| You should carefully consider the risks described below before deciding to invest in our Company |
| The Company’s disclosure controls and procedures and internal control over financial reporting were determined not to be effective as of December 31, 2005 and December 31, 2004, due to the material weaknesses that existed in our internal control over financial reporting |
| Our disclosure controls and procedures and internal control over financial reporting may not be effective in future periods, as a result of existing or newly identified material weaknesses in internal control over financial reporting |
| As required by the federal securities laws, our management periodically performs an evaluation of our disclosure controls and procedures and conducts an assessment of our internal control over financial reporting |
| “Disclosure controls and procedures” are controls and procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files with the SEC under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the SEC’s rules and forms, and that such information is accumulated and communicated to the chief executive officer and chief financial officer to allow timely decisions regarding required disclosures |
| “Internal control over financial reporting” is the process designed by a company’s senior management to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles |
| In performing the assessment at the end of 2005 and 2004, our management identified material weaknesses in our internal control over financial reporting |
| A material weakness is a deficiency, or a combination of deficiencies, that adversely affects a companyapstas ability to initiate, authorize, record, process, or report external financial data reliably in accordance with generally accepted accounting principles such that there is a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected |
| For a discussion of the material weaknesses identified by our management, see Item 9A of this 2005 annual report on Form 10-K Due to these material weaknesses, our management concluded that as of December 31, 2005 and December 31, 2004, our Company did not maintain effective control over financial reporting and concluded that our disclosure controls and procedures were ineffective |
| During our remediation efforts to correct the material weakness that was identified at the end of 2004, errors were discovered in our financial statements which resulted from such material weakness, as well as newly identified material weaknesses |
| These errors required us to restate our financial statements that were previously filed in our annual report on Form 10-K for the year ended December 31, 2004 and our quarterly report on Form 10-Q for the quarter ended March 31, 2005 |
| To address the material weaknesses, we performed additional analysis and other post-closing procedures in order to prepare our consolidated financial statements in accordance with generally accepted accounting principles |
| These additional procedures were costly, time consuming and required us to dedicate a significant amount of our resources, including the time and attention of our senior management, toward the correction of these problems |
| Performing these additional procedures and the need to restate our financial statements also caused us to delay the filing of our quarterly reports for the second and third quarters of 2005 until January 2006, which was well beyond the deadline prescribed by the SEC’s rules to file such reports |
| In addition, during the 2005 year-end closing process, additional errors were identified that required us to restate our 2004 and 2003 financial results |
| These corrections are included in the 2005 annual report on Form 10-K The delays in filing our 2004 Form 10-K/A, and restated quarterly reports, as well as the additional errors identified during the year-end closing process caused the 2005 annual report on Form 10-K to be filed after the SEC deadline for the 2005 annual report on Form 10-K, as well |
| As a result of not timely filing the quarterly and annual reports with the SEC, we lost our eligibility to offer and sell our securities pursuant to our shelf registration statement on Form S-3 which could impair 41 ______________________________________________________________________ our ability to access the capital markets in a timely manner |
| In addition, the restatements and the delay in the filing of our quarterly and annual reports could have other adverse effects on our business, including, but not limited to: · civil litigation or an investigation by the SEC or other regulatory authorities, which could require us to incur significant legal expenses and other costs or to pay damages, fines or other penalties, · covenant defaults, and potentially events of default, under our senior secured credit facilities and the indentures governing our outstanding debt securities, resulting from our failure to timely file our financial statements, · negative publicity, or · the loss or impairment of investor confidence in our Company |
| Because of our decentralized structure and the many disparate accounting systems of varying quality and sophistication at our various businesses throughout the world, there is still extensive work remaining to remedy the material weaknesses in internal control over financial reporting |
| We have developed a remediation plan and have begun implementing this plan, but we expect that this work will extend throughout 2006 and possibly beyond |
| We cannot assure you as to when the remediation plan will be fully implemented, nor can we assure that additional material weaknesses will not be identified by our management or the auditors in the future |
| Until our remediation efforts are completed, we will continue to incur the expense and management burdens associated with the additional procedures required to prepare our consolidated financial statements |
| There will also continue to be an increased risk that we will be unable to timely file future periodic reports with the SEC, that a related default under our senior secured credit facilities and indentures could occur and that our financial statements could contain errors that will be undetected |
| Management, including our CEO and CFO, does not expect that our internal controls will prevent or detect all errors and all fraud |
