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UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-Q

|(Mark One)                                        |                                                                                         
|------------------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                                 | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|For the quarterly period ended September 30, 2003
|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                  

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

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


Registrant's
telephone number, including area code816-421-6600

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

Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes ý    No o

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

Class

Outstanding at October 29, 2003Common Stock, $1 par value

195,166,982


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PART IFINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Information regarding the consolidated financial statements is set forth on pages 3 through 23.

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

Management's discussion and analysis of financial condition and results of operations can be found on pages 24 through 47.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are subject to market risk as described on pages 65 through 68 of our 2002 Annual Report on Form 10-K. See discussion on page 46 of this
document for changes in market risk since December 31, 2002.

ITEM 4. CONTROLS AND PROCEDURES

Information regarding disclosure controls and procedures can be found on page 47.

PART IIOTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Not applicable.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

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

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

Exhibits and Reports on Form 8-K can be found on page 48.

2

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Part I. Financial Information

Item 1.    Financial Statements

Aquila, Inc.

Consolidated Statements of IncomeUnaudited

|                                                    |                                                      | Three Months Ended
September 30, |       
|--------------------------------------------------- | ---------------------------------------------------- | -------------------------------- | ------
|
|
|Sales:                                              |                                                      |                                  |       
|                                                    | Electricityregulated                                |                                  | $     
|                                                    | Natural gasregulated                                |                                  |       
|                                                    | Electricitynon-regulated                            |                                  |       
|                                                    | Natural gasnon-regulated                            |                                  |       
|                                                    | Othernon-regulated                                  |                                  |       
|                                                    |                                                     
|Total sales                                         |                                                      |                                  | 322.0 
|                                                    |                                                     
|Cost of sales:                                      |                                                      |                                  |       
|                                                    | Electricityregulated                                |                                  |       
|                                                    | Natural gasregulated                                |                                  |       
|                                                    | Electricitynon-regulated                            |                                  |       
|                                                    | Natural gasnon-regulated                            |                                  |       
|                                                    | Othernon-regulated                                  |                                  |       
|                                                    |                                                     
|Total cost of sales                                 |                                                      |                                  | 193.3 
|                                                    |                                                     
|Gross profit                                        |                                                      |                                  | 128.7 
|                                                    |                                                     
|Operating expenses:                                 |                                                      |                                  |       
|                                                    | Operating expense                                    |                                  |       
|                                                    | Restructuring charges                                |                                  |       
|                                                    | Impairment charges and net loss on sale of assets    |                                  |       
|                                                    | Depreciation and amortization expense                |                                  |       
|                                                    |                                                     
|Total operating expenses                            |                                                      |                                  | 252.3 
|                                                    |                                                     
|Other income (expense):                             |                                                      |                                  |       
|                                                    | Equity in earnings of investments                    |                                  |       
|                                                    | Minority interest in income of subsidiaries          |                                  |       
|                                                    | Other income                                         |                                  |       
|                                                    |                                                     
|Total other income (expense)                        |                                                      |                                  | 3.9   
|                                                    |                                                     
|Interest expense:                                   |                                                      |                                  |       
|                                                    | Interest expense                                     |                                  |       
|                                                    | Minority interest in income of partnership and trust |                                  |       
|                                                    |                                                     
|Total interest expense                              |                                                      |                                  | 75.1  
|                                                    |                                                     
|Loss from continuing operations before income taxes |                                                      |                                  | (194.8
|Income tax benefit                                  |                                                      |                                  | (50.6 
|                                                    |                                                     
|Loss from continuing operations                     |                                                      |                                  | (144.2
|Loss from discontinued operations, net of tax       |                                                      |                                  | (25.7 
|                                                    |                                                     
|Net loss                                            |                                                      | $                                | (169.9
|                                                    |                                                     
|Basic and diluted earnings (loss) per common share: |                                                      |                                  |       
|                                                    | Continuing operations                                |                                  | $     
|                                                    | Discontinued operations                              |                                  |       
|                                                    |                                                     
|                                                    | Net loss                                             |                                  | $     
|                                                    |                                                     
|Dividends per common share                          |                                                      | $                                |      
|                                                    |                                                     

See accompanying notes to consolidated financial statements.

3

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Aquila, Inc.

Consolidated Statements of IncomeUnaudited

|                                                         |                                                      | Nine Months Ended
September 30, |        
|-------------------------------------------------------- | ---------------------------------------------------- | ------------------------------- | -------
|
|
|Sales:                                                   |                                                      |                                 |        
|                                                         | Electricityregulated                                |                                 | $      
|                                                         | Natural gasregulated                                |                                 |        
|                                                         | Electricitynon-regulated                            |                                 |        
|                                                         | Natural gasnon-regulated                            |                                 |        
|                                                         | Othernon-regulated                                  |                                 |        
|                                                         |                                                     
|Total sales                                              |                                                      |                                 | 1,212.2
|                                                         |                                                     
|Cost of sales:                                           |                                                      |                                 |        
|                                                         | Electricityregulated                                |                                 |        
|                                                         | Natural gasregulated                                |                                 |        
|                                                         | Electricitynon-regulated                            |                                 |        
|                                                         | Natural gasnon-regulated                            |                                 |        
|                                                         | Othernon-regulated                                  |                                 |        
|                                                         |                                                     
|Total cost of sales                                      |                                                      |                                 | 826.1  
|                                                         |                                                     
|Gross profit                                             |                                                      |                                 | 386.1  
|                                                         |                                                     
|Operating expenses:                                      |                                                      |                                 |        
|                                                         | Operating expense                                    |                                 |        
|                                                         | Restructuring charges                                |                                 |        
|                                                         | Impairment charges and net loss on sale of assets    |                                 |        
|                                                         | Depreciation and amortization expense                |                                 |        
|                                                         |                                                     
|Total operating expenses                                 |                                                      |                                 | 747.1  
|                                                         |                                                     
|Other income (expense):                                  |                                                      |                                 |        
|                                                         | Equity in earnings of investments                    |                                 |        
|                                                         | Minority interest in income of subsidiaries          |                                 |        
|                                                         | Other income                                         |                                 |        
|                                                         |                                                     
|Total other income (expense)                             |                                                      |                                 | 128.3  
|                                                         |                                                     
|Interest expense:                                        |                                                      |                                 |        
|                                                         | Interest expense                                     |                                 |        
|                                                         | Minority interest in income of partnership and trust |                                 |        
|                                                         |                                                     
|Total interest expense                                   |                                                      |                                 | 206.9  
|                                                         |                                                     
|Loss from continuing operations before income taxes      |                                                      |                                 | (439.6 
|Income tax benefit                                       |                                                      |                                 | (125.7 
|                                                         |                                                     
|Loss from continuing operations                          |                                                      |                                 | (313.9 
|Earnings (loss) from discontinued operations, net of tax |                                                      |                                 | 11.5   
|                                                         |                                                     
|Net loss                                                 |                                                      | $                               | (302.4 
|                                                         |                                                     
|Basic and diluted earnings (loss) per common share:      |                                                      |                                 |        
|                                                         | Continuing operations                                |                                 | $      
|                                                         | Discontinued operations                              |                                 |        
|                                                         |                                                     
|                                                         | Net loss                                             |                                 | $      
|                                                         |                                                     
|Dividends per common share                               |                                                      | $                               |       
|                                                         |                                                     

See accompanying notes to consolidated financial statements.

4

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Aquila, Inc.

Consolidated Balance Sheets

|In millions                                |                                                    | September 30,
2003 |         | December 31,
2002
|------------------------------------------ | -------------------------------------------------- | ------------------ | ------- | -----------------
|
|
|Assets                                     |                                                    |                    |         |                  
|Current assets:                            |                                                    |                    |         |                  
|                                           | Cash and cash equivalents                          |                    | $       | 632.0            
|                                           | Restricted cash                                    |                    |         | 263.7            
|                                           | Funds on deposit                                   |                    |         | 413.5            
|                                           | Accounts receivable, net                           |                    |         | 580.6            
|                                           | Inventories and supplies                           |                    |         | 174.2            
|                                           | Price risk management assets                       |                    |         | 278.9            
|                                           | Prepayments and other                              |                    |         | 157.2            
|                                           | Current assets of discontinued operations          |                    |         | 273.5            
|                                          
|Total current assets                       |                                                    |                    | 2,773.6 |                  
|                                          
|                                           | Property, plant and equipment, net                 |                    |         | 2,683.3          
|                                           | Investments in unconsolidated subsidiaries         |                    |         | 315.1            
|                                           | Price risk management assets                       |                    |         | 509.4            
|                                           | Goodwill, net                                      |                    |         | 111.0            
|                                           | Deferred charges and other assets                  |                    |         | 275.8            
|                                           | Non-current assets of discontinued operations      |                    |         | 998.1            
|                                          
|Total Assets                               |                                                    | $                  | 7,666.3 |                  
|                                          
|Liabilities and Shareholders' Equity       |                                                    |                    |         |                  
|Current liabilities:                       |                                                    |                    |         |                  
|                                           | Current maturities of long-term debt               |                    | $       | 415.6            
|                                           | Short-term debt                                    |                    |         |                 
|                                           | Accounts payable                                   |                    |         | 516.1            
|                                           | Accrued liabilities                                |                    |         | 330.8            
|                                           | Price risk management liabilities                  |                    |         | 261.0            
|                                           | Current portion of long-term gas contracts         |                    |         | 84.3             
|                                           | Customer funds on deposit                          |                    |         | 274.0            
|                                           | Current liabilities of discontinued operations     |                    |         | 385.4            
|                                          
|Total current liabilities                  |                                                    |                    | 2,267.2 |                  
|                                          
|Long-term liabilities:                     |                                                    |                    |         |                  
|                                           | Long-term debt, net                                |                    |         | 2,291.8          
|                                           | Deferred income taxes and credits                  |                    |         | 355.1            
|                                           | Price risk management liabilities                  |                    |         | 392.4            
|                                           | Long-term gas contracts, net                       |                    |         | 609.6            
|                                           | Minority interest                                  |                    |         |                 
|                                           | Deferred credits                                   |                    |         | 194.3            
|                                           | Non-current liabilities of discontinued operations |                    |         | 178.3            
|                                          
|Total long-term liabilities                |                                                    |                    | 4,021.5 |                  
|                                          
|Common shareholders' equity                |                                                    |                    | 1,377.6 |                  
|                                          
|Total Liabilities and Shareholders' Equity |                                                    | $                  | 7,666.3 |                  
|                                          

See accompanying notes to consolidated financial statements.

5

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Aquila, Inc.

Consolidated Statements of Comprehensive IncomeUnaudited

|                                                   |  | Three Months Ended
September 30, |        | Nine Months Ended
September 30, |  
|-------------------------------------------------- |  | -------------------------------- | ------ | ------------------------------- | -
|
|
|Net loss                                           |  | $                                | (169.9 | )                               | $
|Unrealized translation adjustments, net of tax     |  |                                  | (17.7  | )                               |  
|Unrealized cash flow hedges, net of tax            |  |                                  | 4.1    |                                 |  
|Unrealized loss from available-for-sale securities |  |                                  |       |                                 |  
|                                                   | 
|Comprehensive loss                                 |  | $                                | (183.5 | )                               | $
|                                                   | 

Aquila, Inc.

Consolidated Statements of Common Shareholders' Equity

|In millions                                                                                                                                                                                                                                                                                                    |  | September 30,
2003 |          | December 31,
2002 |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | -------- | ----------------- | -
|
|
|Common stock: authorized 400 million shares at September 30, 2003 and December 31, 2002, par value $1 per share; 195,163,210 shares issued at September 30, 2003 and 193,782,782 shares issued at December 31, 2002;
authorized 20 million shares of Class A common stock, par value $1 per share, none issued |  | $                  | 195.2    |                   | $
|Premium on capital stock                                                                                                                                                                                                                                                                                       |  |                    | 3,161.3  |                   |  
|Retained deficit                                                                                                                                                                                                                                                                                               |  |                    | (2,013.9 | )                 |  
|Treasury stock, at cost (1,588 and 7,443 shares at September 30, 2003 and December 31, 2002, respectively)                                                                                                                                                                                                     |  |                    |         |                   |  
|Accumulated other comprehensive income (losses)                                                                                                                                                                                                                                                                |  |                    | 35.0     |                   |  
|                                                                                                                                                                                                                                                                                                               | 
|Total common shareholders' equity                                                                                                                                                                                                                                                                              |  | $                  | 1,377.6  |                   | $
|                                                                                                                                                                                                                                                                                                               | 

See accompanying notes to consolidated financial statements.

6

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Aquila, Inc.

