws.  The suit does not specify alleged damages and was filed on behalf of all local distribution gas companies in Missouri who bought and sold natural gas from June 2000 to October 2002.  We believe we have strong defenses and will defend this case vigorously.  We cannot predict whether we will incur any liability, nor can we estimate the damages, if any, that might be incurred in connection with this lawsuit. However, given the nature of the claims, an adverse outcome could have a material adverse effect on our financial condition, results of operations and cash flows.

 

**ERISA Litigation**

 

On September 24, 2004, a lawsuit was filed in the U.S. District Court for the Western District of Missouri against us and certain members of our Board of Directors and management, alleging they violated the ERISA and were responsible for losses that participants in our 401(k) plan experienced as a result of the decline in the value of their Aquila common stock held in the 401(k) plan.  A number of similar lawsuits alleging that the defendants breached their fiduciary duties to the plan participants in violation of ERISA by concealing information and/or misleading employees who held our common stock through our 401(k) plan were subsequently filed against us.  The suits also sought damages for the plan's losses resulting from the alleged breaches of fiduciary duties.  The court ordered that all of these lawsuits be consolidated into a single case captioned *In re AquilaERISA Litigation*and certified the case as a class action.  In April 2007, we settled the case for $10.5 million, which was paid by our insurance carrier.  The settlement is subject to final court approval.

 

**South Harper Peaking Facility**

 

We have constructed a 315 MW natural gas power plant and related substation in an unincorporated area of Cass County, Missouri.  Cass County and local residents filed suit claiming that county zoning approval was required to construct the project.  In January 2005, a Circuit Court of Cass County judge granted the County's request for an injunction; however, we were permitted to continue construction while the order was appealed.  We appealed the Circuit Court decision to the Missouri Court of Appeals for the Western District of Missouri and, in June 2005, the appellate court affirmed the circuit court ruling.  In July 2005, we requested that the Court of Appeals either rehear the case or transfer the case 

 

25

to the Missouri Supreme Court and, in October 2005, the Court of Appeals granted our request for rehearing.  

 

In December 2005, the appellate court issued a new opinion affirming the Circuit Court’s opinion, but also opining that it was not too late to obtain the necessary approval.  In light of this, we filed an application for approval with the Missouri Commission on January 24, 2006.  On January 27, 2006, the trial court granted our request to stay the permanent injunction until May 31, 2006, and ordered us to post a $20 million bond to secure the cost of removing the project.  Effective May 31, 2006, the Missouri Commission issued an order specifically authorizing our construction and operation of the power plant and substation.  On June 2, 2006, the trial court dissolved the $20 million bond, further stayed its injunction, and authorized us to operate the plant and substation while Cass County appealed the Missouri Commission’s order.

 

In June 2006, Cass County filed an appeal with the Circuit Court, challenging the lawfulness and reasonableness of the Missouri Commission’s order.  On October 20, 2006, the Circuit Court ruled that the Missouri Commission’s order was unlawful and unreasonable.  The Missouri Commission and Aquila have appealed the court’s decision, and the Missouri Court of Appeals for the Western District of Missouri heard oral arguments in May 2007.  We expect the Court of Appeals to issue its decision later this year.  If we exhaust all of our legal options and are ordered to remove the plant and substation, we estimate the cost to dismantle these facilities to be up to $20 million.  We estimate the incremental cost of relocating and reconstructing the plant and substation on a site that is being developed to meet future generation needs to beapproximately $75 million based on recent engineering studies.  Additional costs may be incurred to store the equipment before relocating it, and to secure replacement power until the plant and substation can be reconstructed.  We cannot reasonably estimate with certainty the total amount of these and other incremental costs that could be incurred, or the potential impairment of the carrying value of our investment in the plant we could suffer to the extent the ultimate costs incurred exceed the amount allowed for recovery in rates.

 

**Coal Supply Litigation**

 

In the spring of 2005, one of our coal suppliers, C. W. Mining, terminated a long term, fixed price coal supply agreement allegedly because of a force majeure event.  We have incurred significant costs procuring replacement coal and dispute that the supplier was entitled to terminate the contract.  We filed a lawsuit against the supplier in federal court in Salt Lake City and the trial was held in February 2007.  On October 29, 2007, the United States District Court for the District of Utah, Central Division held that C.W. Mining's performance under the coal contract was not excused by a force majeure event and awarded us $24.8 million in damages.  With the implementation of a fuel adjustment clause in our recent Missouri rate case, we expect that 95% of any damages collected as a result of this litigation will be for the benefit of our Missouri customers through lower rates.

 

**10.  Share-Based Compensation**

 

In 2002, the Board and our shareholders approved the Omnibus Incentive Compensation Plan.  This plan authorizes the issuance of 9,000,000 shares of Aquila common stock as stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, stock awards, cash-based awards and annual incentive awards to all eligible employees and directors of the company.  All equity-based awards are issued under this plan.  Generally, shares issued for stock option exercises and other share awards are made from treasury shares, if available, and newly issued shares.

 

**Stock Options**

 

Stock options under this plan and preceding plans have been granted at market prices generally with one to three year vesting terms and have been exercisable for seven to 10 years from the date of grant.  Cash received on stock options exercised was $.9 million, the intrinsic value of options exercised was $1.3 million and the tax benefit realized was $.2 million for the nine months ended 

 

26

September 30, 2007.  Stock options as of September 30, 2007 and changes during the nine months ended September 30, 2007 were as follows: 

 

|                                  | **Shares** | **Weighted Average Exercise Prices** | **Remaining Contractual****Term in Years** |
|---------------------------------------|------------|--------------------------------------|--------------------------------------------|
| Beginning balance                     | 4,865,866  | $                                    | 15.57                                      | 3.20 |
| Granted                               | -          |                                 | -                                          |   |
| Exercised                             | (312,540)  |                                 | 4.23                                       |   |
| Forfeited                             | (756,681)  |                                 | 19.78                                      |   |
| **Ending balance**                    | 3,796,645  | $                                    | 15.80                                      | 2.78 |
| **Exercisable at September 30, 2007** | 3,796,645  | $                                    | 15.80                                      | 2.78 |

 

The aggregate intrinsic value of “in-the-money” outstanding and exercisable options was $1.5 million as of September 30, 2007.

 

**Time-Based Restricted Stock Awards**

 

In 2005, 183,823 shares of restricted stock were awarded to certain managers and executives, excluding senior management.  These awards will vest two years after the award date.  On July 31, 2007, 106,000 shares of restricted stock were awarded to senior management; each recipient is a named executive officer of the Company.  These awards will vest in three years, and no restrictions on the sale of shares will apply thereafter.  The time restriction on both of these awards will lapse upon a change in control of the Company.  The fair value of these stock awards is determined based on the number of shares granted and the quoted price of our stock.  The compensation expense related to these awards was $.2 million for the nine months ended September 30, 2007.  As of September 30, 2007, the total compensation cost not yet recognized was $.4 million.  This compensation cost will be recognizedover the respective restriction periods.  The total fair value of restricted stock released for the nine months ended September 30, 2007 was $.3 million.  Non-vested, time-based restricted stock awards as of September 30, 2007 and changes during the nine months ended September 30, 2007 were as follows: 

 

|               | **Shares** | **Weighted Average Grant Date****Fair Value** | **Remaining Contractual****Term in Years** |
|--------------------|------------|-----------------------------------------------|--------------------------------------------|
| Beginning balance  | 351,515    | $                                             | 16.79                                      | .97 |
| Awarded            | 106,000    |                                          | 3.80                                       |   |
| Released           | (82,533)   |                                          | 23.73                                      |   |
| Forfeited          | (2,000)    |                                          | 3.60                                       |   |
| **Ending balance** | 372,982    | $                                             | 11.64                                      | 1.07 |

 

The aggregate intrinsic value of outstanding time-based restricted stock was $1.5 million as of September 30, 2007.

 

**Performance-Based Restricted Stock Awards**

 

Performance-based restricted stock awards were granted in the third quarter of 2006 to qualified individuals, excluding senior management, consisting of the right to receive a number of shares of common stock at the end of the restriction period, March 1, 2008, assuming performance criteria are met.  Additional performance based restricted stock awards were granted to senior management in the third quarter of 2007 and will vest on December 31, 2008.  The performance measure for both awards is the ratio of 2007 annual EBITDA (subject to certain adjustments) to net utility plant investment.  The awards granted to senior management, however, include four additional performance measures relating to network reliability, meter reading accuracy, and response time for customer service calls.  The ratios will be reviewed and approved by the Company’s Compensation and Benefits Committee on orbefore March 1, 2008.  Subject to any approved adjustments, the 

 

27

targeted award levels are set forth below, noting that the number of shares will be interpolated between these levels.  Upon a change in control of the Company, the performance-based restricted stock awards will vest at the award level determined by the Company’s Compensation and Benefits Committee, provided that if a change in control occurs before the Compensation and Benefits Committee has made such determination, then the performance-based restricted stock will vest at target (100%).

 

| **2007 EBITDA to****Net Utility Plant Investment** | **Shares Earned as a****% of Target Shares** |
|----------------------------------------------------|----------------------------------------------|
|                                               |                                         |
| Less than 10%                                      | 0%                                           |
| 10.0%                                              | 50%                                          |
| 11.5%                                              | 100%                                         |
| 13.0% or higher                                    | 150%                                         |

 

For the executive officers who received these awards, the amount of performance-based restricted stock earned based upon the EBITDA-to-net utility plant investment ratio described above will be reduced if the Company fails to achieve one or more of the four operational metrics.  If the Company fails to achieve one of the four operational metrics, the amount of performance-based restricted stock will be reduced by 25%.  If the Company fails to achieve two or three of the four operational metrics, the amount of performance-based restricted stock will be reduced by 50% or 75%, respectively.  If the Company fails to achieve all four operational metrics for fiscal year 2007, the shares of performance-based restricted stock earned under the EBITDA-to-net utility plant investment calculation will be reduced to zero.

 

The four operational metrics include: 

 

|                |                                    | **Electric****States** | **Gas States** |   |
|---------------------|-----------------------------------------|------------------------|----------------|--------|
| **Category**        | **Metric**                              | **CO**                 | **MO**         | **CO** | **KS** | **IA** | **NE** | **Total** |
| Reliability #1      | Network Reliability                     | n/a                    | n/a            | 2      | 2 | 2 | 2 | n/a |
| Reliability #2      | SAIFI                                   | 1.32                   | 1.73           | n/a    | n/a | n/a | n/a | n/a |
| Customer Service #1 | Meter Reading Accuracy                  | 99.4%                  | 99.4%          | 99.4%  | 99.4% | 99.4% | 99.4% | n/a |
| Customer Service #2 | Customer Service Calls within20 Seconds | n/a                    | n/a            | n/a    | n/a | n/a | n/a | 72% |

 

The fair value of these stock awards is determined based on the number of shares granted and the quoted price of our stock on date of the award.  The compensation expense related to this award was $.2 million for the nine months ended September 30, 2007.  As of September 30, 2007, the estimated total compensation cost not yet recognized was $.4 million.  This compensation cost will be recognized over the period through the respective restriction periods.  Non-vested, performance-based restricted stock awards (based on target number) as of September 30, 2007 and changes during the nine months ended September 30, 2007 were as follows:

 

28

|               | **Shares** | **Weighted Average Grant Date****Fair Value** | **Remaining Contractual Term in Years** |
|--------------------|------------|-----------------------------------------------|-----------------------------------------|
| Beginning balance  | 176,000    | $                                             | 4.44                                    | 1.25 |
| Awarded            | 124,000    |                                          | 3.80                                    |   |
| Released           | (8,000)    |                                          | 4.44                                    |   |
| Forfeited          | (4,000)    |                                          | 4.44                                    |   |
| **Ending balance** | 288,000    | $                                             | 4.16                                    | .78 |

 

The aggregate intrinsic value of outstanding performance-based restricted stock was $ 1.2 million as of September 30, 2007.