| A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met |
| Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs |
| Any evaluation of the effectiveness of controls is subject to risks that those internal controls may become inadequate in future periods because of changes in business conditions, or that the degree of compliance with the policies or procedures deteriorates |
| In addition, the effect of new, or changes in, accounting policies and practices and the application of such policies and practices could adversely affect our business |
| Our high level of indebtedness, and the security provided for this indebtedness, could adversely affect our business and our ability to fulfill our obligations |
| At December 31, 2005, we had approximately dlra17dtta7 billion of outstanding indebtedness on a consolidated basis, of which approximately dlra4dtta9 billion was recourse debt of The AES Corporation and approximately dlra12dtta8 billion was non-recourse debt |
| All outstanding borrowings under our Senior Secured Credit Facility, our Second Priority Senior Secured Notes and certain other indebtedness are secured by certain of our assets, including the pledge of capital stock of many of our directly held subsidiaries |
| Most of the debt of our subsidiaries is pledged by substantially all of the assets of those subsidiaries |
| This level of indebtedness and related security could have important consequences to us and our investors because it could: · make it more difficult for us to satisfy our debt service and other obligations, · increase our vulnerability to general adverse economic and industry conditions, 42 ______________________________________________________________________ · require us to dedicate a substantial portion of our cash flow from operations to make payments on our indebtedness, thereby reducing the availability of our cash flow to fund other corporate purposes and grow our business, · limit our flexibility in planning for, or reacting to, changes in our business and the industry, · place us at a competitive disadvantage to our competitors that are not as highly leveraged, and · limit, along with the financial and other restrictive covenants in our and our subsidiaries’ indebtedness, among other things, our ability to borrow additional funds as needed or take advantage of business opportunities as they arise |
| The agreements governing our indebtedness and the indebtedness of our subsidiaries limit but do not prohibit us or our subsidiaries from incurring additional indebtedness |
| Further, our actual cash requirements in the future may be greater than expected |
| Accordingly, our cash flow from operations may not be sufficient to repay at maturity all of the outstanding debt as it becomes due and, in that event, we may not be able to borrow money, sell assets or otherwise raise funds on acceptable terms or at all to refinance our debt as it becomes due |
| We have significant cash requirements and limited sources of liquidity |
| The AES Corporation, which refers to the AES parent company, requires cash primarily to fund: · principal repayments of debt, · interest and preferred dividends, · acquisitions, · construction and other project commitments, · other equity commitments, · taxes, and · parent company overhead and development costs |
| The AES Corporation’s principal sources of liquidity are: · dividends and distributions from its subsidiaries, · proceeds from debt and equity financings at the parent company level, and · proceeds from asset sales |
| For a more detailed discussion of our cash requirements and sources of liquidity, please see “Item 7 |
| Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources and Liquidity” in this 2005 annual report on Form 10-K While we believe that these sources will be adequate to meet our obligations at the parent company level for the foreseeable future, this belief is based on a number of material assumptions, including, without limitation, assumptions about our ability to access the capital or commercial lending markets, the operating and financial performance of our subsidiaries, exchange rates and the ability of its subsidiaries to pay dividends |
| Any number of assumptions could prove to be incorrect and therefore we cannot assure you that these sources will be available when needed or that our actual cash requirements will not be greater than expected |
| In addition, our cash flow may not be sufficient to repay at maturity all of the principal outstanding under our senior secured credit facilities and our debt securities and we may have to refinance such obligations |
| We cannot assure you that we will be successful in obtaining such refinancings |
| 43 ______________________________________________________________________ Existing and potential future defaults by project subsidiaries could adversely affect our results of operations and financial condition |
| We attempt to finance our domestic and foreign projects primarily under loan agreements and related documents which, except as noted below, require the loans to be repaid solely from the project’s revenues and provide that the repayment of the loans (and interest thereon) is secured solely by the capital stock, physical assets, contracts and cash flow of that project subsidiary or affiliate |
| This type of financing is usually referred to as non-recourse debt or “project financing |
| ” In some project financings, The AES Corporation has explicitly agreed to undertake certain limited obligations and contingent liabilities, most of which by their terms will only be effective or will be terminated upon the occurrence of future events |
| These obligations and liabilities take the form of guarantees, indemnities, letter of credit reimbursement agreements, and agreements to pay, in certain circumstances, the project lenders or other parties |
| To the extent The AES Corporation becomes liable under such guarantees and other arrangements, distributions received by The AES Corporation from other projects are subject to the possibility of being utilized by The AES Corporation to satisfy these obligations |
| At December 31, 2005, we had approximately dlra4dtta9 billon of recourse debt and approximately dlra12dtta8 billion of non-recourse debt outstanding |
