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| AES > SEC Filings for AES > Form 10-K on 26-Feb-2009 | All Recent SEC Filings |
26-Feb-2009
Annual Report
Overview of Our Business
AES is a global power company. We own or operate a portfolio of electricity generation and distribution businesses with generation capacity totaling approximately 43,000 MW and distribution networks serving over 11 million people. In addition, we have more than 3,000 MW under construction in ten countries. Our global footprint includes operations in 29 countries on five continents with 83% of our revenue in 2008 generated outside the United States.
We operate two primary lines of business. The first is our Generation business, where we own and/or operate power plants to generate and sell power to wholesale customers such as utilities and other intermediaries. The second is our Utilities business, where we own and/or operate utilities to distribute, transmit and sell electricity to end-user customers in the residential, commercial, industrial and governmental sectors within a defined service area. Each of our primary lines of business generates approximately half of our revenues.
We are also continuing to expand our wind generation business and are pursuing additional renewables projects in solar, climate solutions, biomass and energy storage. These initiatives are not material contributors to our revenue, gross margin or income, but we believe that they may become material in the future.
Generation. We currently own or operate a portfolio of approximately 38,000 MW, consisting of 93 facilities in 26 countries on five continents at our generation businesses. We also have approximately 2,900 MW of capacity currently under construction in six countries. Our core Generation businesses use a wide range of technologies and fuel types including coal, combined-cycle gas turbines, hydroelectric power and biomass.
The majority of the electricity produced by our Generation businesses is sold under long-term contracts, or PPAs, to wholesale customers. Approximately 61% of the revenues from our Generation businesses during 2008 was derived from plants that operate under PPAs of five years or longer for 75% or more of their output capacity. These businesses often reduce their exposure to fuel supply risks by entering into long-term fuel supply contracts or fuel tolling contracts where the customer assumes full responsibility for purchasing and supplying the fuel to the power plant. These long-term contractual agreements result in relatively predictable cash flow and earnings and reduce exposure to volatility in the market price for electricity and fuel; however, the amount of earnings and cash flow predictability varies from business to business based on the degree to which its exposure is limited by the contracts that it has negotiated.
The balance of our Generation businesses sell power through competitive markets under short-term contracts or directly in the spot market. As a result, the cash flows and earnings associated with these businesses are more sensitive to fluctuations in the market price for electricity, natural gas, coal and other fuels. However, for a number of these facilities, including our plants in New York, which include a fleet of coal fired plants, we have hedged the majority of our exposure to fuel, energy and emissions pricing for 2009.
Utilities. Our Utilities businesses distribute power to more than 11 million people in seven countries on five continents. Our Utilities business consists primarily of 14 companies owned and/or operated under management agreements, all of which operate in a defined service area. These businesses also include 15 generation plants in two countries totaling approximately 4,400 MW. In addition, we have one generation plant under construction totaling 86 MW. These businesses have a variety of structures ranging from pure distribution businesses to fully integrated utilities, which generate, transmit and distribute power.
Renewables and Other Initiatives. In recent years, as demand for renewable sources of energy has grown, we have placed increasing emphasis on developing projects in wind, solar, energy storage and the creation of carbon offsets. We have also developed projects and investments in climate solutions and energy storage. AES Wind Generation, which is one of the largest producers of wind power in the U.S., has 16 wind generation facilities in three countries with over 1,200 MW in operation and 11 wind generation facilities under construction in four countries. AES Solar, our joint venture with Riverstone Holdings, was formed to develop, own and operate utility-scale photo voltaic (PV) solar installations. Since its launch, AES Solar has developed eight plants totaling 24 MW of solar projects in Spain. In climate solutions, we have developed and are implementing projects to produce GHG Credits. In the U.S., we formed Greenhouse Gas Services, LLC as a joint venture with GE Energy Financial Services to create high quality verifiable offsets for the voluntary U.S. market. We also have formed an initiative to develop and implement utility scale energy systems (such as batteries), which store and release power when needed. While these renewables and other initiatives are not currently material to our operations, we believe that in the future, they may become a material contributor to our revenue and gross margin. However, there are risks associated with these initiatives, which are further disclosed in Item 1A-Risk Factors of this Form 10-K.
