ILA Aquila

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the accounting policies described in the consolidated financial statements and related notes included in our 2006 Annual Report on Form 10-K filed with the SEC on March 1, 2007. You should read our 2006 Form 10-K in conjunction with this report. The accompanying Consolidated Balance Sheets and Consolidated Statements of Common Shareholders’ Equity as of December 31, 2006, were derived from our audited financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States. In our opinion, the accompanying consolidated financial statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair representation of our financial position and the results of our operations. 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 period amounts in the consolidated financial statements have been reclassified where necessary to conform to the 2007 presentation.

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

Pending Merger

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

Seasonal Variations of Business

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

New Accounting Standards

Fair Value Measurements

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

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Accounting for Planned Major Maintenance

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

Offsetting of Amounts Related to Certain Contracts

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

2. Restructuring Charges

We recorded the following restructuring charges:

Severance Costs

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

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

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

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3. Net Loss on Sale of Assets and Other Charges

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

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

Elwood Tolling Contract

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

Early Retirement of Debt

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

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

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

4. Discontinued Operations

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

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

Electric and Gas Utilities

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

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

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

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

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

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

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

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Other Asset Sales

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

Interest Allocation to Discontinued Operations

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

Summary

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

Operating results from our discontinued operations are as follows:

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

5. Earnings (Loss) per Common Share

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

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6. Reportable Segment Reconciliation

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

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

Our reportable segment reconciliation is shown below:

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7. Financings

Five-Year Unsecured Revolving Credit Facility

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

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

$180 Million Unsecured Revolving Credit and Letter of Credit Facility

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

Four-Year Secured Revolving Credit Facility

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

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

$50 Million Revolving Credit and Letter of Credit Facility

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

Iatan Construction Financing

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

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

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Early Retirement of Debt

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

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

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

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

PIES Conversion

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

Other

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

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8. Employee Benefits