UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended March 31, 2011
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission file number 1-12291
THE AES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 54 1163725 | |
(State or other jurisdiction of incorporation or organization)
|
(I.R.S. Employer Identification No.) | |
4300 Wilson Boulevard Arlington, Virginia | 22203 | |
(Address of principal executive offices) | (Zip Code) |
(703) 522-1315
Registrants telephone number, including area code:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of Registrants Common Stock, par value $0.01 per share, on May 2, 2011, was 782,008,035.
THE AES CORPORATION
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011
TABLE OF CONTENTS
1 | ||||||
ITEM 1. |
FINANCIAL STATEMENTS | 1 | ||||
Condensed Consolidated Statements of Operations | 1 | |||||
Condensed Consolidated Balance Sheets | 2 | |||||
Condensed Consolidated Statements of Cash Flows | 3 | |||||
Condensed Consolidated Statements of Changes in Equity | 4 | |||||
Notes to Condensed Consolidated Financial Statements | 5 | |||||
ITEM 2. |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 43 | ||||
ITEM 3. |
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 75 | ||||
ITEM 4. |
CONTROLS AND PROCEDURES | 77 | ||||
78 | ||||||
ITEM 1. |
LEGAL PROCEEDINGS | 78 | ||||
ITEM 1A. |
RISK FACTORS | 87 | ||||
ITEM 2. |
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS | 90 | ||||
ITEM 3. |
DEFAULTS UPON SENIOR SECURITIES | 91 | ||||
ITEM 4. |
REMOVED AND RESERVED | 91 | ||||
ITEM 5. |
OTHER INFORMATION | 91 | ||||
ITEM 6. |
EXHIBITS | 91 |
THE AES CORPORATION
Condensed Consolidated Statements of Operations
(Unaudited)
Three Months Ended March 31, |
||||||||
2011 | 2010 | |||||||
(in millions, except per share amounts) |
||||||||
Revenue: |
||||||||
Regulated |
$ | 2,413 | $ | 2,241 | ||||
Non-Regulated |
1,851 | 1,679 | ||||||
Total revenue |
4,264 | 3,920 | ||||||
Cost of Sales: |
||||||||
Regulated |
(1,823 | ) | (1,666 | ) | ||||
Non-Regulated |
(1,425 | ) | (1,293 | ) | ||||
Total cost of sales |
(3,248 | ) | (2,959 | ) | ||||
Gross margin |
1,016 | 961 | ||||||
General and administrative expenses |
(95 | ) | (80 | ) | ||||
Interest expense |
(351 | ) | (381 | ) | ||||
Interest income |
95 | 108 | ||||||
Other expense |
(17 | ) | (12 | ) | ||||
Other income |
16 | 9 | ||||||
Gain on sale of investments |
6 | - | ||||||
Foreign currency transaction gains (losses) on net monetary position |
33 | (51 | ) | |||||
INCOME FROM CONTINUING OPERATIONS BEFORE TAXES AND EQUITY IN EARNINGS OF AFFILIATES |
703 | 554 | ||||||
Income tax expense |
(218 | ) | (186 | ) | ||||
Net equity in earnings of affiliates |
10 | 13 | ||||||
INCOME FROM CONTINUING OPERATIONS |
495 | 381 | ||||||
Income (loss) from operations of discontinued businesses, net of income tax (benefit) expense of $(6) and $11, respectively |
(12 | ) | 34 | |||||
Loss from disposal of discontinued businesses, net of income tax expense of $0 and $0, respectively |
- | (13 | ) | |||||
NET INCOME |
483 | 402 | ||||||
Noncontrolling interests: |
||||||||
Income from continuing operations attributable to noncontrolling interests |
(259 | ) | (211 | ) | ||||
Income from discontinued operations attributable to noncontrolling interests |
- | (4 | ) | |||||
Total net income attributable to noncontrolling interests |
(259 | ) | (215 | ) | ||||
NET INCOME ATTRIBUTABLE TO THE AES CORPORATION |
$ | 224 | $ | 187 | ||||
BASIC EARNINGS PER SHARE: |
||||||||
Income from continuing operations attributable to The AES Corporation common stockholders, net of tax |
$ | 0.30 | $ | 0.24 | ||||
Discontinued operations attributable to The AES Corporation common stockholders, net of tax |
(0.02 | ) | 0.03 | |||||
NET INCOME ATTRIBUTABLE TO THE AES CORPORATION COMMON STOCKHOLDERS |
$ | 0.28 | $ | 0.27 | ||||
DILUTED EARNINGS PER SHARE: |
||||||||
Income from continuing operations attributable to The AES Corporation common stockholders, net of tax |
$ | 0.30 | $ | 0.24 | ||||
Discontinued operations attributable to The AES Corporation common stockholders, net of tax |
(0.02 | ) | 0.03 | |||||
NET INCOME ATTRIBUTABLE TO THE AES CORPORATION COMMON STOCKHOLDERS |
$ | 0.28 | $ | 0.27 | ||||
AMOUNTS ATTRIBUTABLE TO THE AES CORPORATION |
||||||||
COMMON STOCKHOLDERS: |
||||||||
Income from continuing operations, net of tax |
$ | 236 | $ | 170 | ||||
Discontinued operations, net of tax |
(12 | ) | 17 | |||||
Net income |
$ | 224 | $ | 187 | ||||
1
Condensed Consolidated Balance Sheets
March 31, 2011 |
December 31, 2010 |
|||||||
(in millions except share and per share data) |
||||||||
(unaudited) | ||||||||
ASSETS |
||||||||
CURRENT ASSETS |
||||||||
Cash and cash equivalents |
$ | 2,008 | $ | 2,552 | ||||
Restricted cash |
512 | 502 | ||||||
Short-term investments |
1,713 | 1,730 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $324 and $307, respectively |
2,489 | 2,316 | ||||||
Inventory |
634 | 562 | ||||||
Receivable from affiliates |
7 | 27 | ||||||
Deferred income taxes current |
310 | 306 | ||||||
Prepaid expenses |
203 | 225 | ||||||
Other current assets |
741 | 1,056 | ||||||
Current assets of discontinued and held for sale businesses |
129 | 170 | ||||||
Total current assets |
8,746 | 9,446 | ||||||
NONCURRENT ASSETS |
||||||||
Property, Plant and Equipment: |
||||||||
Land |
1,147 | 1,126 | ||||||
Electric generation, distribution assets and other |
28,389 | 28,172 | ||||||
Accumulated depreciation |
(9,366 | ) | (9,145 | ) | ||||
Construction in progress |
4,853 | 4,459 | ||||||
Property, plant and equipment, net |
25,023 | 24,612 | ||||||
Other Assets: |
||||||||
Deferred financing costs, net of accumulated amortization of $296 and $287, respectively |
371 | 375 | ||||||
Investments in and advances to affiliates |
1,544 | 1,320 | ||||||
Debt service reserves and other deposits |
688 | 653 | ||||||
Goodwill |
1,269 | 1,271 | ||||||
Other intangible assets, net of accumulated amortization of $163 and $157, respectively |
515 | 511 | ||||||
Deferred income taxes noncurrent |
627 | 646 | ||||||
Other |
1,618 | 1,589 | ||||||
Noncurrent assets of discontinued and held for sale businesses |
99 | 88 | ||||||
Total other assets |
6,731 | 6,453 | ||||||
TOTAL ASSETS |
$ | 40,500 | $ | 40,511 | ||||
LIABILITIES AND EQUITY |
||||||||
CURRENT LIABILITIES |
||||||||
Accounts payable |
$ | 1,873 | $ | 2,053 | ||||
Accrued interest |
383 | 257 | ||||||
Accrued and other liabilities |
2,273 | 2,662 | ||||||
Non-recourse debt current, including $1,169 and $1,152, respectively, related to variable interest entities |
2,610 | 2,567 | ||||||
Recourse debt current |
200 | 463 | ||||||
Current liabilities of discontinued and held for sale businesses |
212 | 63 | ||||||
Total current liabilities |
7,551 | 8,065 | ||||||
LONG-TERM LIABILITIES |
||||||||
Non-recourse debt noncurrent, including $2,256 and $2,201, respectively, related to variable interest entities |
12,492 | 12,372 | ||||||
Recourse debt noncurrent |
4,150 | 4,149 | ||||||
Deferred income taxes noncurrent |
907 | 895 | ||||||
Pension and other post-retirement liabilities |
1,523 | 1,512 | ||||||
Other long-term liabilities |
2,713 | 2,814 | ||||||
Long-term liabilities of discontinued and held for sale businesses |
62 | 231 | ||||||
Total long-term liabilities |
21,847 | 21,973 | ||||||
Contingencies and Commitments (see Note 9) |
||||||||
Cumulative preferred stock of subsidiary |
60 | 60 | ||||||
EQUITY |
||||||||
THE AES CORPORATION STOCKHOLDERS EQUITY |
||||||||
Common stock ($0.01 par value, 1,200,000,000 shares authorized; 806,431,926 issued and 784,643,934 outstanding at March 31, 2011 and 804,894,313 issued and 787,607,240 outstanding at December 31, 2010) |
8 | 8 | ||||||
Additional paid-in capital |
8,460 | 8,444 | ||||||
Retained earnings |
844 | 620 | ||||||
Accumulated other comprehensive loss |
(2,248 | ) | (2,383 | ) | ||||
Treasury stock, at cost (21,787,992 shares at March 31, 2011 and 17,287,073 shares at December 31, 2010) |
(272 | ) | (216 | ) | ||||
Total The AES Corporation stockholders equity |
6,792 | 6,473 | ||||||
NONCONTROLLING INTERESTS |
4,250 | 3,940 | ||||||
Total equity |
11,042 | 10,413 | ||||||
TOTAL LIABILITIES AND EQUITY |
$ | 40,500 | $ | 40,511 | ||||
2
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended March 31, |
||||||||
2011 | 2010 | |||||||
(in millions) | ||||||||
OPERATING ACTIVITIES: |
||||||||
Net income |
$ | 483 | $ | 402 | ||||
Adjustments to net income: |
||||||||
Depreciation and amortization |
305 | 293 | ||||||
Loss from sale of investments and impairment expense |
3 | 4 | ||||||
Loss on disposal and impairment write-down discontinued operations |
- | 13 | ||||||
Provision for deferred taxes |
17 | 29 | ||||||
Contingencies |
22 | 46 | ||||||
Other |
(84 | ) | (20 | ) | ||||
Changes in operating assets and liabilities: |
||||||||
Increase in accounts receivable |
(112 | ) | (64 | ) | ||||
(Increase) decrease in inventory |
(69 | ) | 3 | |||||
Decrease in prepaid expenses and other current assets |
16 | 31 | ||||||
(Increase) decrease in other assets |
11 | (70 | ) | |||||
Increase (decrease) in accounts payable and accrued liabilities |
(41 | ) | 56 | |||||
Decrease in income taxes receivable and other income taxes payable, net |
(105 | ) | (97 | ) | ||||
Increase in other liabilities |
59 | 42 | ||||||
Net cash provided by operating activities |
505 | 668 | ||||||
INVESTING ACTIVITIES: |
||||||||
Capital expenditures |
(479 | ) | (493 | ) | ||||
Acquisitions net of cash acquired |
(138 | ) | (34 | ) | ||||
Proceeds from the sale of businesses |
8 | 99 | ||||||
Proceeds from the sale of assets |
4 | - | ||||||
Sale of short-term investments |
1,241 | 1,006 | ||||||
Purchase of short-term investments |
(1,181 | ) | (1,102 | ) | ||||
(Increase) decrease in restricted cash |
11 | (46 | ) | |||||
Increase in debt service reserves and other assets |
(7 | ) | (61 | ) | ||||
Affiliate advances and equity investments |
(40 | ) | (23 | ) | ||||
Other investing |
(20 | ) | 59 | |||||
Net cash used in investing activities |
(601 | ) | (595 | ) | ||||
FINANCING ACTIVITIES: |
||||||||
Issuance of common stock |
- | 1,570 | ||||||
Borrowings under the revolving credit facilities, net |
24 | 26 | ||||||
Issuance of non-recourse debt |
115 | 216 | ||||||
Repayments of recourse debt |
(268 | ) | - | |||||
Repayments of non-recourse debt |
(201 | ) | (182 | ) | ||||
Payments for deferred financing costs |
(5 | ) | (13 | ) | ||||
Distributions to noncontrolling interests |
(43 | ) | (72 | ) | ||||
Financed capital expenditures |
(17 | ) | (30 | ) | ||||
Purchase of treasury stock |
(63 | ) | - | |||||
Other financing |
(5 | ) | - | |||||
Net cash (used in) provided by financing activities |
(463 | ) | 1,515 | |||||
Effect of exchange rate changes on cash |
15 | (21 | ) | |||||
Total increase (decrease) in cash and cash equivalents |
(544 | ) | 1,567 | |||||
Cash and cash equivalents, beginning |
2,552 | 1,780 | ||||||
Cash and cash equivalents, ending |
$ | 2,008 | $ | 3,347 | ||||
SUPPLEMENTAL DISCLOSURES: |
||||||||
Cash payments for interest, net of amounts capitalized |
$ | 229 | $ | 284 | ||||
Cash payments for income taxes, net of refunds |
$ | 304 | $ | 260 |
See Notes to Condensed Consolidated Financial Statements
3
Condensed Consolidated Statements of Changes in Equity
(Unaudited)
THE AES CORPORATION STOCKHOLDERS | Noncontrolling Interests |
Consolidated Comprehensive Income |
||||||||||||||||||||||||||
Common Stock |
Treasury Stock |
Additional Paid-In Capital |
Retained Earnings |
Accumulated Other Comprehensive Loss |
||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||
Balance at January 1, 2011 |
$ | 8 | $ | (216) | $ | 8,444 | $ | 620 | $ | (2,383) | $ | 3,940 | ||||||||||||||||
Net income |
- | - | - | 224 | - | 259 | $ | 483 | ||||||||||||||||||||
Change in fair value of available-for-sale securities, net of income tax |
- | - | - | - | (1) | - | (1 | ) | ||||||||||||||||||||
Foreign currency translation adjustment, net of income tax |
- | - | - | - | 74 | 54 | 128 | |||||||||||||||||||||
Change in unfunded pensions obligation, net of income tax |
- | - | - | - | 1 | 2 | 3 | |||||||||||||||||||||
Change in derivative fair value, including a reclassification to earnings, net of income tax |
- | - | - | - | 61 | 10 | 71 | |||||||||||||||||||||
Other comprehensive income |
201 | |||||||||||||||||||||||||||
Total comprehensive income |
$ | 684 | ||||||||||||||||||||||||||
Capital contributions from noncontrolling interests |
- | - | - | - | - | 1 | ||||||||||||||||||||||
Distributions to noncontrolling interests |
- | - | - | - | - | (16 | ) | |||||||||||||||||||||
Acquisition of treasury stock |
- | (63) | - | - | - | - | ||||||||||||||||||||||
Issuance of common stock under benefit plans and exercise of stock options and warrants, net of income tax |
- | 7 | 6 | - | - | - | ||||||||||||||||||||||
Stock compensation |
- | - | 10 | - | - | - | ||||||||||||||||||||||
Balance at March 31, 2011 |
$ | 8 | $ | (272) | $ | 8,460 | $ | 844 | $ | (2,248) | $ | 4,250 | ||||||||||||||||
THE AES CORPORATION STOCKHOLDERS | Noncontrolling Interests |
Consolidated Comprehensive Income |
||||||||||||||||||||||||||
Common Stock |
Treasury Stock |
Additional Paid-In Capital |
Retained Earnings |
Accumulated Other Comprehensive Loss |
||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||
Balance at January 1, 2010 |
$ | 7 | $ | (126 | ) | $ | 6,868 | $ | 650 | $ | (2,724 | ) | $ | 4,205 | ||||||||||||||
Net income |
- | - | - | 187 | - | 215 | $ | 402 | ||||||||||||||||||||
Change in fair value of available-for-sale securities, net of income tax |
- | - | - | - | (4 | ) | - | (4 | ) | |||||||||||||||||||
Foreign currency translation adjustment, net of income tax |
- | - | - | - | (88 | ) | (46 | ) | (134 | ) | ||||||||||||||||||
Change in unfunded pensions obligation, net of income tax |
- | - | - | - | 1 | 1 | 2 | |||||||||||||||||||||
Change in derivative fair value, including a reclassification to earnings, net of income tax |
- | - | - | - | (28 | ) | (6 | ) | (34 | ) | ||||||||||||||||||
Other comprehensive income |
(170 | ) | ||||||||||||||||||||||||||
Total comprehensive income |
$ | 232 | ||||||||||||||||||||||||||
Cumulative effect of consolidation of entities under variable interest entity accounting guidance |
- | - | - | (47 | ) | (38 | ) | 15 | ||||||||||||||||||||
Cumulative effect of deconsolidation of entities under variable interest entity accounting guidance |
- | - | - | 1 | - | - | ||||||||||||||||||||||
Capital contributions from noncontrolling interests |
- | - | - | - | - | 2 | ||||||||||||||||||||||
Distributions to noncontrolling interests |
- | - | - | - | - | (97 | ) | |||||||||||||||||||||
Issuance of common stock |
1 | - | 1,566 | - | - | - | ||||||||||||||||||||||
Issuance of common stock under benefit plans and exercise of stock options and warrants, net of income tax |
- | 8 | 6 | - | - | - | ||||||||||||||||||||||
Stock compensation |
- | - | 7 | - | - | - | ||||||||||||||||||||||
Balance at March 31, 2010 |
$ | 8 | $ | (118 | ) | $ | 8,447 | $ | 791 | $ | (2,881 | ) | $ | 4,289 | ||||||||||||||
See Notes to Condensed Consolidated Financial Statements
4
THE AES CORPORATION
Notes to Condensed Consolidated Financial Statements
For the Three Months Ended March 31, 2011 and 2010
1. FINANCIAL STATEMENT PRESENTATION
The prior period condensed consolidated financial statements in this Quarterly Report on Form 10-Q (Form 10-Q) have been reclassified to reflect the businesses held for sale and discontinued operations as discussed in Note 14 Discontinued Operations.