 

**Director Stock Awards**

 

Non-employee directors receive as part of his or her annual retainer, an annual award of 7,500 shares of common stock of the Company.  Each director may elect to defer receipt of their shares until retirement or until they are no longer a member of our Board of Directors.  Shares are awarded on the last trading day of each calendar quarter.  Compensation expense is based upon the fair market value of the Company’s common stock at the date of issuance.  Director stock awards as of September 30, 2007 and changes during the nine months ended September 30, 2007 were as follows:

 

|               | **Shares** | **Weighted Average Grant Date****Fair Value** |
|--------------------|------------|-----------------------------------------------|
| Beginning balance  | 208,372    | $                                             | 4.45 |
| Awarded            | 39,375     |                                          | 4.11 |
| Released           | (11,250)   |                                          | 4.11 |
| **Ending balance** | 236,497    | $                                             | 4.41 |

 

The aggregate intrinsic value of outstanding director stock awards was $.9 million as of September 30, 2007.

 

**11: Income Taxes**

 

We adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (FIN 48) effective January 1, 2007.  This interpretation sets a “more likely than not” threshold before tax benefits can be recognized in our financial statements.  Our practice prior to FIN 48 was to recognize income tax benefits when they were reflected on filed income tax returns and establish a reserve against these tax benefits when their ultimate realization was not deemed to be “probable.”  Our reserve for uncertain tax positions was $377.3 million at December 31, 2006.

 

In connection with the adoption of FIN 48 we analyzed our uncertain tax positions using the new “more likely than not” threshold.  Based on this analysis, the reserve for uncertain tax positions was reduced by $175.4 million.  This resulted in net deferred tax assets of $156.1 million.  The primary deferred tax asset is the tax benefit related to our net operating loss (NOL) carryforwards.  We were required to assess the ultimate realization of the deferred tax assets using a “more likely than not” standard.  This assessment considered tax planning strategies within our control.  The assessment, however, did not take into consideration the expected taxable gains, both ordinary and capital, from the pending sales of our Colorado electric properties and our Colorado, Kansas, Iowa and Nebraska gas properties.  In addition, the assessment did not take into consideration ourpending merger with a subsidiary of Great Plains Energy. 

 

Since the implementation of FIN 48 resulted in a net deferred tax asset position and the primary deferred tax asset relates to NOL carryforwards, we recorded a valuation allowance of $156.1 million against the tax benefit related to the NOL carryforwards equal to the net deferred tax assets.

 

29

 

The net effect of the implementation of FIN 48 including the adjustment for related valuation allowance was effected through an increase of $19.3 million to beginning retained earnings in the first quarter of 2007.

 

As discussed above, our practice prior to implementation of FIN 48 was to record tax benefits based on returns as filed and establish a reserve against these tax benefits when they were deemed to be uncertain.  Under FIN 48, however, tax benefits are not recorded when their ultimate realization is deemed to be uncertain.  As such, we adjusted our deferred tax accounts at January 1, 2007 to reduce deferred tax assets that relate to uncertain tax benefits under the FIN 48 “more likely than not” threshold.  The reserve for uncertain tax benefits was reduced by the same amount.

 

Deferred tax assets impacted by these adjustments were those related to NOL carryforwards, AMT credit carryforwards and general business credit carryforwards.  In addition, some income tax uncertainties relate to the characterization of certain taxable gains as capital instead of ordinary.  Thus, the reduction in deferred tax assets for NOL carryforwards was partially offset by an increase in deferred tax assets for capital loss carryforwards.  However, we maintain a full valuation allowance against the tax benefits from our capital loss carryforwards, so this valuation allowance was likewise increased.  These adjustments did not change the amount of net deferred tax assets.

 

The amount of unrecognized income tax benefits at January 1, 2007 was $222.6 million.  We recognize accrued interest and penalties associated with uncertain tax positions as part of the tax provision.  When interest and penalties are assessed the tax provision is adjusted.  As of January 1, 2007, we had $5 million of accrued interest and penalties included in the reserve for uncertain tax positions.  At September 30, 2007, the amount of unrecognized income tax benefits decreased to $210.3 million.  Of this amount, $177.6 million would impact the effective rate if recognized.  Accrued interest and penalties associated with uncertain tax positions at September 30, 2007 were $5.4 million.

 

The $12.3 million decrease in unrecognized income tax benefits in 2007 includes the following adjustments:  1) a decrease of $25.7 million which impacted the effective rate and an increase of $7 million which did not impact the effective rate, both related to a change in the estimate of the utilization of net operating loss carryovers, net capital loss carryovers and alternative minimum tax credit carryovers in conjunction with the audit by the Internal Revenue Service (IRS) of our federal income tax returns for the years 1998 to 2004; 2) an increase of $8 million which impacted the effective rate related to Canadian tax audits; and 3) a decrease of $1.6 million which impacted the effective rate related to the settlement of a state tax audit during the third quarter. 

 

In addition to our consolidated Federal and various state tax returns, we file separate subsidiary tax returns in Canada and certain other states.  We have open U.S. federal tax examinations in process relating to our 1998 and subsequent tax returns.

 

On May 7, 2007 the Canada Revenue Agency (CRA) proposed to disallow certain deductions relating to Goods and Service Tax (GST) receivable and intercompany accounts taken on the 2002 Canadian income tax return of our wholly-owned subsidiary, Aquila Canada Corp (ACC).  ACC was part of our Merchant Services business in Canada.  We are contesting these proposed adjustments.  If the proposed adjustments are sustained in full the resulting estimated tax and interest liability would be approximately $19.8 million.  Pursuant to FIN 48, during the second quarter of 2007 we wrote off our Canadian current income tax receivable of $4.8 million and recorded a current income tax payable of $3.6 million.

 

On October 9, 2007 we agreed to adjustments contained in IRS audit reports related to our 1998 to 2002 taxable years.  In addition, the agreement stipulates consistent treatment during our 2003 and 2004 taxable years for certain issues related to our former Networks businesses in Australia and Canada.  The agreements must be approved by the Joint Committee on Taxation.  There is no timetable for such approval, but the statute of limitations for the years 1998 to 2002 is scheduled to 

 

30

expire November 30, 2008.  We expect the following adjustments to our tax attributes upon conclusion of these audits:  1) tax refunds of $19.7 million, $4.9 million of which will be received after the full 2003-2004 audit is complete; 2) our net operating loss carryforwards will be decreased by $250.1 million; 3) our capital loss carryforwards will be decreased by $53 million; 4) our AMT credit will be decreased by $7.5 million; 5) our general business credit carryforward will be decreased by $5.5 million; and we will pay interest to the IRS of $7.6 million, $3.3 million of which is currently on deposit with the IRS.  In addition, we expect our deferred tax liability to decrease by $32.7 million for those IRS adjustments that do not impact our effective tax rate.  The impact of these adjustments, both positive and negative, is currently included in our unrecognized tax benefits.

 

It is reasonably possible that the amount of unrecognized tax benefits will change significantly within the next twelve months.  This change will occur if the Joint Committee on Taxation approves our agreement with the IRS regarding our 1998 to 2002 taxable years and certain issues related to 2003 and 2004 and we determine that the IRS is unlikely to reopen these years for examination prior to the expiration of the statute of limitations on November 30, 2008.  In such case, we estimate that our unrecognized tax benefits would decrease by $110 million primarily reflecting the audit consequences discussed above.  In addition, the Canadian income tax audit of 2002 could be settled.  An estimate of any changes to the amount of unrecognized tax benefits related to the Canadian audit cannot be made at this time.

 

On September 30, 2007, we had net deferred tax assets of $24.3 million primarily related to decreases in deferred income tax liabilities related to the sale of our Kansas electric business and a decrease in unrecognized tax benefits.  The primary deferred tax asset is the tax benefit related to our NOL carryforwards.  As described above, we are required to assess the ultimate realization of the deferred tax assets using a “more likely than not” standard.  As a result of this assessment, during 2007 we increased our valuation allowance against the tax benefit of our net operating losses by $24.3 million, the amount of our net deferred tax assets.  Our effective tax rates for the three and nine months ended September 30, 2007 were impacted by reductions in unrecognized tax benefits, our evaluation of the likelihood of realizing our NOL carryforwards as discussed above and by thenotices of proposed adjustment we received from the CRA in the second quarter of 2007 which resulted in adjustments to unrecognized tax benefits.

 

**12: Pending Merger**

 

On February 6, 2007, we entered into an agreement and plan of merger with Great Plains Energy, Gregory Acquisition Corp., a wholly-owned subsidiary of Great Plains Energy, and Black Hills, which provides for the merger of Gregory Acquisition Corp. into us, with Aquila continuing as the surviving corporation.  If the Merger is completed, we will become a wholly-owned subsidiary of Great Plains Energy, and our shareholders will receive cash and shares of Great Plains Energy common stock in exchange for their shares of Aquila common stock.  At the effective time of the Merger, each share of Aquila common stock will convert into the right to receive 0.0856 of a share of Great Plains Energy common stock and a cash payment of $1.80.  The exchange ratio is fixed and will not be adjusted to reflect stock price changes prior to the completion of the Merger.  Upon consummation of the Merger, ourshareholders are expected to own approximately 27% of the outstanding common stock of Great Plains Energy, and the Great Plains Energy shareholders will own approximately 73% of the outstanding common stock of Great Plains Energy.

 

The parties have made customary representations, warranties and covenants in the merger agreement.  We have agreed, subject to certain exceptions set forth in the merger agreement, to conduct our business in the ordinary course during the period between the execution of the merger agreement and consummation of the Merger, and to refrain from engaging in or otherwise limit certain transactions and activities during this interim period.  Consummation of the Merger is subject to a number of conditions, including (i) approval of the Kansas Commission and the Missouri Commission; (ii) the completion of the asset sale transactions described below; and (iii) the absence of a material adverse effect on our businesses that remain after giving effect to the asset sales described below. 

 

31

 

The merger agreement contains certain termination rights for both us and Great Plains Energy, including the right to terminate the merger agreement if the Merger has not closed within 12 months following the date of the merger agreement (subject to extension to up to 18 months for receipt of regulatory approvals required to consummate the Merger and the asset sales). We and Great Plains Energy each have the right to terminate the merger agreement to enter into a superior transaction after giving the other party six business’ days notice and an opportunity to revise the terms of the merger agreement.  If the merger agreement is terminated under specified circumstances (including a termination to enter into a superior transaction), we or Great Plains Energy will pay to the other a $45 million termination fee.