Consolidated Statements of Cash FlowsUnaudited

|                                                                                                                                                                         |                                                                              | Nine Months Ended September 30,                                                             |                                   
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------- | ----------------------------------
|
|
|
|Cash Flows From Operating Activities:                                                                                                                                    |                                                                              |                                                                                             |                                   
|                                                                                                                                                                         | Net loss                                                                     |                                                                                             | $                                 
|                                                                                                                                                                         | Adjustments to reconcile net loss to net cash used for operating activities: |                                                                                             |                                   
|                                                                                                                                                                         |                                                                              | Depreciation and amortization expense                                                       |                                   
|                                                                                                                                                                         |                                                                              | Restructuring charges                                                                       |                                   
|                                                                                                                                                                         |                                                                              | Cash paid for restructuring and impairment charges                                          |                                   
|                                                                                                                                                                         |                                                                              | Impairment charges and net loss on sale of assets                                           |                                   
|                                                                                                                                                                         |                                                                              | Provision for uncollectible notes receivable                                                |                                   
|                                                                                                                                                                         |                                                                              | Foreign currency gains                                                                      |                                   
|                                                                                                                                                                         |                                                                              | Net changes in price risk management assets and liabilities                                 |                                   
|                                                                                                                                                                         |                                                                              | Deferred income taxes and investment tax credits                                            |                                   
|                                                                                                                                                                         |                                                                              | Equity in earnings of investments                                                           |                                   
|                                                                                                                                                                         |                                                                              | Dividends and fees from investments                                                         |                                   
|                                                                                                                                                                         |                                                                              | Minority interests in income of subsidiaries                                                |                                   
|                                                                                                                                                                         |                                                                              | Changes in certain assets and liabilities, net of effects of acquisitions and divestitures: |                                   
|                                                                                                                                                                         |                                                                              |                                                                                             | Restricted cash                   
|                                                                                                                                                                         |                                                                              |                                                                                             | Funds on deposit                  
|                                                                                                                                                                         |                                                                              |                                                                                             | Accounts receivable/payable, net  
|                                                                                                                                                                         |                                                                              |                                                                                             | Accounts receivable sales programs
|                                                                                                                                                                         |                                                                              |                                                                                             | Inventories and supplies          
|                                                                                                                                                                         |                                                                              |                                                                                             | Prepayments and other             
|                                                                                                                                                                         |                                                                              |                                                                                             | Deferred charges and other assets 
|                                                                                                                                                                         |                                                                              |                                                                                             | Accrued liabilities               
|                                                                                                                                                                         |                                                                              |                                                                                             | Customer funds on deposit         
|                                                                                                                                                                         |                                                                              |                                                                                             | Deferred credits                  
|                                                                                                                                                                         |                                                                              |                                                                                             | Other                             
|                                                                                                                                                                         |                                                                             
|Cash used for operating activities                                                                                                                                       |                                                                              |                                                                                             | (154.6                            
|                                                                                                                                                                         |                                                                             
|Cash Flows From Investing Activities:                                                                                                                                    |                                                                              |                                                                                             |                                   
|                                                                                                                                                                         | Network capital expenditures                                                 |                                                                                             |                                   
|                                                                                                                                                                         | Merchant capital expenditures                                                |                                                                                             |                                   
|                                                                                                                                                                         | Net increase in merchant notes receivable                                    |                                                                                             |                                   
|                                                                                                                                                                         | Investments in international businesses                                      |                                                                                             |                                   
|                                                                                                                                                                         | Investments in communication services                                        |                                                                                             |                                   
|                                                                                                                                                                         | Cash proceeds received on sale of assets                                     |                                                                                             |                                   
|                                                                                                                                                                         | Merchant investment in unconsolidated subsidiaries                           |                                                                                             |                                   
|                                                                                                                                                                         | Other                                                                        |                                                                                             |                                   
|                                                                                                                                                                         |                                                                             
|Cash provided from (used for) investing activities                                                                                                                       |                                                                              |                                                                                             | 629.3                             
|                                                                                                                                                                         |                                                                             
|Cash Flows From Financing Activities:                                                                                                                                    |                                                                              |                                                                                             |                                   
|                                                                                                                                                                         | Issuance of common stock                                                     |                                                                                             |                                   
|                                                                                                                                                                         | Issuance of long-term debt                                                   |                                                                                             |                                   
|                                                                                                                                                                         | Retirement of long-term debt                                                 |                                                                                             |                                   
|                                                                                                                                                                         | Retirement of company-obligated preferred securities                         |                                                                                             |                                   
|                                                                                                                                                                         | Short-term borrowings (repayments), net                                      |                                                                                             |                                   
|                                                                                                                                                                         | Cash paid on long-term gas contracts                                         |                                                                                             |                                   
|                                                                                                                                                                         | Cash dividends paid                                                          |                                                                                             |                                   
|                                                                                                                                                                         | Other                                                                        |                                                                                             |                                   
|                                                                                                                                                                         |                                                                             
|Cash provided from (used for) financing activities                                                                                                                       |                                                                              |                                                                                             | (166.7                            
|                                                                                                                                                                         |                                                                             
|Increase in cash and cash equivalents                                                                                                                                    |                                                                              |                                                                                             | 308.0                             
|Cash and cash equivalents at beginning of period (includes $55.6 million and $45.0 million, respectively, of cash included in current assets of discontinued operations) |                                                                              |                                                                                             | 441.7                             
|                                                                                                                                                                         |                                                                             
|Cash and cash equivalents at end of period (includes $117.7 million and $64.8 million, respectively, of cash included in current assets of discontinued operations)      |                                                                              | $                                                                                           | 749.7                             
|                                                                                                                                                                         |                                                                             

See accompanying notes to consolidated financial statements.

7

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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 2002 Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 15, 2003. You should read our 2002
Form 10-K in conjunction with this report. The accompanying Consolidated Balance Sheets and Consolidated Statements of Common Shareholders' Equity as of December 31, 2002,
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. Certain estimates 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 year amounts in the consolidated financial statements have been reclassified where necessary to conform to the 2003 presentation. In particular, as discussed in
Note 4, the results of operations from certain assets that were sold in 2002 and 2003 and certain assets that are currently held for sale have been reclassified as discontinued operations in
the accompanying balance sheets and statements of income for all periods presented.

Stock Based Compensation

We issue stock options to employees from time to time and account for these options under Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" (APB 25). All stock options issued are granted at the common stock's market price at date of issuance. Therefore we record no compensation expense related to stock options. We
historically offered employees a stock purchase plan that enabled them to purchase our common stock at a 15% discount from the market price. This program was suspended during the second quarter of
2003 when all authorized shares in the plan were issued. Shareholder approval is required to authorize additional shares for this program to continue.

8

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Because
we account for options and discounts under APB 25, we disclose a pro forma net loss and a basic and diluted loss per share as if we reflected the estimated fair value of options
and discounts as compensation expense. Our pro forma net loss and basic and diluted loss per share are as follows:

|                                  |                                                                                                        | Three Months Ended
September 30, |        | Nine Months Ended
September 30, |  
|--------------------------------- | ------------------------------------------------------------------------------------------------------ | -------------------------------- | ------ | ------------------------------- | -
|
|
|Net loss:                         |                                                                                                        |                                  |        |                                 |  
|                                  | As reported                                                                                            |                                  | $      | (169.9                          | )
|                                  | Total stock-based employee compensation expense determined under fair value method, net of related tax |                                  |        | (1.3                            | )
|                                  |                                                                                                       
|Pro forma net loss                |                                                                                                        | $                                | (171.2 | )                               | $
|                                  |                                                                                                       
|Basic and diluted loss per share: |                                                                                                        |                                  |        |                                 |  
|                                  | As reported                                                                                            |                                  | $      | (.87                            | )
|                                  | Pro forma                                                                                              |                                  |        | (.88                            | )
|                                  |                                                                                                       

In
April 2003, the Financial Accounting Standards Board (FASB) announced that it would require all companies to expense the value of employee stock options. The FASB plans to
issue a new statement in the second half of 2004 that will further define the method of determining fair value and recognizing compensation expense.

New Accounting Pronouncements

Variable Interest Entities

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51." This
interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the interpretation. The interpretation is effective immediately for variable interest
entities created or obtained after January 31, 2003 and is effective on December 31, 2003 for variable interest entities that existed prior to February 1, 2003. We do not expect
the application of this interpretation to have a material impact on our financial position or results of operations.

Derivative Instruments

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" (SFAS 149). This Statement clarified under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). It also clarified when a derivative contains a financing component that
warrants special reporting in the statement of cash flows. SFAS 149 also amended certain other existing pronouncements regarding derivatives. It is generally effective for contracts entered
into or modified after June 30, 2003, and was applied prospectively. The adoption of this standard had no material impact on our financial position or results of operations.

Financial Instruments

In May 2003, the FASB issued SFAS No. 150, "Accounting for Financial Instruments with Characteristics of both Liabilities and Equity"
(SFAS 150). This statement established standards for the classification and measurement of certain financial instruments that have the characteristics of both liabilities and equities. It
requires that an issuer classify a financial instrument that is within the scope

9

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of
the standard as a liability. This standard is effective for all financial instruments entered into or modified after May 31, 2003, and for the first interim reporting period beginning after
June 15, 2003. The adoption of this standard had no impact on our financial position or results of operations.

2.     Restructuring Charges

In connection with our continued exit from Wholesale Services and the restructuring of our Domestic Networks group, we have recorded the following restructuring
charges:

|                                    |                                      | Three Months Ended
September 30, |     | Nine Months Ended
September 30,
|----------------------------------- | ------------------------------------ | -------------------------------- | --- | -------------------------------
|
|
|Domestic Networks:                  |                                      |                                  |     |                                
|                                    | Severance costs                      |                                  | $   |                               
|                                    | Disposal of corporate aircraft       |                                  |     |                               
|                                   
|Total Domestic Networks             |                                      |                                  |    |                                
|                                   
|Capacity Services:                  |                                      |                                  |     |                                
|                                    | Interest rate swap reductions        |                                  |     |                               
|                                    | Severance costs                      |                                  |     |                               
|                                   
|Total Capacity Services             |                                      |                                  |    |                                
|                                   
|Wholesale Services:                 |                                      |                                  |     |                                
|                                    | Severance costs                      |                                  |     |                               
|                                    | Retention payments                   |                                  |     | 1.0                            
|                                    | Lease agreements                     |                                  |     | (.3                            
|                                    | Leasehold improvements and equipment |                                  |     |                               
|                                    | Disposal of corporate aircraft       |                                  |     |                               
|                                    | Other                                |                                  |     |                               
|                                   
|Total Wholesale Services            |                                      |                                  | .7  |                                
|Corporate and Other severance costs |                                      |                                  | (.1 | )                              
|                                   
|Total restructuring charges         |                                      | $                                | .6  |                                
|                                   

Severance Costs and Retention Payments

We incurred severance costs of $2.1 million for the nine months ended September 30, 2003, in connection with the restructuring of Everest
Connections, our communications business within Domestic Networks. This resulted from a reduction of approximately 160 employees. We also incurred $1.0 million and $1.7 million of
retention payments in the three months and nine months ended September 30, 2003, respectively, related to the continued wind-down of our domestic and international energy trading operations in
Wholesale Services.

We
incurred $13.4 million and $54.1 million of total severance costs for the three and nine months ended September 30, 2002, respectively, related to the
restructuring of Domestic Networks in order to more closely align it with its regulatory service areas and the decision to exit our energy trading business in Wholesale Services. These actions
resulted in the termination of approximately 1,205 energy trading employees, 500 Domestic Networks employees and 75 Corporate employees. These charges were expensed and accrued during the second and
third quarters of 2002 and paid out bi-weekly over the term of the severance benefit. In addition, certain employees of the wholesale energy trading operations had retention agreements in
2002 to ensure an orderly exit of this business. During the third quarter of 2002, we paid approximately $28.9 million of retention payments to these employees.

10

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Disposal of Corporate Aircraft

The $7.1 million charge for disposal of corporate aircraft for the nine months ended September 30, 2002, primarily included the termination of
applicable lease agreements and losses associated with the sale of our corporate aircraft.

Interest Rate Swap Reductions

We incurred $23.1 million of restructuring charges for the nine months ended September 30, 2003, to exit interest rate swaps related to our Clay
County and Piatt County construction financing arrangements. As debt related to these facilities was paid down, our interest rate swaps exceeded the outstanding debt. Thus we reduced our position and
realized the loss associated with the cancelled swaps.

Lease Agreements

During the third quarter of 2002, we recorded a $36.7 million restructuring charge for operating leases for various office facilities used in the wholesale
energy trading operations that we determined would no longer be used. This charge represented the estimated future net lease costs of these facilities after estimated sublease recoveries.

Leasehold Improvements and Equipment

During the three and nine months ended September 30, 2002, we wrote down $36.6 million and $59.0 million, respectively, of leasehold
improvements and equipment in our wholesale energy trading business that were no longer realizable based on our best estimate of their fair value.

