AES CORP quarterly report, Q3 FY2011

AES Corporation — Form 10-Q Summary

Business context and reporting period

AES is a global power company operating Generation and Utilities businesses across Latin America, North America, Europe and Asia. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, with comparisons to the corresponding 2010 periods. Prior periods were reclassified for discontinued and held-for-sale businesses.

Reportable segments were Latin America Generation, Latin America Utilities, North America Generation, North America Utilities, Europe Generation and Asia Generation. Andres Gluski became President and Chief Executive Officer on September 6, 2011; management subsequently announced a planned realignment around Generation and Utilities.

Financial performance and key metrics

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Revenue	$4,381 million	$3,990 million	$13,117 million	$11,777 million
Gross margin	$1,020 million	$967 million	$3,019 million	$2,901 million
Gross margin percentage	23.3%	24.2%	23.0%	24.6%
Income from continuing operations	$150 million	$289 million	$1,062 million	$1,079 million
Net income attributable to AES	$(131) million	$114 million	$267 million	$445 million
Diluted EPS from continuing operations	$(0.15)	$0.05	$0.38	$0.46
Adjusted EPS	$0.27	$0.20	$0.76	$0.70
Net cash from operating activities	$1,127 million	$1,000 million	$2,308 million	$2,416 million

Q3 revenue increased 10% and nine-month revenue increased 11%, driven by favorable foreign exchange, new operations at Angamos and Maritza, the Ballylumford acquisition, higher Latin American prices and volumes, and increased Brazilian utility demand.
Gross margin increased 5% in Q3 and 4% year to date, but margin percentage declined because pass-through fuel and purchased-energy costs increased revenue without a corresponding gross-margin benefit.
Q3 net loss attributable to AES was primarily affected by $92 million of foreign-currency losses, $163 million of asset impairments, $17 million of goodwill impairment, $82 million of other non-operating expense and higher interest expense. Q3 also lacked the $79 million gain from discontinued-business disposals recorded in 2010.
Nine-month net income attributable to AES declined 40%, reflecting lower equity earnings, reduced discontinued-business income, China-related impairments and the absence of prior-year disposal gains.
Adjusted EPS increased despite the GAAP loss because management excludes derivative mark-to-market effects, unrealized currency movements, impairments, significant transaction items and debt-retirement costs.

Cash flow, liquidity and debt

Cash and cash equivalents were $3.392 billion at September 30, 2011, compared with $2.550 billion at December 31, 2010. Restricted cash and short-term investments were $795 million and $1.053 billion, respectively.
Nine-month operating cash flow was $2.308 billion. Investing cash use was $1.734 billion, including $1.832 billion of capital expenditures. Financing activities provided $347 million.
Parent Company liquidity was $2.877 billion, consisting of $2.089 billion of parent and qualified holding-company cash and $788 million of available borrowing capacity.
Total debt was $20.878 billion at September 30, 2011, consisting of $14.686 billion of non-recourse debt and $6.192 billion of recourse debt. Fair value of total debt was $21.101 billion.
Approximately $1.3 billion of current non-recourse debt related to defaults at Maritza, Sonel and Kelanitissa. Management stated that these subsidiaries were not material subsidiaries under the parent debt agreements at period-end, but future changes could create cross-default or acceleration risks.
During the first nine months, AES issued $2.05 billion of recourse debt, including a $1.05 billion term loan and $1.0 billion of 7.375% senior notes due 2021. Subsequent to quarter-end, Dolphin II issued $1.25 billion of notes to support the proposed DPL acquisition.

