| AQUILA INC Item 1A Risk Factors 22 Item 1A Risk Factors Our strategic repositioning plan depends on our ability to raise adequate proceeds from asset sales and retire a sufficient amount of debt and other long-term liabilities with the net sale proceeds |
| In March 2005, we announced our strategic repositioning plan |
| Asset divestitures, including the sale of certain regulated utility properties and our merchant peaking power plants, are a key element of our plan |
| We have signed definitive agreements to sell (i) our electric utility operations in Kansas and our gas utility operations in Michigan, Minnesota and Missouri for an aggregate base purchase price of dlra896dtta7 million, (ii) our Goose Creek and Raccoon Creek merchant peaking plants located in Illinois for an aggregate purchase price of dlra175 million and (iii) Everest Connections for a base purchase price of dlra85dtta7 million |
| We anticipate using the net proceeds generated by these divestitures to retire debt and other obligations, and to fund capital expenditures, including rate-base investments required to satisfy our long-term power generation and transmission needs and comply with environmental rules and regulation |
| If we cannot complete these asset sales, or if we are not able to retire a principal amount of debt sufficient to reduce our interest expense to a level that can be satisfied by the cash flow generated by our remaining utility operations, we will continue to have a cash flow shortfall |
| We may also need to explore alternatives with respect to financing the significant capital expenditures anticipated in connection with environmental upgrades and compliance, as well as capital expenditures generally required to continue to provide safe and reliable service to our remaining utility customers |
| We must substantially reduce our overhead costs |
| Certain costs allocated to our utility divisions held for sale cannot be eliminated immediately upon the completion of our utility sales |
| In 2005, we allocated dlra42dtta3 million of operating costs, comprised of corporate overhead and central services, to our utility divisions held for sale |
| We are developing a comprehensive plan to eliminate the majority of these costs when these support services are no longer required, and we expect that a portion of these allocated costs could be reallocated to our remaining utilities (and therefore recovered in rates) |
| However, there can be no assurances that we will be successful in our efforts to eliminate these costs and/or reallocate them to our remaining utilities |
| We expect to continue to incur net losses |
| Except for the quarter ended March 31, 2005 during which we earned nominal net income, we have not earned net income since the quarter ended March 31, 2002 |
| During the three-year period ending December 31, 2005, we have recorded cumulative net losses of approximately dlra858dtta9 million |
| We may incur material impairment charges if we decide to sell our interest in our Crossroads merchant peaking power plant, and if we are able to exit or otherwise terminate our Elwood tolling contract |
| In addition, we expect to continue to incur operating losses from our remaining Merchant Services business |
| Our fuel and purchased power costs for our Missouri electric utilities are expected to significantly exceed the costs we are able to pass through to customers during 2006 |
| We expect to file a rate case in July 2006 to implement a mechanism that will allow us to fully recover these costs; however, even if we are successful, we will not realize any rate relief until mid 2007 at the earliest |
| Until the Missouri Commission establishes rules to implement the legislation adopted in July 2005 that provides a means for the recovery of prudently incurred fuel and purchased power costs without going through a general rate case, our ability to recover fuel and purchased power 22 _________________________________________________________________ costs for our Missouri electric operations will continue to be limited due to the time lag associated with filing rate cases |
| Our inability to pass through fuel and purchased power costs to our Missouri electric customers may also adversely affect our ability to satisfy the financial covenants in our credit agreements, which if breached could cross default our other debt instruments |
| As of December 31, 2005, we had, on a consolidated basis, dlra3dtta3 billion of total liabilities, including almost dlra2 billion of long-term debt |
| This substantial leverage has important consequences for us, including a substantial portion of our cash flow available from operations will be dedicated to the payment of principal and interest |
| Our non-investment grade credit ratings have an adverse effect on our liquidity and borrowing costs |
| Our long-term senior unsecured debt is presently rated "e B2 "e (Positive Outlook) by Moodyapstas, and our long-term senior unsecured debt is presently rated "e B- "e (Positive Outlook) by S&P Our non-investment grade ratings have increased our borrowing costs |
| These increases in our borrowing costs are not recoverable in our utility rates |
| In addition, our non-investment grade ratings generally require us to prepay our commodity purchases or post collateral to obtain trade credit |
| As of December 31, 2005, we had posted dlra461dtta5 million of collateral (in the form of cash or letters of credit) with counterparties |
| 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 |
| Our revolving credit and letter of credit lines are currently limited to dlra590 million of capacity, as of February 2006 |
| Our ability to further reposition our company as a regulated utility could be restricted by the terms of our finance agreements and our regulatory orders |
| Our credit facilities and regulatory orders contain restrictive covenants that could negatively impact our ability to continue to implement our strategic plan |
| For example, we must generally obtain the approval of the Kansas Commission prior to selling assets, and certain negative covenants contained in our credit facilities limit our ability to sell assets (or use the sale proceeds for various purposes) unless certain conditions are satisfied |
| Even if we were to repay our credit facilities, we would still generally be required to obtain the approval of the Kansas Commission for any asset sales |