Consolidation
In this Quarterly Report the terms AES, the Company, us or we refer to the consolidated entity including its subsidiaries and affiliates. The terms The AES Corporation, the Parent or the Parent Company refer only to the publicly-held holding company, The AES Corporation, excluding its subsidiaries and affiliates. Furthermore, variable interest entities (VIEs) in which the Company has an interest have been consolidated where the Company is the primary beneficiary. Investments in which the Company has the ability to exercise significant influence, but not control, are accounted for using the equity method of accounting. All intercompany transactions and balances have been eliminated in consolidation.
AES Thames, LLC (Thames), a 208 MW coal-fired plant in Connecticut, filed petitions for bankruptcy protection under Chapter 11 in the U. S. Bankruptcy Court on February 1, 2011. Effective that date, the Company lost control of the business and is no longer able to exercise significant influence over its operating and financial policies. In accordance with the accounting guidance on consolidations, Thames was deconsolidated in February 2011 and is now accounted for as a cost method investment. Thames had total assets and total liabilities of $158 million and $170 million, respectively, on February 1, 2011. The deconsolidation resulted in a gain of $12 million, which was deferred pending the completion of the bankruptcy proceedings.
Interim Financial Presentation
The accompanying unaudited condensed consolidated financial statements and footnotes have been prepared in accordance with generally accepted accounting principles in the United States of America (U.S. GAAP) as contained in the Financial Accounting Standards Board (FASB) Accounting Standards Codification (the Codification or ASC) for interim financial information and Article 10 of Regulation S-X issued by the Securities and Exchange Commission (SEC). Accordingly, they do not include all the information and footnotes required by U.S. GAAP for annual fiscal reporting periods. In the opinion of management, the interim financial information includes all adjustments of a normal recurring nature necessary for a fair presentation of the results of operations, financial position, changes in equity and cash flows. The results of operations for the three months ended March 31, 2011 are not necessarily indicative of results that may be expected for the year ending December 31, 2011. The accompanying condensed consolidated financial statements are unaudited and should be read in conjunction with the 2010 audited consolidated financial statements and notes thereto, which are included in the 2010 Form 10-K filed with the SEC on February 25, 2011.
Change in Estimate
In 2011, the Company changed its estimate related to depreciation on property, plant and equipment at its Brazilian concessionary utility and generation businesses. Based on recent information received from regulators, the depreciation rates and salvage values for its concession assets have been adjusted on a prospective basis to reflect a remuneration basis, which equates to the reimbursement expected by the Company at the end of the concession period. For the three months ended March 31, 2011 the impact to the condensed consolidated statement of operations was an increase to depreciation expense of $17 million, or $0.02 per share, and a decrease of $4 million, or $0.01 per share, to net income attributable to The AES Corporation.
5
New Accounting Policies Adopted
Accounting Standards Update (ASU) No. 2009-13, Revenue Recognition (Topic 605), Multiple-Deliverable Revenue Arrangements
In October 2009, the Financial Accounting Standards Board (FASB) issued ASU No. 2009-13, which amended the accounting guidance related to revenue recognition. The amended guidance provides primarily for two changes to the prior guidance for multiple-element revenue arrangements. The first eliminated the requirement that there be objective and reliable evidence of fair value for any undelivered items in order for a delivered item to be treated as a separate unit of accounting. The second required that the consideration from multiple-element revenue arrangements be allocated to all the deliverables based on their relative selling price at the inception of the arrangement. The amended guidance must have been adopted by all entities no later than fiscal years beginning on or after June 15, 2010, or January 1, 2011 for AES. As AES did not elect the early adoption that was permitted for the amended guidance, AES adopted it on January 1, 2011. AES elected prospective adoption and applied the revised guidance to all revenue arrangements entered into or materially modified after the date of adoption. As a result, the adoption of ASU No. 2009-13 did not have a material impact on the financial position and results of operations of AES and ASU No. 2009-13 is not expected to have material impact in future periods.
ASU No. 2010-28, Intangibles Goodwill and Other (Topic 350), When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts
In December 2010, the FASB issued ASU No. 2010-28, which amends the accounting guidance related to goodwill. The amendments in ASU No. 2010-28 modify Step One of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step Two of the goodwill impairment test if it is more likely than not that a goodwill impairment exists, eliminating an entitys ability to assert that a reporting unit is not required to perform Step Two because the carrying amount of the reporting unit is zero or negative despite the existence of qualitative factors that indicate the goodwill is more likely than not impaired. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The Company adopted ASU No. 2010-28 on January 1, 2011. The adoption did not have any impact on the Company as none of its reporting units has a zero or negative carrying amount.
Accounting Pronouncements Issued But Not Yet Effective
The following accounting standards update has been issued, but as of March 31, 2011 is not yet effective for and has not been adopted by AES.
ASU No. 2011-2, A Creditors Determination of Whether a Restructuring Is a Troubled Debt Restructuring
In April 2011, the Financial Accounting Standards Board (FASB) issued ASU No. 2011-2, which provides additional guidance and clarification to help creditors determine whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. ASU 2011-2 is effective for the first interim or annual period beginning on or after June 15, 2011, or the three months ended September 30, 2011 for AES. The adoption is not expected to have a material impact on the Companys financial position, results of operations or cash flows.
6
2. INVENTORY
The following table summarizes the Companys inventory balances as of March 31, 2011 and December 31, 2010:
March 31, 2011 |
December 31, 2010 |
|||||||
(in millions) | ||||||||
Coal, fuel oil and other raw materials |
$ | 341 | $ | 276 | ||||
Spare parts and supplies |
293 | 286 | ||||||
Total |
$ | 634 | $ | 562 | ||||
3. FAIR VALUE DISCLOSURES
The fair value of current financial assets and liabilities, debt service reserves and other deposits approximate their reported carrying amounts. The fair value of non-recourse debt is estimated based upon the type of loan. For variable rate loans, carrying value approximates fair value. For fixed rate loans, the fair value is estimated using quoted market prices or discounted cash flow analyses. See Note 8 Debt for additional information on the fair value and carrying value of debt. The fair value of interest rate swap, cap and floor agreements, foreign currency forwards, swaps and options and energy derivatives is the estimated net amount that the Company would receive or pay to sell or transfer the agreements as of the balance sheet date.
The estimated fair values of the Companys assets and liabilities have been determined using available market information. By virtue of these amounts being estimates and based on hypothetical transactions to sell assets or transfer liabilities, the use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The following table summarizes the carrying amount and fair value of certain of the Companys financial assets and liabilities as of March 31, 2011 and December 31, 2010:
March 31, 2011 | December 31, 2010 | |||||||||||||||
Carrying Amount |
Fair Value | Carrying Amount |
Fair Value | |||||||||||||
(in millions) | ||||||||||||||||
Assets |
||||||||||||||||
Marketable securities |
$ | 1,753 | $ | 1,753 | $ | 1,772 | $ | 1,772 | ||||||||
Derivatives |
139 | 139 | 124 | 124 | ||||||||||||
Total assets |
$ | 1,892 | $ | 1,892 | $ | 1,896 | $ | 1,896 | ||||||||
Liabilities |
||||||||||||||||
Debt |
$ | 19,452 | $ | 20,087 | $ | 19,551 | $ | 20,137 | ||||||||
Derivatives |
358 | 358 | 423 | 423 | ||||||||||||
Total liabilities |
$ | 19,810 | $ | 20,445 | $ | 19,974 | $ | 20,560 | ||||||||
Valuation Techniques:
The fair value measurement accounting guidance describes three main approaches to measuring the fair value of assets and liabilities: (1) market approach; (2) income approach and (3) cost approach. The market approach uses prices and other relevant information generated from market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on current market expectations of the return on those
7
future amounts. The cost approach is based on the amount that would currently be required to replace an asset. The Company measures its investments and derivatives at fair value on a recurring basis. Additionally, in connection with annual or event-driven impairment evaluations, certain nonfinancial assets and liabilities are measured at fair value on a nonrecurring basis. These include long-lived tangible assets (i.e., property, plant and equipment), goodwill and intangible assets (e.g., sales concessions, land use rights and emissions allowances etc). In general, the Company determines the fair value of investments and derivatives using the market approach and the income approach, respectively. In the nonrecurring measurements of nonfinancial assets and liabilities, all three approaches are considered; however, fair value generated by the income approach is often selected.
Investments
The Companys investments measured at fair value generally consist of marketable debt and equity securities. Equity securities are measured at fair value using quoted market prices. Debt securities primarily consist of unsecured debentures, certificates of deposit and government debt securities held by our Brazilian subsidiaries. Returns and pricing on these instruments are generally indexed to the CDI (Brazilian equivalent to London Inter Bank Offered Rate (LIBOR), a benchmark interest rate widely used by banks in the money market) or Selic (overnight borrowing rate) rates in Brazil and are adjusted based on the banks assessment of the specific businesses. Fair value is determined from comparisons to market data obtained for similar assets and are considered Level 2 in the fair value hierarchy. For more detail regarding the fair value of investments see Note 4 Investments in Marketable Securities.
Derivatives
When deemed appropriate, the Company manages its risk from interest and foreign currency exchange rate and commodity price fluctuations through the use of financial and physical derivative instruments. The Companys derivatives are primarily interest rate swaps to hedge non-recourse debt to establish a fixed rate on variable rate debt, foreign exchange instruments to hedge against currency fluctuations, commodity derivatives to hedge against commodity price fluctuations and embedded derivatives associated with commodity contracts. The Companys subsidiaries are counterparties to various over-the-counter derivatives, which include interest rate swaps and options, foreign currency options and forwards and commodity swaps. In addition, the Companys subsidiaries are counterparties to certain power purchase agreements (PPAs) and fuel supply agreements that are derivatives or include embedded derivatives.
For the derivatives where there is a standard industry valuation model, the Company uses that model to estimate the fair value. For the derivatives (such PPAs and fuel supply agreements that are derivatives or include embedded derivatives) where there is not a standard industry valuation model, the Company has created internal valuation models to estimate the fair value, using observable data to the extent available. For all derivatives, the income approach is used, which consists of forecasting future cash flows based on contractual notional amounts and applicable and available market data as of the valuation date. The following are among the most common market data inputs used in the income approach: volatilities, spot and forward benchmark interest rates (such as LIBOR and Euro Inter Bank Offered Rate (EURIBOR)), foreign exchange rates and commodity prices. Forward rates and prices are generally obtained from published information provided by pricing services for an instrument with the same duration as the derivative instrument being valued. In situations where significant inputs are not observable, the Company uses relevant techniques to best estimate the inputs, such as regression analysis, Monte Carlo simulation or prices for similarly traded instruments available in the market.
For each derivative, the income approach is used to estimate the cash flows over the remaining term of the contract. Those cash flows are then discounted using the relevant spot benchmark interest rate (such as LIBOR or EURIBOR) plus a spread that reflects the credit or nonperformance risk. This risk is estimated by the Company using credit spreads and risk premiums that are observable in the market, whenever possible, or estimated borrowing costs based on bank quotes, industry publications and/or information on financing closed on similar projects. To the extent that management can estimate the fair value of these assets or liabilities without the use of significant unobservable inputs, these derivatives are classified as Level 2.
8
In certain instances, the published forward rates or prices may not extend through the remaining term of the contract and management must make assumptions to extrapolate the curve, which necessitates the use of unobservable inputs, such as proxy commodity prices or historical settlements to forecast forward prices. In addition, in certain instances, there may not be third party data readily available which requires the use of unobservable inputs. Similarly, in certain instances, the spread that reflects the credit or nonperformance risk is unobservable. The fair value hierarchy of an asset or a liability is based on the level of significance of the input assumptions. An input assumption is considered significant if it affects the fair value by at least 10%. Assets and liabilities are transferred to Level 3 when the use of unobservable inputs becomes significant. Similarly, when the use of unobservable input becomes insignificant for Level 3 assets and liabilities, they are transferred to Level 2.
Transfers in and out of Level 3 are determined as of the end of the reporting period and are from and to Level 2. The Company has not had any Level 1 derivatives so there have not been any transfers between Levels 1 and 2.
Nonfinancial Assets and Liabilities
For nonrecurring measurements derived using the income approach, fair value is determined using valuation models based on the principles of discounted cash flows (DCF). The income approach is most often used in the impairment evaluation of long-lived tangible assets, goodwill and intangible assets. The Company has developed internal valuation models for such valuations; however, an independent valuation firm may be engaged in certain situations. In such situations, the independent valuation firm largely uses DCF valuation models as the primary measure of fair value though other valuation approaches are also considered. A few examples of input assumptions to such valuations include macroeconomic factors such as growth rates, industry demand, inflation, exchange rates and power and commodity prices. Whenever possible, the Company attempts to obtain market observable data to develop input assumptions. Where the use of market observable data is limited or not possible for certain input assumptions, the Company develops its own estimates using a variety of techniques such as regression analysis and extrapolations.
For nonrecurring measurements derived using the market approach, recent market transactions involving the sale of identical or similar assets are considered. The use of this approach is limited because it is often difficult to find sale transactions of identical or similar assets. This approach is used in the impairment evaluations of certain intangible assets. Otherwise, it is used to corroborate the fair value determined under the income approach.
For nonrecurring measurements derived using the cost approach, fair value is typically determined using the replacement cost approach. Under this approach, the depreciated replacement cost of assets is determined by first determining the current replacement cost of assets and then applying the remaining useful life percentages to such cost. Further adjustments for economic and functional obsolescence are made to the depreciated replacement cost. This approach involves a considerable amount of judgment which is why its use is limited to the measurement of a few long-lived tangible assets. Like the market approach, this approach is also used to corroborate the fair value determined under the income approach. For the three months ended March 31, 2011, the Company did not measure any nonfinancial assets under the cost approach.
Fair Value Considerations:
In determining fair value, the Company considers the source of observable market data inputs, liquidity of the instrument, the credit risk of the counterparty and the risk of the Companys or its counterpartys nonperformance. The conditions and criteria used to assess these factors are:
Sources of market assumptions
The Company derives most of its market assumptions from market efficient data sources (e.g., Bloomberg and Platts). In some cases, where market data is not readily available, management uses comparable market sources and empirical evidence to derive market assumptions to determine the fair value.
9
Market liquidity
The Company evaluates market liquidity based on whether the financial or physical instrument, or the underlying asset, is traded in an active or inactive market. An active market exists if the prices are fully transparent to market participants, can be measured by market bid and ask quotes, the market has a relatively large proportion of trading volume as compared to the Companys current trading volume and the market has a significant number of market participants that will allow the market to rapidly absorb the quantity of the assets traded without significantly affecting the market price. Another factor the Company considers when determining whether a market is active or inactive is the presence of government or regulatory controls over pricing that could make it difficult to establish a market based price when entering into a transaction.
Nonperformance risk
Nonperformance risk refers to the risk that the obligation will not be fulfilled and affects the value at which a liability is transferred or an asset is sold. Nonperformance risk includes, but may not be limited to, the Company or counterpartys credit and settlement risk. Nonperformance risk adjustments are dependent on credit spreads, letters of credit, collateral, other arrangements available and the nature of master netting arrangements. The Company and its subsidiaries are parties to various interest rate swaps and options; foreign currency options and forwards; and derivatives and embedded derivatives which subject the Company to nonperformance risk. The financial and physical instruments held at the subsidiary level are generally non-recourse to the Parent Company.
Nonperformance risk on the investments held by the Company is incorporated in the investments exit price that is derived from quoted market data that is used to mark the investment to fair value.
The Company adjusts for nonperformance or credit risk on its derivative instruments by deducting a credit valuation adjustment (CVA). The CVA is based on the margin or debt spread of the Companys subsidiary or counterparty and the tenor of the respective derivative instrument. The counterparty for a derivative asset position is considered to be the bank or government sponsored banking entity or counterparty to the PPA or commodity contract. The CVA for asset positions is based on the counterpartys credit ratings and debt spreads or, in the absence of readily obtainable credit information, the respective country debt spreads are used as a proxy. The CVA for liability positions is based on the Parent Companys or the subsidiarys current debt spread, the margin on indicative financing arrangements, or in the absence of readily obtainable credit information, the respective country debt spreads are used as a proxy. All derivative instruments are analyzed individually and are subject to unique risk exposures.
10
Recurring Measurements
The following table sets forth, by level within the fair value hierarchy, the Companys financial assets and liabilities that were measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010. Financial assets and liabilities have been classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Companys assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the determination of the fair value of the assets and liabilities and their placement within the fair value hierarchy levels.