 

In connection with the Merger, we also entered into agreements with Black Hills under which we have agreed to sell our Colorado electric utility and our Colorado, Iowa, Kansas and Nebraska gas utilities to Black Hills for $940 million in cash, subject to certain working capital and other purchase price adjustments.  The agreements contain various provisions customary for transactions of this size and type, including representations, warranties and covenants with respect to the Colorado, Iowa, Kansas and Nebraska utility businesses that are subject to usual limitations.  Completion of the sale transactions is subject to various conditions, including: (i) the approval of the Colorado Public Utilities Commission and the Kansas Commission; (ii) the absence of a material adverse effect on the utility businesses being sold to Black Hills; and (iii) the ability and readiness of Aquila, GreatPlains Energy and Gregory Acquisition Corp. to complete the Merger immediately after the completion of the asset sales.  The employees of these utility operations are expected to be transferred to Black Hills upon completion of the sale.

 

The Merger and the asset sales are contingent upon the closing of the other transaction, meaning that one transaction will not close unless the other transaction closes.  

 

On April 4, 2007, we and Great Plains Energy filed joint applications with the Missouri Commission and the Kansas Commission requesting approval of the Merger.  On the same date, we and Black Hills filed joint applications with the Colorado Public Utilities Commission, IUB, Kansas Commission and Nebraska Commission requesting approval of the asset sales to Black Hills.  On May 25, 2007, the parties filed a joint application with the FERC requesting approval of the Merger and the sale of our Colorado electric assets to Black Hills, and we amended the joint application on June 20, 2007.  On July 27, 2007, Aquila and Great Plains Energy filed the antitrust notifications required under the Hart-Scott-Rodino Antitrust Improvements Act (HSR Act) to complete the Merger.  

 

On August 27, 2007, the Federal Trade Commission granted early termination of the statutory waiting period under the HSR Act for both the Merger and the asset sales to Black Hills.  On August 31, 2007, the sale of our Iowa gas utility operation to Black Hills was approved by the IUB.  On October 9, 2007, the merger agreement was adopted by Aquila’s shareholders.  On October 10, 2007, the issuance of common stock by Great Plains Energy in connection with the Merger was approved by Great Plains Energy’s shareholders.  On October 16, 2007, the Nebraska Commission approved the sale of our Nebraska gas operations to Black Hills.  On October 19, 2007, the FERC approved the Merger and the sale of our Colorado electric operations to Black Hills.  Regulatory hearings are scheduled in Missouri and Kansas for December 2007 and January 2008, respectively.  Regulatory orders are expected to bereceived in the first quarter of 2008.

 

We have evaluated the accounting classification of the assets to be acquired by Black Hills relative to SFAS 144.  Based on our assessment, the criteria for classification of the assets as "held for sale" and discontinued operations have not been met.  Important factors underlying our analysis include: our management and board of directors have no intention of selling these assets separately from the contingent, two-step Merger transaction, which is not a usual and customary provision for asset sales; the significant conditions to closing, including numerous regulatory approvals; and, the fact the asset sale will occur immediately prior to the completion of the Merger.  As a result, we have 

 

32

not reclassified the assets to be acquired by Black Hills as "held for sale" and reported those results as discontinued operations.

 

Regardless of whether the Merger is completed, we will incur significant costs, primarily consisting of investment banking, legal, employee retention, change-in-control, and other severance costs which we will expense as they are incurred.  In 2006, we incurred approximately $2.3 million of costs (primarily investment banking and legal costs) relating to these transactions.  In the three and nine months ended September 30, 2007, we incurred $1.3 million and $9.5 million, respectively, of additional costs, including fees paid to our financial advisors of $6.2 million in connection with the signing of the merger agreement.  On approval of the Merger in October 2007 by our shareholders we paid our financial advisors additional fees of approximately $4.5 million.  These costs are or will be included in operation and maintenance expense in Corporate and Other.

 

Beginning in February 2007, we also executed retention agreements totaling $8.8 million with numerous non-executive employees to mitigate employee attrition prior to the closing of the Merger.  The retention awards will be paid on the earlier of the closing of the Merger or January 31, 2008.  We accrued $2.2 million and $5.6 million of expense related to these retention agreements in the three and nine months ended September 30, 2007, respectively.  These costs are included in operation and maintenance expense in Corporate and Other.

 

Further information concerning the Merger and asset sales is included in the definitive proxy statement that we filed with the SEC and mailed to our shareholders.  

 

**Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations**

 

**See Forward-Looking Information beginning on page 51**

 

**Strategy**

 

Our remaining repositioning initiatives continue to be focused on improving operational results of our integrated electric and gas utility operations and strengthening our credit profile in order to efficiently execute our multi-state regulated utility growth strategy.

 

We will continue to focus on building and maintaining the generation, transmission and distribution infrastructure necessary to provide our utility customers with safe and reliable service, while increasing the returns on invested capital in jurisdictions that lag behind those of our peers.  We will also focus on improving our returns through future rate activities and process improvements.

 

**Strengthen Credit Profile**

 

With a stronger credit profile we will have the opportunity to more cost effectively invest in power generation, transmission and distribution capacity, as well as undertake environmental upgrades over the next decade.  We believe these normal course investments will not only improve the reliability and quality of our utility service, but also provide a platform for additional growth in our earnings and enhanced shareholder value.

 

33

**Current Credit Ratings**

 

As of September 30, 2007, our senior unsecured long-term debt ratings, as assessed by the three major credit rating agencies, were as follows: 

 

| **Agency** | **Rating** | **Commentary**                            |
|------------|------------|-------------------------------------------|
| Moody's    | Ba3        | Ratings Under Review for Possible Upgrade |
| S&P    | B+         | Credit Watch Positive                     |
| Fitch      | BB–   | Rating Watch Positive                     |

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

**Working Capital Requirements**

 

The most significant activity impacting working capital is the purchase of natural gas for our gas utility customers.  We could experience significant working capital requirements during peak months of the winter heating season due to higher natural gas consumption, during potential periods of high natural gas prices and due to our current requirement to prepay certain gas commodity suppliers and pipeline transportation companies.  Under a stressed weather and commodity price environment, such as the spike in commodity prices in late 2005 following an active hurricane season, we estimate our peak working capital needs to be up to $200 million.  We anticipate using the combination of revolving credit and letter of credit facilities listed below and cash on hand to meet our peak winter working capital requirements.

 

| **Credit Facility**                                                                                                                     | **Expiration**       | **Maximum****Capacity** | **Borrowings or Letters of****Credit Issued at****September 30, 2007** |
|-----------------------------------------------------------------------------------------------------------------------------------------|----------------------|-------------------------|------------------------------------------------------------------------|
|                                                                                                                                    |                 | *In millions***         |
| Four-Year Secured    Revolving Credit     Facility                                                   | April 22, 2009 *(1)* | $                       | 150.0                                                                  | $ | – |
| Five-Year Unsecured   Revolving Credit     Facility                                                  | September 19, 2009   |                    | 110.0                                                                  |   | – |
| $180 Million Unsecured    Revolving Credit and     Letter of Credit     Facility | April 13, 2010 *(1)* |                    | 180.0                                                                  |   | 121.9 |
| $50 Million Unsecured    Revolving Credit and     Letter of Credit     Facility  | December 19, 2007    |                    | 50.0                                                                   |   | 27.4 |

 

| * * | *(1)* | *Borrowings under these facilities must be repaid within 364 days unless we obtain regulatory approval to incur long-term indebtedness under these facilities.* |
|----------|-------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

34

**Cash Flows**

 

***Cash Flows Provided From Operating Activities***

 

Our positive nine-month 2007 operating cash flows were driven primarily by seasonal declines in working capital requirements for our utility operations and the net return of funds on deposit from our merchant and utility counterparties.

 

Our $10.9 million of negative operating cash flows for the nine months ended September 30, 2006, were largely due to our 2006 operating net loss which was primarily driven by the $218 million loss on our exit from the Elwood toll in the second quarter of 2006. The return of $60.1 million of counterparty collateral resulting from lower natural gas prices since December 2005, and a $25.4 million payment to Calpine in connection with the netting of amounts owed under various contracts at the time of Calpine’s bankruptcy filing also contributed to our negative cash flows.  The decreases were offset by seasonal declines in working capital requirements for our utility operations and the continued wind-down of our merchant trading portfolio which triggered the return of $109.6 million of funds on deposit and a $41.3 million decrease in other current assets.  Additionally, we received $38.7million of funds on deposit returns due to the replacement of cash deposits and cash-collateralized letters of credit with unsecured letters of credit supporting the Elwood tolling contracts, and utilized $18.0 million of gas and other inventory held in storage.

 

The 14.875% interest rate we pay on $500 million of our long-term debt has substantially increased our interest costs and will continue to negatively impact our operating cash flows.  It will be important for us to substantially improve our operating cash flows to cover these interest costs as well as to fund our capital investment plan. We are attempting to do this by improving the efficiency of our remaining businesses, increasing sales through utility rates, retiring debt and completing the wind-down of our Merchant Services business. 

 

***Cash Flows Provided From Investing Activities***

 

The decrease in cash provided from investing activities was primarily the result of lower cash proceeds received on the sale of assets. In addition, utility capital expenditures increased compared to 2006 primarily due to the construction of the Iatan 2 facility and environmental upgrades. 

 

***Cash Flows Used For Financing Activities***

 

Cash flows used for financing activities in the nine months ended September 30, 2007 and 2006 consist primarily of cash we paid to retire our long-term debt obligations and our payments under our remaining long-term gas contracts that expire by early 2008.

 

**Collateral Positions**

 

|   | As of September 30, 2007, we had posted cash collateral for the following: |
|--------|----------------------------------------------------------------------------|

 

| *In millions***                      |   |   |
|--------------------------------------|--------|--------|
| Trading positions                    | $      | 25.9   |
| Utility cash collateral requirements |   | 23.8   |
| Other                                |   | .8     |
| Total Funds on Deposit               | $      | 50.5   |

 

Collateral requirements for our remaining trading positions will fluctuate based on the movement in commodity prices and our credit rating. Changes in collateral requirements will vary depending on the magnitude of the price movement and the current position of our trading portfolio. As these trading positions settle in the future, the collateral will be returned. 

 

35

We are required to post collateral with certain commodity and pipeline transportation vendors. This amount will fluctuate depending on gas prices and projected volumetric deliveries. The ultimate return of this collateral is dependent on the strengthening of our credit profile. 

 

**FINANCIAL REVIEW**

 

This review of performance is organized by business segment, reflecting the way we managed our business during the periods covered by this report. Each business group leader is responsible for operating results down to EBITDA. We use EBITDA as a performance measure as it captures the income and expenses within the management control of our segment business leaders. Because financing for the various business segments is generally completed at the parent company level, EBITDA provides our management and third parties an indication of how well individual business segments are performing. Therefore, each segment discussion focuses on the factors affecting EBITDA, while financing and income taxes are separately discussed at the corporate level. 

 

As further discussed in Note 4 to the Consolidated Financial Statements, we have reported the results of operations of the following assets in discontinued operations in the Consolidated Statements of Income: (i) our former Kansas electric utility operations and our former Michigan, Minnesota and Missouri gas utility operations, (ii) our former peaking power plants in Illinois, and (iii) our former communications business, Everest Connections.  Therefore, the operating results of these assets are discussed separately from the reporting segments to which they relate under the caption “Discontinued Operations.”