Restructuring Reserve Activity

The following is a summary of the activity for accrued restructuring charges for the nine months ended September 30, 2003:

|In millions                                                    |                                                           |   |     
|-------------------------------------------------------------- | --------------------------------------------------------- | - | ----
|
|Severance and Retention Costs:                                 |                                                           |   |     
|                                                               | Accrued severance costs as of December 31, 2002           |   | $   
|                                                               | Additional expense during the period                      |   |     
|                                                               | Cash payments during the period                           |   |     
|                                                               |                                                          
|Accrued severance and retention costs as of September 30, 2003 |                                                           | $ | 2.6 
|                                                               |                                                          
|Other Restructuring Costs:                                     |                                                           |   |     
|                                                               | Accrued other restructuring costs as of December 31, 2002 |   | $   
|                                                               | Additional expense during the period                      |   |     
|                                                               | Cash payments during the period                           |   |     
|                                                               |                                                          
|Accrued other restructuring costs as of September 30, 2003 (a) |                                                           | $ | 16.7
|                                                               |                                                          

11

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3.     Impairment Charges and Net Loss on Sale of Assets

We recorded the following impairment charges and net loss (gain) on sale of assets:

|                                                        |                                       | Three Months Ended
September 30, |      | Nine Months Ended
September 30, |  
|------------------------------------------------------- | ------------------------------------- | -------------------------------- | ---- | ------------------------------- | -
|
|
|Domestic Networks:                                      |                                       |                                  |      |                                 |  
|                                                        | Quanta Services                       |                                  | $    |                                |  
|                                                        | Communications investments            |                                  |      |                                |  
|                                                        | Other                                 |                                  |      |                                |  
|                                                        |                                      
|                                                        | Total Domestic Networks               |                                  |      |                                |  
|                                                        |                                      
|International Networks:                                 |                                       |                                  |      |                                 |  
|                                                        | Australia                             |                                  |      | (1.0                            | )
|                                                        | Midlands                              |                                  |      | 4.0                             |  
|                                                        |                                      
|                                                        | Total International Networks          |                                  |      | 3.0                             |  
|                                                        |                                      
|Capacity Services:                                      |                                       |                                  |      |                                 |  
|                                                        | Acadia tolling agreement              |                                  |      |                                |  
|                                                        | Turbines                              |                                  |      |                                |  
|                                                        | Independent power plants              |                                  |      | 87.9                            |  
|                                                        | Exit from Lodi gas storage investment |                                  |      |                                |  
|                                                        | Termination of Cogentrix acquisition  |                                  |      |                                |  
|                                                        | Other                                 |                                  |      |                                |  
|                                                        |                                      
|                                                        | Total Capacity Services               |                                  |      | 87.9                            |  
|                                                        |                                      
|Wholesale Services:                                     |                                       |                                  |      |                                 |  
|                                                        | Goodwill                              |                                  |      |                                |  
|                                                        | Other                                 |                                  |      |                                |  
|                                                        |                                      
|                                                        | Total Wholesale Services              |                                  |      |                                |  
|                                                        |                                      
|Total impairment charges and net loss on sale of assets |                                       | $                                | 90.9 |                                 | $
|                                                        |                                      

Quanta Services

At June 30, 2002, the cost basis in our 38% equity investment in Quanta Services was $26.69 per share and was significantly above the trading price of
Quanta Services' stock. On July 1, 2002, Quanta Services announced that it had reduced its earnings forecast due to a continued decline in the telecommunications industry, reduced utility
construction spending, and financial difficulties surrounding Quanta Services' two largest customers. Quanta Services' share price dropped to
approximately $3.00 per share after this announcement. Because of these factors, and the termination of our proxy contest for control of Quanta Services in May 2002, we concluded that there was
an other-than-temporary decline in the fair value of this investment. Accordingly, we wrote the investment down by $692.9 million before tax, or $627.3 million
after tax, to its estimated fair value of $3.00 a share.

In
the third quarter of 2002, we sold approximately 8.4 million shares of Quanta stock at an average price of $2.38 per share for an additional pretax and after-tax
loss of $5.2 million, reducing our ownership percentage from 38% to approximately 27%. In October 2002, we sold an additional 8.0 million Quanta shares at a price of $3.00 per
share. After this sale, our ownership percentage was approximately 14%. As a result, beginning in November 2002, we accounted for this asset as an

12

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available-for-sale
security in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115). We sold our remaining
11.6 million shares during the first quarter of 2003 at a net price of $2.90 a share.

Communications Investments

During the second quarter of 2002, we determined that certain cost and equity method investments in communications technology-related businesses were impaired
based on continued losses in these businesses, their failure to achieve certain operational goals, the inability of these businesses to obtain additional capital, and our assessment of the
long-term prospects of these businesses. Accordingly, we recorded a $23.1 million pretax, or $13.9 million after-tax, impairment charge related to these
investments.

Australia

In the fourth quarter 2002, we recorded $127.2 million of pretax impairment charges related to our Australian investments.

In
April 2003, we reached an agreement to sell our interests in Multinet Gas, United Energy Limited and AlintaGas Limited to a consortium consisting of AlintaGas, AMP Henderson
and their affiliates. In May 2003, as the first step in the sale process, we sold our interest in AlintaGas. We received approximately $97.0 million in cash proceeds before transaction
costs and taxes in May and July from this sale. In June, we retired $90.7 million of our $200.0 million, 364-day secured credit facility with these proceeds. We recorded a
pretax loss of $2.6 million, or $1.6 million after tax, in the second quarter of 2003 in connection with this sale.

In
July 2003, we completed the sale of our interests in United Energy and Multinet Gas and received cash proceeds of $525.0 million before transaction costs and taxes.
Approximately $109.3 million of these proceeds were used in July to retire the remaining balance outstanding under the 364-day secured credit facility. We recorded a pretax gain of
$1.0 million, or $.5 million after tax, in the third quarter of 2003 in connection with this sale.

Midlands

In September 2003, we agreed to terminate our agreement to sell our 79.9% interest in Aquila Sterling Limited (ASL), the owner of Midlands Electricity plc,
to a subsidiary of Scottish and Southern Energy plc. The sale was subject to a number of conditions including the successful redemption of the outstanding bonds issued by Avon Energy Partners Holdings
(AEPH), an ASL subsidiary, at 86% of their par value plus accrued interest. The efforts to meet this bond redemption condition were unsuccessful and therefore, the parties terminated the agreement.

In
October 2003, we and FirstEnergy Corp. reached a definitive agreement to sell 100% of the ASL shares outstanding to a subsidiary of Powergen UK plc (Powergen) for approximately
$60.0 million. Our share of the proceeds is expected to be approximately $52.0 million before transaction costs. As a result of this agreement and our continuing analysis of fair value
surrounding this investment, we recorded an additional $4.0 million pretax and after-tax impairment charge to write this investment down to its estimated fair value less costs to
sell. In the fourth quarter 2002, we recorded a $247.5 million pretax impairment charge related to our investment in Midlands.

Powergen's
obligation to acquire ASL is conditioned upon a commitment of the holders of the outstanding bonds of AEPH to sell their bonds to an affiliate of Powergen for 95.8% of their
nominal value (less fees) plus accrued interest to the date of completion. The sale is also subject to approval from the European Commission and Kansas Corporation Commission, as well as other
customary closing conditions. We expect this sale to close in the first quarter of 2004.

13

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Acadia Tolling Agreement

In May 2003, we entered into an agreement to terminate our 20-year tolling agreement for the Acadia power plant in Louisiana. We made a
termination payment of $105.5 million in the second quarter of 2003. We were then released from the remaining aggregate payment obligation of $833.9 million, or $43.5 million on
an annual basis.

Turbines

During the second quarter of 2003, we completed the contract termination and sale of certain turbines which had been written down to an estimated realizable value
at December 31, 2002. In connection with the disposition, we recorded a pretax gain of $5.1 million, or $3.2 million after tax.

Independent Power Plants

In the third quarter of 2003, we decided to proceed with the sale of our investments in independent power plants. We have received bids from parties interested in
acquiring these plants and are in discussions with these bidders. Two of the power plants, Lake Cogen Ltd. (Lake Cogen) and Onondaga Cogen Ltd Partnership (Onondaga), are consolidated on
our balance sheet. Therefore, in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144), we have reported the results of operations and
assets of these two plants in discontinued operations.

The
remaining plants are equity method investments that do not qualify for reporting as discontinued operations under SFAS 144 and are therefore included in continuing operations.
We evaluated the carrying value of these equity method investments based on the bids received and other internal valuations. The results of this assessment indicated that these investments were
impaired. Therefore, we recorded a pretax impairment charge of $87.9 million, or $69.9 million after tax, to reduce the carrying value of our investments to their estimated fair value
less costs to sell.

Exit from Lodi Gas Storage Investment

In August 2001, Merchant Services and a partner agreed to acquire a 12 Bcf gas storage facility under construction near Lodi, California. In
October 2002, we exited our investment in the Lodi project due to our exit from the wholesale energy trading business. We owned 50% of WHP Acquisition Company LLC, a company jointly established
with an affiliate of ArcLight Energy Partners Fund I, L.P. in 2001 to purchase Western Hub Properties, LLC, the developer of the Lodi gas storage project. Under the settlement, WHP Acquisition Company
LLC redeemed Aquila's ownership interest for cash payments totaling $5.0 million over a five-year period. We were also released from all of our guarantee obligations relating to
this transaction. We recorded a $21.9 million pretax, or $21.6 million after-tax loss, on this transaction in the third quarter of 2002.

Termination of Cogentrix Acquisition

In August 2002, we agreed to terminate the purchase agreement we signed in April 2002 to acquire Cogentrix Energy, Inc., an independent power
producer. We agreed with Cogentrix that due to the uncertainty of the electric power market, the deterioration of the creditworthiness of some of Cogentrix's customers and our exit from the wholesale
energy trading business, proceeding with the transaction was impractical and not in either company's interest. In connection with the termination of this transaction, we expensed legal, consulting and
termination fees of $12.2 million pretax, or $7.4 million after tax, in the third quarter of 2002.

14

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Goodwill

In connection with our decision to exit our energy trading operations, we assessed our ability to realize the goodwill associated with our Wholesale Services
business. This assessment was based on our best estimate of the value of this business in a liquidation, which we determined was less than the carrying value of its net assets. Because future earnings
or sufficient sales proceeds could no longer support this asset, we wrote off the entire unamortized goodwill balance of $178.6 million in the second quarter of 2002.

4.     Discontinued Operations

In 2002 and early 2003, we sold our Texas natural gas storage facility, our Texas and Mid-Continent natural gas pipeline systems, including our
natural gas and natural gas liquids processing assets, our ownership interest in the Oasis Pipe Line Company, our coal terminal and handling facility (which were all included in our Capacity Services
segment) and our Merchant loan portfolio (which was included in our Wholesale Services segment).

In
September 2003, we reached an agreement to sell our Canadian utility businesses (which are included in our International Networks segment) for approximately
$992 million, including the repayment or assumption of $228 million of debt, or a net $764 million in proceeds to us before closing adjustments, transaction costs and taxes. In
addition, we will be required to repay $115 million borrowed by Aquila Networks Canada Corp. under its 364-day unsecured loan. We expect to use the remaining net proceeds from the
sale to pay related taxes and transaction fees, improve our liquidity, and reduce debt and other obligations. The transaction is subject to approval by the regulatory commissions in Alberta and
British Columbia, among other regulatory bodies, as well as other customary closing conditions, and is expected to close in the first half of 2004. If the sale does not close
by June 30, 2004, the sale agreement will automatically terminate. We expect to record a gain on this sale at the date of close.

In
the third quarter of 2003, we decided to proceed with the sale of our investments in independent power plants. We have received bids from parties interested in acquiring these plants
and are in discussions with these bidders. Two of the power plants, Lake Cogen and Onondaga, are consolidated on our balance sheet. We have reported the results of operations and assets of these two
plants in discontinued operations. We evaluated the carrying value of these assets based on the bids received and other internal valuations. The results of this assessment indicated these assets were
impaired. We recorded a pretax impairment charge of $47.5 million, or $39.8 million after tax, to reduce the carrying value of these assets to their estimated fair value less costs to
sell.

15

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We have reported the results of operations from the above assets in discontinued operations in the Consolidated Statements of Income. 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 Consolidated Balance Sheets.

|In millions                                              |                                      | September 30, 2003 |       | December 31, 2002
|-------------------------------------------------------- | ------------------------------------ | ------------------ | ----- | -----------------
|
|Current assets of discontinued operations:               |                                      |                    |       |                  
|                                                         | Cash and cash equivalents            |                    | $     | 117.7            
|                                                         | Accounts receivable, net             |                    |       | 35.2             
|                                                         | Price risk management assets         |                    |       | 41.2             
|                                                         | Other current assets                 |                    |       | 79.4             
|                                                        
|Total current assets of discontinued operations          |                                      | $                  | 273.5 |                  
|                                                        
|Non-current assets of discontinued operations:           |                                      |                    |       |                  
|                                                         | Property, plant and equipment, net   |                    | $     | 688.2            
|                                                         | Price risk management assets         |                    |       | 52.1             
|                                                         | Goodwill, net                        |                    |       | 220.4            
|                                                         | Other non-current assets             |                    |       | 37.4             
|                                                        
|Total non-current assets of discontinued operations      |                                      | $                  | 998.1 |                  
|                                                        
|Current liabilities of discontinued operations:          |                                      |                    |       |                  
|                                                         | Current maturities of long-term debt |                    | $     | 47.7             
|                                                         | Short-term debt                      |                    |       | 215.0            
|                                                         | Accounts payable                     |                    |       | 29.2             
|                                                         | Other current liabilities            |                    |       | 93.5             
|                                                        
|Total current liabilities of discontinued operations     |                                      | $                  | 385.4 |                  
|                                                        
|Non-current liabilities of discontinued operations:      |                                      |                    |       |                  
|                                                         | Long-term debt, net                  |                    | $     | 129.9            
|                                                         | Deferred credits                     |                    |       | 48.4             
|                                                        
|Total non-current liabilities of discontinued operations |                                      | $                  | 178.3 |                  
|                                                        