Quoted Market Prices in Active Market for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Total March 31, 2011 |
|||||||||||||
(in millions) | ||||||||||||||||
Assets |
||||||||||||||||
Available-for-sale securities |
$ | 3 | $ | 1,698 | $ | 40 | $ | 1,741 | ||||||||
Trading securities |
12 | - | - | 12 | ||||||||||||
Derivatives |
- | 74 | 65 | 139 | ||||||||||||
Total assets |
$ | 15 | $ | 1,772 | $ | 105 | $ | 1,892 | ||||||||
Liabilities |
||||||||||||||||
Derivatives |
$ | - | $ | 338 | $ | 20 | $ | 358 | ||||||||
Total liabilities |
$ | - | $ | 338 | $ | 20 | $ | 358 | ||||||||
Quoted Market Prices in Active Market for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Total December 31, 2010 |
|||||||||||||
(in millions) | ||||||||||||||||
Assets |
||||||||||||||||
Available-for-sale securities |
$ | 8 | $ | 1,712 | $ | 42 | $ | 1,762 | ||||||||
Trading securities |
10 | - | - | 10 | ||||||||||||
Derivatives |
- | 63 | 61 | 124 | ||||||||||||
Total assets |
$ | 18 | $ | 1,775 | $ | 103 | $ | 1,896 | ||||||||
Liabilities |
||||||||||||||||
Derivatives |
$ | - | $ | 411 | $ | 12 | $ | 423 | ||||||||
Total liabilities |
$ | - | $ | 411 | $ | 12 | $ | 423 | ||||||||
11
The following table presents a reconciliation of derivative assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2011 and 2010 (by type of derivative):
Three Months Ended March 31, 2011 | ||||||||||||||||||||
Interest Rate |
Cross Currency |
Foreign Currency |
Commodity and Other |
Total | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Balance at January 1(1) |
$ | (1 | ) | $ | 10 | $ | 22 | $ | 18 | $ | 49 | |||||||||
Total gains (losses) (realized and unrealized): |
||||||||||||||||||||
Included in earnings(2) |
- | 2 | 1 | 8 | 11 | |||||||||||||||
Included in other comprehensive income |
(4 | ) | (8 | ) | - | - | (12 | ) | ||||||||||||
Included in regulatory assets |
- | - | - | (1 | ) | (1 | ) | |||||||||||||
Settlements |
- | 1 | 1 | - | 2 | |||||||||||||||
Transfers of assets (liabilities) into Level 3(3) |
(2 | ) | - | (1 | ) | (1 | ) | (4 | ) | |||||||||||
Balance at March 31(1) |
$ | (7 | ) | $ | 5 | $ | 23 | $ | 24 | $ | 45 | |||||||||
Total gains/(losses) for the period included in earnings attributable to the change in unrealized gains/(losses) relating to assets and liabilities held at the end of the period |
$ | - | $ | 2 | $ | - | $ | 8 | $ | 10 | ||||||||||
Three Months Ended March 31, 2010 | ||||||||||||||||||||
Interest Rate |
Cross Currency |
Foreign Currency |
Commodity and Other |
Total | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Balance at January 1(1) |
$ | (12 | ) | $ | (12 | ) | $ | - | $ | 24 | $ | - | ||||||||
Total gains (losses) (realized and unrealized): |
||||||||||||||||||||
Included in earnings(2) |
- | 6 | - | 3 | 9 | |||||||||||||||
Included in other comprehensive income |
(3 | ) | (2 | ) | - | - | (5 | ) | ||||||||||||
Included in regulatory assets |
(1 | ) | - | - | - | (1 | ) | |||||||||||||
Settlements |
1 | 1 | - | (8 | ) | (6 | ) | |||||||||||||
Transfers of assets (liabilities) into Level 3(3) |
(4 | ) | - | (1 | ) | - | (5 | ) | ||||||||||||
Transfers of (assets) liabilities out of Level 3(3) |
1 | - | - | - | 1 | |||||||||||||||
Balance at March 31(1) |
$ | (18 | ) | $ | (7 | ) | $ | (1 | ) | $ | 19 | $ | (7 | ) | ||||||
Total gains/(losses) for the period included in earnings attributable to the change in unrealized gains/(losses) relating to assets and liabilities held at the end of the period |
$ | - | $ | 6 | $ | 1 | $ | (5 | ) | $ | 2 | |||||||||
(1) | Derivative assets and (liabilities) are presented on a net basis. |
(2) | The gains (losses) included in earnings for these Level 3 derivatives are classified as follows: interest rate and cross currency derivatives as interest expense, foreign currency derivatives as foreign currency transaction gains (losses) and commodity and other derivatives as either non-regulated revenue, non-regulated cost of sales, or other expense. See Note 5 Derivative Instruments and Hedging Activities for further information regarding the classification of gains and losses included in earnings in the condensed consolidated statements of operations. |
(3) | Transfers in and out of Level 3 are determined as of the end of the reporting period and are from and to Level 2, as the Company has no Level 1 derivative assets or liabilities. The (assets) liabilities transferred out of Level 3 are primarily the result of a decrease in the significance of unobservable inputs used to calculate the credit valuation adjustments of these derivative instruments. Similarly, the assets (liabilities) transferred into Level 3 are primarily the result of an increase in the significance of unobservable inputs used to calculate the credit valuation adjustments of these derivative instruments. |
12
The following table presents a reconciliation of available-for-sale securities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2011 and 2010:
Three Months Ended March 31, |
||||||||
2011 | 2010 | |||||||
(in millions) | ||||||||
Balance at January 1(1) |
$ | 42 | $ | 42 | ||||
Settlements |
(2 | ) | - | |||||
Balance at March 31(1) |
$ | 40 | $ | 42 | ||||
Total gains/(losses) for the period included in earnings attributable to the change in unrealized gains/losses relating to assets held at the end of the period |
$ | - | $ | - | ||||
(1) | Available-for-sale securities in Level 3 are auction rate securities and variable rate demand notes which have failed remarketing or are not actively trading and for which there are no longer adequate observable inputs available to measure the fair value. |
4. INVESTMENTS IN MARKETABLE SECURITIES
The following table sets forth the Companys investments in marketable debt and equity securities reported at fair value as of March 31, 2011 and December 31, 2010 by type of investment and by level within the fair value hierarchy. The security types are determined based on the nature and risk of the security and are consistent with how the Company manages, monitors and measures its marketable securities.
March 31, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||
AVAILABLE-FOR-SALE:(1) |
||||||||||||||||||||||||||||||||
Debt securities: |
||||||||||||||||||||||||||||||||
Unsecured debentures(2) |
$ | - | $ | 742 | $ | - | $ | 742 | $ | - | $ | 727 | $ | - | $ | 727 | ||||||||||||||||
Certificates of deposit(2) |
- | 849 | - | 849 | - | 877 | - | 877 | ||||||||||||||||||||||||
Government debt securities |
- | 43 | - | 43 | - | 47 | - | 47 | ||||||||||||||||||||||||
Other debt securities |
- | - | 40 | 40 | - | - | 42 | 42 | ||||||||||||||||||||||||
Subtotal |
- | 1,634 | 40 | 1,674 | - | 1,651 | 42 | 1,693 | ||||||||||||||||||||||||
Equity securities: |
||||||||||||||||||||||||||||||||
Mutual funds |
1 | 64 | - | 65 | 1 | 61 | - | 62 | ||||||||||||||||||||||||
Common stock |
2 | - | - | 2 | 7 | - | - | 7 | ||||||||||||||||||||||||
Subtotal |
3 | 64 | - | 67 | 8 | 61 | - | 69 | ||||||||||||||||||||||||
Total available-for-sale |
3 | 1,698 | 40 | 1,741 | 8 | 1,712 | 42 | 1,762 | ||||||||||||||||||||||||
TRADING: |
||||||||||||||||||||||||||||||||
Equity securities: |
||||||||||||||||||||||||||||||||
Mutual funds |
12 | - | - | 12 | 10 | - | - | 10 | ||||||||||||||||||||||||
Total trading |
12 | - | - | 12 | 10 | - | - | 10 | ||||||||||||||||||||||||
TOTAL |
$ | 15 | $ | 1,698 | $ | 40 | $ | 1,753 | $ | 18 | $ | 1,712 | $ | 42 | $ | 1,772 | ||||||||||||||||
(1) | Amortized cost approximated fair value at March 31, 2011 and December 31, 2010, with the exception of a common stock investment with a cost basis and fair value of $4 million and $2 million, respectively, at March 31, 2011, and a cost basis and fair value of $6 million and $7 million, respectively, at December 31, 2010. |
(2) | Unsecured debentures are instruments similar to certificates of deposit that are held primarily by our subsidiaries in Brazil. The unsecured debentures and certificates of deposit included here do not qualify as cash equivalents, but meet the definition of a security under the relevant guidance and are therefore classified as available-for-sale securities. |
13
As of March 31, 2011, all available-for-sale debt securities had stated maturities of less than one year, with the exception of variable rate demand notes of $40 million held by IPL. These notes, included in other debt securities in the table above, had a stated maturity of greater than ten years as of March 31, 2011.
The following table summarizes the pre-tax gains and losses related to available-for-sale and trading securities for the three months ended March 31, 2011 and 2010. Gains and losses on the sale of investments are determined using the specific identification method. For the three months ended March 31, 2011 and 2010, there were no realized losses on sales of available-for-sale securities and no other-than-temporary impairment of marketable securities recognized in earnings or other comprehensive income.
Three Months Ended March 31, |
||||||||
2011 | 2010 | |||||||
(in millions) | ||||||||
Gains included in earnings that relate to trading securities held at the reporting date |
$ | 1 | $ | - | ||||
Unrealized gains (losses) on available-for-sale securities included in other comprehensive income |
$ | (2 | ) | $ | (6 | ) | ||
Proceeds from sales of available-for-sale securities |
$ | 1,257 | $ | 962 | ||||
Gross realized gains on sales of available-for-sale securities |
$ | 1 | $ | - |
5. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Risk Management Objectives
The Company is exposed to market risks associated with its enterprise-wide business activities, namely the purchase and sale of fuel and electricity as well as foreign currency risk and interest rate risk. In order to manage the market risks associated with these business activities, we enter into contracts that incorporate derivatives and financial instruments, including forwards, futures, options, swaps or combinations thereof, as appropriate. The Company generally applies hedge accounting to contracts as long as they are eligible under the accounting standards for derivatives and hedging. While derivative transactions are not entered into for trading purposes, some contracts are not eligible for hedge accounting.
Interest Rate Risk
AES and its subsidiaries utilize variable rate debt financing for construction projects and operations, resulting in an exposure to interest rate risk. Interest rate swap, cap and floor agreements are entered into to manage interest rate risk by effectively fixing or limiting the interest rate exposure on the underlying financing. These interest rate contracts range in maturity through 2030, and are typically designated as cash flow hedges. The following table sets forth, by underlying type of interest rate index, the Companys current and maximum outstanding notional under its interest rate derivative instruments, the weighted average remaining term and the percentage of variable-rate debt hedged that is based on the related index as of March 31, 2011 regardless of whether the derivative instruments are in qualifying cash flow hedging relationships:
March 31, 2011 | ||||||||||||||||||||||||
Current | Maximum(1) | Weighted Average Remaining Term(1) |
% of Debt Currently Hedged by Index(2) |
|||||||||||||||||||||
Interest Rate Derivatives |
Derivative Notional |
Derivative Notional Translated to USD |
Derivative Notional |
Derivative Notional Translated to USD |
||||||||||||||||||||
(in millions) | (in years) | |||||||||||||||||||||||
LIBOR (U.S. Dollar) |
2,586 | $ | 2,586 | 2,719 | $ | 2,719 | 10 | 70 | % | |||||||||||||||
EURIBOR (Euro) |
1,096 | 1,552 | 1,096 | 1,552 | 13 | 65 | % | |||||||||||||||||
LIBOR (British Pound Sterling) |
44 | 71 | 61 | 97 | 13 | 69 | % | |||||||||||||||||
Securities Industry and Financial |
||||||||||||||||||||||||
Markets Association Municipal |
||||||||||||||||||||||||
Swap Index (U.S. Dollar) |
40 | 40 | 40 | 40 | 12 | N/A | (3) |
14
(1) | The Companys interest rate derivative instruments primarily include accreting and amortizing notionals. The maximum derivative notional represents the largest notional at any point between March 31, 2011 and the maturity of the derivative instrument, which includes forward starting derivative instruments. The weighted average remaining term represents the remaining tenor of our interest rate derivatives weighted by the corresponding maximum notional. |
(2) | Excludes variable-rate debt tied to other indices where the Company has no interest rate derivatives. |
(3) | The debt that was being hedged is no longer exposed to variable interest payments because it is now held on IPLs behalf and no longer bears interest. |
Cross currency swaps are utilized in certain instances to manage the risk related to fluctuations in both interest rates and certain foreign currencies. These cross currency contracts range in maturity through 2028. The following table sets forth, by type of foreign currency denomination, the Companys outstanding notional of amounts under its cross currency derivative instruments as of March 31, 2011, which are all in qualifying cash flow hedge relationships. These swaps are amortizing and therefore the notional amount represents the maximum outstanding notional as of March 31, 2011:
March 31, 2011 | ||||||||||||||||
Cross Currency Swaps |
Notional | Notional Translated to USD |
Weighted
Average Remaining Term(1) |
% of Debt Currently Hedged by Index(2) |
||||||||||||
(in millions) | (in years) | |||||||||||||||
Chilean Unidad de Fomento (CLF) |
6 | $ | 253 | 15 | 83 | % |
(1) | Represents the remaining tenor of our cross currency swaps weighted by the corresponding notional. |
(2) | Represents the proportion of foreign currency denominated debt hedged by the same foreign currency denominated notional of the cross currency swap. |
Foreign Currency Risk
We are exposed to foreign currency risk as a result of our investments in foreign subsidiaries and affiliates. AES operates businesses in many foreign environments and such operations in foreign countries may be impacted by significant fluctuations in foreign currency exchange rates. Foreign currency options and forwards are utilized, where deemed appropriate, to manage the risk related to fluctuations in certain foreign currencies. These foreign currency contracts range in maturity through 2012. The following tables set forth, by type of foreign currency denomination, the Companys outstanding notional amounts over the remaining terms of its foreign currency derivative instruments as of March 31, 2011 regardless of whether the derivative instruments are in qualifying hedging relationships:
March 31, 2011 | ||||||||||||||||
Foreign Currency Options |
Notional | Notional Translated to USD(1) |
Probability
Adjusted Notional(2) |
Weighted Average Remaining Term(3) |
||||||||||||
(in millions) | (in years) | |||||||||||||||
Brazilian Real (BRL) |
201 | $ | 118 | $ | 26 | <1 | ||||||||||
Euro (EUR) |
16 | 23 | 12 | <1 | ||||||||||||
Argentine Peso (ARS) |
28 | 7 | 3 | <1 | ||||||||||||
Philippine Peso (PHP) |
129 | 3 | - | <1 | ||||||||||||
British Pound (GBP) |
1 | 2 | 1 | <1 |
(1) | Represents contractual notionals at inception of trade. |
(2) | Represents the gross notional amounts times the probability of exercising the option, which is based on the relationship of changes in the option value with respect to changes in the price of the underlying currency. |
(3) | Represents the remaining tenor of our foreign currency options weighted by the corresponding notional. |
15
March 31, 2011 | ||||||||||||
Foreign Currency Forwards |
Notional | Notional Translated to USD |
Weighted Average Remaining Term(1) |
|||||||||
(in millions) | (in years) | |||||||||||
Chilean Peso (CLP) |
99,499 | $ | 203 | <1 | ||||||||
British Pound (GBP) |
19 | 31 | 1 | |||||||||
Colombian Peso (COP) |
36,564 | 19 | 1 | |||||||||
Argentine Peso (ARS) |
29 | 6 | <1 |
(1) | Represents the remaining tenor of our foreign currency forwards weighted by the corresponding notional. |
In addition, certain of our subsidiaries have entered into contracts which contain embedded derivatives that require separate valuation and accounting due to the fact that the item being purchased or sold is denominated in a currency other than the functional currency of that subsidiary or the currency of the item. These contracts range in maturity through 2025. The following table sets forth, by type of foreign currency denomination, the Companys outstanding notional over the remaining terms of its foreign currency embedded derivative instruments as of March 31, 2011:
March 31, 2011 | ||||||||||||
Embedded Foreign Currency Derivatives |
Notional | Notional Translated to USD |
Weighted Average Remaining Term(1) |
|||||||||
(in millions) | (in years) | |||||||||||
Philippine Peso (PHP) |
19,801 | $ | 457 | 3 | ||||||||
Kazakhstani Tenge (KZT) |
31,882 | 219 | 9 | |||||||||
Hungarian Forint (HUF) |
19,699 | 105 | 1 | |||||||||
Argentine Peso (ARS) |
315 | 78 | 9 | |||||||||
Euro (EUR) |
21 | 29 | 2 | |||||||||
Brazilian Real (BRL) |
13 | 8 | 1 | |||||||||
Cameroon Franc (XAF) |
775 | 2 | 2 |
(1) | Represents the remaining tenor of our foreign currency embedded derivatives weighted by the corresponding notional. |
Commodity Price Risk
We are exposed to the impact of market fluctuations in the price of electricity, fuel and environmental credits. Although we primarily consist of businesses with long-term contracts or retail sales concessions (which provide our distribution businesses with a franchise to serve a specific geographic region), a portion of our current and expected future revenues are derived from businesses without significant long-term purchase or sales contracts. These businesses subject our results of operations to the volatility of prices for electricity, fuel and environmental credits in competitive markets. We have used a hedging strategy, where appropriate, to hedge our financial performance against the effects of fluctuations in energy commodity prices. The implementation of this strategy can involve the use of commodity forward contracts, futures, swaps and options. Some of our businesses hedge certain aspects of their commodity risks using financial hedging instruments, as described below.
We also enter into short-term contracts for electricity and fuel in other competitive markets in which we operate. When hedging the output of our generation assets, we have PPAs or other hedging instruments that lock in the spread in dollars per MWh between the cost of fuel to generate a unit of electricity and the price at which the electricity can be sold (Dark Spread where the fuel is coal). The portion of our sales and fuel purchases that are not subject to such agreements will be exposed to commodity price risk.
The PPAs and fuel supply agreements entered into by the Company are evaluated to determine if they meet the definition of a derivative or contain embedded derivatives, either of which require separate valuation and
16
accounting. To be a derivative under the accounting standards for derivatives and hedging, an agreement would need to have a notional and an underlying, require little or no initial net investment and could be net settled. Generally, these agreements do not meet the definition of a derivative, often due to the inability to be net settled. On a quarterly basis, we evaluate the markets for the commodities to be delivered under these agreements to determine if facts and circumstances have changed such that the agreements could then be net settled and meet the definition of a derivative.
Nonetheless, certain of the PPAs and fuel supply agreements entered into by certain of the Companys subsidiaries are derivatives or contain embedded derivatives requiring separate valuation and accounting. These contracts range in maturity through 2024. The following table sets forth by type of commodity, the Companys outstanding notionals for the remaining term of its commodity derivatives and embedded derivative instruments as of March 31, 2011:
March 31, 2011 | ||||||||
Commodity Derivatives |
Notional | Weighted
Average Remaining Term(1) |
||||||
(in millions) | (in years) | |||||||
Natural gas (MMBtu) |
36 | 11 | ||||||
Petcoke (Metric tons) |
14 | 13 | ||||||
Aluminum (MWh) |
17 | (2) | 9 |
(1) | Represents the remaining tenor of our commodity and embedded derivatives weighted by the corresponding volume. |
(2) | Our exposure is to fluctuations in the price of aluminum while the notional is based on the amount of power we sell under the PPA. |
In addition, as part of a settlement agreement terminating the gas transportation contracts with Gasoducto GasAndes (Chile) S.A, we have an embedded derivative related to the dividends that could result from our 13% ownership in this gas transportation company.
17
Accounting and Reporting
The following table sets forth the Companys derivative instruments as of March 31, 2011 and December 31, 2010 by type of derivative and by level within the fair value hierarchy. Derivative assets and liabilities are recognized at their fair value. Derivative assets and liabilities are combined with other balances and included in the following captions in our condensed consolidated balance sheets: current derivative assets in other current assets, noncurrent derivative assets in other noncurrent assets, current derivative liabilities in accrued and other liabilities (except for one in non-recourse debt-current) and long-term derivative liabilities in other long-term liabilities.