Our Organization and Segments. As of the end of 2008, our Generation and
Utilities businesses were organized within four defined geographic regions:
(1) Latin America, (2) North America, (3) Europe & Africa, and (4) Asia and the
Middle East, ("Asia"). Three regions, North America, Latin America and Europe &
Africa, are engaged in both Generation and Utility businesses while the Asia
region operates only Generation businesses. Accordingly, these businesses and
regions account for seven reportable segments. "Corporate and Other" includes
corporate overhead costs which are not directly associated with the operations
of our seven primary reportable segments; interest income and expense; other
inter-company charges such as management fees and self-insurance premiums which
are fully eliminated in consolidation; and revenue, development costs and the
operational results related to AES Wind Generation and our other renewables
projects, which are currently not material to our operations.
Beginning in 2009, the Company began to implement certain organizational
changes in an effort to streamline the organization. The new structure will
continue to be organized along our two lines of business, but within three
regions instead of four: (1) North America, (2) Latin America & Africa and
(3) Europe, Middle East & Asia ("EMEA"). In addition, we will no longer have an
alternative energy group, the operation of which was previously reported under
"Corporate and other." Instead, AES Wind Generation, will be managed as part of
our North America region (even though some projects are not in North America)
while climate solutions projects will be managed in the region in which they are
located. Management is currently evaluating the impact of the reorganization on
the Company's externally reported segments in accordance with SFAS No. 131. AES
Solar is accounted for using the equity method and will continue to be reflected
in Corporate and Other in 2009.
Key Drivers of Our Results of Operations. Our Utilities and Generation businesses are distinguished by the nature of their customers, operational differences, cost structure, regulatory environment and risk exposure. As a result, each line of business has slightly different drivers which affect operating results. Performance drivers for our Generation businesses include, among other things, plant availability and reliability, management of fixed and operational costs and the extent to which our plants have hedged their exposure to fuel cost volatility. For our Generation businesses which sell power under short-term contract or in the spot market one of the most crucial factors is the market price of electricity and the plant's ability to generate electricity at a cost below that price. Growth in our Generation business is largely tied to securing new PPAs, expanding capacity in our existing facilities and building new power plants. Performance drivers for our Utilities businesses include, but are not limited to, reliability of service; negotiation of tariff adjustments; compliance with extensive regulatory requirements; management of working capital; and in developing countries, reduction of
commercial and technical losses. The results of operations of our Utilities businesses are sensitive to changes in economic growth and weather conditions in the area in which they operate.
One of the key factors which affect both our revenue and costs of sales is changes in the cost of fuel. When fuel costs increase, many of our Generation businesses with long-term contracts and our Utilities are able to pass these costs on to the customer through fuel pass-through or fuel indexing arrangements in their contracts or through increases in tariff rates. Therefore, in a rising fuel cost environment as was the case in 2007 and much of 2008, increases in fuel costs for these businesses often resulted in increases in revenue (though not necessarily on a one-for-one basis). While these circumstances may not have a large impact on gross margin, they can significantly affect gross margin as a percentage of revenue. Other factors that can affect gross margin include our ability to expand the number of facilities we own; and in our existing plants, to sign up new customers and/or purchasing parties, collect receivables from existing customers and operate our plants more efficiently.
Another key driver of our results is the management of risk. Our assets are diverse with respect to fuel source and type of market, which helps reduce certain types of operating risk. Our portfolio employs a broad range of fuels, including coal, gas, fuel oil and renewable sources such as hydroelectric power, wind and solar, which reduces the risks associated with dependence on any one fuel source. For additional information regarding our facilities see Item 1-Our Organization and Segments. Our presence in mature markets helps reduce the volatility associated with our businesses in faster-growing emerging markets. In addition, as noted above, our Generation portfolio is largely contracted, which reduces the risk related to the market prices of electricity and fuel. We also attempt to limit risk by hedging much of our currency and commodity risk, and by matching the currency of most of our subsidiary debt to the revenue of the business that issued that debt. However, our businesses are still subject to these risks, as further described in Item 1A-Risk Factors, "We may not be adequately hedged against our exposure to changes in commodity prices or interest rates."
Highlights of 2008
Results of Operations. In 2008, management continued to focus its efforts on increasing shareholder value by improving operations, executing our growth strategy and strategically managing our portfolio of businesses. Our 2008 results of operations were positively impacted by a number of factors including the gain on the sale of Ekibastuz and Maikuben in Kazakhstan, higher generation rates, utilities tariffs and favorable foreign currency translation.