| At December 31, 2005, The AES Corporation had provided outstanding financial and performance related guarantees or other credit support commitments to or for the benefit of its subsidiaries, which were limited by the terms of the agreements, to an aggregate of approximately dlra507 million (excluding those collateralized by letter-of-credit obligations discussed below) |
| The AES Corporation also is obligated under other commitments, which are limited to amounts, or percentages of amounts, received by The AES Corporation as distributions from its project subsidiaries |
| In addition, The AES Corporation has commitments to fund its equity in projects currently under development or in construction |
| At December 31, 2005, The AES Corporation also had dlra294 million in letters of credit outstanding and dlra1 million in surety bonds outstanding, which operate to guarantee performance relating to certain project development activities and subsidiary operations |
| Some of our subsidiaries are currently in default with respect to all or a portion of their outstanding indebtedness |
| The total debt classified as current in our consolidated balance sheets related to such defaults was dlra138 million at December 31, 2005 |
| While the lenders under our non-recourse project financings generally do not have direct recourse to The AES Corporation (other than to the extent of any credit support given by The AES Corporation), defaults thereunder can still have important consequences for The AES Corporation’s results of operations and liquidity, including, without limitation: · reducing The AES Corporation’s cash flows since the project subsidiary will typically be prohibited from distributing cash to The AES Corporation during the pendancy of any default, · triggering The AES Corporation’s obligation to make payments under any financial guarantee, letter of credit or other credit support which The AES Corporation has provided to or on behalf of such subsidiary, · causing The AES Corporation to record a loss in the event the lender forecloses on the assets, or · triggering defaults in The AES Corporation’s outstanding debt and trust preferred instruments |
| For example, The AES Corporation’s senior secured credit facilities and outstanding senior notes and junior subordinated notes include events of default for certain bankruptcy related events involving material subsidiaries |
| In addition, The AES Corporation’s senior secured credit facilities include events of default relating to accelerations of outstanding debt of material subsidiaries |
| None of the projects that are currently in default are owned by subsidiaries that meet the applicable definition of materiality in The AES Corporation’s senior secured credit facilities in order for such defaults to trigger an event of default or permit an acceleration under such indebtedness |
| However, as a result of 44 ______________________________________________________________________ future write down of assets, dispositions and other matters that affect our financial position and results of operations, it is possible that one or more of these subsidiaries could fall within the definition of a “material subsidiary” and thereby upon an acceleration of such subsidiary’s debt, trigger an event of default and possible acceleration of the indebtedness under The AES Corporation’s senior secured credit facilities |
| Our competitive supply and Latin American operations represent a substantial portion of our assets and have caused and are expected to continue to cause significant volatility in our results of operations and cash flows |
| The competitive supply segment of our business and our Latin American operations each experience volatility in revenues and earnings and has had and is expected to continue to cause significant volatility on our results of operations and cash flows |
| The competitive supply segment’s volatility has resulted from volatile electricity prices, which are influenced by peak demand requirements, weather conditions, competition, market regulation, interest rate and foreign exchange rate fluctuations, electricity transmission and environmental emission constraints, the availability or prices of emission credits and fuel prices, as well as plant availability and other relevant factors |
| Our Latin American operations have experienced significant volatility because of regulatory and economic difficulties, political instability and currency devaluations being experienced in many of these countries |
| We do a significant amount of our business outside the United States which presents significant risks |
| During 2005, approximately 79prca of our revenue was generated outside the United States and a significant portion of our international operations is conducted in developing countries |
| Part of our growth strategy is to expand our business in developing countries because the growth rates and the opportunity to implement operating improvements and achieve higher operating margins may be greater than those typically achievable in more developed countries |
| International operations, particularly the operation, financing and development of projects in developing countries, entail significant risks and uncertainties, including, without limitation: · economic, social and political instability in any particular country or region, · adverse changes in currency exchange rates, · government restrictions on converting currencies or repatriating funds, · unexpected changes in foreign laws and regulations or in trade, monetary or fiscal policies, · high inflation and monetary fluctuations, · restrictions on imports of coal, oil, gas or other raw materials required by our generation businesses to operate, · expropriation of our assets by foreign governments, · difficulties in hiring, training and retaining qualified personnel, particularly finance and accounting personnel with US GAAP expertise, · unwillingness of governments, government agencies or similar organizations to honor their contracts, · inability to obtain access to fair and equitable political, regulatory, administrative and legal systems, · difficulties in enforcing our contractual rights or enforcing judgments or obtaining a just result in local jurisdictions, and · potentially adverse tax consequences of operating in multiple jurisdictions |