| Accordingly, our ability to sell assets, such as our Crossroads peaking power plant and Everest Connections, may be limited |
| The terms of our credit facilities and regulatory orders also limit the amount of additional indebtedness that we can incur |
| For example, our ability to incur indebtedness is restricted unless the additional indebtedness satisfies certain conditions (including use of proceeds restrictions), and prior to issuing long-term debt securities we must obtain the approval of the FERC and certain state commissions |
| Even if we were to repay our credit facilities, we would still be required to seek regulatory approvals to issue long-term debt |
| Thus, our ability to raise capital quickly (if at all) on favorable market terms could be limited |
| In addition, the Kansas Commission staff recently proposed rules that would require utilities (including us) to "e ring fence "e their Kansas utility operations |
| As currently written, the proposal would require us to, among other things, transfer our Kansas utility assets to one or more separate wholly-owned subsidiaries, create a money pool that may only be used by our utility 23 _________________________________________________________________ operations, create a separate subsidiary that would provide operating and administrative services to the ring-fencing utility subsidiary, and finance our Kansas utility operations with capital raised by the ring-fenced Kansas utility subsidiary or a finance subsidiary that issues debt on behalf of our Kansas utility subsidiary |
| Because numerous of our contracts, indentures and loan agreements restrict or prohibit the transfer of utility assets from our company to one or more subsidiaries, compliance with any such proposal adopted by the Kansas Commission could have a material adverse effect on us |
| Stockholder approval is required to issue additional common stock |
| Our Restated Certificate of Incorporation currently authorizes us to issue up to 400 million shares of common stock |
| Taking into account the shares of our common stock that have been reserved for issuance under our existing stock option plans, we have less than 14 million shares of our common stock available for future issuance |
| We must seek the approval of our stockholders to increase the number of shares of common stock we may issue |
| To the extent our ability to satisfy our current and future obligations rests on our future ability to raise funds by issuing common stock or securities convertible into common stock, we will be dependent upon our stockholders for this approval |
| Our utility operations are subject to risks associated with higher fuel and purchased power prices, and we may not be able to recover costs of fuel and purchased power |
| Our regulated utilities produce, purchase and distribute power in three states and purchase and distribute natural gas in seven states |
| Generally, the regulations of the states in which we operate allow us to pass through changes in the costs of natural gas to our natural gas utility customers through purchased gas adjustment provisions in the applicable tariffs |
| All of our Gas Utilities have PGA provisions that allow them to pass the prudently-incurred cost of the gas to the customer |
| To the extent that gas prices are higher or lower than amounts in our current billing rates, adjustments are made on a periodic basis to "e true-up "e billed amounts to match the actual cost we incurred |
| There is, however, a timing difference between our purchases of natural gas and the ultimate recovery of these costs |
| In our continuing regulated electric business, we generated approximately 51prca of the power utilized by our utility customers and we purchased the remaining 49prca through long-term contracts or in the open market in 2005 |
| The regulatory provisions for recovering energy costs vary by state |
| In Kansas and Colorado, we have ECAs that serve a purpose similar to the PGAs for our gas utilities |
| In Missouri, which is our largest service area, we currently do not have the ability to adjust the rates we charge for electric service to offset all or part of any increase or decrease in prices we pay for fuel we use in generating electricity or for purchased power (ie, a fuel adjustment mechanism) |
| These costs could substantially reduce our operating results |
| We are experiencing a 15-20prca rail curtailment in our contracted coal deliveries from the Southern Powder River Basin, due in part to weather and other track problems that have caused Union Pacific and Burlington Northern to curtail rail shipments |
| This curtailment affects coal deliveries to our owned coal-fired power plants, and our jointly-owned investments, Iatan and Jeffrey Energy Center |
| Because substitute coal supplies are typically of higher sulfur content, we are required to purchase additional SO[2] emission allowances at a time when the cost of such allowances is substantially higher than historical levels |
| The continuation of either or both of these events for any extended period of time could have a material effect on our operations and cash flows if we are not allowed to pass these costs through to our customers |
| 24 _________________________________________________________________ Regulatory commissions may refuse to approve some or all of the utility rate increases we may request in the future |
| Our regulated electricity and natural gas operations are subject to cost-of-service regulation and annual earnings oversight |
| This regulatory treatment does not provide any assurance as to achievement of earnings levels |
| Our rates are regulated on a state-by-state basis by the relevant state regulatory authorities based on an analysis of our costs, as reviewed and approved in a regulatory proceeding |
| The rates that we are allowed to charge may or may not match our related costs and allowed return on invested capital at any given time |
| While rate regulation is premised on the full recovery of prudently incurred costs and a reasonable rate of return on invested capital, there can be no assurance that the state public utility commissions will judge all of our costs to have been prudently incurred or that the regulatory process in which rates are determined will always result in rates that will produce a full recovery of our costs and the return on invested capital allowed by the applicable state public utility commission |