March 31, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||||
(in millions) | (in millions) | |||||||||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||||||
Current assets: |
||||||||||||||||||||||||||||||||
Foreign currency derivatives |
$ | - | $ | 7 | $ | 3 | $ | 10 | $ | - | $ | 4 | $ | 3 | $ | 7 | ||||||||||||||||
Commodity and other derivatives |
- | 4 | 3 | 7 | - | 2 | 3 | 5 | ||||||||||||||||||||||||
Total current assets |
- | 11 | 6 | 17 | - | 6 | 6 | 12 | ||||||||||||||||||||||||
Noncurrent assets: |
||||||||||||||||||||||||||||||||
Interest rate derivatives |
- | 54 | - | 54 | - | 49 | - | 49 | ||||||||||||||||||||||||
Foreign currency derivatives |
- | 3 | 26 | 29 | - | 4 | 27 | 31 | ||||||||||||||||||||||||
Cross currency derivatives |
- | - | 11 | 11 | - | - | 12 | 12 | ||||||||||||||||||||||||
Commodity and other derivatives |
- | 6 | 22 | 28 | - | 4 | 16 | 20 | ||||||||||||||||||||||||
Total noncurrent assets |
- | 63 | 59 | 122 | - | 57 | 55 | 112 | ||||||||||||||||||||||||
Total assets |
$ | - | $ | 74 | $ | 65 | $ | 139 | $ | - | $ | 63 | $ | 61 | $ | 124 | ||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||||||
Current liabilities: |
||||||||||||||||||||||||||||||||
Interest rate derivatives |
$ | - | $ | 114 | $ | 5 | $ | 119 | $ | - | $ | 137 | $ | - | $ | 137 | ||||||||||||||||
Cross currency derivatives |
- | - | 6 | 6 | - | - | 2 | 2 | ||||||||||||||||||||||||
Foreign currency derivatives |
- | 5 | - | 5 | - | 13 | - | 13 | ||||||||||||||||||||||||
Commodity and other derivatives |
- | 4 | - | 4 | - | - | - | - | ||||||||||||||||||||||||
Total current liabilities |
- | 123 | 11 | 134 | - | 150 | 2 | 152 | ||||||||||||||||||||||||
Long-term liabilities: |
||||||||||||||||||||||||||||||||
Interest rate derivatives |
- | 201 | 2 | 203 | - | 246 | 1 | 247 | ||||||||||||||||||||||||
Foreign currency derivatives |
- | 13 | 6 | 19 | - | 15 | 8 | 23 | ||||||||||||||||||||||||
Commodity and other derivatives |
- | 1 | 1 | 2 | - | - | 1 | 1 | ||||||||||||||||||||||||
Total long-term liabilities |
- | 215 | 9 | 224 | - | 261 | 10 | 271 | ||||||||||||||||||||||||
Total liabilities |
$ | - | $ | 338 | $ | 20 | $ | 358 | $ | - | $ | 411 | $ | 12 | $ | 423 | ||||||||||||||||
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The following table sets forth the fair value and balance sheet classification of derivative instruments as of March 31, 2011 and December 31, 2010:
March 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
Designated as Hedging Instruments |
Not Designated as Hedging Instruments |
Total | Designated as Hedging Instruments |
Not Designated as Hedging Instruments |
Total | |||||||||||||||||||
(in millions) | (in millions) | |||||||||||||||||||||||
Assets |
||||||||||||||||||||||||
Current assets: |
||||||||||||||||||||||||
Foreign currency derivatives |
$ | - | $ | 10 | $ | 10 | $ | - | $ | 7 | $ | 7 | ||||||||||||
Commodity and other derivatives |
- | 7 | 7 | - | 5 | 5 | ||||||||||||||||||
Total current assets |
- | 17 | 17 | - | 12 | 12 | ||||||||||||||||||
Noncurrent assets: |
||||||||||||||||||||||||
Interest rate derivatives |
54 | - | 54 | 49 | - | 49 | ||||||||||||||||||
Foreign currency derivatives |
- | 29 | 29 | - | 31 | 31 | ||||||||||||||||||
Cross currency derivatives |
11 | - | 11 | 12 | - | 12 | ||||||||||||||||||
Commodity and other derivatives |
- | 28 | 28 | - | 20 | 20 | ||||||||||||||||||
Total noncurrent assets |
65 | 57 | 122 | 61 | 51 | 112 | ||||||||||||||||||
Total assets |
$ | 65 | $ | 74 | $ | 139 | $ | 61 | $ | 63 | $ | 124 | ||||||||||||
Liabilities |
||||||||||||||||||||||||
Current liabilities: |
||||||||||||||||||||||||
Interest rate derivatives |
$ | 112 | $ | 7 | $ | 119 | $ | 126 | $ | 11 | $ | 137 | ||||||||||||
Cross currency derivatives |
6 | - | 6 | 2 | - | 2 | ||||||||||||||||||
Foreign currency derivatives |
2 | 3 | 5 | 8 | 5 | 13 | ||||||||||||||||||
Commodity and other derivatives |
- | 4 | 4 | - | - | - | ||||||||||||||||||
Total current liabilities |
120 | 14 | 134 | 136 | 16 | 152 | ||||||||||||||||||
Long-term liabilities: |
||||||||||||||||||||||||
Interest rate derivatives |
189 | 14 | 203 | 232 | 15 | 247 | ||||||||||||||||||
Foreign currency derivatives |
- | 19 | 19 | - | 23 | 23 | ||||||||||||||||||
Commodity and other derivatives |
- | 2 | 2 | - | 1 | 1 | ||||||||||||||||||
Total long-term liabilities |
189 | 35 | 224 | 232 | 39 | 271 | ||||||||||||||||||
Total liabilities |
$ | 309 | $ | 49 | $ | 358 | $ | 368 | $ | 55 | $ | 423 | ||||||||||||
The Company has elected not to offset net derivative positions in the financial statements. Accordingly, the Company does not offset such derivative positions against the fair value of amounts (or amounts that approximate fair value) recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) under master netting arrangements. At March 31, 2011 and December 31, 2010, we held no cash collateral that we received from counterparties to our derivative positions. As we have not received collateral, our derivative assets are exposed to the credit risk of the respective counterparty and, due to this credit risk, the fair value of our derivative assets (as shown in the above two tables) have been reduced by a credit valuation adjustment. Also, at March 31, 2011 and December 31, 2010, we had no cash collateral posted with (held by) counterparties to our derivative positions.
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The table below sets forth the pre-tax accumulated other comprehensive income (loss) expected to be recognized as an increase (decrease) to income from continuing operations before income taxes over the next twelve months as of March 31, 2011 for the following types of derivatives:
Accumulated Other Comprehensive Income (Loss) |
||||
(in millions) | ||||
Interest rate derivatives |
$ | (74) | ||
Cross currency derivatives |
$ | (4) | ||
Foreign currency derivatives |
$ | (2) |
The balance in accumulated other comprehensive loss related to derivative transactions will be reclassified into earnings as interest expense is recognized for interest rate hedges and cross currency swaps, as depreciation is recognized for interest rate hedges during construction, and as foreign currency gains and losses are recognized for hedges of foreign currency exposure. These balances are included in the condensed consolidated statements of cash flows as operating and/or investing activities based on the nature of the underlying transaction.
The following tables set forth the gains (losses) recognized in accumulated other comprehensive loss (AOCL) and earnings related to the effective portion of derivative instruments in qualifying cash flow hedging relationships, as defined in the accounting standards for derivatives and hedging, for the three months ended March 31, 2011 and 2010:
Gains (Losses) Recognized in AOCL |
Gains (Losses) Reclassified from AOCL into Earnings(1) |
|||||||||||||||||
Three Months Ended March 31, |
Classification in
Condensed Statement of Operations |
Three Months Ended March 31, |
||||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||||
(in millions) | (in millions) | |||||||||||||||||
Interest rate derivatives |
$ | 52 | $ | (82 | ) | Interest expense |
$ | (26 | )(2) | $ | (28 | )(2) | ||||||
Non-regulated cost of sales |
(1 | ) | - | |||||||||||||||
Net equity in earnings of affiliates |
(1 | ) | (1 | ) | ||||||||||||||
Cross currency derivatives |
(8 | ) | (3 | ) | Interest expense |
(5 | ) | (1 | ) | |||||||||
Foreign currency derivatives |
5 | - | Foreign currency transaction gains (losses) |
(2 | ) | - | ||||||||||||
Commodity derivatives electricity |
1 | 12 | Non-regulated revenue |
- | - | |||||||||||||
Total |
$ | 50 | $ | (73 | ) | $ | (35 | ) | $ | (30 | ) | |||||||
(1) | Excludes $0 million and $(2) million related to discontinued operations for the three months ended March 31, 2011 and 2010, respectively. |
(2) | Includes amounts that were reclassified from AOCL related to derivative instruments that previously, but no longer, qualify for cash flow hedge accounting. |
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The following table sets forth the pre-tax gains (losses) recognized in earnings related to the ineffective portion of derivative instruments in qualifying cash flow hedging relationships, as defined in the accounting standards for derivatives and hedging, for the three months ended March 31, 2011 and 2010:
Classification in Condensed Consolidated Statement of Operations |
Gains (Losses) Recognized in Earnings |
|||||||||
Three Months Ended March 31, |
||||||||||
2011 | 2010 | |||||||||
(in millions) | ||||||||||
Interest rate derivatives |
Interest expense |
$ | (7) | $ | (8) | |||||
Net equity in earnings of affiliates |
- | (1) | - | (1) | ||||||
Cross currency derivatives |
Interest expense |
- | (1) | 5 | ||||||
Foreign currency derivatives |
Foreign currency transaction gains (losses) |
- | (1) | - | (1) | |||||
Total |
$ | (7) | $ | (3) | ||||||
(1) | De minimis amount. |
The following table sets forth the gains (losses) recognized in earnings related to derivative instruments not designated as hedging instruments under the accounting standards for derivatives and hedging, for the three months ended March 31, 2011 and 2010:
Classification in Condensed |
Gains (Losses) Recognized in Earnings |
|||||||||
Three Months Ended March 31, |
||||||||||
2011 | 2010 | |||||||||
(in millions) | ||||||||||
Interest rate derivatives |
Interest expense |
$ | - | $ | (4 | ) | ||||
Foreign exchange derivatives |
Foreign currency transaction gains (losses) |
7 | 2 | |||||||
Net equity in earnings of affiliates |
- | 1 | ||||||||
Commodity derivatives |
Non-regulated revenue |
4 | - | |||||||
Non-regulated cost of sales |
1 | 4 | ||||||||
Total |
$ | 12 | $ | 3 | ||||||
In addition, IPL has two derivative instruments for which the gains and losses are accounted for in accordance with accounting standards for regulated operations, as regulatory assets or liabilities. Gains and losses on these derivatives due to changes in the fair value of these derivatives are probable of recovery through future rates and are initially recognized as an adjustment to the regulatory asset or liability and recognized through earnings when the related costs are recovered through IPLs rates. Therefore, these gains and losses are excluded from the above table. The following table sets forth the change in regulatory assets and liabilities resulting from the change in the fair value of these derivatives for the three months ended March 31, 2011 and 2010:
March 31, | ||||||||
2011 | 2010 | |||||||
(in millions) | ||||||||
(Increase) in regulatory assets |
$ | - | $ | (1 | ) | |||
(Decrease) in regulatory liabilities |
$ | (1 | ) | $ | (1 | ) |
21
Credit Risk-Related Contingent Features
Gener, our business in Chile, has cross currency swap agreements with counterparties to swap Chilean inflation indexed bonds issued in December 2007 into U.S. Dollars. The derivative agreements contain credit contingent provisions which would permit the counterparties with which Gener is in a net liability position to require collateral credit support when the fair value of the derivatives exceeds the unsecured thresholds established in the agreement. These thresholds vary based on Geners credit rating. If Geners credit rating were to fall below the minimum threshold established in the swap agreements, the counterparties can demand immediate collateralization of the entire mark-to-market value of the swaps (excluding credit valuation adjustments) if Gener is in a net liability position. The mark-to-market value of the swaps was in a net asset position at March 31, 2011 and December 31, 2010. As of March 31, 2011 and December 31, 2010, Gener had not posted collateral to support these swaps.
6. INVESTMENTS IN AND ADVANCES TO AFFILIATES
In February 2011, the Company acquired a 49.6% interest in Entek Elektrik Uretim A.S. (Entek) for approximately $136 million. Entek owns and operates two gas-fired generation facilities with an aggregate capacity of 312 MW in Turkey, and is also engaged in an energy trading business. The Company has significant influence, but not control of Entek and accordingly the investment has been accounted for under the equity method of accounting.
7. FINANCING RECEIVABLES
Accounts and notes receivable are carried at amortized cost. The Company periodically assesses the collectability of accounts receivable considering factors such as specific evaluation of collectability, historical collection experience, the age of accounts receivable and other currently available evidence of the collectability, and records an allowance for doubtful accounts for the estimated uncollectable amount as appropriate. Certain of our businesses charge interest on accounts receivable either under contractual terms or where charging interest is a customary business practice. In such cases, interest income is recognized on an accrual basis. In situations where the collection of interest is uncertain, interest income is recognized as cash is received. Individual accounts and notes receivable are written off when they are no longer deemed collectable.
Included in Noncurrent other assets on the condensed consolidated balance sheets as of March 31, 2011 and December 31, 2010 are long-term financing receivables of $146 million and $151 million, respectively, primarily with certain Latin American governmental bodies. These receivables have contractual maturities of greater than one year and are being collected in installments. Of the total $146 million as of March 31, 2011, amounts of $78 million and $54 million, respectively, relate to our businesses in Argentina and the Dominican Republic. The remaining amounts relate to our distribution businesses in Brazil.
8. DEBT
The Company has two types of debt reported on its condensed consolidated balance sheet: non-recourse and recourse debt. Non-recourse debt is used to fund investments and capital expenditures for the construction and acquisition of electric power plants, wind projects, distribution companies and other project-related investments at our subsidiaries. Non-recourse debt is generally secured by the capital stock, physical assets, contracts and cash flows of the related subsidiary. Absent guarantees, intercompany loans or other credit support, the default risk is limited to the respective business and is without recourse to the Parent Company and other subsidiaries, though the Companys equity investments and/or subordinated loans to projects (if any) are at risk. Recourse
22
debt is direct borrowings by the Parent Company and is used to fund development, construction or acquisitions, including serving as funding for equity investments or loans to the affiliates. The Parent Companys debt is, among other things, recourse to the Parent Company and is structurally subordinated to the affiliates debt.
The following table summarizes the carrying amount and estimated fair values of the Companys recourse and non-recourse debt as of March 31, 2011 and December 31, 2010:
March 31, 2011 | December 31, 2010 | |||||||||||||||
Carrying Amount |
Fair Value | Carrying Amount |
Fair Value | |||||||||||||
(in millions) | ||||||||||||||||
Non-recourse debt |
$ | 15,102 | $ | 15,396 | $ | 14,939 | $ | 15,269 | ||||||||
Recourse debt |
4,350 | 4,691 | 4,612 | 4,868 | ||||||||||||
Total debt |
$ | 19,452 | $ | 20,087 | $ | 19,551 | $ | 20,137 | ||||||||
Recourse and non-recourse debt are carried at amortized cost. The fair value of recourse debt is estimated based on quoted market prices. The fair value of non-recourse debt is estimated differently based upon the type of loan. The fair value of fixed rate loans is estimated using quoted market prices, if available, or a discounted cash flow analysis. In the discounted cash flow analysis, the discount rate is based on the credit rating of the individual debt instruments if available, or the credit rating of the subsidiary. If the subsidiarys credit rating is not available, a synthetic credit rating is determined using certain key metrics, including cash flow ratios and interest coverage, as well as other industry specific factors. For subsidiaries located outside the U.S., in the event that the country rating is lower than the credit rating previously determined, the country rating is used for the purposes of the discounted cash flow analysis. The fair value of recourse and non-recourse debt excludes accrued interest at the valuation date.
The estimated fair value was determined using available market information as of March 31, 2011. The Company is not aware of any factors that would significantly affect the fair value amounts subsequent to March 31, 2011.
Non-Recourse Debt
The following table summarizes the Companys subsidiary non-recourse debt in default or accelerated as of March 31, 2011 and is in the current portion of non-recourse debt unless otherwise indicated:
Subsidiary |
Primary Nature of Default |
March 31, 2011 | ||||||||||
Default | Net Assets | |||||||||||
(in millions) | ||||||||||||
Maritza |
Covenant | $ | 1,015 | $ | 273 | |||||||
Sonel |
Covenant | 388 | 384 | |||||||||
Kelanitissa |
Covenant | 28 | 35 | |||||||||
Aixi |
Payment | 4 | (8 | ) | ||||||||
Total |
$ | 1,435 | ||||||||||
Included in Current liabilities of discontinued and held for sale businesses in the condensed consolidated balance sheet as of March 31, 2011 is approximately $179 million of non-recourse debt relating to our businesses in New York, which has been classified as current due to certain facts and circumstances that create significant uncertainty about the businesss ability to generate sufficient cash flows and remain in compliance with the terms of its contractual obligations in the next twelve months.
None of the subsidiaries that are currently in default are subsidiaries that met the applicable definition of materiality under AES corporate debt agreements as of March 31, 2011 in order to trigger an event of default or
23
permit acceleration under such indebtedness. The bankruptcy or acceleration of material amounts of debt at such entities would cause a cross default under the recourse senior secured credit facility. However, as a result of additional dispositions of assets, other significant reductions in asset carrying values or other matters in the future that may impact our financial position and results of operations or the financial position or results of operations of the individual subsidiary, it is possible that one or more of these subsidiaries could fall within the definition of a material subsidiary and thereby a bankruptcy or an acceleration of its non-recourse debt trigger an event of default and possible acceleration of the indebtedness under the AES Parent Companys outstanding debt securities.
9. CONTINGENCIES AND COMMITMENTS
Environmental
The Company periodically reviews its obligations as they relate to compliance with environmental laws, including site restoration and remediation. As of March 31, 2011, the Company had recorded liabilities of $23 million for projected environmental remediation costs. Due to the uncertainties associated with environmental assessment and remediation activities, future costs of compliance or remediation could be higher or lower than the amount currently accrued. Based on currently available information and analysis, the Company believes that it is reasonably possible that costs associated with such liabilities, or as yet unknown liabilities, may exceed current reserves in amounts that could be material but cannot be estimated as of March 31, 2011.