 

The use of EBITDA as a performance measure is not meant to be considered an alternative to net income or cash flows from operating activities, which are determined in accordance with GAAP. In addition, our use of EBITDA may not be comparable to similarly titled measures used by other entities. 

 

|                                                                   | **Three Months Ended** | **Nine Months Ended** |
|------------------------------------------------------------------------|------------------------|-----------------------|
|                                                                   | **September 30,**      | **September 30,**     |
| *In millions*                                                          | **2007**               | **2006**              | **2007** | **2006** |
| Earnings (Loss) Before Interest, Taxes, Depreciation and Amortization: |                   |                  |   |   |   |   |   |   |
| Utilities:                                                             |                   |                  |   |   |   |   |   |   |
| Electric Utilities                                                     | $                      | 94.9                  | $ | 58.0 | $ | 149.3 | $ | 120.5 |
| Gas Utilities                                                          |                   | 5.2                   |   | 1.6 |   | 41.7 |   | 29.3 |
| Total Utilities                                                        |                   | 100.1                 |   | 59.6 |   | 191.0 |   | 149.8 |
| Merchant Services                                                      |                   | (1.3)                 |   | (17.0) |   | (1.9) |   | (249.0) |
| Corporate and Other                                                    |                   | (2.7)                 |   | (3.7) |   | (7.5) |   | (32.8) |
| Total EBITDA                                                           |                   | 96.1                  |   | 38.9 |   | 181.6 |   | (132.0) |
| Depreciation and amortization                                          |                   | 27.3                  |   | 27.0 |   | 81.4 |   | 78.5 |
| Interest expense                                                       |                   | 31.5                  |   | 42.7 |   | 111.6 |   | 124.4 |
| Income tax expense (benefit)                                           |                   | 5.6                   |   | (10.2) |   | (.6) |   | (43.9) |
| Income (loss) from continuing   operations              |                   | 31.7                  |   | (20.6) |   | (10.8) |   | (291.0) |
| Earnings from discontinued    operations, net of tax    |                   | 8.8                   |   | 136.3 |   | 12.3 |   | 250.6 |
| Net income (loss)                                                      | $                      | 40.5                  | $ | 115.7 | $ | 1.5 | $ | (40.4) |

 

**Key Factors Impacting Results of Continuing Operations**

 

For the nine months ended September 30, 2007, total EBITDA increased $313.6 million compared to 2006. Key factors affecting 2007 results were as follows: 

 

36

|   | **•** | Total Utilities EBITDA increased $41.2 million primarily due to increased EBITDA in our Electric Utilities driven mainly by rate increases approved in Missouri, including the implementation of a Fuel Adjustment Clause and due to increased EBITDA in our Gas Utilities due to favorable weather and other volumes and an interim rate increase in Nebraska.  These EBITDA increases were offset in part by increased fuel and purchased power costs in our Electric Utilities resulting from reduced availability of certain power plants due to unplanned or extended outages and curtailed delivery under a purchased power contract, unfavorable settlements of hedge transactions and increased operation and maintenance expenses primarily in the first quarter of 2007. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Merchant Services loss before interest, taxes, depreciation and amortization decreased $247.1 million in 2007 compared to 2006 primarily due to the $218 million loss on the assignment of our rights and obligations under the Elwood tolling agreements, the elimination of $17.8 million of margin losses incurred in 2006 related to these agreements and $15.8 million in lower provisions for price reporting litigation reserves, offset in part by $4.4 million of reversals of allowances for bad debts in 2006 that did not recur in 2007. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Corporate and other loss before interest, taxes, depreciation and amortization decreased $25.3 million in 2007 compared to 2006, primarily due to decreased losses on early retirement of debt from the 2006 debt tender offer, lower restructuring severance costs, higher other income from gains on sales of land and buildings offset in part by increased legal and financial advisors fees related to the pending merger and asset sale. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**Electric Utilities**

 

The table below summarizes the operations of our Missouri and Colorado Electric Utilities, which represent our continuing electric operations:

 

|                                                                      | **Three Months Ended** | **Nine Months Ended** |
|---------------------------------------------------------------------------|------------------------|-----------------------|
|                                                                      | **September 30,**      | **September 30,**     |
| *Dollars in millions***                                                   | **2007**               | **2006**              | **2007** | **2006** |
| Sales:                                                                    |                   |                  |   |   |   |   |   |   |
| Electricity—regulated                                                | $                      | 282.1                 | $ | 242.8 | $ | 651.9 | $ | 601.0 |
| Other—non-regulated                                                  |                   | .2                    |   | .2 |   | .6 |   | .5 |
| Total sales                                                               |                   | 282.3                 |   | 243.0 |   | 652.5 |   | 601.5 |
| Cost of sales:                                                            |                   |                  |   |   |   |   |   |   |
| Electricity—regulated                                                |                   | 136.1                 |   | 135.0 |   | 354.2 |   | 327.7 |
| Other—non-regulated                                                  |                   | .2                    |   | (.4) |   | .5 |   | .3 |
| Total cost of sales                                                       |                   | 136.3                 |   | 134.6 |   | 354.7 |   | 328.0 |
| Gross profit                                                              |                   | 146.0                 |   | 108.4 |   | 297.8 |   | 273.5 |
| Operation and maintenance expense                                         |                   | 48.2                  |   | 44.6 |   | 139.8 |   | 134.4 |
| Taxes other than income taxes                                             |                   | 4.6                   |   | 5.8 |   | 15.3 |   | 18.1 |
| Other income (expense)                                                    |                   | 1.7                   |   | – |   | 6.6 |   | (.5) |
| EBITDA                                                                    | $                      | 94.9                  | $ | 58.0 | $ | 149.3 | $ | 120.5 |
| Reconciliation of EBITDA to Income    Before Income Taxes: |                   |                  |   |   |   |   |   |   |
| EBITDA                                                                    | $                      | 94.9                  | $ | 58.0 | $ | 149.3 | $ | 120.5 |
| Depreciation and amortization expense                                     |                   | 18.0                  |   | 18.4 |   | 54.6 |   | 52.1 |
| Interest expense                                                          |                   | 14.9                  |   | 11.2 |   | 43.4 |   | 37.5 |
| Income before income taxes                                                | $                      | 62.0                  | $ | 28.4 | $ | 51.3 | $ | 30.9 |
| Electric sales and transportation   volumes (GWh)     |                   | 3,179.8               |   | 3,053.5 |   | 8,553.6 |   | 8,398.7 |
| Electric customers at end of period                                       |                   |                  |   |   |   | 402,196 |   | 397,721 |

 

 

37

 

***Quarter-to-Quarter***

 

*Sales, Cost of Sales and Gross Profit*

 

Sales and cost of sales for the Electric Utilities business increased $39.3 million and $1.7 million, respectively, for a gross profit increase of $37.6 million in 2007 compared to 2006.  These changes were primarily due to the following factors:  

 

|   | **•** | Sales and gross profit increased by $18.2 million due to a rate increase in Missouri effective May 31, 2007. |
|--------|------------|--------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Cost of sales decreased and gross profit increased by $1.6 million primarily related to favorable derivative settlements of $4.7 million related to fuel hedges for our Missouri operations partially offset by an increase in demand costs of $3.0 million due to a scheduled capacity and cost increase in a Colorado contract, as well as additional contracts entered into for Missouri operations. |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Gross profit increased $12.1 million resulting from an increase in base energy recovery of $4.3 million and the implementation of the FAC in Missouri compared to the third quarter of 2006.  Effective June 1, 2007, the FAC in Missouri allows us to recover 95% of our actual fuel costs in excess of those included in base rates.  We established a receivable for unbilled revenue of $17.2 million during the quarter for 95% of our fuel and purchased power energy costs incurred that exceeded our base rate energy recovery.  These increased sales were offset in part by increases in certain energy costs that are not recovered in the FAC.  Costs will be accumulated through November 2007 and rate changes to the customers’ bills will be effective March 2008.  Additional costs will accumulate through May 2008 for rate changes effective September 2008. |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Favorable weather, customer growth and other volume and price variances increased sales, cost of sales and gross profit by $8.2 million, $2.7 million and $5.5 million, respectively, in 2007. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Sales and cost of sales decreased $8.0 million and $8.2 million, respectively, from lower sales for resale for the quarter. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------|

 

*Operation and Maintenance Expense*

 

Operation and maintenance expense increased $3.6 million in 2007 compared to 2006.  A primary factor contributing to this increase was an increase in labor and benefit costs of 

$1.8 million and bad debt expense of $.7 million.

 

***Year-to-Date***

 

*Sales, Cost of Sales and Gross Profit*

 

Sales and cost of sales for the Electric Utilities business increased $51.0 million and $26.7 million, respectively, resulting in a gross profit increase of $24.3 million in 2007 compared to 2006.  These changes were primarily due to the following factors:  

 

|   | **•** | Sales and gross profit increased by $26.9 million due to rate increases in Missouri effective March 2006 and May 31, 2007. |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Favorable weather and higher usage per customer, as well as customer growth increased sales, cost of sales and gross profit by $17.2 million, $5.5 million and $11.7 million, respectively, in 2007. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

38

 

|   | **•** | Cost of sales increased and gross profit decreased by $29.2 million due to several factors.  First, several of our wholly-owned and jointly-owned coal-fired, baseload plants experienced outages (both unplanned outages and extended planned outages) in 2007 that required us to purchase replacement power in the spot market, which increased costs by $4.9 million.  In addition, a baseload purchased power contract was curtailed under a force majeure due to transmission constraints and a scheduled outage, thereby requiring additional power to be purchased in the spot market resulting in increased costs of sales of $4.9 million.  Also contributing to the increased costs was higher generation cost of $3.3 million caused by higher coal and delivery costs as well as a greater percentage of generation from gas fired units.  A combination of the above events, as well as otherregional market conditions, generally resulted in higher purchased power prices in the spot market during the first nine months of the year, which added $10.5 million to our cost of sales.  Cost of sales also increased $5.6 million due to additional demand contracts executed to access additional supply for Missouri operations and a scheduled increase in a Colorado demand contract. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Gross profit increased $12.6 million resulting from an increase in base energy recovery of $5.0 million and the implementation of the FAC in Missouri compared to the nine months ended September 30, 2006.  We established a receivable for unbilled revenue of $18.6 million for 95% of our fuel and purchased power energy costs incurred that exceeded our base rate energy recovery since implementation.  These increased sales were offset in part by increases in certain energy costs that are not recovered in the FAC. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Sales and cost of sales decreased $16.3 million and $17.7 million, respectively, from lower sales for resale.  Gross profit increased, however, by $1.4 million from 2006 to 2007. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

*Operation and Maintenance Expense*

 

Operation and maintenance expense increased $5.4 million in 2007 compared to 2006.  A primary factor contributing to this increase was a $5.1 million increase in labor and benefit costs.  

 

*Taxes Other Than Income Taxes Expense*

 

Taxes other than income taxes expense decreased $2.8 million in 2007 compared to 2006.  The primary cause of this decrease was an unfavorable settlement of a property tax dispute in the second quarter of 2006 that did not recur in 2007.

