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| AES > SEC Filings for AES > Form 10-Q on 8-May-2009 | All Recent SEC Filings |
8-May-2009
Quarterly Report
In this Quarterly Report on Form 10-Q, the terms "AES," "the Company," "us," or "we" refer to The AES Corporation and all of its subsidiaries and affiliates, collectively. The term "The AES Corporation" or "the Parent Company" refers only to the parent, publicly-held holding company, The AES Corporation, excluding its subsidiaries and affiliates.
Forward-Looking Information
The following discussion may contain forward-looking statements regarding us, our business, prospects and our results of operations that are subject to certain risks and uncertainties posed by many factors and events that could cause our actual business, prospects and results of operations to differ materially from those that may be anticipated by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those described in the "Risk Factors" section of our 2008 Form 10-K filed on February 26, 2009. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC that advise interested parties of the risks and factors that may affect our business.
The interim financial statements filed on this Form 10-Q and the discussions contained herein should be read in conjunction with our 2008 Form 10-K.
Overview of Our Business
We are a global power company. We own a portfolio of electricity generation and distribution businesses with generation capacity totaling approximately 43,000 Megawatts ("MW") and distribution networks serving more than 11 million people. In addition, we have more than 3,400 MW under construction in ten countries. Our global workforce of approximately 25,000 people provides electricity to people in diverse markets ranging from urban centers in the United States to remote villages in India. Our global footprint includes operations in 29 countries on five continents with 80% of our revenue for the first quarter of 2009 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 and climate solutions. These initiatives are not material contributors to our revenue, gross margin or net income, but we believe that they may become material in the future.
Generation. We currently own or operate 93 Generation facilities in 26 countries on five continents totaling more than 38,000 MW. 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 56% of the revenues from our Generation businesses during the first quarter of 2009 was derived from plants that operate under PPAs of three 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 sells 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.
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 operate under 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 our renewables business including wind, solar and climate solutions. Climate solutions is our business that develops projects that produce greenhouse gas emission offset credits ("GHG credits").
Our wind generation business ("AES Wind Generation") currently has 20 plants in operation in three countries totaling more than 1,200 MW and is one of the largest producers of wind power in the U.S. In addition, more than 400 MW are under construction in four countries outside the U.S. In the area of climate solutions, we have operating projects in Latin America to produce GHG credits and are currently developing projects in Asia. While none of these renewable and other initiatives are 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 the 2008 Form 10-K. As further described in "Our Organization and Segments" below, some of these projects will be managed within the region where they are located, while others are managed as business units.
Our solar business, AES Solar Energy LLC ("AES Solar"), was formed in March 2008 as a joint venture with Riverstone Holdings, LLC ("Riverstone"), a private equity firm. AES Solar has since commenced commercial operations of eight plants totaling 24 MW of solar projects in Spain and has development potential in three other countries. We account for our investment in AES Solar under the equity method of accounting.
Key Drivers of Our Results of Operations. Our Generation and Utilities 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 currency and commodities such as fuel. For our Generation businesses which sell power under short-term contracts or in the spot market, the most crucial factors are 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 areas in which they operate.
One of the key factors which affect both our revenue and costs of sales is change in the cost of fuel. When fuel costs increase, many of our Generation businesses with long-term contracts and our Utilities businesses 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 increases in fuel costs for these businesses often result in increases in revenue (though not necessarily on a one-for-one basis). In addition, where fuel is a pass-through cost, increased fuel costs could result in counterparties electing to purchase less energy from our Generation businesses. This would result in a decrease in generation volume and an unfavorable impact on revenue with no corresponding impact to gross margin. 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 our existing plants, our ability 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. 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 certain 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, we do not fully hedge currency or commodity risks and our businesses are still subject to these risks, as further described in the 2008 Form 10-K, Item 1A - Risk Factors, "We may not be adequately hedged against our exposure to changes in commodity prices or interest rates." and "Our financial position and results of operations may fluctuate significantly due to fluctuations in currency exchange rates experienced at our foreign operations."
In each country where we conduct business, we are subject to extensive and complex governmental regulations which affect most aspects of our business, such as regulations governing the generation and distribution of electricity, and environmental regulations. Regulations differ on a country by country basis and are based upon the type of business we operate in a particular country, but affect the operation, development, capital expenditures, growth and ownership of our businesses. While not currently material to our operations, environmental and land use regulations, including proposed regulation of carbon emissions, could substantially increase our capital expenditures, which could in turn have a material adverse affect on our business and results of operations. As noted in Note 7 - Contingencies and Commitments - Environmental, recent actions by the EPA could be interpreted as signaling willingness to regulate GHG emissions under the CAA. For additional discussion regarding the potential risks to the Company relating to carbon emissions, see the following sections in our 2008 Form 10-K: Item 1: Business - Regulatory Matters - Environmental and Land Use Regulations; Item 1A: Risk Factors - Risks Associated with Government Regulation and Laws - Our businesses are subject to stringent environmental laws and regulation;and. Item 1A: Risk Factors - Risks Associated with Government Regulation and Laws - Regulators, politicians, non-governmental organizations and other private parties have expressed concern about greenhouse gas, or GHG, emissions and are taking actions which, in addition to the potential physical risks associated with climate change, could have a material adverse impact on our consolidated results of operations, financial condition and cash.