The Company is subject to numerous environmental laws and regulations in the jurisdictions in which it operates. The Company expenses environmental regulation compliance costs as incurred unless the underlying expenditure qualifies for capitalization under its property, plant and equipment policies. The Company faces certain risks and uncertainties related to these environmental laws and regulations, including existing and potential greenhouse gas (GHG) legislation or regulations, and actual or potential laws and regulations pertaining to water discharges, waste management (including disposal of coal combustion byproducts), and certain air emissions, such as SO2, NOx, particulate matter and mercury. Such risks and uncertainties could result in increased capital expenditures or other compliance costs which could have a material adverse effect on certain of our U.S. or international subsidiaries and our consolidated results of operations.
Legislation and Regulation of GHG Emissions.
Currently, in the United States there is no Federal legislation establishing mandatory GHG emissions reduction programs (including CO2) affecting the electric power generation facilities of the Companys subsidiaries. There are numerous state programs regulating GHG emissions from electric power generation facilities and there is a possibility that federal GHG legislation will be enacted within the next several years. Further, the United States Environmental Protection Agency (EPA) has adopted regulations pertaining to GHG emissions and has announced its intention to propose new regulations for electric generating units under Section 111 of the United States Clean Air Act (CAA).
Potential U.S. Federal GHG Legislation. Federal legislation passed the U.S. House of Representatives in 2009 that, if adopted, would have imposed a nationwide cap-and-trade program to reduce GHG emissions. This legislation was never signed into law, and is no longer under consideration. In the U.S. Senate, several different draft bills pertaining to GHG legislation have been considered, including comprehensive GHG legislation similar to the legislation that passed the U.S. House of Representatives and more limited legislation focusing only on the utility and electric generation industry. It is uncertain whether any legislation pertaining to GHG emissions will be voted on and passed by the U.S. Senate and House of Representatives. If any such legislation is enacted into law, the impact could be material to the Company.
EPA GHG Regulation. The EPA has promulgated regulations governing GHG emissions from automobiles under the CAA. The effect of EPAs regulation of GHG emissions from mobile sources is that
24
certain provisions of the CAA will also apply to GHG emissions from existing stationary sources, including many U.S. power plants. In particular, beginning January 2, 2011, construction of new stationary sources and modifications to existing stationary sources that result in increased GHG emissions became subject to permitting requirements under the prevention of significant deterioration (PSD) program of the CAA. The PSD program, as currently applicable to GHG emissions, requires sources that emit above a certain threshold of GHGs to obtain PSD permits prior to commencement of new construction or modifications to existing facilities. In addition, major sources of GHG emissions may be required to amend, or obtain new, Title V air permits under the CAA to reflect any new applicable GHG emissions requirements for new construction or for modifications to existing facilities.
The EPA promulgated a final rule on June 3, 2010, (the Tailoring Rule) that sets thresholds for GHG emissions that would trigger PSD permitting requirements. The Tailoring Rule, which became effective in January of 2011, provides that sources already subject to PSD permitting requirements need to install Best Available Control Technology (BACT) for greenhouse gases if a proposed modification would result in the increase of more than 75,000 tons per year of GHG emissions. Also, under the Tailoring Rule, commencing in July of 2011, any new sources of GHG emissions that would emit over 100,000 tons per year of GHG emissions, in addition to any modification that would result in GHG emissions exceeding 75,000 tons per year, would require PSD review and be subject to related permitting requirements. The EPA anticipates that it will adjust downward the permitting thresholds of 100,000 tons and 75,000 tons for new sources and modifications, respectively, in future rulemaking actions. The Tailoring Rule substantially reduces the number of sources subject to PSD requirements for GHG emissions and the number of sources required to obtain Title V air permits, although new thermal power plants may still be subject to PSD and Title V requirements because annual GHG emissions from such plants typically far exceed the 100,000 ton threshold noted above. The 75,000 ton threshold for increased GHG emissions from modifications to existing sources may reduce the likelihood that future modifications to plants owned by some of our United States subsidiaries would trigger PSD requirements, although some projects that would expand capacity or electric output are likely to exceed this threshold, and in any such cases the capital expenditures necessary to comply with the PSD requirements could be significant.
In December 2010, the EPA entered into a settlement agreement with several states and environmental groups to resolve a petition for review challenging the EPAs new source performance standards (NSPS) rulemaking for electric utility steam generating units (EUSGUs) based on the NSPSs failure to address GHG emissions. Under the settlement agreement, the EPA has committed to propose GHG emissions standards for EUSGUs by July 26, 2011 and to finalize GHG emissions standards for EUSGUs by May 26, 2012. The NSPS will establish GHG emission standards for newly constructed and reconstructed EUSGUs. The NSPS also will establish guidelines regarding the best system for achieving further GHG emissions reductions from EUSGUs and, based on such guidelines, individual states will be required to submit plans to the EPA to establish GHG emission standards for existing EUSGUs within their states. It is impossible to estimate the impact and compliance cost associated with any future NSPS applicable to EUSGUs until such regulations are finalized. However, the compliance costs could have a material and adverse impact on our consolidated financial condition or results of operations.
Regional Greenhouse Gas Initiative. To date, the primary regulation of GHG emissions affecting the Companys U.S. plants has been through the Regional Greenhouse Gas Initiative (RGGI). Under RGGI, ten Northeastern States have coordinated to establish rules that require reductions in CO2 emissions from power plant operations within those states through a cap-and-trade program. States participating in RGGI in which our subsidiaries have generating facilities include Connecticut, Maryland, New York and New Jersey. Under RGGI, power plants must acquire one carbon allowance through auction or in the emission trading markets for each ton of CO2 emitted. As noted in the Companys 2010 Form 10-K, we have estimated the costs to the Company of compliance with RGGI to be approximately $15 million for 2011.
International GHG Regulation. The primary international agreement concerning GHG emissions is the Kyoto Protocol, which became effective on February 16, 2005 and requires the industrialized countries that have
25
ratified it to significantly reduce their GHG emissions. The vast majority of the developing countries which have ratified the Kyoto Protocol have no GHG emissions reduction requirements. Many of the countries in which the Companys subsidiaries operate have no emissions reduction obligations under the Kyoto Protocol. In addition, of the 28 countries in which the Companys subsidiaries operate, all but one the United States (including Puerto Rico) have ratified the Kyoto Protocol. The Kyoto Protocol is currently expected to expire at the end of 2012, and countries have been unable to agree on a successor agreement. The next annual United Nations conference to develop a successor international agreement is scheduled for November 2011 in South Africa. It currently appears unlikely that a successor agreement will be reached at such conference; however, if a successor agreement is reached the impact could be material to the Company.
There is substantial uncertainty with respect to whether U.S. federal GHG legislation will be enacted into law, whether new country-specific GHG legislation will be adopted in countries in which our subsidiaries conduct business, and whether a new international agreement to succeed the Kyoto Protocol will be reached. There is additional uncertainty regarding the final provisions or implementation of any potential U.S. federal or foreign country GHG legislation, the EPAs rules regulating GHG emissions and any international agreement to succeed the Kyoto Protocol. In light of these uncertainties, the Company cannot accurately predict the impact on its consolidated results of operations or financial condition from potential U.S. federal or foreign country GHG legislation, the EPAs regulation of GHG emissions or any new international agreement on such emissions, or make a reasonable estimate of the potential costs to the Company associated with any such legislation, regulation or international agreement; however, the impact from any such legislation, regulation or international agreement could have a material adverse effect on certain of our U.S. or international subsidiaries and on the Company and its consolidated results of operations.
Other U.S. Air Emissions Regulations and Legislation
The Companys subsidiaries in the United States are subject to the Clean Air Act (CAA) and various state laws and regulations that regulate emissions of air pollutants, including SO2, NOX, particulate matter (PM), mercury and other hazardous air pollutants (HAPs).
The EPA promulgated the Clean Air Interstate Rule (CAIR) on March 10, 2005, which required allowance surrender for SO2 and NOX emissions from existing power plants located in 28 eastern states and the District of Columbia. CAIR was subsequently challenged in federal court, and on July 11, 2008, the United States Court of Appeals for the D.C. Circuit issued an opinion striking down much of CAIR and remanding it to the EPA. In response to the D.C. Circuits opinion, on July 6, 2010, the EPA issued a new proposed rule (the Clean Air Transport Rule) to replace CAIR. The final Clean Air Transport Rule (Transport Rule) is scheduled to be issued by July 2011. The Transport Rule would require significant additional reductions in SO2 and NOX emissions in 31 states and the District of Columbia starting in 2012, including several states where subsidiaries of the Company conduct business.
The Transport Rule contemplates three possible options for reducing SO2 and NOX emissions in the designated states. The EPAs preferred option contemplates a set limit or budget on SO2 and NOX emissions for each of the states, with limited interstate trading of emissions allowances and unlimited intrastate trading of SO2 and NOX emissions allowances. Affected power plants would receive emissions allowances based on the applicable state emissions budgets. The EPAs second option under the Transport Rule would establish emission budgets for each state, but only allow intrastate trading of emissions allowances. The final option would set emission rate limitations for each power plant, but would allow for some intrastate averaging of emission rates. Under any of the proposed options, additional pollution control technology may be required by some of our subsidiaries, and the cost of implementing any such technology could affect the financial condition or results of operations of these subsidiaries or the parent company. The EPA has received public comments on the Transport Rule, and such public comments will be considered by the EPA prior to promulgating a final rule.
As a result of prior EPA determinations and the D.C. Circuit Court ruling, the EPA is obligated under Section 112 of the CAA to develop a rule requiring pollution controls for hazardous air pollutants, including
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mercury, hydrogen chloride, hydrogen fluoride, and nickel species from coal and oil-fired power plants. The EPA has entered into a consent decree under which it is obligated to finalize the rule by November 2011. In connection with such rule, the CAA requires the EPA to establish maximum achievable control technology (MACT) standards for each pollutant regulated under the rule. MACT is defined as the emission limitation achieved by the best performing 12% of sources in the source category. The EPA issued a proposed rule on March 16, 2011 that would establish national emissions standards for hazardous air pollutants (NESHAP) from coal- and oil-fired electric utility steam generating units. The rule, as currently proposed, may require all coal-fired power plants to install acid gas control technology, upgrade particulate control devices and/or install some other type of mercury control technology, such as sorbent injection. The EPA is receiving public comments on the proposed rule, and such public comments will be considered by the EPA prior to promulgating a final rule. Most of the United States coal-fired plants operated by the Companys subsidiaries have acid gas scrubbers or comparable control technologies, but as proposed there are other improvements to such control technologies that may be needed at some of our plants. Under the CAA, compliance is required within three years of the effective date of the rule; however, the compliance period for a unit, or group of units, may be extended by state permitting authorities (for one additional year) or through a determination by the President (for up to two additional years). At this time, the Company cannot predict the extent of the final regulations for hazardous air pollutants, but the cost of compliance with any such regulations could be material.
Other International Air Emissions Regulations and Legislation.
On January 18, 2011, the President of Chile approved a new air emissions regulation submitted to him by the national environmental regulatory agency (CONAMA). The new regulation establishes limits on emissions of NOX, SO2, metals and particulate matter for both existing and new thermal power plants, with more stringent limitations on new facilities. The regulation will become effective upon approval of the General Comptroller of Chile. The regulation will require AES Gener, our Chilean subsidiary, to install emissions reduction equipment at its existing thermal plants from late 2011 through 2015. The exact costs of compliance with such regulation have not yet been determined and the Company believes some of the compliance costs are contractually passed through to counterparties. However, the compliance costs could be material.
Cooling Water Intake Regulations.
The Companys U.S. facilities are subject to the U.S. Clean Water Act Section 316(b) rule issued by the EPA which seeks to protect fish and other aquatic organisms by requiring existing steam electric generating facilities to utilize the best technology available for cooling water intake structures. The EPA published a proposed rule establishing requirements under 316(b) regulations on April 20, 2011. The proposal, based on Section 316(b) of the U.S. Clean Water Act, establishes Best Technology Available (BTA) requirements regarding impingement standards with respect to aquatic organisms for all facilities that withdraw above 2 million gallons per day of water from certain water bodies and utilize at least 25% of the withdrawn water for cooling purposes. To meet these BTA requirements, as currently proposed, cooling water intake structures associated with once through cooling processes will need modifications of existing traveling screens that protect aquatic organisms and will need to add a fish return and handling system for each cooling system. Existing closed cycle cooling facilities may require upgrades to water intake structure systems. The proposal would also require comprehensive site-specific studies during the permitting process and may require closed-cycle cooling systems in order to meet BTA entrainment standards.
The EPA is accepting public comments on the proposed rule until July 2011, and until such regulations are final the EPA has instructed state regulatory agencies to use their best professional judgment in determining how to evaluate what constitutes best technology available for protecting fish and other aquatic organisms from cooling water intake structures. Certain states in which the Company operates power generation facilities, such as New York, have been delegated authority and are moving forward with best technology available determinations in the absence of any final rule from the EPA. On September 27, 2010, the California Office of Administrative Law approved a policy adopted by the California Water Resources Control Board with respect to power plant
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cooling water intake structures. This policy became effective on October 1, 2010, and establishes technology-based standards to implement Section 316(b) of the U.S. Clean Water Act. At this time, it is contemplated that the Companys Redondo Beach, Huntington Beach and Alamitos power plants in California will need to have in place best technology available by December 31, 2020, or repower the facilities. At present, the Company cannot predict the final requirements under Section 316(b) or whether compliance with the anticipated new 316(b) rule will have a material impact on our operations or results, but the Company expects that capital investments and/or modifications resulting from such requirements could be significant.
Waste Management.
In the course of operations, many of the Companys facilities generate coal combustion byproducts (CCB), including fly ash, requiring disposal or processing. On June 21, 2010 the EPA published in the Federal Register a proposed rule to regulate CCB under the Resource Conservation and Recovery Act (RCRA). The proposed rule provides two possible options for CCB regulation, and both options contemplate heightened structural integrity requirements for surface impoundments of CCB. The first option contemplates regulation of CCB as a hazardous waste subject to regulation under Subtitle C of the RCRA. Under this option, existing surface impoundments containing CCB would be required to be retrofitted with composite liners and these impoundments would likely be phased out over several years. State and/or federal permit programs would be developed for storage, transport and disposal of CCB. States could bring enforcement actions for non-compliance with permitting requirements, and the EPA would have oversight responsibilities as well as the authority to bring lawsuits for non-compliance. The second option contemplates regulation of CCB under Subtitle D of the RCRA. Under this option, the EPA would create national criteria applicable to CCB landfills and surface impoundments. Existing impoundments would also be required to be retrofitted with composite liners and would likely be phased out over several years. This option would not contain federal or state permitting requirements. The primary enforcement mechanism under regulation pursuant to Subtitle D would be private lawsuits.
The public comment period for this proposed regulation has expired, and EPA is required to consider the public comments prior to promulgating a final rule. Requirements under a final rule are expected to become effective by January 2012, with a compliance schedule of five years. While the exact impact and compliance cost associated with future regulations of CCB cannot be established until such regulations are finalized, there can be no assurance that the Companys businesses, financial condition or results of operations would not be materially and adversely affected by such regulations.
Guarantees, Letters of Credit and Commitments
In connection with certain project financing, acquisition, power purchase, and other agreements, AES has expressly undertaken limited obligations and commitments, most of which will only be effective or will be terminated upon the occurrence of future events. In the normal course of business, AES has entered into various agreements, mainly guarantees and letters of credit, to provide financial or performance assurance to third parties on behalf of AES businesses. These agreements are entered into primarily to support or enhance the creditworthiness otherwise achieved by a business on a stand-alone basis, thereby facilitating the availability of sufficient credit to accomplish their intended business purposes. Most of the contingent obligations primarily relate to future performance commitments which the Company or its businesses expect to fulfill within the normal course of business. The expiration dates of these guarantees vary from less than one year to more than 15 years.
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The following table summarizes the Parent Companys contingent contractual obligations as of March 31, 2011. Amounts presented in the table below represent the Parent Companys current undiscounted exposure to guarantees and the range of maximum undiscounted potential exposure. The maximum exposure is not reduced by the amounts, if any, that could be recovered under the recourse or collateralization provisions in the guarantees. The amounts include obligations made by the Parent Company for the direct benefit of the lenders associated with the non-recourse debt of businesses of $39 million.
Contingent contractual obligations |
Amount | Number of Agreements |
Maximum Exposure Range for Each Agreement |
|||||||||
(in millions) | (in millions) | |||||||||||
Guarantees |
$ | 344 | 22 | < $1 - $53 | ||||||||
Letters of credit under the senior secured credit facility |
28 | 14 | < $1 - $16 | |||||||||
Cash collateralized letters of credit |
27 | 12 | < $1 - $15 | |||||||||
Total |
$ | 399 | 48 | |||||||||
As of March 31, 2011, the Company had $58 million of commitments to invest in subsidiaries under construction and to purchase related equipment that were not included in the letters of credit discussed above. The Company expects to fund these net investment commitments in 2011. The exact payment schedules will be dictated by the construction milestones. We expect to fund these commitments from a combination of current liquidity and internally generated Parent Company cash flow.
Litigation
The Company is involved in certain claims, suits and legal proceedings in the normal course of business, some of which are described below. The Company has accrued for litigation and claims where it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. The Company has evaluated claims in accordance with the accounting guidance for contingencies that it deems both probable and reasonably estimable and accordingly, has recorded aggregate reserves for all claims of approximately $466 million and $448 million as of March 31, 2011 and December 31, 2010, respectively. These reserves are reported on the condensed consolidated balance sheets within accrued and other liabilities and other long-term liabilities. A significant portion of the reserves relate to employment, non-income tax and customer disputes in international jurisdictions, principally Brazil. Certain of the Companys subsidiaries, principally in Brazil, are defendants in a number of labor and employment lawsuits. The complaints generally seek unspecified monetary damages, injunctive relief, or other relief. The subsidiaries have denied any liability and intend to vigorously defend themselves in all of these proceedings. There can be no assurance that these reserves will be adequate to cover all existing and future claims or that we will have the liquidity to pay such claims as they arise.