16

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Operating
results from our discontinued operations are as follows:

|                                             |                                                   | Three Months Ended
September 30, |       | Nine Months Ended
September 30, |  
|-------------------------------------------- | ------------------------------------------------- | -------------------------------- | ----- | ------------------------------- | -
|
|
|Sales                                        |                                                   | $                                | 75.1  |                                 | $
|Cost of sales                                |                                                   |                                  | 14.9  |                                 |  
|                                             |                                                  
|Gross profit                                 |                                                   |                                  | 60.2  |                                 |  
|                                             |                                                  
|Operating expenses:                          |                                                   |                                  |       |                                 |  
|                                             | Operating expense                                 |                                  |       | 33.5                            |  
|                                             | Restructuring charges                             |                                  |       |                                |  
|                                             | Impairment charges and net loss on sale of assets |                                  |       | 47.5                            |  
|                                             | Depreciation and amortization expense             |                                  |       | .1                              |  
|                                             |                                                  
|Total operating expenses                     |                                                   |                                  | 81.1  |                                 |  
|                                             |                                                  
|Other income (expense):                      |                                                   |                                  |       |                                 |  
|                                             | Equity in earnings of investments                 |                                  |       |                                |  
|                                             | Other income (expense)                            |                                  |       | (9.2                            | )
|                                             |                                                  
|Earnings (loss) before interest and taxes    |                                                   |                                  | (30.1 | )                               |  
|Interest expense                             |                                                   |                                  | 3.7   |                                 |  
|                                             |                                                  
|Earnings (loss) before income taxes          |                                                   |                                  | (33.8 | )                               |  
|Income tax expense (benefit)                 |                                                   |                                  | (8.1  | )                               |  
|                                             |                                                  
|Earnings (loss) from discontinued operations |                                                   | $                                | (25.7 | )                               | $
|                                             |                                                  

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 net loss 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. As a result of the net losses in the three and nine months ended September 30, 2003 and 2002, the potential issuances of
common stock for dilutive securities were considered anti-dilutive and therefore not included in the calculation of diluted earnings (loss) per share.

|                                                                                             |                                   | Three Months Ended September 30, |        | Nine Months Ended September 30, |  
|-------------------------------------------------------------------------------------------- | --------------------------------- | -------------------------------- | ------ | ------------------------------- | -
|
|
|Loss from continuing operations                                                              |                                   | $                                | (144.2 | )                               | $
|Earnings (loss) from discontinued operations                                                 |                                   |                                  | (25.7  | )                               |  
|                                                                                             |                                  
|Net loss                                                                                     |                                   | $                                | (169.9 | )                               | $
|                                                                                             |                                  
|Basic and diluted earnings (loss) per share:                                                 |                                   |                                  |        |                                 |  
|                                                                                             | Loss from continuing operations   |                                  | $      | (.74                            | )
|                                                                                             | Earnings (loss) from discontinued |                                  |        |                                 |  
|                                                                                             | operations                        |                                  |        | (.13                            | )
|                                                                                             |                                  
|Net loss                                                                                     |                                   | $                                | (.87   | )                               | $
|                                                                                             |                                  
|Weighted average number of common shares used in basic and diluted earnings (loss) per share |                                   |                                  | 195.1  |                                 |  
|                                                                                             |                                  

17

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6.     Reportable Segment Reconciliation

Our reportable segment reconciliation is shown below.

|                                                    |                        | Three Months Ended September 30, |        | Nine Months Ended September 30, |  
|--------------------------------------------------- | ---------------------- | -------------------------------- | ------ | ------------------------------- | -
|
|
|Sales:                                              |                        |                                  |        |                                 |  
|                                                    | Domestic Networks      |                                  | $      | 352.2                           |  
|                                                    | International Networks |                                  |        |                                |  
|                                                    |                       
|Total Global Networks Group                         |                        |                                  | 352.2  |                                 |  
|                                                    |                       
|                                                    | Capacity Services      |                                  |        | 20.7                            |  
|                                                    | Wholesale Services     |                                  |        | (50.9                           | )
|                                                    |                       
|Total Merchant Services                             |                        |                                  | (30.2  | )                               |  
|                                                    |                       
|Total                                               |                        | $                                | 322.0  |                                 | $
|                                                    |                       
|Earnings (Loss) Before Interest and Taxes (EBIT):   |                        |                                  |        |                                 |  
|                                                    | Domestic Networks      |                                  | $      | 44.5                            |  
|                                                    | International Networks |                                  |        | 3.7                             |  
|                                                    |                       
|Total Global Networks Group                         |                        |                                  | 48.2   |                                 |  
|                                                    |                       
|                                                    | Capacity Services      |                                  |        | (100.5                          | )
|                                                    | Wholesale Services     |                                  |        | (55.9                           | )
|                                                    |                       
|Total Merchant Services                             |                        |                                  | (156.4 | )                               |  
|Corporate and Other                                 |                        |                                  | (11.5  | )                               |  
|                                                    |                       
|Total EBIT                                          |                        |                                  | (119.7 | )                               |  
|Interest expense                                    |                        |                                  | 75.1   |                                 |  
|                                                    |                       
|Loss from continuing operations before income taxes |                        | $                                | (194.8 | )                               | $
|                                                    |                       

|In millions                 |                        | September 30, 2003 |         | December 31, 2002
|--------------------------- | ---------------------- | ------------------ | ------- | -----------------
|
|Assets:*                    |                        |                    |         |                  
|                            | Domestic Networks      |                    | $       | 2,857.5          
|                            | International Networks |                    |         | 1,372.0          
|                           
|Total Global Networks Group |                        |                    | 4,229.5 |                  
|                           
|                            | Capacity Services      |                    |         | 1,015.5          
|                            | Wholesale Services     |                    |         | 1,863.7          
|                           
|Total Merchant Services     |                        |                    | 2,879.2 |                  
|Corporate and Other         |                        |                    | 557.6   |                  
|                           
|Total assets                |                        | $                  | 7,666.3 |                  
|                           

18

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7.     Financings

Revolving Credit Facility

In April 2002, we entered into a revolving credit facility totaling $650.0 million. The credit facility consisted of two $325.0 million
credit agreements, one with a maturity of 364 days, and the other with a maturity of three years. In April 2003, the 364-day credit facility was repaid in full and
the unused portion of the three-year credit facility was terminated. During the second quarter of 2003, we terminated the remainder of the three-year facility and replaced the
letters of credit issued under it with new letters of credit issued under our letter of credit facility discussed below.

364-Day Secured Credit Facility

In April 2003, we closed on a $200.0 million, 364-day secured loan. The borrower was UtiliCorp Australia, Inc., a wholly-owned
subsidiary. At closing, we borrowed $100.0 million of the available $200.0 million. The interest rate on this financing was initially the London Inter Bank Offering Rate (LIBOR) (with a
3% floor) plus 4.0% for the first 90 days. After the first 90 days, the interest rate increased an additional 2% and would increase an additional 2% every subsequent 90 days with
a maximum rate at maturity of LIBOR (with a 3% floor) plus 10%. We paid up-front arrangement fees of $4.1 million in connection with this borrowing. Proceeds from this borrowing
were used to retire debt.

In
May 2003, we exercised our option under the 364-day financing to borrow the remaining $100.0 million available under the facility. The proceeds were used to
terminate our Acadia Tolling Agreement as discussed in Note 3. We paid additional arrangement fees of $4.1 million for this borrowing. We retired $90.7 million of this borrowing
in June 2003 with proceeds from the sale of our interest in AlintaGas. The remaining balance of $109.3 million was retired in July 2003 with proceeds from the sale of our
interests in United Energy and Multinet Gas.

Three-Year Secured Credit Facility

In April 2003, we closed on a $430.0 million, three-year secured loan. The initial interest rate on the facility was LIBOR (which has a
3% floor) plus 5.75%. In addition, we were required to pay up-front arrangement fees of $17.8 million. Proceeds from the financing were used to retire debt and support letters of
credit.

The
three-year facility is secured by (i) $430.0 million of first mortgage bonds issued under a new indenture that constitutes a lien on our existing and future
Michigan, Nebraska and Colorado utility network assets, (ii) a pledge of the equity of two wholly-owned subsidiaries that indirectly hold our Canadian utility business, and (iii) a
pledge of the equity of a wholly-owned subsidiary that indirectly holds our interests in independent power plants. In October 2003, the Iowa Utility Board conditionally approved our request to
pledge Iowa utility network assets as collateral for the loan. We are in the process of amending the agreement to include these assets as collateral. If we default on this loan, the lenders would be
entitled to be fully repaid from the sale proceeds of this collateral before other creditors could assert their claims against the pledged assets.

We
have also committed to use reasonable efforts to obtain approvals that would provide these lenders additional domestic utility assets as collateral for their loans. If, as a result of
the addition of any such collateral, the value of the domestic regulated utility asset collateral securing the indenture exceeds 167% of the loan secured by the indenture, the pledge of the Canadian
and independent power projects equity interest may be released and the interest rate would be reduced to LIBOR (which has a 3% floor) plus 5.00%. In April 2003, we filed applications with the
state regulatory bodies in Kansas, Minnesota and Missouri requesting authority to pledge our utility assets located in their respective states. In September 2003, the Staff of the Missouri
Public Service Commission

19

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recommended
that our request to pledge Missouri utility assets be denied. Hearings were held before the Commission in October 2003 and a ruling is expected by the end of 2003. However, there is
no statutory deadline for a decision in Missouri. In October 2003, the Minnesota Public Utility Commission also voted to deny our request to pledge Minnesota utility assets. We are currently
evaluating whether we will seek a reconsideration of this decision or re-file the application to address the concerns raised by the Minnesota Commission. We continue to work with the
Kansas Corporation Commission to obtain its approval for the additional collateral. A hearing is scheduled for November 2003.

After
our Iowa utility assets have been formally pledged, we will request that our interest rate be reduced as described above, and we will have pledged utility assets in Michigan,
Nebraska, Iowa and Colorado which would then fully collateralize the loan. Following the pledge of our Iowa utility assets, we will not be required by the credit facility to maintain collateral for
the loan beyond the utility assets pledged. However, it is our intention that borrowings under the credit facility that are not needed to support our utility operations be collateralized by
non-utility assets.

The
$430.0 million secured debt would become immediately due and payable if we do not complete an exchange offer, tender offer, refinancing or other retirement transaction with
regard to 80% of our $250.0 million, 7% senior note series due July 15, 2004 and our $150.0 million, 6.875% senior note series due October 1, 2004, at least two weeks prior
to their respective maturity dates. Among other restrictions, the three-year secured facility contains the following financial covenants with which we were in compliance as of
September 30, 2003:



The
three-year facility also contains covenants that restrict certain activities including, among others, limitations on additional indebtedness, restrictions on
acquisitions, sale transactions, and the amount that we can fund our unregulated merchant businesses and our Everest Connections communications business. 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 Standard & Poor's, or if such a payment would cause a default under
the facility.

Amounts
under the three-year facility cannot be voluntarily prepaid except with payment of a make-whole amount. Amounts that are repaid cannot be
re-borrowed. To the extent we default on any of our loan covenants, our interest rate will increase an additional 2% during the default period.

Letter of Credit Facility

In April 2003, we executed a 364-day Letter of Credit Agreement with a commercial bank. Under terms of the Agreement, the bank committed to
initially issue letters of credit under the facility subject to a limit of $200.0 million outstanding at any one time. All letters of credit issued are fully secured by cash deposits with the
bank. The committed amount automatically decreased to $175.0 million at June 30, 2003 and will decrease further to $150.0 million at December 31, 2003. At
September 30, 2003, $65.3 million of letters of credit were outstanding under this facility.

20

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Canadian Subsidiaries

On July 31, 2003, we closed on a $215.0 million, 364-day unsecured loan. The borrowers are Aquila Networks Canada Corp. (ANCC) and
Aquila Networks Canada (Alberta) Ltd. (ANCA), each of which is an indirect wholly-owned subsidiary. At closing, ANCC borrowed $115.0 million and ANCA borrowed $100.0 million. The
interest rate on this financing is LIBOR (with 2.50% floor) plus 4.25%. Proceeds were used by ANCA to repay and terminate its existing 364-day credit agreement that matured on
July 31, 2003, and a letter of credit facility. ANCC will use its proceeds to
finance the capital expenditure and working capital requirements of its regulated utility subsidiaries, as well as repay certain bank debt of Aquila Networks Canada (British Columbia) Ltd
(ANCBC). The facilities will be repaid with the proceeds received in connection with the sale of our Canadian utility businesses. We paid up-front arrangement fees of $4.3 million
in connection with this borrowing.

Aquila
has fully and unconditionally guaranteed $200.0 million of 7.75% senior notes issued in the U.S. debt market by our wholly-owned Canadian finance subsidiary, Aquila Networks
Canada Finance Corporation in June 2001. Aquila Networks Canada Finance Corporation has since been merged into its direct parent corporation, UtiliCorp Canada Ventures LLC, a Delaware limited
liability company.

8.     Restatement of Consolidated Statement of Cash Flow

As stated in previous filings, between 1997 and 2000, we entered into long-term gas contracts that require us to deliver natural gas to municipal
utility customers over periods of 10 to 12 years. In exchange for our commitment to deliver the natural gas, we were paid in advance. We considered these contracts part of our energy trading
operations. As such, both the receipt of the advance cash payments and the monthly cash outflows to purchase the gas to be delivered to the customers in satisfaction of our commitments historically
were included in our Consolidated Statements of Cash Flows under the caption Net Changes in Price Risk Management Assets and Liabilities and included in Cash Flows From Operating Activities. These
contracts were included under the caption Price Risk Management Liabilities in our Consolidated Balance Sheets prior to December 31, 2002, but are now separately disclosed as
Long-term Gas Contracts for all periods presented.