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 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. The crisis continued through the quarter ended March 31, 2009 and beyond.
Beginning in the second half of 2007 and through the second quarter of 2008, the Company began a series of debt-related initiatives including the refinancing of approximately $2 billion of recourse debt which enabled it to reduce the 2009 maturities of its recourse debt from $467 million as of June 30, 2007 to $154 million as of December 31, 2008. Recourse debt maturing in 2009 as of March 31, 2009 was $154 million. In addition, in the
second quarter of 2008, the Parent Company was also able to eliminate many of the restrictive covenants in its 8.75% Second Priority Senior Secured Notes due 2013 and modified certain covenants in its senior secured credit facility. The amendments made the financial covenants less restrictive and made certain other changes, such as expanding the Parent Company's ability to repurchase its own common stock. In March and April 2009, the Parent Company furthered these initiatives by amending and extending the maturity date of its existing revolving credit facility; issuing $535 million of 9.75% senior unsecured notes due 2016 and reducing the commitment under its $600 million senior unsecured credit facility to $175 million, each of which is more fully discussed under "Recourse Debt".
Because of the key drivers and factors described above, management currently believes that it can meet its liquidity requirements through a combination of existing cash balances, cash provided by operating activities, financings, and, if needed, borrowings under its secured and unsecured 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 power purchase agreements, fuel supply agreements, our 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, the Company has not suffered any material effects related to its counterparties for the quarter ended March 31, 2009.
The global economic slowdown could also result in a decline in the value of our assets including the businesses we operate, equity investments and projects under development, which could result in impairments that could be material to our operations. For example, during the fourth quarter of 2008, and in response to the financial market crisis, the Company reviewed and prioritized the projects in its development pipeline and consequently recognized an impairment charge of approximately $75 million ($34 million, net of noncontrolling interests and income taxes). The Company did not realize material impairment charges during the first quarter of 2009. However in the future, we may be required to adjust to fair value and record an impairment of certain of our assets if any of the following events occur: a significant adverse change in business climate or legal factors, an adverse action or assessment by a regulator, sale of assets at below book value, unanticipated competition, a loss of key personnel or our acquisitions do not perform as expected. The likelihood of the occurrence of these events may increase as a result of the credit crisis and deteriorating global macroeconomic conditions, such as a loss of key personnel, asset sales or a change in business climate.
As previously discussed in the Company's 2008 Form 10-K within Item 1A: Risk Factors - Risks Associated with our Operations - Our acquisitions may not perform as expected, the Company continued to evaluate its Masinloc operations, acquired in April 2008, and completed a goodwill impairment test of the Masinloc reporting unit as of March 31, 2009 and concluded that no impairment existed. The Company will continue to monitor Masinloc's operating results and business outlook to identify any changes that could indicate a potential impairment of the business's goodwill, whose balance was approximately $60 million as of March 31, 2009.
A decline in asset value could result in a material increase in our obligations as a result of the deterioration in the financial markets. For instance, 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. Total employer contributions for the three months ended March 31, 2009 for our U.S. and foreign subsidiaries were $6 million and $38 million, respectively. The expected remaining scheduled annual employer contributions for 2009 are $16 million for U.S. subsidiaries, and $102 million for foreign subsidiaries.
Furthermore, volatility in foreign currency exchange rates has had an impact on the Company's financial results. For example, in the first quarter of 2009, our gross margin declined by $159 million compared to the same
period last year. During the same period the Company experienced foreign currency translation losses of $130 million. If the current volatility in foreign currencies continues, our gross margin and other financial metrics could be impacted at the same or more severe levels than those noted above. It is also possible that commodity or power price volatility could impact our financial metrics. As further discussed in Item 3. Quantitative and Qualitative Disclosures About Market Risk - Commodity Price Risk, we estimate that a 10% decline in power prices will result in an estimated reduction in gross margin of $12 million for our U.S.-based assets.
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 macroeconomic conditions deteriorates further, or are protracted or indicating a global recession, there could be a material adverse impact on the Company. The Company could be materially affected 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 or refinance its activities, 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 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 availability and/or an increase in the cost of capital, a reduction in the value of currencies in these markets relative to the U.S. 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.