The Company believes, based upon information it currently possesses and taking into account established reserves for liabilities and its insurance coverage, that the ultimate outcome of these proceedings and actions is unlikely to have a material effect on the Companys financial statements. However, even where no reserve has been recognized, it is reasonably possible that some matters could be decided unfavorably to the Company and could require the Company, to pay damages or make expenditures in amounts that could be material but could not be estimated as of March 31, 2011. The material contingencies where a loss is reasonably possible are described below. In aggregate, the Company estimates that the range of potential losses related to these material contingences to be up to $1.8 billion. The amounts considered reasonably possible do not include amounts reserved discussed above. Where a loss or range of loss cannot be estimated, a statement to this effect has been included in the applicable case descriptions presented below.
In 1989, Centrais Elétricas Brasileiras S.A. (Eletrobrás) filed suit in the Fifth District Court in the State of Rio de Janeiro against Eletropaulo Eletricidade de São Paulo S.A. (EEDSP) relating to the methodology for calculating monetary adjustments under the parties financing agreement. In April 1999, the Fifth District Court
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found for Eletrobrás and in September 2001, Eletrobrás initiated an execution suit in the Fifth District Court to collect approximately R$1.1 billion ($668 million) from Eletropaulo (as estimated by Eletropaulo) and a lesser amount from an unrelated company, Companhia de Transmissão de Energia Elétrica Paulista (CTEEP) (Eletropaulo and CTEEP were spun off from EEDSP pursuant to its privatization in 1998). In November 2002, the Fifth District Court rejected Eletropaulos defenses in the execution suit. Eletropaulo appealed and in September 2003, the Appellate Court of the State of Rio de Janeiro (AC) ruled that Eletropaulo was not a proper party to the litigation because any alleged liability had been transferred to CTEEP pursuant to the privatization. In June 2006, the Superior Court of Justice (SCJ) reversed the Appellate Courts decision and remanded the case to the Fifth District Court for further proceedings, holding that Eletropaulos liability, if any, should be determined by the Fifth District Court. Eletropaulos subsequent appeals to the Special Court (the highest court within the SCJ) and the Supreme Court of Brazil were dismissed. Eletrobrás later requested that the amount of Eletropaulos alleged debt be determined by an accounting expert appointed by the Fifth District Court. Eletropaulo consented to the appointment of such an expert, subject to a reservation of rights. In February 2010, the Fifth District Court appointed an accounting expert to determine the amount of the alleged debt and the responsibility for its payment in light of the privatization, in accordance with the methodology proposed by Eletrobrás. Pursuant to its reservation of rights, Eletropaulo filed an interlocutory appeal with the AC asserting that the expert was required to determine the issues in accordance with the methodology proposed by Eletropaulo, and that Eletropaulo should be entitled to take discovery and present arguments on the issues to be determined by the expert. In April 2010, the AC issued a decision agreeing with Eletropaulos arguments and directing the Fifth District Court to proceed accordingly. Eletrobrás has restarted the accounting proceedings at the Fifth District Court, which will proceed in accordance with the ACs April 2010 decision. In the Fifth District Court proceedings, the experts conclusions will be subject to the Fifth District Courts review and approval. If Eletropaulo is determined to be responsible for the debt, after the amount of the alleged debt is determined, Eletrobrás will be entitled to resume the execution suit in the Fifth District Court at any time. If Eletrobrás does so, Eletropaulo will be required to provide security in the amount of its alleged liability. In that case, if Eletrobrás requests the seizure of such security and the Fifth District Court grants such request, Eletropaulos results of operations may be materially adversely affected, and in turn the Companys results of operations could be materially adversely affected. In addition, in February 2008, CTEEP filed a lawsuit in the Fifth District Court against Eletrobrás and Eletropaulo seeking a declaration that CTEEP is not liable for any debt under the financing agreement. The parties are disputing the proper venue for the CTEEP lawsuit. Eletropaulo believes it has meritorious defenses to the claims asserted against it and will defend itself vigorously in these proceedings; however, there can be no assurances that it will be successful in its efforts.
In August 2000, the Federal Energy Regulatory Commission (FERC) announced an investigation into the organized California wholesale power markets to determine whether rates were just and reasonable. Further investigations involved alleged market manipulation. FERC requested documents from each of the AES Southland, LLC plants and AES Placerita, Inc. AES Southland and AES Placerita have cooperated fully with the FERC investigations. AES Southland was not subject to refund liability because it did not sell into the organized spot markets due to the nature of its tolling agreement. After hearings at FERC, AES Placerita was found subject to refund liability of $588,000 plus interest for spot sales to the California Power Exchange from October 2, 2000 to June 20, 2001. As FERC investigations and hearings progressed, numerous appeals on related issues were filed with the U.S. Court of Appeals for the Ninth Circuit. Over the years, the Ninth Circuit issued several opinions that had the potential to expand the scope of the FERC proceedings and increase refund exposure for AES Placerita and other sellers of electricity. Following remand of one of the Ninth Circuit appeals in March 2009, FERC started a new hearing process involving AES Placerita and other sellers. In May 2009, AES Placerita entered into a settlement, approved by FERC in July 2009, concerning the claims before FERC against AES Placerita relating to the California energy crisis of 2000-2001, including the California refund proceeding. Pursuant to the settlement, AES Placerita paid $6 million and assigned a receivable of $168,119 due to it from the California Power Exchange in return for a release of all claims against it at FERC by the settling parties and other consideration. More than 98% of the buyers in the market elected to join the settlement. A small amount of AES Placeritas settlement payment was placed in escrow for buyers that did not join the settlement (non-settling parties). It is unclear whether the escrowed funds will be enough to satisfy any additional sums that
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might be determined to be owed to non-settling parties at the conclusion of the FERC proceedings concerning the California energy crisis. However, any such additional sums are expected to be immaterial to the Companys consolidated financial statements. In November 2009, one non-settling party, the Sacramento Municipal Utility District (SMUD), filed an appeal of the FERCs approval of the settlement which is pending in the Ninth Circuit. SMUDs appeal has been stayed pending further order of the court. The settlement agreement is still effective and will continue to remain effective unless it is vacated by the Ninth Circuit. SMUD has reached a settlement in principal with buyers of electricity that, if approved by FERC, will leave only immaterial claims of non-settling parties against AES Placerita. As a consequence of SMUDs settlement, it will withdraw its appeal of the Placerita order. In March 2011, the FERC approved the sale of AES Placerita to an unaffiliated entity. Pursuant to the stock purchase agreement, certain AES affiliates agreed to indemnify the purchaser against losses related to the claims against AES Placerita in the FERC proceedings, which losses, if any, are expected to be immaterial to the Companys consolidated financial statements.
In August 2001, the Grid Corporation of Orissa, India, now Gridco Ltd. (Gridco), filed a petition against the Central Electricity Supply Company of Orissa Ltd. (CESCO), an affiliate of the Company, with the Orissa Electricity Regulatory Commission (OERC), alleging that CESCO had defaulted on its obligations as an OERC-licensed distribution company, that CESCO management abandoned the management of CESCO, and asking for interim measures of protection, including the appointment of an administrator to manage CESCO. Gridco, a state-owned entity, is the sole wholesale energy provider to CESCO. Pursuant to the OERCs August 2001 order, the management of CESCO was replaced with a government administrator who was appointed by the OERC. The OERC later held that the Company and other CESCO shareholders were not necessary or proper parties to the OERC proceeding. In August 2004, the OERC issued a notice to CESCO, the Company and others giving the recipients of the notice until November 2004 to show cause why CESCOs distribution license should not be revoked. In response, CESCO submitted a business plan to the OERC. In February 2005, the OERC issued an order rejecting the proposed business plan. The order also stated that the CESCO distribution license would be revoked if an acceptable business plan for CESCO was not submitted to and approved by the OERC prior to March 31, 2005. In its April 2, 2005 order, the OERC revoked the CESCO distribution license. CESCO has filed an appeal against the April 2, 2005 OERC order and that appeal remains pending in the Indian courts. In addition, Gridco asserted that a comfort letter issued by the Company in connection with the Companys indirect investment in CESCO obligates the Company to provide additional financial support to cover all of CESCOs financial obligations to Gridco. In December 2001, Gridco served a notice to arbitrate pursuant to the Indian Arbitration and Conciliation Act of 1996 on the Company, AES Orissa Distribution Private Limited (AES ODPL), and Jyoti Structures (Jyoti) pursuant to the terms of the CESCO Shareholders Agreement between Gridco, the Company, AES ODPL, Jyoti and CESCO (the CESCO arbitration). In the arbitration, Gridco appeared to be seeking approximately $189 million in damages, plus undisclosed penalties and interest, but a detailed alleged damage analysis was not filed by Gridco. The Company counterclaimed against Gridco for damages. In June 2007, a 2-to-1 majority of the arbitral tribunal rendered its award rejecting Gridcos claims and holding that none of the respondents, the Company, AES ODPL, or Jyoti, had any liability to Gridco. The respondents counterclaims were also rejected. In September 2007, Gridco filed a challenge of the arbitration award with the local Indian court. In June 2008, Gridco filed a separate application with the local Indian court for an order enjoining the Company from selling or otherwise transferring its shares in Orissa Power Generation Corporation Ltd.s (OPGC), an equity method investment, and requiring the Company to provide security in the amount of the contested damages in the CESCO arbitration until Gridcos challenge to the arbitration award is resolved. In June 2010, a 2-to-1 majority of the arbitral tribunal awarded the Company some of its costs relating to the arbitration. In August 2010, Gridco filed a challenge of the cost award with the local Indian court. The Company believes that it has meritorious defenses to the claims asserted against it and will defend itself vigorously in these proceedings; however, there can be no assurances that it will be successful in its efforts.
In March 2003, the office of the Federal Public Prosecutor for the State of São Paulo, Brazil (MPF) notified AES Eletropaulo that it had commenced an inquiry related to the BNDES financings provided to AES
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Elpa and AES Transgás and the rationing loan provided to Eletropaulo, changes in the control of Eletropaulo, sales of assets by Eletropaulo and the quality of service provided by Eletropaulo to its customers, and requested various documents from Eletropaulo relating to these matters. In July 2004, the MPF filed a public civil lawsuit in the Federal Court of São Paulo (FSCP) alleging that BNDES violated Law 8429/92 (the Administrative Misconduct Act) and BNDESs internal rules by: (1) approving the AES Elpa and AES Transgás loans; (2) extending the payment terms on the AES Elpa and AES Transgás loans; (3) authorizing the sale of Eletropaulos preferred shares at a stock-market auction; (4) accepting Eletropaulos preferred shares to secure the loan provided to Eletropaulo; and (5) allowing the restructurings of Light Serviços de Eletricidade S.A. and Eletropaulo. The MPF also named AES Elpa and AES Transgás as defendants in the lawsuit because they allegedly benefited from BNDESs alleged violations. In May 2006, the FCSP ruled that the MPF could pursue its claims based on the first, second, and fourth alleged violations noted above. The MPF subsequently filed an interlocutory appeal with the Federal Court of Appeals (FCA) seeking to require the FCSP to consider all five alleged violations. Also, in July 2006, AES Elpa and AES Transgás filed an interlocutory appeal with the FCA, which was subsequently consolidated with the MPFs interlocutory appeal, seeking a transfer of venue and to enjoin the FCSP from considering any of the alleged violations. In June 2009, the FCA granted the injunction sought by AES Elpa and AES Transgás and transferred the case to the Federal Court of Rio de Janeiro. In May 2010, the MPF filed an appeal with the Superior Court of Justice challenging the transfer. The MPFs lawsuit before the FCSP has been stayed pending a final decision on the interlocutory appeals. AES Elpa and AES Brasiliana (the successor of AES Transgás) believe they have meritorious defenses to the allegations asserted against them and will defend themselves vigorously in these proceedings; however, there can be no assurances that they will be successful in their efforts.
In July 2004, the Corporación Dominicana de Empresas Eléctricas Estatales (CDEEE) filed lawsuits against Itabo, an affiliate of the Company, in the First and Fifth Chambers of the Civil and Commercial Court of First Instance for the National District. CDEEE alleges in both lawsuits that Itabo spent more than was necessary to rehabilitate two generation units of an Itabo power plant and, in the Fifth Chamber lawsuit, that those funds were paid to affiliates and subsidiaries of AES Gener and Coastal Itabo, Ltd. (Coastal), a former shareholder of Itabo, without the required approval of Itabos board of administration. In the First Chamber lawsuit, CDEEE seeks an accounting of Itabos transactions relating to the rehabilitation. In November 2004, the First Chamber dismissed the case for lack of legal basis. On appeal, in October 2005 the Court of Appeals of Santo Domingo ruled in Itabos favor, reasoning that it lacked jurisdiction over the dispute because the parties contracts mandated arbitration. The Supreme Court of Justice is considering CDEEEs appeal of the Court of Appeals decision. In the Fifth Chamber lawsuit, which also names Itabos former president as a defendant, CDEEE seeks $15 million in damages and the seizure of Itabos assets. In October 2005, the Fifth Chamber held that it lacked jurisdiction to adjudicate the dispute given the arbitration provisions in the parties contracts. The First Chamber of the Court of Appeal ratified that decision in September 2006. In a related proceeding, in May 2005, Itabo filed a lawsuit in the U.S. District Court for the Southern District of New York seeking to compel CDEEE to arbitrate its claims. The petition was denied in July 2005. Itabos appeal of that decision to the U.S. Court of Appeals for the Second Circuit has been stayed since September 2006. Further, in September 2006, in an International Chamber of Commerce arbitration, an arbitral tribunal determined that it lacked jurisdiction to decide arbitration claims concerning these disputes. Itabo believes it has meritorious claims and defenses and will assert them vigorously in these proceedings; however, there can be no assurances that it will be successful in its efforts.
In July 2007, the Competition Committee of the Ministry of Industry and Trade of the Republic of Kazakhstan (the Competition Committee) ordered Nurenergoservice, an AES subsidiary, to pay approximately KZT 18 billion ($122 million) for alleged antimonopoly violations in 2005 through the first quarter of 2007. The Competition Committees order was affirmed by the economic court in April 2008 (April 2008 Decision). The economic court also issued an injunction to secure Nurenergoservices alleged liability, freezing Nurenergoservices bank accounts and prohibiting Nurenergoservice from transferring or disposing of its property. Nurenergoservices subsequent appeals to the court of appeals were rejected. In February 2009, the Antimonopoly Agency (the Competition Committees successor) seized approximately KZT 778 million ($5 million) from a frozen Nurenergoservice bank account in partial satisfaction of Nurenergoservices alleged
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damages liability. However, on appeal to the Kazakhstan Supreme Court, in October 2009, the Supreme Court annulled the decisions of the lower courts because of procedural irregularities and remanded the case to the economic court for reconsideration. On remand, in January 2010, the economic court reaffirmed its April 2008 Decision. Nurenergoservices appeals in the court of appeals (first panel) and the court of appeals (second panel) were unsuccessful. Nurenergoservice intends to file a further appeal to the Kazakhstan Supreme Court. In separate but related proceedings, in August 2007, the Competition Committee ordered Nurenergoservice to pay approximately KZT 1.8 billion ($12 million) in administrative fines for its alleged antimonopoly violations. Nurenergoservices appeal to the administrative court was rejected in February 2009. Given the adverse court decisions against Nurenergoservice, the Antimonopoly Agency may attempt to seize Nurenergoservices remaining assets, which are immaterial to the Companys consolidated financial statements. The Antimonopoly Agency has not indicated whether it intends to assert claims against Nurenergoservice for alleged antimonopoly violations post first quarter 2007. Nurenergoservice believes it has meritorious defenses to the claims asserted against it; however, there can be no assurances that it will prevail in these proceedings.
In April 2009, the Antimonopoly Agency initiated an investigation of the power sales of Ust-Kamenogorsk HPP (UK HPP) and Shulbinsk HPP, hydroelectric plants under AES concession (collectively, the Hydros), in January through February 2009. The investigation of both Hydros has now been completed. The Antimonopoly Agency determined that the Hydros abused their market position and charged monopolistically high prices for power in January through February 2009. The Agency sought an order from the administrative court requiring UK HPP to pay an administrative fine of approximately KZT 120 million ($1 million) and to disgorge profits for the period at issue, estimated by the Antimonopoly Agency to be approximately KZT 440 million ($3 million). No fines or damages have been paid to date, however, as the proceedings in the administrative court have been suspended due to the initiation of related criminal proceedings against officials of the Hydros. In the course of criminal proceedings, the financial police have expanded the periods at issue to the entirety of 2009 in the case of UK HPP and from January through October 2009 in the case of Shulbinsk HPP, and sought increased damages of KZT 1.2 billion ($8 million) in the case of UK HPP and KZT 1.3 billion ($9 million) in the case of Shulbinsk HPP. The Hydros believe they have meritorious defenses and will assert them vigorously in these proceedings; however, there can be no assurances that they will be successful in their efforts.
In July 1993 the Public Attorneys office filed a claim against Eletropaulo, the Sao Paulo State Government, SABESP (a state-owned company), CETESB (a state-owned company) and DAEE (the municipal Water and Electric Energy Department) alleging that they were liable for pollution of the Billings Reservoir as a result of pumping water from the Pinheiros River into the Billings Reservoir. The events in question occurred while Eletropaulo was a state-owned company. An initial lower court decision in 2007 found the parties liable for the payment of approximately R$670 million ($407 million) for remediation. Eletropaulo subsequently appealed the decision to the Appellate Court of the State of Sao Paulo which reversed the lower court decision. In 2009, the Public Attorneys Office has filed appeals to both Superior Court of Justice (SCJ) and the Supreme Court (SC) and such appeals were answered by Eletropaulo in the fourth quarter of 2009. Eletropaulo believes it has meritorious defenses to the claims asserted against it and will defend itself vigorously in these proceedings; however, there can be no assurances that it will be successful in its efforts.
In February 2009, a CAA Section 114 information request from the EPA regarding Cayuga and Somerset was received. The request seeks various operating and testing data and other information regarding certain types of projects at the Cayuga and Somerset facilities, generally for the time period from January 1, 2000 through the date of the information request. This type of information request has been used in the past to assist the EPA in determining whether a plant is in compliance with applicable standards under the CAA. Cayuga and Somerset responded to the EPAs information request in June 2009, and they are awaiting a response from the EPA regarding their submittal. At this time, it is not possible to predict what impact, if any, this request may have on the Company, its results of operations or its financial position.