In
2002, the Emerging Issues Task Force (EITF), in its deliberations regarding EITF No. 02-3, discussed a number of items related to energy trading and risk management
activities. In order to more fully address certain of the items discussed, the EITF formed a working group. One of the items discussed by the working group was "prepaid gas contracts." These
discussions included the cash flow presentation of contracts similar to our long-term gas contracts. Based on this discussion, and other accounting and industry discussions and guidance
occurring in 2002, we believe that the current industry and accounting consensus is to report these contracts as financing activities in the statement of cash flows. As a result, we have reported
these cash flows in accordance with the current accounting interpretations and guidance for all periods presented in our Consolidated Statements of Cash Flows. This resulted in a $58.5 million
increase in Cash Flows From Operating Activities for the nine months ended September 30, 2002, as compared to the amount previously reported. Cash Flows From Financing Activities changed by the
corresponding amount, resulting in no change in total cash flow. This change had no impact on earnings or losses.

21

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The
net effects of the change discussed above are shown in the following table:

|                                          |  | Nine Months Ended
September 30, 2002 |       
|----------------------------------------- |  | ------------------------------------ | ------
|
|
|Cash used for operating activities        |  | $                                    | (166.2
|Cash used for investing activities        |  |                                      | (494.4
|Cash provided from financing activities   |  |                                      | 912.6 
|                                          | 
|Net increase in cash and cash equivalents |  | $                                    | 252.0 
|                                          | 

9.     Aries Power Project

MEP Pleasant Hill, LLC, our 50 percent-owned joint venture that owns and operates the Aries Power Project in Pleasant Hill, Missouri, did not refinance or
repay $270.0 million of construction loans prior to their June 26, 2003 maturity. In response to the default, the lenders have drawn on $75.0 million of letters of credit that we
and our partner equally pledged to support the loans, reducing the loan balances to $195.0 million. Although the project is current on its interest payments and other operating expenses, the
loans remain in default. The loans are non-recourse to us and the default has no direct impact on our other credit arrangements or utility operations. We are currently working with our
partner and lenders to cure the default. As of September 30, 2003, our investment balance in the Aries Power Project was $44.4 million.

10.   Legal and Environmental Matters

In February 2002, we filed a suit against Chubb Insurance Group, the issuer of surety bonds in support of certain of our long-term gas supply
contracts. Previously, Chubb had demanded that it be released from its surety obligation of up to $523.8 million or, alternatively, that we post collateral to secure its obligation. We do not
believe that Chubb is entitled to be released from its surety obligations or that we are obligated to post collateral to secure its obligations unless it is likely we will default on the contracts.
Chubb has not alleged that we are likely to default on the contracts. If Chubb were to prevail, it would have a material adverse impact on our liquidity and financial position. We rely on other
sureties in support of long-term gas supply contracts similar to those described above. There can be no assurance that these sureties will not make claims similar to those raised by Chubb.
We have performed under these contracts since their inception and intend to continue to fully perform under these contracts.

A
consolidated lawsuit was filed against us in federal court in Missouri in connection with our recombination with our Aquila Merchant subsidiary that occurred pursuant to an exchange
offer completed in January 2002. The suit raised allegations concerning the lack of independent members on the board of directors of Aquila Merchant to negotiate the terms of the exchange offer
on behalf of the public shareholders of Aquila Merchant. Persons holding certificates formerly representing approximately 1.8 million shares of Aquila Merchant common stock are also pursuing
their appraisal rights in connection with the recombination. The dissenters' rights action is scheduled for trial in May 2004. We do not believe that either of these actions will have an
outcome materially adverse to us.

A
number of companies that have engaged in energy trading activities, including us, have received requests from various regulatory agencies to furnish data and answer questions relating
to the possible inaccurate reporting of gas trade information to various industry publications in 2000 and 2001. In response to such inquiries, we initiated a review of our reported information
relative to recorded data

22

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and
are fully cooperating with these investigations. Additionally, we have reported to the Federal Energy Regulatory Commission and the Commodity Futures Trading Commission (CFTC) that we have been
unable to reconcile all of the gas trade data reported to various trade publications with the gas trade data in our internal records and that our former traders may have reported inaccurate
information. We are continuing to work with the CFTC on this matter.

A
lawsuit was filed against us and numerous other energy trading companies in November 2002 by the Lieutenant Governor of the State of California alleging that we misreported gas
trade data that, in turn, affected the market price of electricity in California. Our motion to be dismissed from the lawsuit was granted by the court on July 11, 2003.

The
Environmental Protection Agency (EPA) has been conducting enforcement initiatives nationwide, and recently has inquired at several coal-fired power plants operated by
other companies in our region. These investigations are being made to determine whether modifications at those facilities were subject to New Source Review requirements (NSR) under the Clean Air Act.
The EPA contends that power plants are required to update emission controls at the time of major maintenance or capital activity, and it has initiated civil enforcement actions in some cases. The EPA
has not requested any information from our company in that regard, nor has it indicated that it intends to do so. We believe that the maintenance and capital activities performed at our power plants
are routine and not subject to NSR. It is possible, if the EPA does pursue such action with us, that our additional investment to comply could be material. We would expect to obtain recovery of such
costs through rates.

23

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

AQUILA, INC.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Except where noted, the following discussion refers to the consolidated entity, Aquila, Inc. During the periods covered by this
report, our businesses were structured as follows: (a) Global Networks Group, consisting of two segments, (i) Domestic Networks, our electric and gas utilities in seven mid-continent
states, which also includes our communications business and our former investment in Quanta Services, Inc. (sold in late 2002 and early 2003), and (ii) International Networks, our
investments in Australian electric and gas utilities (sold in the second and third quarters of 2003), our United Kingdom investment in an electric utility business (in the process of being sold), our
investment in New Zealand electric and gas utility businesses (sold in the fourth quarter of 2002) and our Canadian electric utility businesses (which are in the process of being sold and are
classified as discontinued operations for all periods presented); and (b) Merchant Services, consisting of two segments, (i) Capacity Services, our power generation operations, our
investments in independent power plants (in the process of being sold; two consolidated plants, Lake Cogen and Onondaga, have been classified as discontinued operations for all periods presented), our
natural gas gathering and processing operations (sold in 2002 and classified as discontinued operations for all periods presented), and (ii) Wholesale Services, our North American and European
commodity and client service businesses (including our capital business which was also sold in 2002 and is classified as discontinued operations for all periods presented).

FORWARD-LOOKING INFORMATION AND RISK FACTORS

This report contains forward-looking information, including statements that (i) we expect our utility rates to be increased in certain states where we have
utility operations, and (ii) our long-term liquidity
depends upon the sale of assets, return of collateral posted, restructuring of generation capacity obligations, the ability to refinance or retire maturing obligations such as long-term gas contracts
and the ability to use regulated assets as collateral for debt. The words "may," "will," "should," "expect," "anticipate," "intend," "plan," "believe," "seek," "estimate," or the negative of these
terms or similar expressions identify further forward-looking statements. Similar statements that identify our objectives, plans and goals are forward-looking statements.

These
forward-looking statements involve risks and uncertainties, and there are certain important factors that can cause actual results to differ materially from those anticipated. Some
of the important factors and risks that could cause actual results to differ materially from those anticipated include:



24

---



25

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RESULTS OF OPERATIONS

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 earnings before interest and taxes (EBIT). We use EBIT as a performance measure as it captures the income and expenses within the management
control of our segment business leaders. Corporate management is responsible for making all financing decisions. Therefore, each segment discussion focuses on the factors affecting EBIT, while
interest expense and income taxes are separately discussed at the corporate level.

The
use of EBIT 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
generally accepted accounting principles (GAAP), as an indicator of operating performance or as a measure of liquidity, or other performance measures used under GAAP. In addition, the term may not be
comparable to similarly titled measures used by other companies.

|                                                         |                        | Three Months Ended
September 30, |        | Nine Months Ended
September 30, |  
|-------------------------------------------------------- | ---------------------- | -------------------------------- | ------ | ------------------------------- | -
|
|
|Earnings (Loss) Before Interest and Taxes:               |                        |                                  |        |                                 |  
|                                                         | Domestic Networks      |                                  | $      | 44.5                            |  
|                                                         | International Networks |                                  |        | 3.7                             |  
|                                                         |                       
|Total Global Networks Group                              |                        |                                  | 48.2   |                                 |  
|                                                         |                       
|                                                         | Capacity Services      |                                  |        | (100.5                          | )
|                                                         | Wholesale Services     |                                  |        | (55.9                           | )
|                                                         |                       
|Total Merchant Services                                  |                        |                                  | (156.4 | )                               |  
|Corporate and Other                                      |                        |                                  | (11.5  | )                               |  
|                                                         |                       
|Total EBIT                                               |                        |                                  | (119.7 | )                               |  
|Interest expense                                         |                        |                                  | 75.1   |                                 |  
|Income tax benefit                                       |                        |                                  | (50.6  | )                               |  
|                                                         |                       
|Loss from continuing operations                          |                        |                                  | (144.2 | )                               |  
|Earnings (loss) from discontinued operations, net of tax |                        |                                  | (25.7  | )                               |  
|                                                         |                       
|Net loss                                                 |                        | $                                | (169.9 | )                               | $
|                                                         |                       

26

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DISCONTINUED OPERATIONS

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: (1) our Texas natural gas storage facility, our Texas and Mid-Continent natural gas pipeline systems, including our natural gas and natural
gas liquids processing assets and our ownership interest in the Oasis Pipe Line Company, our coal terminal and handling facility and our Merchant loan portfolio that were all sold in 2002 and early
2003, and (2) our Canadian network businesses and our consolidated independent power plants, Lake Cogen and Onondaga, that we are in the process of selling. The unaudited operating results of
our operations that are considered discontinued operations for accounting purposes are as follows:

|                                             |                                                   | Three Months Ended
September 30, |       | Nine Months Ended
September 30, |  
|-------------------------------------------- | ------------------------------------------------- | -------------------------------- | ----- | ------------------------------- | -
|
|
|Sales                                        |                                                   | $                                | 75.1  |                                 | $
|Cost of sales                                |                                                   |                                  | 14.9  |                                 |  
|                                             |                                                  
|Gross profit                                 |                                                   |                                  | 60.2  |                                 |  
|                                             |                                                  
|Operating expenses:                          |                                                   |                                  |       |                                 |  
|                                             | Operating expense                                 |                                  |       | 33.5                            |  
|                                             | Restructuring charges                             |                                  |       |                                |  
|                                             | Impairment charges and net loss on sale of assets |                                  |       | 47.5                            |  
|                                             | Depreciation and amortization expense             |                                  |       | .1                              |  
|                                             |                                                  
|Total operating expenses                     |                                                   |                                  | 81.1  |                                 |  
|                                             |                                                  
|Other income (expense):                      |                                                   |                                  |       |                                 |  
|                                             | Equity in earnings of investments                 |                                  |       |                                |  
|                                             | Other income (expense)                            |                                  |       | (9.2                            | )
|                                             |                                                  
|Earnings (loss) before interest and taxes    |                                                   |                                  | (30.1 | )                               |  
|Interest expense                             |                                                   |                                  | 3.7   |                                 |  
|                                             |                                                  
|Earnings (loss) before income taxes          |                                                   |                                  | (33.8 | )                               |  
|Income tax expense (benefit)                 |                                                   |                                  | (8.1  | )                               |  
|                                             |                                                  
|Earnings (loss) from discontinued operations |                                                   | $                                | (25.7 | )                               | $
|                                             |                                                  

27

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Quarter-to-Quarter

Sales, Cost of Sales and Gross Profit

Sales, cost of sales and gross profit decreased $97.0 million, $54.3 million and $42.7 million, respectively, in 2003 compared to 2002. These
decreases were primarily due to the sale of our gas gathering and pipeline assets and our coal handling facility in the fourth quarter of 2002. In addition, sales, cost of sales and gross profit for
Lake Cogen and Onondaga were lower in 2003 by $21.8 million, $4.7 million and $17.1 million, respectively, due to mark-to-market losses on
long-term gas and power swaps resulting from lower natural gas and power prices and lower volumes delivered in the third quarter of 2003 compared to 2002.

Operating Expense

Operating expense decreased $34.8 million in 2003 compared to 2002 primarily due to the sale of our gas gathering and pipeline assets, our Merchant loan
portfolio and our coal handling facility in the fourth quarter of 2002.

Impairment Charges and Net Loss on Sale of Assets

Impairment charges and net loss on sale of assets consisted of $47.5 million related to our consolidated independent power plants, Lake Cogen and Onondaga.
In the third quarter of 2003, we decided to proceed with the sale of these assets and therefore wrote these assets down to estimated fair value less costs to sell, which was less than their carrying
value. Impairment charges in 2002 consisted of a $236.6 million loss on the sale of our gas gathering and pipeline assets.

Depreciation and Amortization Expense

Depreciation and amortization expense decreased $22.4 million in 2003 compared to 2002. The elimination of depreciation from our Canadian utility plant was
due to its classification as held for sale in accordance with SFAS 144, which decreased depreciation expense $14.5 million. SFAS 144 requires that depreciation expense no longer
be recorded for those assets classified for accounting purposes as held for sale. In addition, approximately $7.9 million of the decrease was due to the sale of our gas gathering and pipeline
assets and our coal handling facility in the fourth quarter of 2002.