 

*Other Income (Expense)*

 

Other income increased $7.1 million primarily due to the receipt in 2007 of $3.2 million in breakup fees related to the unsuccessful attempt to purchase the Aries power plant for which we had been named the stalking horse bidder in an auction process run on behalf of creditors of Calpine Corporation.  AFUDC related to the construction of Iatan 2 of $2.9 million also contributed to the overall increase.

 

***Earnings Trend***

 

Our Missouri electric assets comprise a majority of our utility assets, and the earnings generated by our Missouri electric operations account for a majority of our total utility earnings and revenue.  We expect this trend to continue, and for our financial condition to become increasingly dependent on the revenue and earnings generated by our Missouri electric operations.  We are making significant investments in our Missouri electric operations which will require us to file multiple rate cases between now and 2010.  As we increase rates, we expect the earnings generated by our Missouri electric operations to improve.

 

39

**Gas Utilities**

 

The table below summarizes the operations of our Colorado, Iowa, Kansas and Nebraska Gas Utilities, which represent our continuing gas operations:

 

|                                                                            | **Three Months Ended** | **Nine Months Ended** |
|---------------------------------------------------------------------------------|------------------------|-----------------------|
|                                                                            | **September 30,**      | **September 30,**     |
| *Dollars in millions***                                                         | **2007**               | **2006**              | **2007** | **2006** |
| Sales:                                                                          |                   |                  |   |   |   |   |   |   |
| Natural gas—regulated                                                      | $                      | 68.0                  | $ | 71.4 | $ | 435.4 | $ | 413.3 |
| Other—non-regulated                                                        |                   | 9.1                   |   | 6.6 |   | 21.8 |   | 23.0 |
| Total sales                                                                     |                   | 77.1                  |   | 78.0 |   | 457.2 |   | 436.3 |
| Cost of sales:                                                                  |                   |                  |   |   |   |   |   |   |
| Natural gas—regulated                                                      |                   | 38.1                  |   | 43.9 |   | 310.8 |   | 300.2 |
| Other—non-regulated                                                        |                   | 4.5                   |   | 2.7 |   | 11.3 |   | 14.6 |
| Total cost of sales                                                             |                   | 42.6                  |   | 46.6 |   | 322.1 |   | 314.8 |
| Gross profit                                                                    |                   | 34.5                  |   | 31.4 |   | 135.1 |   | 121.5 |
| Operation and maintenance expense                                               |                   | 25.2                  |   | 27.4 |   | 83.1 |   | 83.3 |
| Taxes other than income taxes                                                   |                   | 3.8                   |   | 2.7 |   | 9.5 |   | 8.8 |
| Other income (expense)                                                          |                   | (.3)                  |   | .3 |   | (.8) |   | (.1) |
| EBITDA                                                                          | $                      | 5.2                   | $ | 1.6 | $ | 41.7 | $ | 29.3 |
| Reconciliation of EBITDA to Income   (Loss) Before Income Taxes: |                   |                  |   |   |   |   |   |   |
| EBITDA                                                                          | $                      | 5.2                   | $ | 1.6 | $ | 41.7 | $ | 29.3 |
| Depreciation and amortization expense                                           |                   | 8.4                   |   | 7.7 |   | 23.8 |   | 24.6 |
| Interest expense                                                                |                   | 2.6                   |   | 1.9 |   | 8.1 |   | 8.5 |
| Income (loss) before income taxes                                               | $                      | (5.8)                 | $ | (8.0) | $ | 9.8 | $ | (3.8) |
|                                                                            |                   |                  |   |   |   |   |   |   |
| Gas sales and transportation volumes (Bcf)                                 |                   | 17.1                  |   | 16.4 |   | 74.5 |   | 68.1 |
| Gas customers at end of period                                                  |                   |                  |   |   |   | 509,463 |   | 505,544 |

 

***Quarter-to-Quarter***

 

*Sales, Cost of Sales and Gross Profit*

 

Sales and cost of sales for the Gas Utilities business decreased $.9 million and $4.0 million, respectively, for a gross profit increase of $3.1 million in 2007 compared to 2006.  These changes were primarily due to the following factors:  

 

|   | **•** | Sales and cost of sales decreased by approximately $4.8 million due to a 10.1% decrease in natural gas prices in the third quarter of 2007 compared to 2006.  However, because gas purchase costs for our gas utility operations are passed through to our customers, the change in gas prices did not have a corresponding impact on gross profit. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Sales and gross profit increased by $2.2 million due to rate increases in Nebraska and Kansas. |
|--------|------------|------------------------------------------------------------------------------------------------|

 

|   | **•** | Non-regulated gross profit increased $.9 million primarily due to the sale of excess pipeline capacity. |
|--------|------------|---------------------------------------------------------------------------------------------------------|

 

*Operation and Maintenance Expense*

 

Operation and maintenance expense decreased $2.2 million in 2007 compared to 2006.  The decrease was primarily due to lower bad debt expense.

 

40

***Year-to-Date***

 

*Sales, Cost of Sales and Gross Profit*

 

Sales and cost of sales for the Gas Utilities business increased $20.9 million and $7.3 million, respectively, for a gross profit increase of $13.6 million in 2007 compared to 2006.  These changes were primarily due to the following factors:  

 

|   | **•** | Sales and gross profit increased by $5.6 million due to rate increases in Nebraska and Kansas. |
|--------|------------|------------------------------------------------------------------------------------------------|

 

|   | **•** | Favorable weather and volume variances, net of weather hedges, increased sales, cost of sales and gross profit by $54.3 million, $49.3 million and $5.0 million, respectively. |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Increased sales and cost of sales were partially offset by approximately $36.0 million due to a 6.4% decrease in natural gas prices in the first nine months of 2007 compared to 2006.  However, because gas purchase costs for our gas utility operations are passed through to our customers, the change in gas prices did not have a corresponding impact on gross profit. |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Non-regulated gross profit increased $1.6 million primarily due to the sale of excess pipeline capacity. |
|--------|------------|----------------------------------------------------------------------------------------------------------|

 

***Regulatory Matters***

 

|   | The following is a summary of our recent rate case activity through October 31, 2007: |
|--------|---------------------------------------------------------------------------------------|

 

| *In millions*  | **Type of****Service** | **Date****Requested** | **Date****Effective** | **Amount****Requested** | **Amount****Approved** |
|----------------|------------------------|-----------------------|-----------------------|-------------------------|------------------------|
| Iowa *(1)*     | Gas                    | 5/2005                | 3/2006                | $                       | 4.1                    | $ | 2.9 |
| Missouri *(2)* | Electric               | 5/2005                | 3/2006                |                    | 78.6                   |   | 44.8 |
| Missouri *(2)* | Steam                  | 5/2005                | 3/2006                |                    | 5.0                    |   | 4.5 |
| Missouri *(3)* | Electric               | 7/2006                | 6/2007                |                    | 118.9                  |   | 58.8 |
| Kansas *(4)*   | Gas                    | 11/2006               | 6/2007                |                    | 7.2                    |   | 5.1 |
| Nebraska *(5)* | Gas                    | 11/2006               | 9/2007                |                    | 16.3                   |   | 9.2 |

 

|   | (1) | Under Iowa regulations, we instituted interim rates, subject to refund, totaling approximately $1.7 million in May 2005.  In March 2006, the IUB issued an order approving a $2.9 million rate increase, including recovery of rate case costs.  Final rates became effective March 17, 2006. |
|--------|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | (2) | The Missouri electric settlement terminated the interim energy charge established in our 2003 rate case filing and required a $1.0 million refund to our St. Joseph Light & Power customers as part of the termination.  The settlement also established the value of our South Harper peaking facility at approximately $140 million, resulting in an additional $4.4 million impairment of the plant’s turbines.  The settlement was approved by the Missouri Commission in February 2006, and the new rates became effective March 1, 2006.  In addition, in February 2006, we settled the Missouri steam rate case for a $4.5 million rate increase.  This settlement includes a provision for sharing 80% of fuel cost variability from the established base fuel rates.  It was approved by the Missouri Commission in February 2006, and the new rates became effective March 6,2006. |
|--------|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | (3) | In July 2006, we filed for a $94.5 million rate increase, or 22.0%, in our Missouri Public Service territory and a $24.4 million increase, or 22.1%, in our St. Joseph Light & Power territory.  These increases were requested to recover increases in the cost of fuel and purchased power capacity, including the estimated revenue requirement for the previously planned purchase of the Aries plant, and increased operating costs.  The amount of the |
|--------|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

41

request was based, among other things, on a return on equity of 11.5% and an adjusted equity ratio of 47.5%.  In addition, we requested the implementation of a fuel adjustment clause.

 

On April 4, 2007, Aquila, the Missouri Commission staff and various intervenors entered into a stipulation and agreement that settled several issues raised in the pending Missouri rate cases.  Among other things, the stipulation and agreement (i) established a $918.5 million rate base for the Missouri Public Service operations and a $186.8 million rate base for the St. Joseph Light & Power operations; and (ii) authorized the inclusion in base rates of $156.4 million and $38.2 million of fuel and purchased power costs for the Missouri Public Service and St. Joseph Light & Power operations, respectively.  On April 12, 2007, the Missouri Commission approved the stipulation and agreement.  We received a final order from the Missouri Commission, effective May 31, 2007.  The final order increased base rates $58.8 million, or 11.9%, based on a return on equity of 10.25% and authorized afuel adjustment recovery mechanism with a 95% sharing of costs with our customers.

 

|   | (4) | In November 2006, we filed for a $7.2 million rate increase for our Kansas gas utility operations.  Also included in this filing was a request to redesign the rate structure to shift most fixed-cost of service recovery from the usage-based delivery charge to a customer and demand charge. On April 20, 2007, Aquila, the Kansas Commission staff, and various intervenors entered into a stipulation and agreement that resulted in a "black box" settlement of $5.1 million, with a residential customer charge of $16 per month that will recover approximately 65% of the margin in the customer charge.  The Kansas Commission approved the settlement and new rates in May 2007, with implementation beginning June 1, 2007. |
|--------|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | (5) | In November 2006, we filed for a $16.3 million rate increase for our Nebraska gas utility operations.  Interim rates were implemented on February 15, 2007.  On July 24, 2007, the Nebraska Commission issued an order approving a $9.2 million increase based upon a return on equity of 10.4%.  We appealed Commission’s order with the District Court of Lancaster County, Nebraska.  Briefs were filed on October 15, 2007 and reply briefs were filed October 26, 2007.  Brief oral arguments will be heard on November 8, 2007.  If the interim rates are higher than the final rates approved, the difference plus interest will be refunded or credited to customers. |
|--------|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

42

**Merchant Services**

 

|   | The table below summarizes the operations of our Merchant Services businesses: |
|--------|--------------------------------------------------------------------------------|