| 45 ______________________________________________________________________ Any of these factors, by itself or in combination with others, could materially and adversely affect our business, results of operations and financial condition |
| Furthermore, the ability to obtain financing on a commercially acceptable non-recourse basis in developing nations is difficult |
| Even when such non-recourse financing is available, lenders may require us to make higher equity investments or provide greater credit support than historically have been the case |
| In addition, financing in countries with less than investment grade sovereign credit ratings may also require substantial participation by multilateral financing agencies |
| Our financial position and results of operations may fluctuate significantly due to fluctuations in currency exchange rates |
| We operate in many foreign environments and such investment in foreign countries may be impacted by significant fluctuations in foreign currency exchange rates |
| Our exposure to currency exchange rate fluctuations results primarily from the translation exposure associated with the preparation of our consolidated financial statements, as well as from transaction exposure associated with generating revenues and incurring expenses in different currencies |
| While our consolidated financial statements are reported in US dollars, the financial statements of many of our subsidiaries outside the United States are prepared using the local currency as the functional currency and translated into US dollars by applying an appropriate exchange rate |
| As a result, fluctuations in the exchange rate of the US dollar relative to the local currencies in which our subsidiaries outside the United States report could cause significant fluctuations in our results |
| In addition, while our expenses with respect to foreign operations are generally denominated in the same currency as corresponding sales, we have transaction exposure to the extent our receipts and expenditures, including debt service expenditures, are not offsetting in any currency |
| Moreover, the costs of doing business abroad may increase as a result of adverse exchange rate fluctuations |
| Our financial position and results of operations have been significantly affected by fluctuations in the value of the Argentine peso, Brazilian real, the Dominican Republic peso, the Pakistani rupee and the Venezuelan bolivar relative to the US dollar |
| Depreciation of the Argentine peso and Brazilian real has resulted in foreign currency translation and transaction losses, while the appreciation of those currencies has resulted in gains |
| Conversely, depreciation of the Venezuelan bolivar has resulted in foreign currency gains and appreciation has resulted in losses |
| Our business is subject to substantial development uncertainties |
| Certain of our subsidiaries and affiliates are in various stages of developing and constructing greenfield power plants, some but not all of which have signed long-term contracts or made similar arrangements for the sale of electricity |
| Successful completion depends upon overcoming substantial risks, including, but not limited to, risks relating to failures of siting, financing, construction, permitting, governmental approvals or the potential for termination of the power sales contract as a result of a failure to meet certain milestones |
| We believe that capitalized costs for projects under development are recoverable; however, we cannot assure you that any individual project will be completed and reach commercial operation |
| If these development efforts are not successful, we may abandon a project under development |
| At the time of abandonment, we would expense all capitalized development costs incurred in connection therewith and could incur additional losses associated with any related contingent liabilities |
| Our acquisitions may not perform as expected |
| Historically, we have achieved a majority of our growth through acquisitions |
| We plan to continue to grow our business through acquisitions |
| Although acquired businesses may have significant operating histories at the time we acquired them, we will have a limited or no history of owning and operating many of these businesses and possibly limited or no experience operating in the country or region where these businesses are located |
| Some of these businesses may be government owned and some may be operated as 46 ______________________________________________________________________ part of a larger integrated utility prior to their acquisition |
| If we were to acquire any of these types of businesses, we cannot assure you that: · we will be successful in transitioning them to private ownership, · such businesses will perform as expected, · we will not incur unforeseen obligations or liabilities, · such business will generate sufficient cash flow to support the indebtedness incurred to acquire them or the capital expenditures needed to develop them, or · the rate of return from such businesses will justify our decision to invest our capital to acquire them |
| Acquisitions have placed, and in the future may place, a strain on our internal accounting and managerial controls |
| In addition, our acquisitions outside the United States have required, and will require, us to hire personnel with sufficient expertise in US GAAP to timely and accurately comply with our reporting obligations |
| An inability to maintain adequate internal accounting and managerial controls and hire and retain qualified personnel could have an adverse affect on our ability to report our financial condition and results of operations |
| Most of our contract generation businesses are dependent to a large degree on one or a limited number of customers and a limited number of fuel suppliers |
| Most of our contract generation businesses rely on power sales contracts with one or a limited number of customers for the majority of, and in some case all of, the relevant plant’s output and revenues over the term of the power sales contract |
| The remaining term of the power sales contracts related to our contract generation power plants ranges from 1 to 25 years |
| Many of these businesses also limit their exposure to fluctuations in fuel prices by entering into long term contracts for fuel with a limited number of suppliers |