| Our operating results can be adversely affected by milder weather |
| Our utility businesses are seasonal businesses and weather patterns can have a material impact on our operating performance |
| Demand for electricity is typically greater in the summer and winter months associated with cooling and heating, and demand for natural gas is extremely sensitive to winter weather effects on space heating requirements |
| Because natural gas is heavily used for residential and commercial heating, the demand for this product depends heavily upon weather patterns throughout our service territory and a significant amount of natural gas revenues are recognized in the first and fourth quarters related to the heating seasons |
| Accordingly, our operations have historically generated less revenues and income when weather conditions are cooler in the summer and warmer in the winter |
| We expect that unusually mild summers and winters would have an adverse effect on our financial condition and results of operations |
| Our utility business is subject to complex government regulations and changes in these regulations or in their implementation may affect the costs of operating our businesses, which may negatively impact our results of operations |
| Our natural gas and electric utilities operate in a highly regulated environment |
| Retail operations, including the prices charged, are regulated by the state public utility commissions for our service areas as well as by the FERC Changes in regulatory requirements or adverse regulatory actions could have an adverse effect on our performance by, for example, increasing competition or costs, threatening investment recovery or impacting rate structure |
| In addition, our operations are subject to extensive federal, state and local statutes, rules and regulations relating to environmental protection |
| To comply with these legal requirements, we must spend significant sums on environmental monitoring, pollution control and emission fees |
| New environmental laws and regulations affecting our operations, and new interpretations of existing laws and regulations, may be adopted or become applicable to us |
| For example, the laws governing air emissions from coal-burning plants have recently been revised by federal and state authorities |
| These changes will result in the imposition of substantially more stringent limitations on these emissions than those currently in effect |
| We may not be able to obtain or maintain all environmental regulatory approvals necessary to our business |
| If there is a delay in obtaining any required environmental regulatory approval or if we fail to obtain, maintain or comply with any such approval, operations at our affected facilities could be halted or subjected to additional costs |
| 25 _________________________________________________________________ The outcome of legal proceedings cannot be predicted |
| An adverse finding could have a material adverse effect on our financial condition |
| We are from time to time party to various material litigation matters and regulatory matters arising out of our business operations |
| The ultimate outcome of these matters cannot presently be determined, nor can the liability that could potentially result from a negative outcome in each case presently be reasonably estimated |
| The liability we may ultimately incur with respect to any of these cases in the event of a negative outcome may be in excess of amounts currently reserved and insured against with respect to such matters and, as a result, these matters may have a material adverse effect on our consolidated financial position |
| In addition, on December 20, 2005, the Missouri Court of Appeals for the Western District of Missouri affirmed an order of the Circuit Court of Cass County, Missouri, which held that we lacked the requisite approvals to construct our South Harper power peaking facility and related transmission substation |
| In affirming the trial courtapstas decision, however, the appellate court opined that we could obtain the requisite approval either from Cass County (in the form of zoning approval) or the Missouri Commission (in the form of specific authority) |
| We decided not to appeal the order of the Court of Appeals and instead filed an application for approval with the Missouri Commission on January 24, 2006 |
| On January 27, 2006, the trial court granted our request to stay the permanent injunction until May 31, 2006, and ordered us to post a dlra20 million bond to secure the cost of removing the project |
| Given that the remedy sought is the removal of the plant and substation, an adverse outcome could have a material impact on our financial condition, results of operations and cash flows |
| If we are not successful in obtaining the required approvals, we currently estimate the cost to dismantle the plant and substation to be approximately dlra20 million based on an engineering study |
| Significant additional costs would be incurred to store the equipment, secure replacement power and build the plant at a new site |
| We cannot estimate with certainty the total amount of these incremental costs that could be incurred, or the potential impairment of the carrying value of our investment in the plant we could suffer to the extent the cost exceeds the amount allowed for recovery in rates |
| We have several matters pending before the Internal Revenue Service, the negative outcome of which could materially impact our financial condition |
| As a large corporate taxpayer all of our federal income tax returns are examined by the IRS Currently, our federal income tax returns for the years 1998-2002 are under audit and we expect an audit of the 2003 and 2004 tax years to begin soon |
| In addition, our returns for the taxable years 1996 and 1997 are before the Appeals division of the IRS As of December 31, 2005, we had approximately dlra287dtta6 million of cumulative tax provisions for tax deduction or income positions that we believe are proper but for which it is reasonably likely that these deductions or income positions will be challenged upon audit by the IRS The timing of the resolution of these issues is uncertain |
| If our positions are not sustained, we may be required to utilize our capital loss and net operating loss or alternative minimum tax credit carryforwards and/or make cash payments plus interest |