 

|                                                                           | **Three Months Ended** | **Nine Months Ended** |
|--------------------------------------------------------------------------------|------------------------|-----------------------|
|                                                                           | **September 30,**      | **September 30,**     |
| *Inmillions*                                                                   | **2007**               | **2006**              | **2007** | **2006** |
| Sales                                                                          | $                      | (1.6)                 | $ | (4.4) | $ | (9.1) | $ | (7.3) |
| Cost of sales                                                                  |                   | (.1)                  |   | .6 |   | (.1) |   | 18.4 |
| Gross loss                                                                     |                   | (1.5)                 |   | (5.0) |   | (9.0) |   | (25.7) |
| Operating expenses:                                                            |                   |                  |   |   |   |   |   |   |
| Operation and maintenance expense, net                                         |                   | 1.6                   |   | 11.1 |   | (.7) |   | 10.8 |
| Taxes other than income taxes                                                  |                   | **–**            |   | (.1) |   | (3.0) |   | (4.6) |
| Net loss on sale of assets and other charges                                   |                   | –                |   | – |   | – |   | 218.7 |
| Total operating expenses (income), net                                         |                   | 1.6                   |   | 11.0 |   | (3.7) |   | 224.9 |
| Other income (expense)                                                         |                   | 1.8                   |   | (1.0) |   | 3.4 |   | 1.6 |
| Earnings (loss) before interest, taxes, depreciation and amortization          | $                      | (1.3)                 | $ | (17.0) | $ | (1.9) | $ | (249.0) |
| Reconciliation of EBITDA to Loss      Before Income Taxes: |                   |                  |   |   |   |   |   |   |
| EBITDA                                                                         | $                      | (1.3)                 | $ | (17.0) | $ | (1.9) | $ | (249.0) |
| Depreciation and amortization expense                                          |                   | 1.0                   |   | 1.0 |   | 3.0 |   | 3.1 |
| Interest expense                                                               |                   | 7.9                   |   | 3.7 |   | 17.1 |   | 13.5 |
| Loss before income taxes                                                       | $                      | (10.2)                | $ | (21.7) | $ | (22.0) | $ | (265.6) |
|                                                                           |                   |                  |   |   |   |   |   |   |

 

We show our gains and losses from energy trading contracts on a net basis. To the extent losses exceeded gains, sales are shown as a negative number. 

 

***Quarter-to-Quarter***

 

*Sales, Cost of Sales and Gross Loss*

 

Gross loss for our Merchant Services operations for the three months ended September 30, 2007 was $1.5 million, primarily due to margin losses of $2.0 million resulting from the difference between revenue recognized on our two remaining long-term gas delivery contracts compared to the net cost of gas delivered under these contracts.  These contracts will expire by March 2008.

 

Gross loss for our Merchant Services operations for the three months ended September 30, 2006 was $5.0 million, primarily due to the following factors:

 

|   | **•** | We incurred margin losses of $1.9 million resulting from the difference between revenue recognized on our two remaining long-term gas delivery contracts compared to the net cost of gas delivered under these contracts.  These contracts expire by March 2008. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | We also incurred a $3.1 million gross loss related to the settlement of various contracts and trade positions and other settlements in the third quarter of 2006 due to the continued wind-down of our merchant operations. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

*Operation and Maintenance Expense, net*

 

Operation and maintenance expense decreased $9.5 million from 2006 primarily due to the 2006 provision of a $9.3 million net reserve related to price reporting litigation. 

 

43

***Year-to-Date***

 

*Sales, Cost of Sales and Gross Loss*

 

Gross loss for our Merchant Services operations for the nine months ended September 30, 2007 was $9.0 million, primarily due to the following factors:

 

|   | **•** | We incurred margin losses of $6.1 million resulting from the difference between revenue recognized on our two remaining long-term gas delivery contracts compared to the net cost of gas delivered under these contracts. |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | We also incurred a $3.1 million gross loss related to the settlement of various contracts and trade positions in the first nine months of 2007 due to the continued wind-down of our merchant operations. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Gross loss for our Merchant Services operations for the nine months ended September 30, 2006 was $25.7 million, primarily due to the following factors:

 

|   | **•** | In the first nine months of 2006, we recorded net margin losses associated with our Elwood tolling agreements of $17.8 million.  We did not generate material revenues on this capacity. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | We incurred margin losses of $5.7 million resulting from the difference between revenue recognized on our two remaining long-term gas delivery contracts and the net cost of gas delivered under these contracts. |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | We also incurred a $2.2 million gross loss related to the settlement of various contracts and trade positions and other settlements due to the continued wind-down of our merchant operations. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

*Operation and Maintenance Expense, net*

 

Operation and maintenance expense decreased $11.5 million in 2007 from 2006 primarily due to a $15.8 million decrease in the provision for price reporting litigation offset by the first quarter of 2006 reversal of $4.4 million of allowances for bad debts provided in prior years as our receivable balance declined with the roll-off of the legacy trading portfolio.

 

*Net Loss on Sale of Assets and Other Charges*

 

In the first nine months of 2006, we recorded a pretax loss of $218.0 million on the assignment of our rights and obligations under the Elwood tolling agreement.  

 

***Earnings Trend and Impact of Changing Business Environment***

 

The merchant energy sector has been negatively impacted by the increase in generation capacity that became operational in 2002 and 2003.  This increase in supply has placed downward pressure on power prices and subsequently the value of unsold merchant generation capacity.  It is generally expected that the fuel and start-up costs of operating our Crossroads plant will exceed the revenues that would be generated from the power sold.  We therefore believe that during the next few years we have limited ability to generate power at the Crossroads facility for a profit.  We have assessed the realizability of our investment in this plant and do not believe an impairment has occurred.  We will continue to have operating and maintenance costs associated with this plant, whether it is being utilized to generate power or is idle.  As of September 30, 2007, the carrying value of this plant was $113.1million.  Additionally, we continue to wind down and terminate our remaining trading positions with various counterparties.  However, it will take a number of years to complete the wind-down, and we continue to deliver gas under our remaining long-term gas contracts which expire by early 2008.  Because most of our remaining trading positions are hedged, we should experience 

 

44

limited fluctuation in earnings or losses other than the impacts from counterparty credit, the discounting or accretion of interest, and the termination or liquidation of additional trading contracts.  As a result of the above factors, we do not expect Merchant Services to be profitable in the next two to three years.

 

**Corporate and Other**

 

|   | The table below summarizes the operating results of Corporate and Other: |
|--------|--------------------------------------------------------------------------|

 

|                                                                                          | **Three Months Ended** | **Nine Months Ended** |
|-----------------------------------------------------------------------------------------------|------------------------|-----------------------|
|                                                                                          | **September 30,**      | **September 30,**     |
| *In millions***                                                                               | **2007**               | **2006**              | **2007** | **2006** |
| Sales                                                                                         | $                      | (.1)                  | $ | **–** | $ | (.1) | $ | .1 |
| Cost of sales                                                                                 |                   | **–**            |   | **–** |   | **–** |   | **–** |
| Gross profit                                                                                  |                   | (.1)                  |   | **–** |   | (.1) |   | .1 |
| Operating expenses:                                                                           |                   |                  |   |   |   |   |   |   |
| Operation and maintenance expense                                                             |                   | 3.4                   |   | 4.7 |   | 18.6 |   | 12.3 |
| Taxes other than income taxes                                                                 |                   | .1                    |   | .1 |   | .1 |   | .3 |
| Restructuring charges                                                                         |                   | **–**            |   | .6 |   | 1.6 |   | 5.5 |
| Net loss on sales of assets and other charges                                                 |                   | **–**            |   | 5.5 |   | 1.3 |   | 28.2 |
| Total operating expenses                                                                      |                   | 3.5                   |   | 10.9 |   | 21.6 |   | 46.3 |
| Other income                                                                                  |                   | .9                    |   | 7.2 |   | 14.2 |   | 13.4 |
| Earnings (loss) before interest, taxes,     depreciation and amortization | $                      | (2.7)                 | $ | (3.7) | $ | (7.5) | $ | (32.8) |
| Reconciliation of EBITDA to Loss      Before Income Taxes:                |                   |                  |   |   |   |   |   |   |
| EBITDA                                                                                        | $                      | (2.7)                 | $ | (3.7) | $ | (7.5) | $ | (32.8) |
| Depreciation and amortization expense                                                         |                   | (.1)                  |   | (.1) |   | **–** |   | (1.3) |
| Interest expense                                                                              |                   | 6.1                   |   | 25.9 |   | 43.0 |   | 64.9 |
| Loss before income taxes                                                                      | $                      | (8.7)                 | $ | (29.5) | $ | (50.5) | $ | (96.4) |
|                                                                                          |                   |                  |   |   |   |   |   |   |

 

***Quarter-to-Quarter***

 

*Net Loss on Sale of Assets and Other Charges*

 

In the third quarter of 2006 we recorded a pretax loss of $5.5 million primarily upon the prepayment of our five-year term loan.

 

*Other Income*

 

Other income decreased $6.3 million in 2007 compared to 2006 primarily due to lower income on invested cash due to the utilization of cash balances to retire debt.

 

***Year-to-Date***

 

*Operation and Maintenance Expense*

 

Operation and maintenance expense increased $6.3 million primarily due to advisor fees and legal costs related to the pending merger.

 

*Restructuring Charges*

 

We recorded $1.6 million of one-time termination benefits in first quarter of 2007 related to the departure of our Chief Operating Officer.  In 2006, we accrued approximately $5.5 million of one-

 

45

time termination benefits related to the plan to reduce executive management and central services costs in connection with the sale of our Kansas electric and Michigan, Minnesota and Missouri gas operations.

 

*Net Loss on Sale of Assets and Other Charges*

 

In the second quarter of 2007, we recorded a pretax loss of $1.3 million related to the early retirement of $344 million of outstanding senior notes.  In the nine months of 2006, we recorded pretax losses of $28.2 million upon the completion of a cash tender offer that resulted in the early retirement of approximately $350 million of outstanding senior notes and the prepayment of our five-year term loan.

 

*Other Income*

 

Other income increased $.8 million in 2007 compared to 2006 primarily due to $3.6 million of net gains on the sale of excess land and office space and a $2.2 million release of Canadian withholding tax reserves, offset by lower interest income on invested cash.

 

**Interest Expense and Income Tax Expense (Benefit)**

 

|   | The table below summarizes our consolidated interest expense and income tax expense (benefit): |
|--------|------------------------------------------------------------------------------------------------|

 

|                                 | **Three Months Ended** | **Nine Months Ended** |
|--------------------------------------|------------------------|-----------------------|
|                                 | **September 30,**      | **September 30,**     |
| *In millions***                      | **2007**               | **2006**              | **2007** | **2006** |
|                                 |                   |                  |   |   |   |   |   |   |
| Interest expense                     | $                      | 31.5                  | $ | 42.7 | $ | 111.6 | $ | 124.4 |
|  

Income tax expense (benefit) | $                      | 5.6                   | $ | (10.2) | $ | (.6) | $ | (43.9) |

 

 

***Quarter-to-Quarter***

 

*Interest Expense*

 

Interest expense decreased $11.2 million in 2007 compared to 2006 primarily due to $12.1 million of interest savings on debt retired in 2006 and 2007.  Also contributing to the decrease in interest expense was $3.5 million of deferred debt costs related to the prepayment of our five-year term loan in September 2006.  These decreases were partially offset by an increase of $4.5 million of decreased allocations of interest to discontinued operations due to the completion of the sale of certain assets in 2007.

 

*Income Tax Expense (Benefit)*

 

Income tax expense increased $15.8 million in 2007 compared to 2006.  The effective tax rate in 2007 was 15.2% compared to 33.1% in 2006.  The effective tax rate for 2007 differed from the combined statutory rate as a result of a reduction of $23.3 million in unrecognized tax benefits, offset in part by $17.0 million of valuation allowance provided on deferred tax assets for NOL carryforwards.