| The cash flows and results of operations of such businesses are dependent on the continued ability of their customers and suppliers to meet their obligations under the relevant power sales contract or fuel supply contract, respectively |
| Some of contract generation businesses’ long-term power sales agreements are for prices above current spot market prices |
| The loss of one or more significant power sales contracts or fuel supply contracts, or the failure by any of the parties to such contracts to fulfill its obligations thereunder, could have a material adverse impact on our business, results of operations and financial condition |
| We have sought to reduce this counter-party credit risk for our contract generation businesses in part by entering into power sales contracts with utilities or other customers of strong credit quality and by obtaining guarantees from the sovereign government of the customer’s obligations |
| However, many of our contract generation businesses’ customers do not have, or have failed to maintain, an investment grade credit rating, and our generation businesses can not always obtain government guarantees and if they do, the government does not always have an investment grade credit rating |
| We have also sought to reduce our credit risk by locating our plants in different geographic areas in order to mitigate the effects of regional economic downturns |
| However, we cannot assure you that our efforts to mitigate this risk will be successful |
| Competition is increasing and could adversely affect us |
| The power production markets in which we operate are characterized by numerous strong and capable competitors, many of whom may have extensive and diversified developmental or operating experience (including both domestic and international experience) and financial resources similar to or greater than ours |
| Further, in recent years, the power production industry has been characterized by strong and increasing competition with respect to both obtaining power sales agreements and acquiring existing power generation assets |
| In certain markets, these factors have caused reductions in prices contained in new power sales agreements and, in many cases, have caused higher acquisition prices for existing assets 47 ______________________________________________________________________ through competitive bidding practices |
| The evolution of competitive electricity markets and the development of highly efficient gas-fired power plants have also caused, or are anticipated to cause, price pressure in certain power markets where we sell or intend to sell power |
| There can be no assurance that the foregoing competitive factors will not have a material adverse effect on us |
| Our distribution businesses are highly regulated |
| Our distribution businesses face increased regulatory and political scrutiny in the normal conduct of their operations |
| This scrutiny may adversely impact our results of operations to the extent that such scrutiny or pressure prevents us from reducing losses as quickly as we planned or denies us a rate increase called for by our concession agreements |
| In general, our distribution businesses have lower margins and are more dependent on regulation to ensure expected annual rate increases for inflation, capital expenditures and increased fuel and power costs, among other things |
| There can be no assurance that these rate reviews will be granted, or occur in a timely manner |
| Our ability to raise capital on favorable terms, to refinance existing corporate or subsidiary indebtedness or to fund operations, capital expenditures, future acquisitions, construction of greenfield projects could adversely affect our results of operations |
| Our ability to arrange for financing on either a recourse or non-recourse basis and the costs of such capital are dependent on numerous factors, some of which are beyond our control, including · general economic and capital market conditions, · the availability of bank credit, · investor confidence, · the financial condition, performance, prospects and credit rating of our company in general and/or that of our subsidiary requiring the financing, and · changes in tax and securities laws which are conducive to raising capital |
| Should future access to capital not be available, we may have to sell assets or decide not to build new plants or acquire existing facilities |
| While a decision not to build new plants or acquire existing facilities would not affect the results of operations of our currently operating facilities or facilities under construction, such a decision would affect our future growth |
| Our business and results of operations could be adversely affected by changes in our operating performance or cost structure |
| We are in the business of generating and distributing electricity, which involves certain risks that can adversely affect financial and operating performance, including: · changes in the availability of our generation facilities or distribution systems due to increases in scheduled and unscheduled plant outages, equipment failure, labor disputes, disruptions in fuel supply, inability to comply with regulatory or permit requirements or catastrophic events such as fires, floods, storms, hurricanes, earthquakes, explosions, terrorist acts or other similar occurrences; and · changes in our operating cost structure, including, but not limited to, increases in costs relating to: gas, coal, oil and other fuel; fuel transportation; purchased electricity; operations, maintenance and repair; environmental compliance, including the cost of purchasing emissions offsets and capital expenditures to install environmental emission equipment; transmission access; and insurance |
| Any of the above risks could adversely affect our business and results of operations, and our ability to meet our publicly announced projections or analysts expectations |
| 48 ______________________________________________________________________ We are subject to significant government regulation and our business and results of operations could be adversely affected by changes in the law or regulatory schemes |
| We operate a portfolio of electricity generation and distribution businesses in 25 countries and, therefore, we are subject to significant and diverse government regulation |