Our Organization and Segments
As further described below, beginning with this Quarterly Report on Form 10-Q, the Company has modified its segment reporting in accordance with FAS No. 131, Disclosures about Segments of an Enterprise and Related Information ("FAS No. 131")
Background
Through the end of 2008, the Company organized its operations for management reporting purposes along two primary lines of business - Generation and Utilities, within four geographic regions: Latin America; North America; Europe & Africa; and Asia & the Middle East ("Asia"). Three regions, North America, Latin America and Europe & Africa, are engaged in both Generation and Utility businesses. Our Asia region only has Generation businesses. This regional management structure resulted in the Company reporting seven segments, as defined in FAS No. 131 in the 2008 Form 10-K. These reportable segments included Latin America - Generation, Latin America - Utilities, North America - Generation, North America - Utilities, Europe & Africa - Generation, Europe & Africa - Utilities and Asia - Generation. In addition, the Company reports certain activities in "Corporate and Other" including corporate overhead costs which are not directly associated with the operations of our primary operating segments and other intercompany charges such as self-insurance premiums which are fully eliminated in consolidation. Our alternative energy business which included AES Wind Generation, climate solutions, and certain other initiatives, was managed by our alternative energy group. The associated revenue, development and operational costs were reported under "Corporate and Other" since its results were not material to the presentation of our operation segments.
2009 Segment Reporting
Management Reporting Structure - In early 2009, we implemented certain internal organizational changes in an effort to streamline the organization. These changes affected how results are reported internally for management review, but did not change any of the chief operating decision makers. The new management
reporting structure continues to be organized along our two lines of businesses, but there are now three regions: (1) Latin America & Africa; (2) North America and AES Wind; and (3) Europe, Middle East & Asia (collectively "EMEA"), each managed by a regional president. The Company no longer has an alternative energy group. Instead, AES Wind Generation is managed as part of our North America region while climate solutions projects are now managed in the region in which they are located. In addition to the change in regional management structure, with the exception of AES Wind Development, the Company now manages all development efforts centrally through a development group.
Segment Reporting Structure - The new segment reporting structure uses the management reporting structure as its foundation. The Company's segment reporting structure continues to be organized along our two lines of business and three regions to reflect how the Company manages the business internally. The Company applied the guidance in FAS No. 131, which provides certain quantitative thresholds and aggregation criteria, and the Company concluded that it now has six reportable segments. The operating segments comprising the former Europe & Africa Generation and Utilities reportable segments are no longer managed together. Under the new management structure Africa is managed with the Latin America region and Europe is managed with the Asia region. Only Europe - Generation was determined to be a reportable segment based on the Company's application of FAS No. 131. As described below, our Europe Utilities, Africa Utilities and Africa Generation operating segments are now reported within "Corporate and Other" because they do not meet the quantitative thresholds for separate disclosure under FAS No. 131.
Therefore as a result of this analysis, the Company will now report six segments, which include:
• Latin America - Generation;
• Latin America - Utilities;
• North America - Generation;
• North America - Utilities;
• Europe - Generation;
• Asia - Generation.
Corporate and Other - Corporate and Other now includes corporate overhead costs which are not directly associated with the operations of our six primary reportable segments and other intercompany charges such as self-insurance premiums which are fully eliminated in consolidation; the operations for the Company's Europe and Africa Utilities and Africa Generation businesses; the operations of AES Wind and the development and operational costs related to the development group. None of these operations is currently material to our presentation of reportable segments, individually or in the aggregate.
As required by FAS No. 131, all prior period information within this Form 10-Q has been recast to reflect the realignment of reportable segments.
First Quarter 2009 Highlights
First Quarter Events
During the first quarter we reached an agreement with Kazakhmys PLC ("Kazakhmys") to terminate the management agreement signed at the time AES Ekibastuz LLP ("Ekibastuz") and AES Maikuben LLP
("Maikuben") were sold to Kazakhmys in May 2008 for $1.1 billion. Under the original terms of the management agreement, we would have continued to manage and operate Ekibastuz and Maikuben through 2010. The termination agreement provided for an $80 million management performance incentive bonus as compensation for the management services provided by AES in 2008. This was recognized as other income in the first quarter of 2009. In addition, AES will also receive $102 million in early 2010 to terminate the management agreement. Kazakhmys agreed to post collateral in the form of letters of credit as security for this payment. AES will transition the management of the businesses to Kazakhmys over the next several months.
Local Chilean regulators approved the issuance of 954 million shares of AES Gener ("Gener") in late December 2008. Gener anticipates using these proceeds for future expansion plans, working capital and other operating needs. During the first quarter of 2009, one of our wholly-owned subsidiaries, Cachagua, paid $175 million to purchase 681 million shares using the proceeds from Gener's November 2008 share sale to maintain its ownership percentage of 71%. This is . . .
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