º •
º revenues of $16.1 billion and gross margin of $3.7 billion, or 23% of
revenue;
º •
º income from continuing operations of $1.2 billion, or $1.80 per
diluted share; and
º •
º cash flow from operating activities of $2.2 billion.
Our results were negatively impacted by higher fuel costs in Asia and the unfavorable impact of mark-to-market adjustments on derivative instruments. We also saw an increase in fixed costs, primarily in Brazil and Cameroon, related to maintenance, higher provisions for bad debt, contractor services and higher purchased energy costs.
In the fourth quarter of 2008, and in response to the financial market crisis, we reviewed and prioritized projects in our development pipeline. As a result, we recognized an impairment charge of approximately $75 million ($34 million, net of minority interest and income taxes). The projects determined to be impaired primarily included two liquefied natural gas projects in North America and a non-power development project at one of our facilities in North America. As the Company continues to review and streamline its project pipeline, it is possible that further impairments could be identified in the future, some of which could be material. During 2008, we also recognized additional impairment charges of $36 million related to long-lived assets at Uruguaiana, our gas-powered generation plant in Brazil. The impairment was triggered by the combination of gas curtailments and increases in the spot
market price of energy in 2007 that continued in 2008. Following an initial impairment charge in the fourth quarter of 2007, further charges were incurred in 2008 due to fixed asset purchase agreements in place. During the first half of 2008, we withdrew from projects in South Africa and Israel which resulted in impairment charges of $36 million. We also recognized an impairment of $18 million related to the shutdown of the Hefei plant in China.
Investment and Financing Activities. In addition to the financial results presented above, the additional highlights for the year ended December 31, 2008 include the following:
Financing activities
º •
º We were able to refinance recourse debt at lower interest rates and
with extended maturities, reducing our 2009 recourse debt maturities
from $467 million at December 31, 2007 to $154 million at December 31,
2008.
º •
º Our consolidated subsidiaries raised approximately $2.7 billion in
2008 for the purposes of refinancing existing debt and to fund
acquisitions and construction. For example, in October, the Company
obtained approximately $1 billion in non-recourse financing to support
the development of Angamos, a 518 MW coal-fired generation facility in
Chile. Angamos is expected to begin commercial operations in 2011.
º •
º We reduced outstanding recourse debt by $360 million and repurchased
10.7 million shares of our common stock at a total cost of
$143 million.
º •
º In April, the Company completed the purchase of a 92% interest in
Masinloc, a 660 gross MW coal-fired thermal power generation facility
in Masinloc, Philippines. The purchase price was $930 million in cash
(excluding anticipated improvements). Non-recourse financing of
$665 million was obtained to fund the acquisition and improve the
facilities.
º •
º Wind Generation-Highlights from AES Wind Generation include the
following:
º •
º The Company expanded its portfolio of wind generation businesses
with the acquisition of Mountain View Power Partners
("Mountain View"), which consists of 111 wind turbines with a
capacity of 67 MW in Palm Springs, California.
º •
º In July, we acquired a 49% interest in Guohua Hulunbeier Wind
Farm, a 49.5 MW wind farm development in China. The Company also
reached a separate agreement with Guohua to move to phase II of
our jointly-owned Huanghua wind project to expand the facility,
doubling the capacity to 99 MW. AES has a 49% interest in the
Huanghua Project.
º •
º In December, the Company obtained financing to build a 156 MW
wind farm in Kavarna, the largest in Bulgaria, and a 22 MW wind
farm in Scotland. Additionally we acquired a 34 MW wind farm from
our affiliate, InnoVent. All three are expected to commence
commercial operations in 2009.
º •
º Solar Energy-In March, the Company formed AES Solar, a joint venture
with Riverstone. AES Solar will develop land-based solar photovoltaic
panels that capture sunlight to convert into electricity that feed
directly into power grids. AES Solar has commenced commercial
operations of 24 MW solar projects in Spain. Under the terms of the
agreement, the Company and Riverstone will each provide up to
$500 million of capital over the next five years. Through December 31,
2008, the Company has contributed total capital of $135 million.