| Our inability to predict, influence or respond appropriately to changes in law or regulatory schemes, including our inability to obtain expected or contracted increases in electricity tariff rates or tariff adjustments for increased expenses, could adversely impact our results of operations or our ability to meet our publicly announced projections or analyst’s expectations |
| Furthermore, changes in laws or regulations or changes in the application or interpretation of regulatory provisions in jurisdictions where we operate, particularly our regulated utilities where electricity tariffs are subject to regulatory review or approval, could adversely affect our business, including, but not limited to: · changes in the determination, definition or classification of costs to be included as reimbursable or pass-through costs, · changes in the definition or determination of controllable or non-controllable costs, · changes in the definition of events which may or may not qualify as changes in economic equilibrium, · changes in the timing of tariff increases, or · other changes in the regulatory determinations under the relevant concessions |
| Our businesses, particularly our businesses in our competitive supply segment, may incur substantial costs and liabilities and be exposed to price volatility as a result of risks associated with the wholesale electricity markets |
| Our generation businesses, especially our businesses in the competitive supply segment, sell electricity in the wholesale spot markets |
| Our regulated utility businesses, and to the extent they require additional capacity our generations businesses, also buy electricity in the wholesale spot markets |
| The open market wholesale prices for electricity are very volatile and often reflect the fluctuating cost of coal, natural gas, or oil |
| Consequently, any changes in the supply and cost of coal, natural gas, and oil may impact the open market wholesale price of electricity |
| A significant percentage of our generation facilities, particularly the facilities in our competitive supply segment, operate wholly or partially without long-term power sales agreements |
| As a result, power from these facilities is sold on the spot market or on a short-term contractual basis, which if not fully hedged may affect the volatility of our financial results |
| In addition, our business depends upon transmission facilities owned and operated by others; if transmission is disrupted or capacity is inadequate or unavailable, our ability to sell and deliver our wholesale power may be limited |
| Volatility in market prices for fuel and electricity may result from among other things: · weather conditions, · seasonality, · electricity usage, · illiquid markets, · transmission or transportation constraints or inefficiencies, · availability of competitively priced alternative energy sources, 49 ______________________________________________________________________ · demand for energy commodities, · available supplies of natural gas, crude oil and refined products, and coal, · generating unit performance, · natural disasters, terrorism, wars, embargoes and other catastrophic events, · federal and state energy and environmental regulation, legislation and policies, · geopolitical concerns affecting global supply of oil and natural gas, and · general economic conditions in areas where we generate which impact energy consumption |
| We are a holding company and our ability to make payments on our outstanding indebtedness at the parent company level is dependent upon the receipt of funds from our subsidiaries by way of dividends, fees, interest, loans, or otherwise |
| The AES Corporation is a holding company with no material assets, other than the stock of its subsidiaries |
| All of our revenue generating operations are conducted through our subsidiaries |
| Accordingly, almost all of our cash flow is generated by the operating activities of our subsidiaries |
| Our subsidiaries are separate and distinct legal entities and, unless they have expressly guaranteed any of our indebtedness, have no obligation, contingent or otherwise, to pay any amounts due pursuant to our debt or to make any funds available therefore, whether by dividends, fees, loans or other payments |
| While some of our subsidiaries guarantee our indebtedness under our senior secured credit facility and certain other indebtedness, none of our subsidiaries guarantee, or is otherwise obligated with respect to, our outstanding public debt securities |
| Accordingly, our ability to make payments on our indebtedness and to fund our other obligations at the parent company level is dependent not only on the ability of our subsidiaries to generate cash, but also on the ability of our subsidiaries to distribute cash to us in the form of dividends, fees, interest, loans or otherwise |
| Most of our subsidiaries are obligated, pursuant to loan agreements, indentures or project financing arrangements, to satisfy certain restricted payment covenants or other conditions before they may make distributions to us |
| In addition, the payment of dividends or the making of loans, advances or other payments to us may be subject to legal or regulatory restrictions |
| Our subsidiaries in foreign countries may also be prevented from distributing funds to us as a result of restrictions imposed by the foreign government on repatriating funds or converting currencies |
| Any right we have to receive any assets of any of our subsidiaries upon any liquidation, dissolution, winding up, receivership, reorganization, assignment for the benefit of creditors, marshaling of assets and liabilities or any bankruptcy, insolvency or similar proceedings (and the consequent right of the holders of our indebtedness to participate in the distribution of, or to realize proceeds from, those assets) will be effectively subordinated to the claims of any such subsidiary’s creditors (including trade creditors and holders of debt issued by such subsidiary) |
| We may not be able to raise sufficient capital to fund greenfield projects in certain less developed economies |