Material changes versus the prior comparable period

Q3 revenue rose $391 million, while gross margin rose $53 million; however, AES shifted from $114 million of attributable net income to a $131 million loss.
Nine-month revenue rose $1.340 billion and gross margin rose $118 million, but attributable net income fell $178 million and operating cash flow fell $108 million.
Latin America Generation gross margin increased 14% in both Q3 and the nine-month period; Latin America Utilities gross margin increased 23% in Q3 and 13% year to date.
North America Utilities gross margin declined 9% in Q3 and 17% year to date, primarily due to outages, maintenance costs, weather and lower wholesale and retail margins.
Asia Generation gross margin declined 27% in Q3 and 31% year to date, primarily because of lower prices and volumes at Masinloc and higher coal prices.
Europe Generation benefited from Ballylumford and Maritza, with Q3 gross margin increasing 102% and nine-month gross margin increasing 9%.
Asset impairment expense declined to $163 million in Q3 and $196 million year to date, versus $296 million and $297 million in the comparable 2010 periods. Current-year charges included wind turbines and deposits, carbon reduction projects and Kelanitissa.
Other-than-temporary impairment of the YangCheng equity investment reduced its carrying value from $100 million to $26 million, generating a $74 million charge. Chigen goodwill was fully impaired by $17 million.
Eletropaulo recorded an estimated $104 million regulatory liability and corresponding revenue reduction for expected refunds following a delayed Brazilian tariff reset.
AES repurchased approximately 20.0 million shares for $224 million during the nine months, and held 36.8 million treasury shares at September 30, 2011.

Guidance, outlook, management commentary and risks

The filing does not provide a formal earnings guidance range. Management expects improved performance at selected businesses and growth from new operations to partially offset tariff pressure, outages, foreign-exchange volatility, commodity exposure and weaker merchant-generation conditions.
Management prioritized closing the DPL acquisition, reducing corporate debt, allocating capital geographically, returning capital to shareholders, selling or restructuring selected businesses, realigning management, improving operations, repairing the Esti hydro tunnel in Panama and completing approximately 2,294 MW of projects under construction.
Maritza was operating at approximately 620 MW versus its 670 MW design capacity, with final regulatory approval pending. Its project debt was in default, and AES was in litigation with the contractor concerning construction delays.
The Esti hydroelectric plant in Panama was offline because of tunnel damage and was projected to resume operations in the second quarter of 2012, subject to construction risk.
Eastern Energy was held for sale and faced negative cash flow, lease obligations and debt-related forbearance issues. Failure to sell or restructure the business could result in defaults, cross-defaults, loss of control or reclassification of its results from discontinued operations.
AES was committed, subject to approvals, to purchase DPL for approximately $3.5 billion in cash, with an enterprise value of approximately $4.7 billion including assumed net debt. The acquisition remained subject to regulatory and other closing conditions.
Environmental and regulatory risks include potential costs from greenhouse-gas rules, the Cross-State Air Pollution Rule, hazardous-air-pollutant standards, cooling-water requirements, coal-combustion-byproduct regulation and Chilean emissions standards. The filing states that potential costs could be material but were not yet estimable.
Recorded litigation and claims reserves were approximately $372 million. Management estimated reasonably possible losses from material contingencies, excluding recorded reserves, at up to $1.2 billion.
Parent Company guarantees, letters of credit and cash-collateralized letters of credit totaled $629 million. The company also had $16 million of additional construction and equipment investment commitments.
Market risks include electricity, fuel and environmental-credit prices, foreign exchange, interest rates and counterparty credit. For the remainder of 2011, management estimated approximately $5 million of pre-tax earnings exposure for a $10-per-barrel oil move and approximately $5 million for a $1/MMBTU natural-gas move, excluding certain New York merchant assets.

Most important facts for investors to verify

Whether the DPL acquisition closed on the expected timetable and how the related $1.25 billion of acquisition financing was ultimately treated.
Resolution of defaults at Maritza, Sonel and Kelanitissa and any effect on parent-company covenants, cross-defaults or required funding.
Final Eletropaulo tariff-reset terms and whether the $104 million estimated regulatory liability requires adjustment.
Progress and final cost of the Esti tunnel repair and Maritza’s approval to operate at full capacity.
Whether Eastern Energy was sold or restructured before its liquidity and forbearance issues became material.
Final proceeds, gain and tax effects from the October 2011 sale of the Brazilian telecommunications businesses and the proposed AES Cartagena sale.
Potential additional impairments involving wind assets, carbon projects, Kelanitissa, YangCheng, Chigen and other merchant or regulated assets.
Exposure to the disclosed litigation, environmental proceedings and up to $1.2 billion of reasonably possible unreserved contingency losses.
Reconciliation of Adjusted EPS to GAAP results, particularly the recurring effects of derivative mark-to-market movements, foreign-currency losses and impairments.