º •
º Climate Solutions-Highlights from our climate solutions activities
include:
º •
º In April, the Company acquired the rights to the gas from a
landfill project in El Salvador ("Nejapa"). Nejapa produces
emission reduction credits and plans to build a 6 MW generation
facility that could potentially increase to 25 MW in the future.
º •
º In June, as a result of a financial restructuring, the Company
assumed 100% ownership of AgCert International Plc, an Irish
company investing in GHG projects primarily in Brazil and Mexico.
AgCert currently produces approximately 1.4 million tonnes per
year of CERs.
º •
º In September, Greenhouse Gas Services LLC, the Company's joint
venture with General Electric, announced an agreement with Google
to co-develop projects to reduce GHG emissions and produce
GHG credits. The first project will capture methane gas in North
Carolina.
As of December 31, 2008, the Company has more than 3,000 Gross MW of new generation capacity. The projects under construction include 14 core power projects totaling 2,993 MW and 11 wind power projects totaling 410 MW.
º •
º We began construction of Angamos, a 518 MW coal-fired generation
facility in Chile expected to begin commercial operations in 2011.
º •
º We also further advanced our recent projects with the start of
construction of three hydro projects in Turkey that are being
developed through our investment made in May 2007 in the IC Ictas
Energy Group.
º •
º In July, the Company achieved early successful testing of simple cycle
operation for the Amman East facility in Jordan, a 380 MW natural
gas-fired project expected to achieve full combined-cycle operation in
the first half of 2009.
º •
º In August, the Company started commercial operations of the 170 MW
Buffalo Gap III wind farm in Abilene, Texas, bringing the total wind
generation capacity of the Buffalo Gap wind farm to 524 MW.
For a complete listing of the Company's projects under construction or in development please see Item 1-Our Organizations and Segments.
º •
º In the first quarter of 2008, the Company finalized our termination
agreement with the Chinese government and shut down Hefei, a 115 MW
oil-fueled generation facility. The plant became the property of the
Anhui Province and we received termination compensation of
approximately $39 million in March 2008.
º •
º In May 2008, the Company completed the sale of Ekibastuz and Maikuben
West, a coal-fired power plant and a coal mine with operations in
Kazakhstan. Proceeds from the sale of these businesses totaled
approximately $1.1 billion, a portion of which was used to pay down
debt in June 2008. We have the opportunity to receive additional
consideration of up to approximately $380 million under performance
incentives and a management agreement to continue operation and
management of the plants for the next three years.
º •
º In November 2008, the Company sold a 9.6% ownership in AES Gener for
$175 million which reduced the Company's ownership percentage from
80.2% to 70.6%. As a result, the Company recognized a pre-tax loss of
$31 million in the fourth quarter of 2008. The net proceeds from
this transaction were used to participate in Gener's capital increase in February 2009 as discussed under Outlook for the Future.
º •
º In December 2008, the Company sold its 70% interest in Jiaozuo, a
250 MW coal-fired generation plant in China for net proceeds of
$73 million. Prior periods have been restated to reflect this business
within Discontinued Operations for all periods presented.
Credit Crisis and the Macroeconomic Environment
In the second half of 2007, conditions in the credit markets began to deteriorate in the United States and abroad. In the third and fourth quarter of 2008, this crisis and associated market conditions worsened dramatically, with unprecedented market volatility, widening credit spreads, volatile currencies, illiquidity, and increased counterparty credit risk.
Beginning in the second half of 2007, the Company began a series of debt-related initiatives, including the refinancing of approximately $2.0 billion of recourse debt in transactions executed in the fourth quarter of 2007 and the second quarter of 2008. As a result of these transactions, The AES Corporation reduced the 2009 maturities on its recourse debt from $467 million as of June 30, 2007 to $154 million as of December 31, 2008. The AES Corporation also eliminated many of the restrictive covenants in its 8.75% Second Priority Senior Secured Notes due 2013 and modified certain covenants contained in its senior secured credit facility. The amendments made the financial covenants less restrictive and made certain other changes, such as expanding the Company's ability to repurchase its own common stock. For further information regarding these covenant changes, see the Capital Resources and Liquidity-Parent Company Liquidity section of Management's Discussion and Analysis of Financial Condition and Results of Operations. In addition, The AES Corporation successfully replaced Lehman Commercial Paper with another bank as a lender under its senior secured credit facility.