| Commercial lending institutions sometimes refuse to provide non-recourse project financing (including financial guarantees) in certain less developed economies, thus we have sought and will continue to seek, in such locations, direct or indirect (through credit support or guarantees) project financing from a limited number of multilateral or bilateral international financial institutions or agencies |
| As a precondition to making such project financing available, these institutions may also require governmental guarantees of certain project and sovereign related risks |
| Depending on the policies of specific governments, such guarantees may not be offered and as a result, we may determine that sufficient financing will ultimately not be available to fund the related project |
| In addition, we are frequently required to provide more sponsor equity for projects that sell their electricity into the merchant market than for projects that sell their electricity under long term contracts |
| 50 ______________________________________________________________________ A downgrade in our or our subsidiaries’ credit ratings could adversely affect our ability to access the capital markets which could increase our interest costs or adversely affect our liquidity and cash flow |
| From time to time we rely on access to capital markets as a source of liquidity for capital requirements not satisfied by operating cash flows |
| If any of our or our subsidiaries credit ratings were to be downgraded, our ability to raise capital on favorable terms could be impaired and our borrowing costs would increase |
| Furthermore, as a result of The AES Corporation’s credit ratings and the trading prices of its equity and debt securities, counter parties may no longer be as willing to accept general unsecured commitments by The AES Corporation to provide credit support |
| Accordingly, with respect to both new and existing commitments, The AES Corporation may be required to provide some other form of assurance, such as a letter of credit, to backstop or replace any credit support by The AES Corporation |
| We cannot provide assurance that such counter parties will accept such guarantees in the future |
| In addition, to the extent The AES Corporation is required and able to provide letters of credit or other collateral to such counterparties, it will limit the amount of credit available to The AES Corporation to meet its other liquidity needs |
| Our generation business in the United States is subject to the provisions of various laws and regulations administered in whole or in part by the FERC, including the Public Utility Regulatory Policies Act of 1978(“PURPA”) and the Federal Power Act |
| The recently enacted Energy Policy Act of 2005 (“EPAct 2005”) made a number of changes to these and other laws that may affect our business |
| Actions by the FERC and by state utility commissions can have a material effect on our operations |
| EPAct 2005 authorizes the FERC to remove the obligation of electric utilities under Section 210 of PURPA to enter into new contracts for the purchase or sale of electricity from or to ‘Qualified Facilities’ (“QFs”) if certain market conditions are met |
| Pursuant to this authority the FERC has recently proposed to remove the purchase/sale obligation for all utilities located within the control areas of the Midwest Transmission System Operator, Inc, PJM Interconnection, LLC, ISO New England, Inc |
| and the New York Independent System Operator |
| While the new law does not affect existing contracts, as a result of the changes to PURPA our QFs may face a more difficult market environment when their current long-term contracts expire |
| PUHCA 1935 had the effect of requiring utility holding companies to operate in geographically proximate regions and therefore limited the range of potential combinations and mergers among utilities |
| By comparison PUHCA 2005 has no such restrictions and simply provides the FERC and state utility commissions with enhanced access to the books and records of certain utility holding companies |
| The repeal of PUHCA 1935 may spur an increased number of mergers and the creation of large, geographically dispersed utility holding companies |
| These entities may have enhanced financial strength and therefore an increased ability to compete with us in the US generation market |
| In accordance with Congressional mandates in the Energy Policy Act of 1992 and now in EPAct 2005, the FERC has strongly encouraged competition in wholesale electric markets |
| Increased competition may have the effect of lowering our operating margins |
| Among other steps, the FERC has encouraged regional transmission organizations and independent system operators to develop demand response bidding programs as a mechanism for responding to peak electric demand |
| These programs may reduce the value of our peaking assets which rely on very high prices during a relatively small number of hours to recover their costs |
| Similarly, the FERC is encouraging the construction of new transmission infrastructure in accordance with provisions of EPAct 2005 |
| Although new transmission lines may increase our market opportunities, they may also increase the competition in our existing markets |
| While the FERC continues to promote competition, some state utility commissions have reversed course and begun to encourage the construction of generation facilities by traditional utilities to be paid 51 ______________________________________________________________________ for on a cost-of-service basis by retail ratepayers |
| Such actions have the effect of reducing sale opportunities in the competitive wholesale generating markets in which we operate |
| Finally, EPAct 2005 affects nearly every aspect of the energy business and energy regulation |
| We are still in the process of analyzing the new law’s effects, and those effects could have a material adverse effect on our business |
| We are subject to material litigation and regulatory proceedings |
| We and our affiliates are parties to material litigation and regulatory proceedings |
| Investors should review the descriptions of such matters contained in this annual report, as well as our other periodic reports we file in the future with the Commission |
| There can be no assurances that the outcome of such matters will not have a material adverse effect on our consolidated financial position |
| Our business is subject to stringent environmental laws and regulations |