Other Income

Other income decreased $27.5 million in 2003 compared to 2002 primarily due to the sale of our Merchant loan portfolio in the fourth quarter of 2002. This
business generated $13.4 million of other income in the third quarter of 2002. In 2003, we incurred $6.8 million of costs related to a currency put option intended to protect us from
unfavorable currency movements on the Canada sale proceeds and $2.2 million of foreign currency losses related to U.S. dollar denominated debt issued by our Canadian subsidiaries.

Interest Expense

Interest expense decreased $3.5 million in 2003 compared to 2002 primarily due to the retirement of $85.3 million of Canadian bank borrowings in
April 2003.

Income Tax Benefit

The income tax benefit for 2003 decreased $62.9 million from 2002 primarily due to lower pretax losses in 2003.

28

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Year-to-Date

Sales, Cost of Sales and Gross Profit

Sales, cost of sales and gross profit decreased $239.5 million, $161.9 million and $77.6 million, respectively, in 2003 compared to 2002.
These decreases were primarily due to the sale of our gas gathering and pipeline assets and our coal handling facility in the fourth quarter of 2002. In addition, sales and gross profit for our
Canadian network operations decreased $30.0 million and $27.0 million, respectively, due to the decision by the Alberta Energy and Utilities Board (AEUB) to decrease our 2002 and 2003
customer billing rates. Offsetting these decreases were sales and gross profit for Lake Cogen and Onondaga that were higher in 2003 by $12.7 million and $14.3 million, respectively, due
to mark-to-market gains on long-term gas and power swaps resulting from higher natural gas and power prices in the first half of 2003, partially offset by lower
volumes delivered.

Operating Expense

Operating expense decreased $61.7 million in 2003 compared to 2002 primarily due to the sale of our gas gathering and pipeline assets, our Merchant loan
portfolio and our coal handling facility in 2002 and early 2003.

Impairment Charges and Net Loss on Sale of Assets

Impairment charges and net loss on sale of assets consisted of $47.5 million related to our consolidated independent power plants, Lake Cogen and Onondaga.
In the third quarter of 2003, we decided to proceed with the sale of these assets and therefore wrote these assets down to estimated fair value less costs to sell, which was less than their carrying
value. Impairment charges in 2002 consisted of a $236.6 million loss on the sale of our gas gathering and pipeline assets.

Depreciation and Amortization Expense

Depreciation and amortization expense decreased $58.4 million in 2003 compared to 2002. The elimination of depreciation from our Canadian utility plant was
due to its classification as held for sale which decreased depreciation expense $14.5 million as discussed above. In addition, approximately $23.2 million of the decrease was due to the
sale of our gas gathering and pipeline assets and our coal handling facility in the fourth quarter of 2002. The remaining decrease was primarily due to the decision by the AEUB to reduce the
depreciation rates on most of our distribution assets in Alberta, which impacted the first six months of 2003.

Equity in Earnings of Investments

Equity in earnings of investments decreased $4.9 million due to the sale of our investment in the Oasis Pipe Line Company in the fourth quarter of 2002.

Other Income

Other income decreased $50.4 million in 2003 compared to 2002, primarily due to the sale of our Merchant loan portfolio in the fourth quarter of 2002. This
business generated $37.1 million of other income in 2002. In 2003, we incurred $6.8 million of costs related to a currency put option intended to protect us from unfavorable currency
movements on the Canada sale proceeds and $2.2 million of foreign currency losses related to U.S. dollar denominated debt issued by our Canadian subsidiaries.

29

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Income Tax Expense (Benefit)

Income tax expense (benefit) decreased $56.5 million primarily due to pretax income in 2003 compared to a pretax loss in 2002 and the AEUB decision
discussed above. This decision decreased sales and depreciation; however, only the sales impact is tax effected for Canadian regulatory purposes.

DOMESTIC NETWORKS

The table below summarizes the operations of our Domestic Networks.

|                                                |                                                          | Three Months Ended
September 30, |         | Nine Months Ended
September 30, |  
|----------------------------------------------- | -------------------------------------------------------- | -------------------------------- | ------- | ------------------------------- | -
|
|
|Sales                                           |                                                          | $                                | 352.2   |                                 | $
|Cost of sales                                   |                                                          |                                  | 174.5   |                                 |  
|                                                |                                                         
|Gross profit                                    |                                                          |                                  | 177.7   |                                 |  
|                                                |                                                         
|Operating expenses:                             |                                                          |                                  |         |                                 |  
|                                                | Operating expense                                        |                                  |         | 101.0                           |  
|                                                | Restructuring charges                                    |                                  |         |                                |  
|                                                | Impairment charges and net loss (gain) on sale of assets |                                  |         |                                |  
|                                                | Depreciation and amortization expense                    |                                  |         | 32.0                            |  
|                                                |                                                         
|Total operating expenses                        |                                                          |                                  | 133.0   |                                 |  
|                                                |                                                         
|Other income (expense):                         |                                                          |                                  |         |                                 |  
|                                                | Equity in earnings (loss) of investments                 |                                  |         |                                |  
|                                                | Minority interest in income of subsidiaries              |                                  |         |                                |  
|                                                | Other income (expense)                                   |                                  |         | (.2                             | )
|                                                |                                                         
|Earnings (loss) before interest and taxes       |                                                          | $                                | 44.5    |                                 | $
|                                                |                                                         
|Electric sales and transportation volumes (GWh) |                                                          |                                  | 3,426.7 |                                 |  
|Gas sales and transportation volumes (Bcf)      |                                                          |                                  | 34.4    |                                 |  
|Electric customers at end of period             |                                                          |                                  |         |                                 |  
|Gas customers at end of period                  |                                                          |                                  |         |                                 |  
|                                                |                                                         

Quarter-to-Quarter

Sales, Cost of Sales and Gross Profit

Sales and cost of sales for the Domestic Networks businesses decreased $49.3 million and $52.4 million, respectively, and gross profit increased
$3.1 million in 2003 compared to 2002. These changes were primarily due to the following factors:



30

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Impairment Charges and Net Loss (Gain) on Sale of Assets

As further discussed in Note 3 to the Consolidated Financial Statements, Domestic Networks incurred $5.2 million of losses in 2002 related to the
sale of part of our investment in Quanta Services.

Depreciation and Amortization Expense

Depreciation and amortization expense decreased $4.8 million in 2003 compared to 2002 primarily due to the reduced depreciable base at Everest Connections
resulting from the impairment charge recorded in the fourth quarter of 2002.

Year-to-Date

Sales, Cost of Sales and Gross Profit

Sales and cost of sales for the Domestic Networks businesses decreased $110.2 million and $111.3 million, respectively, and gross profit increased
$1.1 million in 2003 compared to 2002. These changes were primarily due to the following factors:



Operating Expense

Operating expense decreased $25.9 million in 2003 compared to 2002, primarily due to lower labor, benefits and administrative expenses resulting from our
restructuring in 2002.

31

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Restructuring Charges

Restructuring charges decreased $17.8 million in 2003 compared to 2002. In the first half of 2003, we completed the restructuring of the operations of
Everest Connections resulting in the termination of approximately 160 employees and $2.1 million of severance costs.

We
restructured our domestic utility business in the second quarter of 2002 to more closely align it with our state service areas. In connection with this restructuring, we incurred
$19.9 million in costs, primarily for severance for terminated employees and the disposition of our corporate aircraft operation.

Impairment Charges and Net (Gain) Loss on Sale of Assets

As further discussed in Note 3 to the Consolidated Financial Statements, Domestic Networks incurred $721.2 million of losses resulting from
impairments in 2002. The impairments consisted of $698.1 million and $23.1 million related to our investments in Quanta Services and other communication technology investments,
respectively.

Depreciation and Amortization Expense

Depreciation and amortization expense decreased $9.4 million in 2003 compared to 2002, primarily due to the reduced depreciable base at Everest Connections
resulting from the impairment charge recorded in the fourth quarter of 2002.

Minority Interest in Income of Subsidiaries

Minority interest in income of subsidiaries decreased $6.6 million in 2003 compared to 2002 due to the reduction of Everest Connections' minority capital
balances to zero in October 2002. Therefore, we have recorded all of Everest Connections' losses in 2003.

Regulatory Matters

The following is a summary of our recent rate case activity:

|In millions |  | Type of
Service |  | Date
Requested |  | Date
Approved |  | Amount
Requested |      | Amount
Approved
|----------- |  | --------------- |  | -------------- |  | ------------- |  | ---------------- | ---- | ---------------
|
|Minnesota   |  | Gas             |  | 8/2000         |  | 7/2003        |  | $                | 9.8  |                
|Iowa        |  | Gas             |  | 6/2002         |  | 2/2003        |  |                  | 9.3  |                
|Michigan    |  | Gas             |  | 8/2002         |  | 3/2003        |  |                  | 14.3 |                
|Colorado    |  | Electric        |  | 10/2002        |  | 6/2003        |  |                  | 23.4 |                
|Nebraska    |  | Gas             |  | 6/2003         |  | Pending       |  |                  | 9.9  |                
|Missouri    |  | Electric        |  | 7/2003         |  | Pending       |  |                  | 80.9 |                
|Missouri    |  | Gas             |  | 8/2003         |  | Pending       |  |                  | 6.4  |                

2003 Regulatory Activity

A settlement was reached with the intervenors in the Minnesota rate case for $5.7 million. The settlement was approved by the Commission in
July 2003. This rate increase has been collected on an interim basis since November 2001.

In
June 2002, we filed for a $9.3 million general rate increase in Iowa. We received approval to place an interim increase of $5.6 million into effect, subject to
refund. In February 2003, a settlement was approved by the Commission for an increase of $4.3 million.

In
August 2002, we filed for a $14.3 million general rate increase in Michigan. We received approval to place an interim increase of $8.2 million into effect as of
December 2002. We reached a

32

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settlement
with the Commission staff and other intervening parties for an increase of $9.1 million. This settlement was approved by the Commission in March 2003 and the new rates were
effective in second quarter 2003. This increase was partially offset by a separate depreciation case whereby our annual rates were reduced by $.7 million. This decrease relates to our
depreciation rates, which have little impact on earnings, but reduces cash flow.

In
October 2002, we filed for a $23.4 million increase in our Colorado electric rates. In April 2003, we reached a settlement with the Commission staff and other
intervening parties for an increase of $16.0 million. This settlement was approved in June 2003 by the Commission and new rates were effective beginning in July 2003.

In
June 2003, we filed for a total of $9.9 million of gas rate increases in three rate areas of Nebraska. We received approval to place an interim rate increase of
$9.9 million into effect beginning in October 2003. Hearings will be held in December 2003 regarding each request and decisions rendered in February 2004.

In
July 2003, we filed for rate increases totaling $80.9 million for our electric territories in Missouri. These applications were to recover increased costs of natural gas
used to fuel our power plants, necessary capital expenditures since our prior rate case, increased pension costs and decreased off-system sales. Hearings are scheduled to be held in
February and March 2004.

In
August 2003, we filed for a rate increase totaling $6.4 million for our gas territories in Missouri. These increases are needed primarily to recover the cost of system
improvements and higher operating costs. Hearings are scheduled to be held in March and April 2004.

INTERNATIONAL NETWORKS

The operating results for our Canadian networks have been reclassified as discontinued operations for all periods presented. The table below summarizes our
remaining operations in International Networks, including our equity method investments in Australia (sold in the second and third quarters of 2003), New Zealand (sold in the fourth quarter of 2002)
and the United Kingdom (in the process of being sold).

|                                   |                                                          | Three Months Ended September 30, |     | Nine Months Ended September 30, |  
|---------------------------------- | -------------------------------------------------------- | -------------------------------- | --- | ------------------------------- | -
|
|
|Operating expenses:                |                                                          |                                  |     |                                 |  
|                                   | Operating expense                                        |                                  | $   | 3.3                             |  
|                                   | Impairment charges and net loss (gain) on sale of assets |                                  |     | 3.0                             |  
|                                   |                                                         
|Total operating expenses           |                                                          |                                  | 6.3 |                                 |  
|                                   |                                                         
|Other income (expense):            |                                                          |                                  |     |                                 |  
|                                   | Equity in earnings of investments                        |                                  |     | 1.9                             |  
|                                   | Other income                                             |                                  |     | 8.1                             |  
|                                   |                                                         
|Earnings before interest and taxes |                                                          | $                                | 3.7 |                                 | $
|                                   |                                                         

Quarter-to-Quarter

Impairment Charges and Net Loss (Gain) on Sale of Assets

Impairment charges and net loss (gain) on sale of assets for 2003 included a $1.0 million pretax gain on the sale of our interests in United Energy and
Multinet Gas in Australia, offset by a $4.0 million impairment charge related to our investment in Midlands (our United Kingdom electric network) resulting from the new sale agreement with
Powergen. The gain in 2002 reflected United Energy's sale of its interest in its retail energy businesses and utility back-office business.

33

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Equity in Earnings of Investments

Equity in earnings of investments decreased $40.7 million in 2003 compared to 2002. This decrease was primarily due to the October 2002 sale of our
interest in UnitedNetworks Limited in New Zealand, which contributed equity earnings of $12.8 million in the third quarter of 2002, and the recent sale of our Australian investments which
contributed equity earnings of $13.0 million in the third quarter of 2002 compared to $1.9 million in 2003.