Because of the factors described above, management currently believes that it can meet its near-term liquidity requirements through a combination of existing cash and cash equivalent balances, cash provided by operating activities, financings, and, if needed, borrowings under its secured and unsecured credit facilities. Although there can be no assurance due to the challenging times currently faced by financial institutions, management believes that the participating banks under its facilities will be able to meet their funding commitments.
The Company is also subject to credit risk, which includes risk related to the ability of counterparties (such as parties to our PPAs, fuel supply agreements, hedging agreements, and other contractual arrangements) to meet their contractual payment obligations or the potential nonperformance of counterparties to deliver contracted commodities or services at the contracted price. While counterparty credit risk has increased in the current crisis and there can be no assurances regarding the future, to date the Company has not suffered any material effects related to its counterparties.
The global economic slowdown could also result in a decline in the value of our assets, which could result in material impairments of certain assets or result in an increase in our obligations which could be material to our operations. For example, as discussed above, during the fourth quarter of 2008, and in response to the financial market crisis, the Company reviewed and prioritized the projects in our development pipeline. As a result we recognized an impairment charge of approximately $75 million ($34 million, net of minority interest and income taxes). The projects that were impaired included two liquefied natural gas projects in North America and a non-power development project at one of our facilities in North America.
In addition to the decline in development assets noted above, there is a risk that the fair value of other assets could also decline, resulting in additional impairment charges and/or a material increase in
our obligations. Certain subsidiaries of the Company have defined benefit pension plans. The Company periodically evaluates the value of the pension plan assets to ensure that they will be sufficient to fund their respective pension obligations. Given the declines in worldwide asset values, we are expecting an increase in pension expense and funding requirements in future periods, which may be material. As of December 31, 2008 we expect the Company to make future employer contributions to its defined benefit pension plans in 2009 of approximately $154 million, of which $21 million will be made to its U.S. plans and $133 million to foreign plans primarily in Brazil (subject to changes in foreign currency exchange rates), compared to employer contributions made in 2008 of $197 million, of which $59 million was made to U.S. plans and $138 million to foreign plans. In Brazilian real ("R$") contributions for our subsidiaries in Brazil are expected to increase from R$236 million in 2008 to R$294 million in 2009. The decline in the fair value of pension plan assets will also result in increased pension expense in 2009, currently estimated at $124 million in 2009 (subject to changes in foreign currency exchange rates) compared to $60 million in 2008. Expense at our subsidiaries in Brazil, in local currency, is expected to be R$176 million in 2009 compared to R$77 million in 2008. See Item 1A-Risk Factors, "Some of our subsidiaries participate in defined benefit pension plans and their net pension plan obligations may require additional significant contributions."
To date, other than the impacts described above, the global economic slowdown has not significantly impacted the Company. However, in the event that the credit crisis and global recession deteriorate further, or are protracted, there could be a material adverse impact on the Company. The Company could be materially impacted if such events or other events occur such that participating lenders under its secured and unsecured facilities fail to meet their commitments, or the Company is unable to access the capital markets on favorable terms or at all, is unable to raise funds through the sale of assets, or is otherwise unable to finance its activities or refinance its debt, or if capital market disruptions result in increased borrowing costs (including with respect to interest payments on the Company's variable rate debt). The Company could also be adversely affected if general economic or political conditions in the markets where the Company operates deteriorate, resulting in a reduction in cash flow from operations, a reduction in the value of currencies in these markets relative to the dollar (which could cause currency losses), an increase in the price of commodities used in our operations and construction, or if the value of its assets remain depressed or decline further. If any of the foregoing events occur, such events (or a combination thereof) could have a material impact on the Company, its results of operations, liquidity, financial covenants, and/or its credit rating.
The Company could also be adversely affected if the foregoing effects are exacerbated or general economic or political conditions in the markets where the Company operates deteriorate, resulting in a reduction in cash flow from operations, a reduction in the value of currencies in these markets relative to the dollar (which could cause currency losses), an increase in the price of commodities used in our operations and construction or a decline in asset values.
Outlook for the Future
In 2008, management continued to focus its efforts on improving operations, executing our growth strategy, managing our risk and strategically managing our portfolio of businesses. As market conditions deteriorated in the second half of . . .
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