On February 2, 2009, the Cayuga facility received a Notice of Violation from the New York State Department of Environmental Conservation (NYSDEC) that the facility had exceeded the permitted volume
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limit of coal ash that can be disposed of in the on-site landfill. Cayuga has met with NYSDEC and submitted a Landfill Liner Demonstration Report to them. Such report found that the landfill has adequate engineering integrity to support the additional coal ash and there is no inherent environmental threat. NYSDEC has indicated they accept the finding of the report. A permit modification was approved by the NYSDEC on May 14, 2010 and such permit modification allows for closure of this approximately 10-acre portion of the landfill. The construction in accordance with the approved permit modification was completed in November 2010 and the certification report for this construction project is currently being drafted to submit to the NYSDEC in the second quarter of 2011. While at this time it is not possible to predict what impact, if any, this matter may have on the Company, its results of operations or its financial position, based upon the discussions to date, the Company does not believe the impact will be material.
In March 2009, AES Uruguaiana Empreendimentos S.A. (AESU) initiated arbitration in the International Chamber of Commerce (ICC) against YPF S.A. (YPF) seeking damages and other relief relating to YPFs breach of the parties gas supply agreement (GSA). Thereafter, in April 2009, YPF initiated arbitration in the ICC against AESU and two unrelated parties, Companhia de Gas do Esado do Rio Grande do Sul and Transportador de Gas del Mercosur S.A. (TGM), claiming that AESU wrongfully terminated the GSA and caused the termination of a transportation agreement (TA) between YPF and TGM (YPF Arbitration). YPF seeks an unspecified amount of damages from AESU, a declaration that YPFs performance was excused under the GSA due to certain alleged force majeure events, or, in the alternative, a declaration that the GSA and the TA should be terminated without a finding of liability against YPF because of the allegedly onerous obligations imposed on YPF by those agreements. In addition, in the YPF Arbitration, TGM asserts that if it is determined that AESU is responsible for the termination of the GSA, AESU is liable for TGMs alleged losses, including losses under the TA. In April 2011, the arbitrations were consolidated into a single proceeding, and a new procedural schedule was established for the consolidated proceeding. The hearing on liability issues will take place in December 2011. AESU believes it has meritorious defenses to the claims asserted against it and will defend itself vigorously; however, there can be no assurances that it will be successful in its efforts.
In June 2009, the Inter-American Commission on Human Rights of the Organization of American States (IACHR) requested that the Republic of Panama suspend the construction of AES Changuinola S.A.s hydroelectric project (Project) until the bodies of the Inter-American human rights system can issue a final decision on a petition (286/08) claiming that the construction violates the human rights of alleged indigenous communities. In July 2009, Panama responded by informing the IACHR that it would not suspend construction of the Project and requesting that the IACHR revoke its request. In June 2010, the Inter-American Court of Human Rights vacated the IACHRs request. With respect to the merits of the underlying petition, the IACHR heard arguments by the communities and Panama in November 2009, but has not issued a decision to date. The Company cannot predict Panamas response to any determination on the merits of the petition by the bodies of the Inter-American human rights system. While at this time it is not possible to predict what impact, if any, this matter may have on the Company, its results of operations or its financial position, based upon the discussions to date, the Company does not believe the impact will be material.
In July 2009, AES Energía Cartagena S.R.L. (AES Cartagena) received notices from the Spanish national energy regulator, Comisión Nacional de Energía (CNE), stating that the proceeds of the sale of electricity from AES Cartagenas plant should be reduced by roughly the value of the CO2 allowances that were granted to AES Cartagena for free for the years 2007, 2008, and the first half of 2009. In particular, the notices stated that CNE intended to invoice AES Cartagena to recover that value, which CNE calculated as approximately 20 million ($28 million) for 2007-2008 and an amount to be determined for the first half of 2009. In September 2009, AES Cartagena received invoices for 523,548 (approximately $738,000) for the allowances granted for free for 2007 and 19,907,248 (approximately $28 million) for 2008. In July 2010, AES Cartagena received an invoice for approximately 5 million ($7 million) for the allowances granted for free for the first half of 2009. AES Cartagena does not expect to be charged for CO2 allowances issued free of charge for subsequent periods. AES Cartagena has paid the amounts invoiced and has filed challenges to the CNEs demands in the Spanish judicial system. There can be no assurances that the challenges will be successful. AES Cartagena has demanded
34
indemnification from its fuel supply and electricity toller, GDF-Suez, in relation to the CNE invoices under the long-term energy agreement (the Energy Agreement) with GDF-Suez. However, GDF-Suez has disputed that it is responsible for the CNE invoices under the Energy Agreement. Therefore, in September 2009, AES Cartagena initiated arbitration against GDF-Suez, seeking to recover the payments made to CNE. In the arbitration, AES Cartagena also seeks a determination that GDF-Suez is responsible for procuring and bearing the cost of CO2 allowances that are required to offset the CO2 emissions of AES Cartagenas power plant, which is also in dispute between the parties. To date, AES Cartagena has paid approximately 25 million ($35 million) for the CO2 allowances that have been required to offset 2008, 2009 and 2010 CO2 emissions. AES Cartagena expects that allowances will need to be purchased to offset emissions for subsequent years. The evidentiary hearing in the arbitration took place from May 31-June 4, 2010, and closing arguments were heard on September 1, 2010. In February 2011, the arbitral tribunal requested further briefing on certain issues in the arbitration, which was later submitted by the parties. The tribunal has the matter under consideration. If AES Cartagena does not prevail in the arbitration and is required to bear the cost of carbon compliance, its results of operations could be materially adversely affected and, in turn, there could be a material adverse effect on the Company and its results of operations. AES Cartagena believes it has meritorious claims and will assert them vigorously in these proceedings; however, there can be no assurances that it will be successful in its efforts.
In September 2009, the Public Defenders Office of the State of Rio Grande do Sul (PDO) filed a class action against AES Sul in the 16th District Court of Porto Alegre, Rio Grande do Sul (District Court), claiming that AES Sul has been illegally passing PIS and COFINS taxes (taxes based on AES Suls income) to consumers. According to ANEELs Order No. 93/05, the federal laws of Brazil, and the Brazilian Constitution, energy companies such as AES Sul are entitled to highlight PIS and COFINS taxes in power bills to final consumers, as the cost of those taxes is included in the energy tariffs that are applicable to final consumers. Before AES Sul had been served with the action, the District Court dismissed the lawsuit in October 2009 on the ground that AES Sul had been properly highlighting PIS and COFINS taxes in consumer bills in accordance with Brazilian law. In April 2010, the PDO appealed to the Appellate Court of the State of Rio Grande do Sul (AC). In November 2010, the AC affirmed the dismissal. The PDO did not appeal, and the District Courts decision became final and unappealable in March 2011.
In November 2009, April 2010, December 2010, and April 2011, substantially similar personal injury lawsuits were filed by a total of 41 residents and estates in the Dominican Republic against the Company, AES Atlantis, Inc., AES Puerto Rico, LP, AES Puerto Rico, Inc., and AES Puerto Rico Services, Inc., in the Superior Court for the State of Delaware. In each lawsuit the plaintiffs allege that the coal combustion byproducts of AES Puerto Ricos power plant were illegally placed in the Dominican Republic in October 2003 through March 2004 and subsequently caused the plaintiffs birth defects, other personal injuries, and/or deaths. The plaintiffs do not quantify their alleged damages, but generally allege that they are entitled to compensatory and punitive damages. The AES defendants have moved for partial dismissal of both the November 2009 and April 2010 lawsuits on various grounds. (By agreement with the plaintiffs, the AES defendants have not yet responded to the December 2010 or April 2011 lawsuits, and will not do so until after the Superior Court rules on the pending partial dismissal motions in the other cases.) In September 2010, the Superior Court heard arguments on the motions. The Superior Court dismissed the plaintiffs fraud allegations without prejudice to replead, and the plaintiffs filed amended complaints in November 2010. The AES defendants have filed a renewed motion to dismiss the amended issues. A ruling on that motion is pending. Also, a ruling on the remaining claims (other than fraud) addressed in the original partial dismissal motions is still pending. The AES defendants believe they have meritorious defenses to the claims asserted against them and will defend themselves vigorously; however, there can be no assurances that they will be successful in their efforts. While at this time it is not possible to predict what impact, if any, this matter may have on the Company, its results of operations or its financial position, based upon the discussions to date, the Company does not believe the impact will be material.
On December 21, 2010, AES-3C Maritza East 1 EOOD, which owns an unfinished 670 MW lignite-fired power plant in Bulgaria, made the first in a series of demands on the performance bond securing the construction
35
Contractors obligations under the parties EPC Contract. The Contractor failed to complete the plant on schedule. The total amount demanded by Maritza under the performance bond is approximately 155 million ($219 million). However, the Contractor has obtained an injunction from a French court purportedly preventing the issuing bank from honoring the bond demands. Maritza is seeking relief in the French and English courts to attempt to lift that injunction or otherwise obtain payment on its demands. In addition, in December 2010, the Contractor issued a notice of dispute alleging that the lignite that has been supplied by Maritza for commissioning of the power plant is out of specification, allegedly entitling the Contractor to an extension of time to complete the power plant, an increase to the contract price of approximately 62 million ($87 million), and other relief. The Contractor thereafter advised Maritza that it had stopped commissioning of the power plants two units because of the characteristics of the lignite supplied, and, in January 2011, initiated arbitration on its lignite claim. The Contractor later added claims seeking further extensions of time and an additional 10 million ($14 million) relating to the alleged unavailability of the grid during commissioning. Maritza has rejected the Contractors claims and asserted counterclaims for delay liquidated damages and other relief relating to the Contractors failure to complete the power plant and other breaches of the EPC contract. Maritza has also terminated the construction contract for cause and asserted arbitration claims against the Contractor relating to the termination. Maritza believes it has meritorious claims and defenses and will assert them vigorously in these proceedings; however, there can be no assurances that it will be successful in its efforts.
10. PENSION PLANS
Total pension cost for the three months ended March 31, 2011 and 2010 included the following components:
Three Months Ended March 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
U.S. | Foreign | U.S. | Foreign | |||||||||||||
(in millions) | ||||||||||||||||
Service cost |
$ | 2 | $ | 5 | $ | 2 | $ | 5 | ||||||||
Interest cost |
8 | 142 | 8 | 125 | ||||||||||||
Expected return on plan assets |
(8 | ) | (128 | ) | (8 | ) | (105 | ) | ||||||||
Amortization of prior service cost |
1 | - | 1 | - | ||||||||||||
Amortization of net loss |
3 | 6 | 3 | 3 | ||||||||||||
Loss on curtailment |
- | 4 | - | - | ||||||||||||
Total pension cost |
$ | 6 | $ | 29 | $ | 6 | $ | 28 | ||||||||
Total employer contributions for the three months ended March 31, 2011 for the Companys U.S. and foreign subsidiaries were $6 million and $42 million, respectively. The expected remaining scheduled annual employer contributions for 2011 are $31 million for U.S. subsidiaries and $126 million for foreign subsidiaries.
11. EQUITY
STOCK REPURCHASE PROGRAM
In July 2010, the Companys Board of Directors approved a stock repurchase program under which the Company may repurchase up to $500 million of AES common stock. The Board authorization permits the Company to repurchase stock through a variety of methods, including open market repurchases and/or privately negotiated transactions. The original authorization was set to expire on December 31, 2010; however, in December 2010, the Board authorized an extension of the stock repurchase program. There can be no assurance as to the amount, timing or prices of repurchases, which may vary based on market conditions and other factors. The stock repurchase program may be modified, extended or terminated by the Board of Directors at any time. During the three months ended March 31, 2011, shares of common stock repurchased under this plan totaled 4,943,011 at a total cost of
36
$63 million plus a nominal amount of commissions (average of $12.68 per share including commissions), bringing the cumulative total purchases under the program to 13,325,836 shares at a total cost of $162 million plus a nominal amount of commissions (average of $12.16 per share including commissions). There was $338 million remaining under the stock repurchase program available for future repurchases at March 31, 2011.
The shares of stock repurchased have been classified as treasury stock and accounted for using the cost method. A total of 21,787,992 and 17,287,073 shares were held as treasury stock at March 31, 2011 and December 31, 2010, respectively. The Company has not retired any shares held in treasury during the three months ended March 31, 2011.
COMPREHENSIVE INCOME
The components of comprehensive income (loss) for the three months ended March 31, 2011 and 2010 were as follows:
March 31, | ||||||||
2011 | 2010 | |||||||
(in millions) | ||||||||
Net income |
$ | 483 | $ | 402 | ||||
Change in fair value of available-for-sale securities, net of income tax benefit of $1 and $2, respectively |
(1 | ) | (4 | ) | ||||
Foreign currency translation adjustments, net of income tax (expense) benefit of $(4) and $5, respectively |
128 | (134 | ) | |||||
Derivative activity: |
||||||||
Reclassification to earnings, net of income tax (expense) of $(8) and $(11), respectively |
30 | 32 | ||||||
Change in derivative fair value, net of income tax (expense) benefit of $(9) and $13, respectively |
|
41 |
|
|
(66 |
) | ||
Total change in fair value of derivatives |
71 | (34 | ) | |||||
Change in unfunded pension obligation, net of income tax (expense) of $(2) and $(1), respectively |
3 | 2 | ||||||
Other comprehensive income (loss) |
201 | (170 | ) | |||||
Comprehensive income |
684 | 232 | ||||||
Less: Comprehensive income attributable to noncontrolling interests(1) |
(325 | ) | (164 | ) | ||||
Comprehensive income attributable to The AES Corporation |
$ | 359 | $ | 68 | ||||
(1) | Includes the income attributed to noncontrolling interests in the form of common securities and dividends on preferred stock of subsidiary. |
The components of accumulated other comprehensive loss as of March 31, 2011 and December 31, 2010 were as follows:
March 31, 2011 |
December 31, 2010 |
|||||||
(in millions) | ||||||||
Foreign currency translation adjustment |
$ | 1,749 | $ | 1,824 | ||||
Unrealized derivative losses, net |
283 | 344 | ||||||
Unfunded pension obligation |
216 | 216 | ||||||
Securities available-for-sale |
- | (1 | ) | |||||
Accumulated other comprehensive loss |
$ | 2,248 | $ | 2,383 | ||||
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12. SEGMENTS
The management reporting structure is organized along our two lines of business (Generation and Utilities) and three regions: (1) Latin America & Africa; (2) North America; and (3) Europe, Middle East & Asia (collectively EMEA), each managed by a regional president. The segment reporting structure uses the Companys management reporting structure as its foundation to reflect how the Company manages the business internally. The Company applied the segment reporting accounting guidance, which provides certain quantitative thresholds and aggregation criteria, and concluded it has the following six reportable segments:
| Latin America Generation; |
| Latin America Utilities; |
| North America Generation; |
| North America Utilities; |
| Europe Generation; |
| Asia Generation. |
Corporate and Other The Companys Europe Utilities, Africa Utilities, Africa Generation, Wind Generation and Climate Solutions operating segments are reported within Corporate and Other because they do not meet the criteria to allow for aggregation with another operating segment or the quantitative thresholds that would require separate disclosure under segment reporting accounting guidance. None of these operating segments are currently material to our presentation of reportable segments, individually or in the aggregate. AES Solar and certain other unconsolidated businesses are accounted for using the equity method of accounting; therefore, their operating results are included in Net Equity in Earnings of Affiliates on the face of the Consolidated Statements of Operations, not in revenue or gross margin. Corporate and Other also includes costs related to corporate overhead costs which are not directly associated with the operations of our six reportable segments and other intercompany charges such as self-insurance premiums which are fully eliminated in consolidation.
The Company uses Adjusted Gross Margin, a non-GAAP measure, to evaluate the performance of its segments. Adjusted Gross Margin is defined by the Company as: Gross Margin plus depreciation and amortization less general and administrative expenses.
Segment revenue includes inter-segment sales related to the transfer of electricity from generation plants to utilities within Latin America. No material inter-segment revenue relationships exist between other segments. Corporate allocations include certain self insurance activities which are reflected within segment Adjusted Gross Margin. All intra-segment activity has been eliminated with respect to revenue and Adjusted Gross Margin within the segment. Inter-segment activity has been eliminated within the total consolidated results. All balance sheet information for businesses that were discontinued or classified as held for sale as of March 31, 2011 is segregated and is shown in the line Discontinued Businesses in the accompanying segment tables.