Our
share of undistributed net earnings from Midlands was $5.1 million in the third quarter of 2003, however, as we stated in our 2002 Form 10-K, we did not
recognize the equity earnings from this investment due to regulatory limitations on cash payments by Midlands to its owners. We record equity earnings and management fees from this investment only to
the extent cash is received. In the third quarter of 2002, we recorded equity earnings of $16.8 million from our Midlands' investment.

Other Income

Other income increased $7.1 million in 2003 compared to 2002. This increase was primarily due to $9.3 million of second quarter 2003 costs related
to a currency put option intended to protect us from unfavorable currency movements on the Australian sale proceeds. These currency put option costs were reclassified to Impairment Charges and Net
Loss on Sale of Assets in the third quarter of 2003.

Year-to-Date

Impairment Charges and Net Loss (Gain) on Sale of Assets

Impairment charges and net loss (gain) on sale of assets for 2003 included a $1.6 million pretax loss on the sale of our interests in AlintaGas, United
Energy and Multinet Gas in Australia and a $4.0 million impairment charge related to our investment in Midlands resulting from the new sale agreement with Powergen. The gain in 2002 reflected
United Energy's sale of its interest in its retail energy businesses and utility back-office business.

Equity in Earnings of Investments

Equity in earnings of investments decreased $67.0 million in 2003 compared to 2002. This decrease was primarily due to the October 2002 sale of our
interest in UnitedNetworks Limited in New Zealand, which contributed equity earnings of $30.6 million in the first nine months of 2002, and the recent sale of our Australian investments which
contributed $27.2 million of equity earnings in 2002 compared to $16.0 million in 2003.

We
recorded no equity earnings from our investment in Midlands in 2003 for the reasons discussed above. Our share of undistributed net earnings from Midlands was $38.8 million in
2003. During 2002, we recorded equity earnings of $25.2 million related to our Midlands' investment.

Other Income

Other income increased $14.0 million in 2003 compared to 2002. This increase was primarily due to $12.1 million of foreign currency gains recognized
in the second quarter of 2003 due to the strengthening of the Canadian dollar on U.S. dollar obligations.

34

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Current Operating Developments

Australia.In April 2003, we reached an agreement to sell our interests in Multinet Gas, United Energy Limited and
AlintaGas Limited to a consortium consisting of AlintaGas, AMP Henderson and their affiliates. In May 2003, as the first step in the sale process, we sold our interest in AlintaGas. We received
approximately $97.0 million in cash proceeds in May and July before transaction costs and taxes from this sale. In June, we retired $90.7 million of our $200.0 million,
364-day secured credit facility with these proceeds. We recorded a pretax loss of $2.6 million, or $1.6 million after tax, in the second quarter of 2003 in connection with
this sale.

In
July 2003, we completed the sale of our interests in United Energy and Multinet Gas and received cash proceeds of $525.0 million before transaction costs and taxes.
Approximately $109.3 million of these proceeds were used in July to retire the remaining balance outstanding under the 364-day secured credit facility. We recorded a pretax gain of
$1.0 million, or $.5 million after tax, in connection with this sale.

Midlands.In September 2003, we agreed to terminate the agreement to sell our 79.9% interest in Aquila Sterling
Limited (ASL), the owner of Midlands Electricity plc, to a subsidiary of Scottish and Southern Energy plc. The sale was subject to a number of conditions including the successful redemption of the
outstanding bonds issued by Avon Energy Partners Holdings (AEPH), an Aquila Sterling subsidiary, at 86% of their par value plus accrued interest. The efforts to meet this bond redemption condition
were unsuccessful and therefore, all parties agreed to terminate the agreement.

In
October 2003, we and FirstEnergy Corp. reached a definitive agreement to sell 100% of the ASL shares outstanding to a subsidiary of Powergen UK plc (Powergen) for approximately
$60.0 million. Our share of the proceeds is expected to be approximately $52.0 million before transaction costs. As a result of this agreement and our continuing analysis of fair value
surrounding this investment, we recorded an additional $4.0 million pretax and after-tax impairment charge to write this investment down to its estimated fair value less costs to
sell.

Powergen's
obligation to acquire ASL is conditioned upon a commitment of the holders of the outstanding bonds of AEPH to sell their bonds to an affiliate of Powergen for 95.8% of their
nominal
value (less fees) plus accrued interest to the date of completion. The sale is also subject to approval from the European Commission and Kansas Corporation Commission, as well as other customary
closing conditions. We expect this sale to close in the first quarter of 2004.

Canada.In September 2003, we reached an agreement to sell our Canadian utility businesses for approximately
$992 million. The transaction is subject to approval of the regulatory commissions in Alberta and British Columbia, among other regulatory bodies, as well as other customary closing conditions,
and is expected to close in the first half of 2004. If the sale does not close by June 30, 2004, the sale agreement will automatically terminate. We expect to record a gain on this sale at the
date of close. The results of operations and related assets and liabilities of our Canadian utility business are included in discontinued operations.

35

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CAPACITY SERVICES

The table below summarizes the operations of our Capacity Services businesses.

|                               |                                                   | Three Months Ended September 30, |        | Nine Months Ended September 30, |  
|------------------------------ | ------------------------------------------------- | -------------------------------- | ------ | ------------------------------- | -
|
|
|Sales                          |                                                   | $                                | 20.7   |                                 | $
|Cost of sales                  |                                                   |                                  | 18.8   |                                 |  
|                               |                                                  
|Gross profit (loss)            |                                                   |                                  | 1.9    |                                 |  
|                               |                                                  
|Operating expenses:            |                                                   |                                  |        |                                 |  
|                               | Operating expense                                 |                                  |        | 6.4                             |  
|                               | Restructuring charges                             |                                  |        |                                |  
|                               | Impairment charges and net loss on sale of assets |                                  |        | 87.9                            |  
|                               | Depreciation and amortization expense             |                                  |        | 6.2                             |  
|                               |                                                  
|Total operating expenses       |                                                   |                                  | 100.5  |                                 |  
|                               |                                                  
|Other income (expense):        |                                                   |                                  |        |                                 |  
|                               | Equity in earnings (losses) of investments        |                                  |        | (2.0                            | )
|                               | Other income                                      |                                  |        | .1                              |  
|                               |                                                  
|Loss before interest and taxes |                                                   | $                                | (100.5 | )                               | $
|                               |                                                  

Quarter-to-Quarter

Sales, Cost of Sales and Gross Profit

Sales and cost of sales for our Capacity Services operations decreased approximately $118.9 million and $158.8 million, respectively, in 2003
compared to 2002, resulting in an increase in gross profit of $39.9 million. These changes were primarily due to the following factors:



Operating Expense

Operating expense increased $7.6 million primarily due to higher insurance, legal and other costs related to the continuing wind-down of these operations
in 2003.

36

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Impairment Charges and Net Loss on Sale of Assets

Impairment charges and net loss on sale of assets in 2003 consists of $87.9 million related to our equity method investments in independent power plants.
In the third quarter of 2003, we decided to sell our interest in these plants and therefore wrote our investments down to estimated fair value less costs to sell, which was less than their carrying
value.

Impairment
charges and net loss on sale of assets in 2002 primarily consisted of $21.9 million related to our exit from the Lodi Gas Storage investment and $12.2 million
related to fees and expenses associated with the termination of the Cogentrix acquisition.

Equity in Earnings of Investments

Equity in earnings of investments decreased $22.2 million mainly due to $13.8 million of decreased earnings resulting from
mark-to-market losses occurring at the operating level of one of our equity investments. These losses are directly related to a decrease in gas prices during the third quarter.
The remaining decrease stems from $2.9 million of earnings related to our Lockport Energy investment that was sold in September 2002 and lower earnings from several of our remaining
equity investments.

Year-to-Date

Sales, Cost of Sales and Gross Profit

Sales and cost of sales for our Capacity Services operations decreased approximately $299.8 million and $214.4 million, respectively, in 2003
compared to 2002, resulting in a decrease in gross profit of $85.4 million. These decreases were primarily due to the following factors:



Operating Expense

Operating expense decreased $12.3 million primarily due to labor, benefit savings and lower corporate costs resulting from the restructuring of this
business in 2002.

Restructuring Charges

During the first nine months of 2003, we recorded restructuring charges of $23.1 million relating to the termination of our remaining interest rate swaps
associated with the construction financings for our Clay County and Piatt County power plants. As debt related to these facilities was retired earlier than anticipated, our swaps were in excess of our
outstanding debt. We therefore reduced our position and realized the loss associated with the cancelled portion of the swaps.

37

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Impairment Charges and Net Loss on Sale of Assets

During the first nine months of 2003, we recorded $188.3 million of impairment charges and net loss on sale of assets. These charges consist of
$87.9 million related to the write-down of our equity method investments in independent power plants. In the third quarter of 2003, we decided to sell our interest in these plants
and therefore wrote our investments down to estimated fair value less costs to sell, which was less than their carrying value. Impairment charges also includes a $105.5 million payment for the
termination our 20-year tolling contract for the Acadia power plant, partially offset by a $5.1 million gain related to the contract termination and sale of certain turbines that we
had previously written down to estimated fair value.

Impairment
charges and net loss on sale of assets in 2002 primarily consisted of $21.9 million related to our exit from the Lodi Gas Storage investment and $12.2 million
related to fees and expenses associated with the termination of the Cogentrix acquisition.

Depreciation and Amortization Expense

Depreciation and amortization expense increased $19.5 million in 2003 compared to 2002. Approximately $12.5 million of this increase was due to a
decrease in the estimated amortizable life of certain plant premiums relating to our acquisition of GPU International in December 2000. In addition, the start of commercial operations at three owned
power plants contributed an additional $7.9 million of depreciation and amortization expense in 2003.

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 by the continued construction
of additional power plants. This increase in supply has placed downward pressure on power prices and subsequently the value of unsold merchant generation capacity. As a result of the above factors, we
do not expect our Capacity Services unit to be profitable in the foreseeable future.

We
attempt to optimize and hedge our power plants with forward contracts which qualify as derivative instruments. When we enter into these positions, they are accounted for at fair value
under mark-to-market accounting. The hedges are an offset to our power plants, which use accrual accounting. Because different accounting methods are required for each side of
the transaction, significant fluctuations in earnings can occur with limited impacts on future cash flow.

Current Operating Development

Independent Power Plants.In the third quarter of 2003, we decided to proceed with the sale of our investments in independent
power plants. We have received bids from parties interested in acquiring these plants and are in discussions with these bidders. We recorded an impairment charge to reduce the carrying amount of our
interests in these plants to their estimated fair value less costs to sell. Two of the power plants, Lake Cogen and Onondaga, are consolidated on our balance sheet. We have included the results of
operations from these plants in discontinued operations. The remaining plants are equity method investments whose results of operations are included in continuing operations.

38

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WHOLESALE SERVICES

The table below summarizes the operations of our domestic and international Wholesale Services businesses.

|                               | Three Months Ended September 30,                  |       | Nine Months Ended September 30, |  
|------------------------------ | ------------------------------------------------- | ----- | ------------------------------- | -
|
|
|Sales                          | $                                                 | (50.9 | )                               | $
|Cost of sales                  |                                                   |      |                                 |  
|                               |                                                  
|Gross profit (loss)            |                                                   | (50.9 | )                               |  
|                               |                                                  
|Operating expenses:            |                                                   |       |                                 |  
|                               | Operating expense                                 |       | 8.4                             |  
|                               | Restructuring charges                             |       | .7                              |  
|                               | Impairment charges and net loss on sale of assets |       |                                |  
|                               | Depreciation and amortization expense             |       | .7                              |  
|                               |                                                  
|Total operating expenses       |                                                   | 9.8   |                                 |  
|Other income                   |                                                   | 4.8   |                                 |  
|                               |                                                  
|Loss before interest and taxes | $                                                 | (55.9 | )                               | $
|                               |                                                  

As
a result of the implementation of EITF No. 02-3 (which requires that all gains and losses on derivatives held for trading purposes be reported net in sales), all
Wholesale Services' sales are reported net for all periods presented. To the extent losses exceeded gains, sales are shown as a negative number.

Quarter-to-Quarter

Sales and Gross Profit (Loss)

Sales and gross profit for our Wholesale Services operations increased by $38.9 million, primarily due to the following factors:



39

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Operating Expense

Operating expense decreased $27.9 million primarily due to labor and benefit savings and related operating cost reductions resulting from the exit from our
wholesale energy trading operations in 2002.

Restructuring Charges

In connection with the exit from our wholesale energy trading business, we incurred $109.0 million of restructuring charges in the third quarter of 2002.
These charges mainly included $35.4 million of severance and retention payments to terminated employees, $36.7 million of lease costs connected to future lease commitments and
$36.6 million of excess leasehold improvements and equipment that were expensed when we vacated the related leased properties.

Year-to-Date

Sales and Gross Profit

Sales and gross profit for our Wholesale Services operations decreased by $97.1 million, primarily due to the following factors:





Operating Expense

Operating expense decreased $61.8 million primarily due to labor and benefit savings and related operating cost reductions resulting from the exit from our
wholesale energy trading operations in 2002, partially offset by regulatory review costs in 2003.

40

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Restructuring Charges

In connection with the exit from our wholesale energy trading business, we incurred $159.9 million of restructuring charges in 2002. These charges mainly
included $60.2 million of severance and retention payments to terminated employees, $36.7 million of lease costs connected to future lease commitments and $59.0 million of excess
leasehold improvements and equipment that were expensed when we vacated the related leased properties.