 

46

***Year-to-Date***

 

*Interest Expense*

 

Interest expense decreased $12.8 million in 2007 compared to 2006 due to $22.4 million of interest savings on the retirement of $350 million of debt in 2006 and 2007 and $17.1 million related to the prepayment of the five-year term loan in September 2006.  These decreases were offset in part by $26.6 million of decreased allocations of interest to discontinued operations due to the completion of the sale of certain assets in 2006 and 2007.  

 

*Income Tax Benefit*

 

Income tax benefit decreased $43.3 million in 2007 compared to 2006.  The effective tax rate in 2007 was 5.2% compared to 13.1% in 2006.  The effective tax rate for 2007 differed from the combined statutory rate as a result of approximately $24.3 million of valuation allowance provided on deferred tax assets for NOL carryforwards and $8.6 million of tax provisions resulting from Canadian tax audit adjustments received in the second quarter, offset in part by $27.3 million of reductions in unrecognized tax benefits.  The effective tax rate for 2006 differed from the combined statutory rate as a result of $81.8 million of unrecognized tax benefits provided in the second quarter of 2006 in connection with the $218 million loss on the assignment of our obligations under the Elwood tolling agreement.

 

**Discontinued Operations**

 

As further discussed in Note 4 to the Consolidated Financial Statements, we have reported the results of operations of our former utilities, our former merchant peaking plants and our former Everest Connections business in discontinued operations in the Consolidated Statements of Income for all periods presented.  The operating results of these operations are summarized in the table below.  

 

 

47

 

|  

* *                                                               | **Three Months Ended** | **Nine Months Ended** |
|--------------------------------------------------------------------------------|------------------------|-----------------------|
| * *                                                                       | **September 30,**      | **September 30,**     |
| *Dollars in millions*                                                          | **2007**               | **2006**              | **2007** | **2006** |
| Sales                                                                          | $                      | .3                    | $ | 61.8 | $ | 46.0 | $ | 479.3 |
| Cost of sales                                                                  |                   | –                |   | 30.5 |   | 23.4 |   | 322.6 |
| Gross profit                                                                   |                   | .3                    |   | 31.3 |   | 22.6 |   | 156.7 |
| Operating expenses:                                                            |                   |                  |   |   |   |   |   |   |
| Operation and maintenanceexpense                                               |                   | .1                    |   | 11.0 |   | 11.3 |   | 61.0 |
| Taxes other than income taxes                                                  |                   | –                |   | 1.4 |   | 2.0 |   | 9.8 |
| Restructuring charges                                                          |                   | –                |   | – |   | – |   | 2.0 |
| Net (gain) on sale of assets andother charges                                  |                   | (2.7)                 |   | (122.2) |   | (3.0) |   | (270.8) |
| Total operating expenses                                                       |                   | (2.6)                 |   | (109.8) |   | 10.3 |   | (198.0) |
| Other income (expense)                                                         |                   | –                |   | (.4) |   | .2 |   | .1 |
| EBITDA                                                                         |                   | 2.9                   |   | 140.7 |   | 12.5 |   | 354.8 |
| Depreciation and amortization     expense             |                   | –                |   | – |   | – |   | .9 |
| Interest expense                                                               |                   | –                |   | 4.5 |   | 4.1 |   | 30.7 |
| Income before income taxes                                                     |                   | 2.9                   |   | 136.2 |   | 8.4 |   | 323.2 |
| Income tax expense (benefit)                                                   |                   | (5.9)                 |   | (.1) |   | (3.9) |   | 72.6 |
| Earnings from discontinued     operations, net of tax | $                      | 8.8                   | $ | 136.3 | $ | 12.3 | $ | 250.6 |
|                                                                           |                   |                  |   |   |   |   |   |   |
| Electric sales and transportation   volumes (GWh)               |                   | –                |   | 669.7 |   | 549.6 |   | 1,755.3 |
| Electric customers at end of period                                            |                   |                  |   |   |   | – |   | 69,077 |
| Gas sales and transportation   volumes (Bcf)                    |                   | –                |   | – |   | – |   | 52.6 |
| Gas customers at end of period                                                 |                   |                  |   |   |   | – |   | – |

 

***Quarter-to-Quarter***

 

*Sales, Cost of Sales and Gross Profit*

 

Electric Utilities

 

Sales and cost of sales for our Kansas electric utility decreased $61.8 million and $30.4 million, respectively, resulting in a gross profit decrease of $31.4 million in 2007 compared to 2006 due to the sale of these operations on April 1, 2007. 

 

*Operation and Maintenance and Taxes Other Than Income Taxes Expense*

 

Operation and maintenance and taxes other than income taxes expense decreased $10.9 million and $1.4 million, respectively, in 2007 compared to 2006 primarily as a result of the sale of our Kansas electric operations on April 1, 2007.

 

*Interest Expense*

 

Interest expense decreased $4.5 million in 2007 compared to 2006 as the allocations to our Kansas electric operations ended when it was sold April 1, 2007.

 

48

*Income Tax Expense (Benefit)*

 

Income tax benefit increased $5.8 million in 2007 compared to 2006.  The income tax benefit in 2007 included the release of $7.1 million of valuation allowance due to additional capital gains recognized on our 2006 income tax return.  The 2006 income tax benefit was the result of the reversal of $56.0 million of valuation allowances on capital losses resulting from estimated capital gains realized on the sale of our Michigan and Missouri gas operations.

 

***Year-to-Date***

 

*Sales, Cost of Sales and Gross Profit*

 

Electric Utilities

 

Sales and cost of sales for our Kansas electric utility decreased $105.4 million and $51.6 million, respectively, resulting in a gross profit decrease of $53.8 million in 2007 compared to 2006 primarily due to the sale of these operations on April 1, 2007. 

 

Gas Utilities

 

Sales and cost of sales for our Michigan, Minnesota, and Missouri gas utilities decreased $300.6 million and $238.6 million, respectively, resulting in a gross profit decrease of $62.0 million due to the closing of the sales of these operations in 2006.  

 

Corporate and Other

 

Sales, cost of sales and gross profit decreased $25.1 million, $8.2 million, and $16.9 million, respectively, in 2007 compared to 2006 due to the sale of our Everest Connections subsidiary in June 2006 and our Illinois merchant peaking facilities in March 2006.

 

*Operation and Maintenance and Taxes Other Than Income Taxes Expense*

 

Operation and maintenance and taxes other than income taxes expense decreased $49.7 million and $7.8 million, respectively, in 2007 compared to 2006 primarily as a result of the sale of our former Michigan, Missouri, and Minnesota gas operations and our Everest Connections subsidiary in 2006 and our Kansas electric operations on April 1, 2007.

 

*Net (Gain) on Sale of Assets and Other Charges*

 

In the first nine months of 2006, we sold our Michigan, Missouri and Minnesota gas operations and Everest Connections and recognized gains of $94.2 million, $30.0 million, $122.0 million and $25.5 million, respectively.

 

*Interest Expense*

 

Interest expense decreased $26.6 million in 2007 compared to 2006 as the allocations to our Michigan, Missouri and Minnesota gas operations, our two Illinois merchant peaking facilities and our Everest Connections subsidiary ended when they were sold.

 

*Income Tax Expense (Benefit)*

 

Income tax expense decreased $76.5 million in 2007 compared to 2006 primarily due to taxes provided on higher pretax earnings in 2006 resulting from gains on the sale of Michigan and Missouri gas operations and Everest Connections.  The effective income tax rate for 2007 was (46.4)% compared to 22.5% for 2006.  The 2007 tax rate was affected by the release of $7.1 million of valuation allowance due to additional capital gains on the sale of operations recognized on our 2006 

 

49

income tax return.  The 2006 effective income tax rate was impacted by the release of $56.0 million of valuation allowances resulting from estimated capital gains on the sale of our Michigan and Missouri gas operations.

 

**Significant Balance Sheet Movements**

 

Total assets decreased by $564.5 million since December 31, 2006.  This decrease is primarily due to the following:

 

|   | **•** | Cash decreased $140.3 million. See our Consolidated Statement of Cash Flows for analysis of this decrease. |
|--------|------------|------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Funds on deposit decreased $57.4 million, primarily due to the return of margin deposits associated with the seasonal decrease in gas purchases by our regulated utilities. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Accounts receivable decreased $37.1 million, primarily reflecting seasonal declines in regulated gas customer deliveries and lower volumes of gas delivered due to our exit from wholesale energy trading. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Price risk management assets decreased $50.1 million, primarily due to scheduled deliveries and settlements under trading contracts and a decrease in natural gas forward prices since December 31, 2006. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Utility plant, net increased $92.3 million, primarily due to additional capital expenditures, including the construction of Iatan 2 and environmental upgrades. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Regulatory assets, current decreased $21.2 million due to lower purchased gas cost adjustment clause assets at the end of the winter heating season. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Regulatory assets, non-current decreased $20.6 million due primarily to decreases in the regulatory asset related to gas hedges for Missouri electric generation caused by declines in natural gas prices. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Current and non-current assets of discontinued operations decreased $312.6 million due to the sale of our Kansas electric operations on April 1, 2007. |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Total liabilities decreased by $593.5 million and common shareholders’ equity increased by $29.0 million since December 31, 2006.  These changes are primarily attributable to the following:

 

|   | **•** | Accounts payable decreased by $91.7 million, primarily reflecting the seasonal decrease in gas purchases by our regulated utilities, the effects of lower natural gas prices, and lower volumes of gas delivered due to our exit from wholesale energy trading. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Other accrued liabilities decreased $34.6 million primarily due to the settlement of reserves for price reporting litigation and scheduled deliveries under long-term gas contracts. |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Price risk management liabilities decreased $55.9 million, primarily due to scheduled deliveries and settlements under trading contracts and a decrease in natural gas forward prices since December 31, 2006. |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Long-term debt including current maturities of long-term debt, decreased $367.4 million primarily due to the early retirement of senior notes and other debt. |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Deferred income taxes and credits decreased $19.3 million due to the implementation of FIN 48 as discussed in Note 11 to the Consolidated Financial Statements. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

50

|   | **•** | Current and non-current liabilities of discontinued operations decreased $37.3 million due to the sale of our Kansas electric operations on April 1, 2007. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Common shareholders equity increased $29.0 million primarily due to the $19.3 million cumulative effect of adopting FIN 48 on January 1, 2007, the conversion of our PIES units to common stock and net income for the nine months ended September 30, 2007. |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**Forward-Looking Information**

 

This report contains forward-looking information.  Forward-looking information involves risks and uncertainties, and certain important factors can cause actual results to differ materially from those anticipated.  The forward-looking statements contained in this report include:

 

|   | **•** | We expect to merge with a subsidiary of Great Plains Energy and, if completed, we will become a wholly-owned subsidiary of Great Plains Energy and our shareholders will receive a combination of 0.0856 shares of Great Plains Energy common stock and $1.80 in cash upon the effectiveness of the Merger.  Some important factors that could cause actual results to differ materially from those anticipated include: |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | § | We or Great Plains Energy may not receive in a timely manner the regulatory approvals required to complete the Merger.  Even if we and Great Plains Energy obtain the regulatory approvals required to complete the Merger, the approvals may contain unacceptable terms or conditions that would permit us or Great Plains Energy to terminate the Merger. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | § | We may not complete the sale of our Colorado electric utility assets and Colorado, Iowa, Kansas and Nebraska gas utility assets to Black Hills, which must occur prior to the completion of the Merger. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | § | The occurrence of certain events outside of our control may permit Great Plains Energy to terminate the Merger, to the extent the events result in a material adverse effect on our Missouri electric operations. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | We expect our financial condition to be increasingly dependent upon the revenues and earnings generated by our Missouri electric operations, and for these earnings to increase in the future.  Some important factors that could cause actual results to differ materially from those anticipated include: |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | § | If the Missouri Commission does not approve rate increases requested in the future, the earnings of our Missouri electric operations (and, therefore, our overall financial condition) may not improve. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | § | The occurrence of certain unforeseeable events or events outside of our control could impede our ability to improve the earnings of our Missouri operations, in which case our financial condition may not improve. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | § | Employee turnover, as well as the substantial time and resources being devoted to our pending transactions with Great Plains Energy and Black Hills, may affect our ability to increase our Missouri earnings. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | We anticipate that our current revolving credit capacity and available cash will be sufficient to fund our working capital requirements.  Some important factors that could cause actual results to differ materially from those anticipated include: |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | § | Our access to revolving credit capacity depends on maintaining compliance with loan covenants.  If we violate these covenants, we may lose revolving credit |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

51

capacity and not have sufficient cash available for our winter needs and working capital requirements.