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The tables below present the breakdown of business segment balance sheet and income statement data for the three months ended March 31, 2011 and 2010:
Total Revenue | Intersegment | External Revenue | ||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
(in millions) | ||||||||||||||||||||||||
Revenue |
||||||||||||||||||||||||
Latin America Generation |
$ | 1,131 | $ | 983 | $ | (251 | ) | $ | (255 | ) | $ | 880 | $ | 728 | ||||||||||
Latin America Utilities |
1,904 | 1,765 | - | - | 1,904 | 1,765 | ||||||||||||||||||
North America Generation |
372 | 391 | - | - | 372 | 391 | ||||||||||||||||||
North America Utilities |
289 | 288 | - | - | 289 | 288 | ||||||||||||||||||
Europe Generation |
400 | 322 | (1 | ) | - | 399 | 322 | |||||||||||||||||
Asia Generation |
115 | 176 | - | - | 115 | 176 | ||||||||||||||||||
Corp/Other & eliminations |
53 | (5 | ) | 252 | 255 | 305 | 250 | |||||||||||||||||
Total Revenue |
$ | 4,264 | $ | 3,920 | $ | - | $ | - | $ | 4,264 | $ | 3,920 | ||||||||||||
Total Adjusted Gross Margin | Intersegment | External Adjusted Gross Margin | ||||||||||||||||||||||
2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||
(in millions) | ||||||||||||||||||||||||
Adjusted Gross Margin |
||||||||||||||||||||||||
Latin America Generation |
$ | 470 | $ | 394 | $ | (239 | ) | $ | (251 | ) | $ | 231 | $ | 143 | ||||||||||
Latin America Utilities |
341 | 299 | 245 | 255 | 586 | 554 | ||||||||||||||||||
North America Generation |
126 | 138 | 4 | 4 | 130 | 142 | ||||||||||||||||||
North America Utilities |
90 | 113 | - | - | 90 | 113 | ||||||||||||||||||
Europe Generation |
106 | 125 | 1 | 1 | 107 | 126 | ||||||||||||||||||
Asia Generation |
45 | 69 | 1 | 1 | 46 | 70 | ||||||||||||||||||
Corp/Other & eliminations |
39 | 9 | (12 | ) | (10 | ) | 27 | (1 | ) | |||||||||||||||
Reconciliation to Income from Continuing Operations before Taxes |
|
|||||||||||||||||||||||
Depreciation and amortization |
|
(296 | ) | (266 | ) | |||||||||||||||||||
Interest expense |
|
(351 | ) | (381 | ) | |||||||||||||||||||
Interest income |
|
95 | 108 | |||||||||||||||||||||
Other expense |
|
(17 | ) | (12 | ) | |||||||||||||||||||
Other income |
|
16 | 9 | |||||||||||||||||||||
Gain on sale of investments |
|
6 | - | |||||||||||||||||||||
Foreign currency transaction gains (losses) on net monetary position |
|
33 | (51 | ) | ||||||||||||||||||||
Income from continuing operations before taxes and equity in earnings of affiliates |
|
$ | 703 | $ | 554 | |||||||||||||||||||
Assets by segment as of March 31, 2011 and December 31, 2010 were as follows:
Total Assets | ||||||||
March 31, 2011 |
December 31, 2010 |
|||||||
(in millions) | ||||||||
Assets |
||||||||
Latin America Generation |
$ | 10,569 | $ | 10,373 | ||||
Latin America Utilities |
10,131 | 10,081 | ||||||
North America Generation |
4,512 | 4,681 | ||||||
North America Utilities |
3,174 | 3,139 | ||||||
Europe Generation |
4,510 | 4,178 | ||||||
Asia Generation |
1,693 | 1,762 | ||||||
Discontinued businesses |
228 | 258 | ||||||
Corp/Other & eliminations |
5,683 | 6,039 | ||||||
Total Assets |
$ | 40,500 | $ | 40,511 | ||||
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13. OTHER INCOME (EXPENSE)
Other income was $16 million and $9 million for the three months ended March 31, 2011 and 2010, respectively, and generally includes gains on asset sales and extinguishments of liabilities, favorable judgments on contingencies and income from miscellaneous transactions.
Other expense for the three months ended March 31, 2011 and 2010 of $17 million and $12 million, respectively, was primarily comprised of losses on disposal of assets at Eletropaulo. Other expense generally includes losses on asset sales, losses on the extinguishment of debt, contingencies and losses from miscellaneous transactions.
14. DISCONTINUED OPERATIONS AND HELD FOR SALE BUSINESSES
Discontinued operations includes the results of the following generation businesses: Eastern Energy including Cayuga, Greenidge, Somerset and Westover, in New York (held for sale in March 2011); Borsod and Tiszapalkonya, in Hungary (held for sale in March 2011); Ras Laffan, in Qatar (sold in October 2010); Barka, in Oman (sold in August 2010); and Lal Pir and Pak Gen, in Pakistan (sold in June 2010).
For the three months ended March 31, 2010, the Company recognized impairments of $13 million ($7 million, net of tax and noncontrolling interests) to reflect the change in the carrying value of net assets of Lal Pir and Pak Gen subsequent to meeting the held for sale criteria as of December 31, 2009. The carrying value of net assets was compared to the agreed upon sales proceeds of Lal Pir and Pak Gen, resulting in the impairment.
The following table summarizes the revenue, income from operations of discontinued businesses, income tax expense and impairment of discontinued operations for the three months ended March 31, 2011 and 2010:
Three Months Ended March 31, |
||||||||
2011 | 2010 | |||||||
(in millions) | ||||||||
Revenue |
$ | 89 | $ | 378 | ||||
Income (loss) from operations of discontinued businesses |
$ | (18 | ) | $ | 45 | |||
Income tax benefit (expense) |
6 | (11 | ) | |||||
Income (loss) from operations of discontinued businesses, net of tax |
$ | (12 | ) | $ | 34 | |||
Impairment of discontinued operations |
$ | - | $ | (13 | ) | |||
15. EARNINGS PER SHARE
Basic and diluted earnings per share are based on the weighted average number of shares of common stock and potential common stock outstanding during the period. Potential common stock, for purposes of determining diluted earnings per share, includes the effects of dilutive restricted stock units, stock options and convertible securities. The effect of such potential common stock is computed using the treasury stock method or the if-converted method, as applicable.
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The following table presents a reconciliation of the numerator and denominator of the basic and diluted earnings per share computation for income from continuing operations for the three months ended March 31, 2011 and 2010. In the table below income represents the numerator (in millions) and weighted-average shares represent the denominator (in millions):
Three Months Ended March 31, | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
Income | Shares | $ per Share |
Income | Shares | $ per Share |
|||||||||||||||||||
BASIC EARNINGS PER SHARE |
||||||||||||||||||||||||
Income from continuing operations attributable to The AES Corporation common stockholders |
$ | 236 | 787 | $ | 0.30 | $ | 170 | 695 | $ | 0.24 | ||||||||||||||
EFFECT OF DILUTIVE SECURITIES |
||||||||||||||||||||||||
Stock options |
- | 2 | - | - | 2 | - | ||||||||||||||||||
Restricted stock units |
- | 3 | - | - | 4 | - | ||||||||||||||||||
DILUTED EARNINGS PER SHARE |
$ | 236 | 792 | $ | 0.30 | $ | 170 | 701 | $ | 0.24 | ||||||||||||||
There were approximately 16,253,344 and 16,446,542 additional options outstanding at March 31, 2011 and 2010, respectively, that could potentially dilute basic earnings per share in the future. Those options were not included in the computation of diluted earnings per share because the exercise price exceeded the average market price during the related periods. For the three months ended March 31, 2011 and 2010, all convertible debentures were omitted from the computation of diluted earnings per share because they were anti-dilutive. During the three months ended March 31, 2011, 1,060,839 shares of common stock were issued under the Companys profit sharing plan and 218,800 shares of common stock were issued upon the exercise of stock options.
16. SUBSEQUENT EVENTS
Subsequent to March 31, 2011, the Company continued to repurchase stock under the stock repurchase program announced on July 7, 2010. The Company has repurchased 2,774,700 shares at a cost of $36 million subsequent to March 31, 2011, bringing the cumulative total through May 6, 2011 to 16,100,536 shares at a total cost of $198 million (average price of $12.29 per share including commissions). As of May 6, 2011, $302 million of the $500 million authorized remained available under the stock repurchase program. For additional information, see Note 11 Equity.
On April 20, 2011, the Company announced the execution of a definitive agreement (the Merger Agreement) with DPL Inc.(DPL), the parent company of Dayton Power & Light Company, a utility company based in Ohio. Under the terms of the agreement, AES has agreed to acquire DPL for an enterprise value of $4.7 billion, consisting of cash proceeds of $3.5 billion and the assumption of net debt of approximately $1.2 billion. Through its operating subsidiaries DP&L and DPL Energy Resources, DPL serves over 500,000 customers in West Central Ohio. Additionally, DPL operates over 3,800 MW of power generation facilities and provides competitive retail energy services to industrial and commercial customers. Upon closing of the transaction, DPL will become a wholly-owned subsidiary of AES.
Simultaneously with the execution of the Merger Agreement, the Company entered into commitment letters (the Commitment Letters) with Bank of America, N.A. and Merrill Lynch, Pierce, Fenner & Smith Incorporated (together, the Bridge Providers). The Commitment Letters provide that, subject to certain customary terms and conditions, the Bridge Providers will provide senior unsecured bridge loans in an aggregate principal amount of $3.3 billion (the Bridge Facilities) to backstop a portion of the Companys payment obligations upon consummation of the merger. The Company will pay certain customary fees and expenses in connection therewith. To the extent funded, the agreement governing the Bridge Facilities will subject the
41
Company to customary terms and covenants and will be subject to customary events of default. Permanent financing is expected to include a combination of non-recourse debt, the issuance of corporate debt at AES and cash on hand.
The Merger Agreement contains certain termination rights and conditions precedent. The Merger Agreement contains certain termination rights for DPL and AES and further provides that, if DPL terminates the Merger Agreement prior to DPL shareholder approval in order to pursue a superior offer, DPL is required to pay AES a termination fee of $106 million (or $53 million if DPL terminates the Merger Agreement within 45 days after its execution, in order to pursue a superior offer with a party that presents its offer within 30 days of the execution of the Merger Agreement). The consummation of the transaction is subject to approval of DPL shareholders, the Public Utilities Commission of Ohio, FERC, and antitrust review under the Hart-Scott-Rodino Act. Approvals are expected to be completed within six to nine months, although there can be no assurance that such approvals will be obtained. The transaction is also subject to certain other closing conditions. After the announcement of the transaction, certain lawsuits were filed seeking to enjoin the merger and/or seek unspecified monetary damages, some of which name AES as a defendant. The Company does not believe the suits will be successful; however, there can be no assurances regarding the outcome of the litigation.
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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this Quarterly Report on Form 10-Q (Form 10-Q), the terms AES, the Company, us, or we refer to the consolidated entity 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.
The condensed consolidated financial statements included in Item 1. Financial Statements of this Form 10-Q and the discussions contained herein should be read in conjunction with our 2010 Form 10-K.
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 Item 1A. Risk Factors of our 2010 Form 10-K filed on February 25, 2011 and this Form 10-Q, and our ability to successfully consummate and integrate the proposed DPL acquisition described elsewhere in this Quarterly Report. 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. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements. 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 of the risks and factors that may affect our business.
Overview of Our Business
We are a global power company. 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, other intermediaries and certain end-users. The second is our Utilities business, where we own and/or operate utilities which distribute, transmit and sell electricity to end-user customers in the residential, commercial, industrial and governmental sectors within a defined service area and in certain circumstances, sell electricity on the wholesale market. For the three months ended March 31, 2011 our Generation and Utilities businesses comprised approximately 43% and 57% of our consolidated revenue, respectively.
We are also continuing to expand our wind generation business and are pursuing additional opportunities in the renewable business including solar and climate solutions, which develops and invests in projects that generate greenhouse gas offsets and/or other renewable projects. These initiatives are not material contributors to our operating results, but we believe that certain of these initiatives may become material in the future. For additional information regarding our business, see Item 1. Business of the 2010 Form 10-K.
Our Organization and Segments. The management reporting structure is organized along our two lines of business (Generation and Utilities) and three regions: (1) Latin America & Africa; (2) North America; and (3) Europe, Middle East & Asia (collectively EMEA), each managed by a regional president. The financial reporting segment structure uses the Companys management reporting structure as its foundation and reflects how the Company manages the business internally. The Company applied the segment reporting accounting guidance, which provides certain quantitative thresholds and aggregation criteria, and concluded that it has the following six reportable segments:
| Latin America Generation; |
| Latin America Utilities; |
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| North America Generation; |
| North America Utilities; |
| Europe Generation; |
| Asia Generation. |
Corporate and Other. The Companys Europe Utilities, Africa Utilities, Africa Generation, Wind Generation and Climate Solutions operating segments are reported within Corporate and Other because they do not meet the criteria to allow for aggregation with another operating segment or the quantitative thresholds that would require separate disclosure under segment reporting accounting guidance. None of these operating segments are currently material to our financial statement presentation of reportable segments, individually or in the aggregate. Corporate and Other also includes costs related to corporate overhead which are not directly associated with the operations of our six reportable segments and other intercompany charges such as self-insurance premiums which are fully eliminated in consolidation.
Components of Revenue and Cost of Sales. Revenue includes revenue earned from the sale of energy from our utilities and the generation of energy from our generation plants, which are classified as regulated and unregulated on the condensed consolidated statement of operations, respectively. Cost of sales includes costs incurred directly by the businesses in the ordinary course of business. Examples include electricity and fuel purchases, maintenance, operations, non-income taxes and bad debt expense and recoveries as well as depreciation, general and administrative and support costs, including employee-related costs, that are directly associated with the operations of a particular business. Cost of sales also includes the gains or losses on derivatives (including embedded derivatives other than foreign currency embedded derivatives) associated with the purchase of electricity or fuel.
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 reliability and efficiency, power prices, volume, management of fixed and variable operating costs, management of working capital including collection of receivables, 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 current market price of electricity and the marginal costs of production. Growth in our Generation business is largely tied to securing new PPAs, expanding capacity in our existing facilities and building or acquiring new power plants. Performance drivers for our Utilities businesses include, but are not limited to, reliability of service; management of working capital, including collection of receivables; negotiation of tariff adjustments; compliance with extensive regulatory requirements; management of pension assets; and in developing countries, reduction of commercial and technical losses. The operating results of our Utilities businesses are sensitive to changes in inflation, economic growth and weather conditions in areas in which they operate. In addition to these drivers, as explained below, the Company also has exposure to currency exchange rate fluctuations.
One of the key factors which affect our Generation business is our ability to enter into contracts for the sale of electricity and the purchase of fuel used to produce that electricity. Long-term contracts are intended to reduce the exposure to volatility associated with fuel prices in the market and the price of electricity by fixing the revenue and costs for these businesses. The majority of the electricity produced by our Generation businesses is sold under long-term contracts, or PPAs, to wholesale customers. In turn, most of these businesses enter into long-term fuel supply contracts or fuel tolling arrangements where the customer assumes full responsibility for purchasing and supplying the fuel to the power plant. While these long-term contractual agreements reduce exposure to volatility in the market price for electricity and fuel, the predictability of operating results and cash
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flows vary by business based on the extent to which a facilitys generation capacity and fuel requirements are contracted and the negotiated terms of these agreements. Entering into these contracts exposes us to counterparty credit risk. For further discussion of these risks, see Supplier and/or customer concentration may expose the Company to significant financial credit or performance risks. in Item 1A. Risk Factors of the 2010 Form 10-K.
When fuel costs increase, many of our businesses are able to pass these costs on to their customers. Generation businesses with long-term contracts in place do this by including fuel pass-through or fuel indexing arrangements in their contracts. Utilities businesses can pass costs on to their customers through increases in current or future tariff rates. Therefore, in a rising fuel cost environment, the increased fuel costs for these businesses often result in an increase in revenue to the extent these costs can be passed through (though not necessarily on a one-for-one basis). Conversely, in a declining fuel cost environment, the decreased fuel costs can result in a decrease in revenue. Increases or decreases in revenue at these businesses that have the ability to pass through costs to the customer have a corresponding impact on cost of sales, to the extent the costs can be passed through, resulting in a limited impact on gross margin, if any. Although these circumstances may not have a large impact on gross margin, they can significantly affect gross margin as a percentage of revenue. As a result, gross margin as a percentage of revenue is a less relevant measure when evaluating our operating performance. To the extent our businesses are unable to pass through fuel cost increases to their customers, gross margin may be adversely affected.
Global diversification also helps us to mitigate risk. Our presence in mature markets helps mitigate the exposure associated with our businesses in emerging markets. Additionally, our portfolio employs a broad range of fuels, including coal, gas, fuel oil, water (hydroelectric power), wind and solar, which reduces the risks associated with dependence on any one fuel source. However, to the extent the mix of fuel sources enabling our generation capabilities in any one market is not diversified, the spread in costs of different fuels may also influence the operating performance and the ability of our subsidiaries to compete within that market. For example, in a market where gas prices fall to a low level compared to coal prices, power prices may be set by low gas prices which can affect the profitability of our coal plants in that market. In certain cases, we may attempt to hedge fuel prices to manage this risk, but there can be no assurance that these strategies will be effective.
We also attempt to limit risk by hedging much of our interest rate and commodity risk, and by matching the currency of most of our subsidiary debt to the revenue of the underlying business. However, we only hedge a portion of our currency and commodity risks, and our businesses are still subject to these risks, as further described in Item 1A. Risk Factors of the 2010 Form 10-K, We may not be adequately hedged against our exposure to changes in commodity prices or interest rates. Commodity and power price volatility could continue to impact our financial metrics to the extent this volatility is not hedged. For a discussion of our sensitivities to commodity, currency and interest rate risk, see Item 3. Quantitative and Qualitative Disclosures About Market Risk in this Form 10-Q.
Due to our global presence, the Company has significant exposure to foreign currency fluctuations. The exposure is primarily associated with the impact of the translation of our foreign subsidiaries operating results from their local currency to U.S. dollars that is required for the preparation of our consolidated financial statements. Additionally, there is a risk of transaction exposure when an entity enters into transactions, including debt agreements, in currencies other than their functional currency. These risks are further described in Item 1A. Risk Factors of the 2010 Form 10-K, Our financial position and results of operations may fluctuate significantly due to fluctuations in currency exchange rates experienced at our foreign operations. In the three months ended March 31, 2011, changes in foreign currency exchange rates have had a significant impact on our operating results. If the current foreign currency exchange rate volatility continues, our gross margin and other financial metrics could be affected.
Another key driver of our results is our ability to bring new businesses into commercial operations successfully. We currently have approximately 2,038 MW of projects under construction in ten countries. Our
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prospects for increases in operating results and cash flows are dependent upon successful completion of these projects on time and within budget. However, as disclosed in Item 1A. Risk Factors of the 2010 Form 10-K, Our business is subject to substantial development uncertainties, construction is subject to a number of risks, including risks associated with site identification, financing and permitting and our ability to meet construction deadlines. Delays or the inability to complete projects and commence commercial operations can result in increased costs, impairment of assets and other challenges involving partners and counterparties to our construction agreements, PPAs and other agreements.
Our gross margin is also impacted by the fact that in each country in which we conduct business, we are subject to extensive and complex governmental regulations such as regulations governing the generation and distribution of electricity, and environmental regulations which affect most aspects of our business. Regulations differ on a country by country basis (and even at the state and local municipality levels) and are based upon the type of business we operate in a particular country, and affect many aspects of our operations and development projects.
Our ability to negotiate tariffs, enter into long-term contracts, pass through costs related to capital expenditures and otherwise navigate these regulations can have an impact on our revenue, costs and gross margin. Environmental and land use regulations, including existing and proposed regulation of greenhouse gas (GHG) emissions, could substantially increase our capital expenditures or other compliance costs, which could in turn have a material adverse affect on our business and results of operations. For a further discussion of the Regulatory Environment, see Note 9 Contingencies and Commitments Environmental, included in Item 1. Financial Statements of this Form 10-Q and Item 1. Business Regulatory Matters Environmental and Land Use Regulations and Item&