Impairment Charges and Net Loss on Sale of Assets

Impairment charges and net loss on sale of assets in 2002 consisted primarily of an impairment charge of $178.6 million related to goodwill associated with
Wholesale Services that became unrealizable due to our exit from wholesale energy trading.

CORPORATE AND OTHER

The table below summarizes our Corporate and Other expenses and other income.

|                                          |                                       | Three Months Ended
September 30, |       | Nine Months Ended
September 30, |  
|----------------------------------------- | ------------------------------------- | -------------------------------- | ----- | ------------------------------- | -
|
|
|Operating expenses:                       |                                       |                                  |       |                                 |  
|                                          | Operating expense                     |                                  | $     | 3.1                             |  
|                                          | Restructuring charges                 |                                  |       | (.1                             | )
|                                          | Depreciation and amortization expense |                                  |       | (.3                             | )
|                                          |                                      
|Total operating expenses                  |                                       |                                  | 2.7   |                                 |  
|                                          |                                      
|Other income (expense):                   |                                       |                                  |       |                                 |  
|                                          | Equity in earnings of investments     |                                  |       |                                |  
|                                          | Other income (expense)                |                                  |       | (8.8                            | )
|                                          |                                      
|Earnings (loss) before interest and taxes |                                       | $                                | (11.5 | )                               | $
|                                          |                                      

Quarter-to-Quarter

Restructuring Charges

Restructuring charges decreased $8.1 million in the third quarter of 2003 compared to 2002. This decrease was primarily due to $7.6 million of
executive severance that was paid in 2002 in connection with the separation agreement with the former Chief Executive Officer.

Other Income (Expense)

Other income (expense) decreased $8.6 million mainly due to foreign currency losses in 2003 resulting from unfavorable movements in the Australian and New
Zealand dollar against the U.S. dollar.

Year-to-Date

Operating Expense

Operating expense increased $18.1 million in 2003 compared to 2002, primarily due to $11.3 million of restructuring consulting fees and
$14.9 million of increased insurance and other costs associated with having non-investment grade credit. This increase was partially offset by $3.7 million of costs incurred
in 2002 associated with retiring debt and company-obligated preferred securities. In

41

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addition,
we incurred a net $2.7 million of losses in 2002 on investments associated with the cash surrender value of certain life insurance policies that did not occur in 2003.

Restructuring Charges

Restructuring charges decreased $7.1 million in 2003 compared to 2002. This decrease was primarily due to $7.6 million of executive severance that
was paid in 2002 in connection with the separation agreement with the former Chief Executive Officer.

Other Income (Expense)

Other income (expense) increased $52.5 million mainly due to $41.2 million of foreign currency gains in 2003 resulting from favorable movements in
the Australian and New Zealand dollar against the U.S. dollar. In addition, 2002 included $5.9 million of foreign exchange and interest rate hedge losses relating to our original planned
financing structure that was not consummated in connection with our Midlands acquisition.

INTEREST EXPENSE AND INCOME TAX BENEFIT

The table below summarizes our consolidated interest expense and income tax benefit:

|                   |  | Three Months Ended
September 30, |       | Nine Months Ended
September 30, |  
|------------------ |  | -------------------------------- | ----- | ------------------------------- | -
|
|
|Interest expense   |  | $                                | 75.1  |                                 | $
|                   | 
|Income tax benefit |  | $                                | (50.6 | )                               | $
|                   | 

Quarter-to-Quarter

Interest Expense

Interest expense increased $8.1 million in the third quarter of 2003 compared to 2002. The increase was primarily the result of $3.8 million of
higher interest costs related to the $500.0 million of 14.875% senior notes issued in July 2002, the April 2003 borrowing of $430.0 million under our three-year
secured facility that resulted in $8.3 million of interest expense and $4.3 million of debt amortization costs mainly associated with the early retirement of our remaining debt balance
under our 364-day secured credit facility. These increases were offset in part by the retirement of debt outstanding in Australia, New Zealand and the United Kingdom in late 2002 and
early 2003 and the conversion of the premium equity participating securities to common equity in November 2002.

Income Tax Benefit

The income tax benefit decreased $51.1 million in 2003 compared to 2002, primarily as a result of lower losses before income taxes in 2003 compared to 2002
and certain expenses not being deductible in 2003 for income tax purposes.

Year-to-Date

Interest Expense

Interest expense increased $42.4 million in 2003 compared to 2002. The increase was primarily the result of $41.0 million of higher interest costs
related to the $500.0 million of 14.875% senior notes issued in July 2002, the borrowing in the 2003 second quarter of $430.0 million under our three-year

42

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secured
facility that resulted in $17.2 million of additional interest expense and $11.3 million of debt amortization costs mainly associated with the early retirement of our
364-day secured credit facility. These increases were offset in part by the retirement of debt outstanding in Australia, New Zealand and the United Kingdom in late 2002 and early 2003 and
the conversion of the premium equity participating securities to common equity in November 2002.

Income Tax Benefit

The income tax benefit decreased $70.7 million in 2003 compared to 2002, primarily as a result of lower losses before income taxes in 2003 compared to 2002
and equity earnings in Australia that were taxed in 2003 due to the removal of our permanent investment election. Partially offsetting these increases were certain tax benefits not being recognized on
a significant amount of the 2002 losses as a result of valuation allowances being provided and certain expenses in 2002 not being deductible for income tax purposes.

SIGNIFICANT BALANCE SHEET MOVEMENTS

Total assets decreased by $1,592.9 million since December 31, 2002. This decrease is primarily due to the following:



Total
liabilities decreased by $1,362.6 million and common shareholders' equity decreased by $230.3 million since December 31, 2002. These changes are primarily
attributable to the following:



43

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LIQUIDITY AND CAPITAL RESOURCES

Short-term Liquidity

As of September 30, 2003, we had the following cash and short-term debt (including cash and short-term debt reported in discontinued
operations):

|In millions                           |                                                 | September 30,
2003
|------------------------------------- | ----------------------------------------------- | ------------------
|
|Cash                                  |                                                 | $                 
|                                     
|Short-term debt:                      |                                                 |                   
|                                      | Bank borrowingsCanada                          |                   
|                                     
|                                      | Subtotal                                        |                   
|                                     
|Current maturities of long-term debt: |                                                 |                   
|                                      | Senior notes due on July 15 and October 1, 2004 |                   
|                                      | Canadian asset securitization (a)               |                   
|                                      | Miscellaneous                                   |                   
|                                     
|                                      | Subtotal                                        |                   
|                                     
|Total                                 |                                                 | $                 
|                                     

On
July 31, 2003, we closed on a $215.0 million, 364-day unsecured loan. The borrowers are ANCC and ANCA, each of which is an indirect wholly-owned subsidiary.
At closing, ANCC borrowed $115.0 million and ANCA borrowed $100.0 million. The interest rate on this financing is LIBOR (with 2.50% floor) plus 4.25%. Proceeds were used by ANCA to repay
and terminate its existing 364-day credit agreement that matured on July 31, 2003 and a letter of credit facility. ANCC will use its proceeds to finance the capital expenditure and
working capital requirements of its regulated utility subsidiaries, as well as repay certain bank debt of ANCBC. The facilities will be repaid with the

44

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proceeds
received in connection with the sale of its Canadian utility investments. We paid up-front arrangement fees of $4.3 million in connection with this borrowing.

In
September 2003, we reached an agreement to sell our Canadian utility businesses for approximately $992 million, including the repayment or assumption of
$228 million of debt, or a net $764 million in proceeds to us before closing adjustments, transaction costs and taxes. In addition, we will be required to repay $115 million
borrowed by ANCC under its 364-day unsecured loan. We expect to use the remaining net proceeds from the sale to pay related taxes and transaction fees, improve our liquidity and reduce
debt and other obligations. The transaction is subject to approval of the regulatory commissions in Alberta and British Columbia, among other regulatory bodies, as well as other customary closing
conditions, and is expected to close in the first half of 2004. If the sale does not close by June 30, 2004, the sale agreement will automatically terminate.

In
October 2003, we reached a definitive agreement to sell our 79.9% interest in ASL, the owner of Midlands Electricity plc, to a subsidiary of Powergen UK plc (Powergen), for
approximately
$52.0 million, before transaction costs. The sale is subject to a number of conditions including approval from the European Commission and Kansas Corporation Commission and the commitment of
the holders of the outstanding bonds of AEPH to sell their bonds to an affiliate of Powergen for 95.8% of their par value (less fees) plus accrued interest to the date of completion. We expect this
sale to close in the first quarter of 2004.

Due
to our non-investment grade credit rating and lack of short-term lines of credit, we must maintain sufficient cash on hand to cover all of the working capital
requirements of our business. 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 winter heating months due to higher natural gas consumption, potential periods of high natural gas prices and the fact that we are currently required to prepay certain of our
gas commodity suppliers and pipeline companies. However, based on our current forecast and cash on hand at September 30, 2003, we believe we have sufficient cash on hand to meet our
short-term cash requirements. In addition, we expect to have our Canadian asset sale closed during the first half of 2004, which will significantly improve our overall
short-term liquidity.

Long-term Liquidity

As we continue to transition the company back to a domestic utility business, our long-term liquidity is dependent upon the following actions:



Cash Flows

Cash Flows from Operating ActivitiesCash used for operating activities increased in the nine months
ended September 30, 2003, compared to the same period in 2002, primarily due to increases in funds on deposit resulting from higher natural gas prices and required collaterization on our
letters of credit, higher net cash outflows for inventory as our wholesale operations liquidated its gas storage

45

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inventory
in 2002, less cash received from our trading portfolio as we announced our exit from this business in 2002, and cash paid for restructuring and impairment charges. These decreases in cash
flows were partially offset by the collection of $217.8 million of income tax refunds that we received in 2003.

Cash Flows from Investing ActivitiesCash flows from investing activities increased in the first nine months of 2003 primarily
due to the collection of cash proceeds in 2003 from the sale of assets in 2002 and 2003, reduced Merchant capital expenditures in 2003 due to the completion of construction on several new plants in
2002 and no additional investments in international businesses.

Cash Flows from Financing ActivitiesCash flows from financing activities decreased in the first nine months of 2003 compared
to 2002 primarily as a result of our issuance in 2002 of common stock and senior notes. These proceeds were used to pay down short-term debt on our revolving credit agreement and to
replace the liquidity under the Merchant Services accounts receivable sales program that was terminated. In the first nine months of 2003, the primary financing activities were the borrowings under
the secured credit facilities, the repayment of debt under the revolving credit facility, the Clay County and Piatt County construction financings and our Australian notes.

Certain Trading Activities

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 133 are accounted for under the fair value method of accounting. Under SFAS 133, our energy commodity trading contracts, including physical
transactions (mainly gas and power) 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 or use 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 trading and other contracts for 2003 are summarized below:

|In millions                            |  | Wholesale
Services |       | Capacity
Services
and other |   | Total |  
|-------------------------------------- |  | ------------------ | ----- | --------------------------- | - | ----- | -
|
|Fair value at December 31, 2002        |  | $                  | 180.2 |                             | $ | (19.7 | )
|Change in fair value during the period |  |                    | 4.8   |                             |   | (37.1 | )
|Contracts realized or cash settled     |  |                    | (14.5 | )                           |   | 21.2  |  
|                                       | 
|Fair value at September 30, 2003       |  | $                  | 170.5 |                             | $ | (35.6 | )
|                                       | 

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The fair value of contracts maturing in the remainder of 2003, each of the next three years and thereafter are shown below:

|In millions      |  | Wholesale
Services |       | Capacity
Services
and other |   | Total |  
|---------------- |  | ------------------ | ----- | --------------------------- | - | ----- | -
|
|2003             |  | $                  | (2.4  | )                           | $ | .3    |  
|2004             |  |                    | 29.7  |                             |   | (6.8  | )
|2005             |  |                    | 33.3  |                             |   | (18.9 | )
|2006             |  |                    | 26.8  |                             |   | (3.1  | )
|Thereafter (a)   |  |                    | 83.1  |                             |   | (7.1  | )
|                 | 
|Total fair value |  | $                  | 170.5 |                             | $ | (35.6 | )
|                 | 

Item 4.    Controls and Procedures

Our Chief Executive Officer (CEO) and Chief Financial Officer (CFO) 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 CFO. 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 CFO. Based on this evaluation, our CEO and CFO 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 Securities and Exchange Commission. There has been
no change in our internal controls over financial reporting during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting.

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Part IIOther Information

Item 6.    Exhibits and Reports on Form 8-K

|Exhibit No. |  | Description                                               
|----------- |  | ----------------------------------------------------------
|31.1        |  | Certification of Chief Executive Officer under Section 302
|31.2        |  | Certification of Chief Financial Officer under Section 302
|32.1        |  | Certification of Chief Executive Officer under Section 906
|32.2        |  | Certification of Chief Financial Officer under Section 906

We furnished Current Reports on Form 8-K to the Securities and Exchange Commission during the quarter ended September 30, 2003, as
follows:

|Date Filed      |  | Item No.
|--------------- |  | --------
|August 12, 2003 |  | Item  7
|                |  | Item 12

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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/RICK J. DOBSONRick J. Dobson Chief Financial Officer                               |  | 
|----- |  | ------------------------------------------------------------------------------------- |  | 
|      |  | Signing on behalf of the registrant and as principal financial and accounting officer |  | 
|Date: |  | November 5, 2003                                                                      |  | 

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