 

|   | § | Unanticipated increases in the price of natural gas that we purchase for our utility customers could exhaust our liquidity in the winter months. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | § | Counterparties may default on their obligations to supply commodities or return collateral to us or to meet their obligations under commercial contracts, including those designed to hedge against movements in commodity prices. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | We believe that we have strong defenses to litigation pending against us.  Some important factors that could cause actual results to differ materially from those anticipated include: |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | § | Judges and juries can be difficult to predict and may, in fact, rule against us. |
|--------|--------|----------------------------------------------------------------------------------|

 

|   | § | Our positions may be weakened by adverse developments in the law or the discovery of facts that hurt our cases. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------|

 

**Item 3.  Quantitative and Qualitative Disclosures About Market Risk**

 

**Price Risk Management**

 

We engage in price risk management activities for both trading and non-trading activities.  Transactions carried out in connection with trading activities that are derivatives under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (SFAS 133) are accounted for under the mark-to-market method of accounting.  Under SFAS 133, our energy commodity trading contracts, including physical transactions (mainly gas) and financial instruments, are recorded at fair value.  As part of the valuation of our portfolio, we value the credit risks associated with the financial condition of counterparties and the time value of money.  We primarily use quoted market prices from published sources or comparable transactions in liquid markets to value our contracts.  If actively quoted market prices are not available, we contact brokers and other external sources oruse comparable transactions to obtain current values of our contracts.  In addition, the market prices or fair values used in determining the value of the portfolio are our best estimates utilizing information such as historical volatility, time value, counterparty credit and the potential impact on market prices of liquidating our positions in an orderly manner over a reasonable period of time under current market conditions.  When market prices are not readily available or determinable, certain contracts are recorded at fair value using an alternative approach such as model pricing. 

 

The changes in fair value of our Utilities and Merchant Services derivative contracts for 2007 are summarized below:

 

| *In millions***                        | **Utilities** | **Merchant****Services** | **Total** |
|----------------------------------------|---------------|--------------------------|-----------|
|                                   |          |                     |      |   |   |   |
| Fair value at December 31, 2006        | $             | (19.1)                   | $         | 32.2 | $ | 13.1 |
| Change in fair value during the period |          | 3.7                      |      | (3.1) |   | .6 |
| Contracts realized or cash settled     |          | 19.6                     |      | (14.4) |   | 5.2 |
| Fair value at September 30, 2007       | $             | 4.2                      | $         | 14.7 | $ | 18.9 |

 

 

52

The fair value of contracts maturing in the remainder of 2007, each of the next three years and thereafter are shown below:

 

| *In millions***  | **Utilities** | **Merchant****Services** | **Total** |
|------------------|---------------|--------------------------|-----------|
|             |          |                     |      |   |   |   |
| 2007             | $             | (1.2)                    | $         | 2.7 | $ | 1.5 |
| 2008             |          | 2.4                      |      | 4.0 |   | 6.4 |
| 2009             |          | 3.0                      |      | 1.0 |   | 4.0 |
| 2010             |          | –                   |      | 1.2 |   | 1.2 |
| Thereafter       |          | –                   |      | 5.8 |   | 5.8 |
| Total fair value | $             | 4.2                      | $         | 14.7 | $ | 18.9 |

 

In addition to the natural gas derivative instruments purchased to mitigate our exposure to changes in natural gas and purchased power prices in our Missouri electric operations, the totals above include natural gas derivative instruments purchased to reduce our natural gas customers’ underlying exposure to fluctuations in gas prices where programs have been approved by state regulatory commissions.  These instruments are collectible under the provisions of the purchased gas adjustment provisions of those states.  The changes in fair value of these contracts are recorded in current assets or liabilities for under- or over-recovered purchase gas adjustments until passed through to customers in rates.

 

**Item 4.  Controls and Procedures**

 

Our Chief Executive Officer (CEO) and Chief Accounting Officer (CAO) (our principal financial and accounting officer) are responsible for establishing and maintaining the company’s disclosure controls and procedures.  These controls and procedures were designed to ensure that material information relating to the company and its subsidiaries are communicated to the CEO and the CAO.  We evaluated these disclosure controls and procedures as of the end of the period covered by this report under the supervision of our CEO and CAO.  Based on this evaluation, our CEO and CAO concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports filed with the SEC.  There has been no change in our internal controls over financial reporting during the period covered by this report that has materiallyaffected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

53

**Part** **II.  Other Information**

 

**Item 1.  Legal Proceedings**

 

Information on our legal proceedings is set forth in Note 9 to the Consolidated Financial Statements, which is incorporated herein by reference.

 

**Item 4.  Submission of Matters to a Vote of Securities Holders**

 

We held a special meeting of stockholders on October 9, 2007.  At the meeting, the following matters were voted on by our stockholders:

 

|   | 1. | Proposal to adopt the merger agreement with Great Plains Energy dated as of February 6, 2007: |
|--------|----|-----------------------------------------------------------------------------------------------|

 

| **Votes For** | **Votes Against** | **Votes Abstain** |
|---------------|-------------------|-------------------|
|          |              |              |
| 226,258,156   | 25,832,507        | 3,292,516         |
|          |              |              |

 

|   | 2. | Proposal to adjourn the special meeting of stockholders, if necessary, to permit further solicitation of proxies in the event there are not sufficient votes at the time of the special meeting to adopt the merger agreement: |
|--------|----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

| **Votes For** | **Votes Against** | **Votes Abstain** |
|---------------|-------------------|-------------------|
|          |              |              |
| 220,037,685   | 34,451,700        | 893,794           |
|          |              |              |

 

**Item 5.  Other information**

 

On November 6, 2007, the Company’s Supplemental Executive Retirement Plan, Amended and Restated, was amended to comply with changes in the Internal Revenue Code relating to the taxation of nonqualified deferred compensation (as set forth in the final regulations released by the Department of Treasury on April 10, 2007, in respect of Section 409A of the Internal Revenue Code), and to align certain provisions of the deferred compensation plan with the terms of our merger agreement with Great Plains Energy.   

 

The foregoing description is qualified by reference to the amendment filed as an exhibit to this Quarterly Report, and to the plan document filed by the Company with the SEC previously.

 

On November 7, 2007, the Company amended the employment agreement of Richard C. Green and the severance compensation agreements of four named executives, Jon R. Empson, Senior Vice President, Regulated Operations, Leo E. Morton, Senior Vice President and Chief Administrative Officer, Beth A. Armstrong, Senior Vice President and Chief Accounting Officer, and Christopher M. Reitz, Senior Vice President, General Counsel and Corporate Secretary.  The agreements were amended to comply with changes in the Internal Revenue Code relating to the taxation of nonqualified deferred compensation (as set forth in the final regulations released by the Department of Treasury on April 10, 2007, in respect of Section 409A of the Internal Revenue Code), and to make certain other changes consistent with the terms of our merger agreement with Great Plains Energy.   

 

The foregoing description is qualified by reference to the amendment to Rick Green's employment agreement or, as applicable, the form of the amendment applicable to the severance compensation agreements of Jon Empson, Leo Morton, Chris Reitz, and Beth Armstrong, filed as exhibits to this Quarterly Report, and to the original agreements filed by the Company with the SEC previously.

 

54

**Item 6.  Exhibits**

 

**(a)  List of Exhibits**

 

Exhibits filed herewith are designated by an asterisk (*).  All exhibits not so designated are incorporated by reference to a prior filing, as indicated below.

 

| **Exhibit No.** | **Description**                                                                                                                                                                                                                                       |
|-----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1*           | Certification of Chief Executive Officer under Section 302.                                                                                                                                                                                           |
| 31.2*           | Certification of Chief Accounting Officer under Section 302.                                                                                                                                                                                          |
| 32.1*           | Certification of Chief Executive Officer under Section 906.                                                                                                                                                                                           |
| 32.2*           | Certification of Chief Accounting Officer under Section 906.                                                                                                                                                                                          |
| 10.1            | Aquila, Inc. Supplemental Executive Retirement Plan, Amended and Restated Effective as of January 1, 2005 (incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007).        |
| 10.2*           | Amendment One to the Aquila, Inc. Supplemental Retirement Plan, Amended and Restated Effective as of January 1, 2005.                                                                                                                                 |
| 10.3            | Employment Agreement of Richard C. Green (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002).                                                                    |
| 10.4*           | Amendment to Employment Agreement of Richard C. Green, dated November 7, 2007.                                                                                                                                                                        |
| 10.5            | Severance Compensation Agreement, by and between Aquila, Inc. and Leo E. Morton, dated October 6, 2006 (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 10, 2006).                        |
| 10.6            | Severance Compensation Agreement, by and between Aquila, Inc. and Jon R. Empson, dated October 6, 2006 (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on October 10, 2006).                        |
| 10.7            | Severance Compensation Agreement, by and between Aquila, Inc. and Beth A. Armstrong, dated August 22, 2006 (incorporated by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006).  |
| 10.8            | Severance Compensation Agreement, by and between Aquila, Inc. and Christopher M. Reitz, dated August 28, 2006 (incorporated by reference to Exhibit 10(a)(30) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006). |
| 10.9*           | Form of Amendment to Severance Compensation Agreement, dated November 7, 2007.                                                                                                                                                                        |

 

 

55

**Signatures**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Aquila, Inc.

 

| By:    | /s/  Beth A. Armstrong

Beth A. Armstrong

*Senior Vice President and Chief Accounting Officer* |   |
|--------|-------------------------------------------------------------------------------------------------|--------|
|   | Signing on behalf of the registrant and as principal financial officer                          |   |
|   |                                                                                            |   |
| Date:  | November 7, 2007                                                                                |   |
|   |                                                                                            |   |

 

 

 

56