| Our activities are subject to stringent environmental laws and regulation by federal, state, local authorities, international treaties and foreign governmental authorities |
| These regulations generally involve emissions into the air, effluents into the water, use of water, wetlands preservation, waste disposal, endangered species, and noise regulation, among others |
| Failure to comply with such laws and regulations or to obtain any necessary environmental permits pursuant to such laws and regulations could result in fines or other sanctions |
| Environmental laws and regulations affecting power generation and distribution are complex and have tended to become more stringent over time |
| Congress and other domestic and foreign governmental authorities have either considered or implemented various laws and regulations to restrict or tax certain emissions, particularly those involving air and water emissions |
| See the various descriptions of these laws and regulations contained in this annual report on Form 10-K under the caption “Regulation Matters—Environmental and Land Use Regulations |
| ” These laws and regulations have imposed, and proposed laws and regulations could impose in the future, additional costs on the operation of our power plants |
| We have made and will continue to make significant capital and other expenditures to comply with these and other environmental laws and regulations |
| Changes in, or new, environmental restrictions may force us to incur significant expenses or exceed our estimates |
| There can be no assurance that we would be able to recover all or any increased environmental costs from our customers or that our business, financial condition or results of operations would not be materially and adversely affected by such expenditures or any changes in domestic or foreign environmental laws and regulations |
| Catastrophic events could adversely affect our facilities and operations |
| Catastrophic events such as fires, explosions, terrorist acts or natural disasters such as floods or tornadoes, or other similar occurrences could adversely affect our facilities, operations, earnings and cash flow |
| Our business is sensitive to variations in weather and seasonal variations |
| The energy business is affected by variations in general weather conditions and unusually severe weather |
| We forecast electric sales on the basis of normal weather, which represents a long-term historical average |
| Significant variations from normal weather (such as warmer winters and cooler summers) where our business are located could have a material impact on our results of operations |
| Storms that interrupt our services to our customers have in the past required us, and in the future may require us, to incur significant costs to restore services |
| 52 ______________________________________________________________________ Some of our subsidiaries participate in defined benefit pension plans and their net pension plan obligations may require additional significant contributions |
| Certain of our subsidiaries have defined benefit pension plans covering substantially all of their respective employees |
| Of the thirteen defined benefit plans, two are at US subsidiaries and the remaining plans are at foreign subsidiaries |
| Pension costs are based upon a number of actuarial assumptions, including an expected long-term rate of return on pension plan assets, the expected life span of pension plan beneficiaries and the discount rate used to determine the present value of future pension obligations |
| Any of these assumptions could prove to be wrong, resulting in a shortfall of pension plan assets compared to pension obligations under the pension plan |
| Our subsidiaries who participate in these plans are responsible for funding any shortfall of pension plan assets compared to pension obligations under the pension plan |
| Future downturns in the equity markets, or the failure of any of our assumptions underlying the estimates of our subsidiaries’ pension plan obligations to prove correct, could increase the underfunding of the pension plan |
| This may necessitate additional cash contributions to the pension plans that could adversely affect our and our subsidiaries’ liquidity |
| See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates—Pension and Postretirement Obligations” and footnote 12 to our consolidated financial statements included in this annual report on Form 10-K The operation of power generation facilities involves significant risks that could adversely affect our financial results |
| The operation of power generation facilities involves many risks, including: · equipment failure causing unplanned outages, · failure of transmission systems, · the dependence on a specified fuel source, including the transportation of fuel, or · the impact of unusual or adverse weather conditions (including natural disasters such as hurricanes) or · environmental compliance Any of these risks could have an adverse effect on our generation facilities |
| A portion of our generation facilities were constructed many years ago |
| Older generating equipment may require significant capital expenditures to keep it operating at peak efficiency |
| This equipment is also likely to require periodic upgrading and improvement |
| Breakdown or failure of one of our operating facilities may prevent the facility from performing under applicable power sales agreements which, in certain situations, could result in termination of the agreement or incurring a liability for liquidated damages |
| We may not fully hedge our exposure against changes in commodity prices |
| To lower our financial exposure related to commodity price fluctuations, we routinely enter into contracts to hedge a portion of our purchase and sale commitments for electricity, fuel requirements and other commodities |
| As part of this strategy, we routinely utilize fixed-price forward physical purchase and sales contracts, futures, financial swaps, and option contracts traded in the over-the-counter markets or on exchanges |
| However, we may not cover the entire exposure of our assets or positions to market price volatility, and the coverage will vary over time |
| Fluctuating commodity prices may negatively impact our financial results to the extent we have unhedged positions |