The AES Corporation 10-Q 2006
WASHINGTON, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2005
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-19281
THE AES CORPORATION
(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 o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes x No o
The number of shares outstanding of Registrants Common Stock, par value $0.01 per share, at April 28, 2005, was 653,174,893.
This Form 10-Q/A (the Amendment) is being filed for the purpose of amending Items 1, 2 and 4 of Part I and Item 6 of Part II of Form 10-Q for the quarterly period ended March 31, 2005, that was originally filed with the Securities and Exchange Commission on May 5, 2005. This Amendment is being filed to correct accounting errors in the consolidated financial statements in our previously filed Form 10-Q as of March 31, 2005 and December 31, 2004, and for the three months ended March 31, 2005 and 2004.
This Form 10-Q/A should be read in conjunction with the Companys Form 10-K/A filed with the U.S. Securities and Exchange Commission on January 19, 2006. Refer to Note 1 to the condensed consolidated financial statements in Item 1 of this Form 10-Q/A for a discussion of the nature of the errors and the impact of the errors on the restated condensed consolidated financial statements.
We included as exhibits to this Amendment new certifications of our principal executive officer and principal financial and accounting officer.
This Form 10-Q/A has also been amended to reflect a prior interim period adjustment as required by Statement of Financial Accounting Standards No. 16 (FAS 16) as discussed in Note 1 to the condensed consolidated financial statements. Except for errors and the FAS 16 adjustment disclosed in Note 1, no attempt has been made in this Amendment to amend or update other disclosures presented in this Form 10-Q/A. This Amendment does not reflect events occurring after the filing of Form 10-Q on May 5, 2005 (except as required by Statement of Financial Accounting Standard No. 16), or amend or update those disclosures, including exhibits to the Form 10-Q affected by subsequent events. Accordingly, this Amendment should be read in conjunction with our filings with the SEC subsequent to the filing of the Form 10-Q, including any amendments to those filings.
* See Note 1
See Notes to Condensed Consolidated Financial Statements.
* See Note 1
See Notes to Condensed Consolidated Financial Statements.
* See Note 1
See Notes to Condensed Consolidated Financial Statements.
The condensed consolidated financial statements include the accounts of The AES Corporation, its subsidiaries and controlled affiliates (Company or AES). Furthermore, variable interest entities in which the Company has an interest have been consolidated where the Company is identified as the primary beneficiary. In all cases, AES holds a majority ownership interest in those variable interest entities that have been consolidated. Investments in which the Company has the ability to exercise significant influence but not control are accounted for using the equity method. All intercompany transactions and balances have been eliminated in consolidation.
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 for interim financial information and Article 10 of Regulation S-X of the Securities and Exchange Commission (SEC). Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles in the United States of America 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 statement of the results of operations, financial position and cash flows for the interim periods. The results of operations for the three months ended March 31, 2005 are not necessarily indicative of results that may be expected for the year ending December 31, 2005. The accompanying condensed consolidated financial statements are unaudited and should be read in conjunction with the audited 2004 consolidated financial statements and notes thereto, which are included in the Companys Annual Report on Form 10-K/A for the year ended December 31, 2004 as filed with the SEC on January 19, 2006.
Share-Based Payment. In December 2004, the Financial Accounting Standards Board (FASB) issued a revised Statement of Financial Accounting Standard (SFAS) No. 123 (SFAS No. 123R), Share-Based Payment, which is a revision of SFAS No. 123. SFAS No. 123R eliminates the intrinsic value method under Accounting Principles Board No. 25 (APB 25) as an alternative method of accounting for stock-based awards by requiring that all share-based payments to employees, including grants of stock options for all outstanding years be recognized in the financial statements based on their fair values. It also revises the fair-value based method of accounting for share-based payment liabilities, forfeitures and modifications of stock-based awards and clarifies the guidance under SFAS No. 123 related to measurement of fair value, classifying an award as equity or as a liability and attributing compensation to reporting periods. In addition, SFAS No. 123R amends SFAS No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as a financing cash flow rather than as an operating cash flow.
Management is currently evaluating the effect of adoption of SFAS No. 123R under the modified prospective application transition method, but does not expect the adoption to have a material effect on the Companys financial condition, results of operations or cash flows, as the Company had previously adopted income statement treatment for compensation related to share-based payments under SFAS No. 123.
On April 14, 2005, the SEC deferred the effective date of SFAS No. 123R until the beginning of 2006 for calendar year companies.
Implicit Variable Interest Entities. In March 2005, the FASB issued Staff Position (FSP) No. FIN 46(R)-5, Implicit Variable Interests under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities. This FSP clarifies that when applying the variable interest consolidation model, a reporting enterprise should consider whether it holds an implicit variable interest in a variable interest entity (VIE) or potential VIE. FSP No. FIN 46(R)-5 is effective as of April 1, 2005. Management is currently evaluating the effect that adoption of FSP No. FIN 46(R)-5 will have on the Companys financial position and results of operations.
Asset Retirement Obligations. In March 2005, the FASB issued FASB Interpretation No. (FIN) 47 Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143, which clarifies the term conditional asset retirement obligation as used in SFAS No. 143 Accounting for Asset Retirement Obligations. Specifically, FIN 47 provides that an asset retirement obligation is conditional when either the timing and/or method of settling the obligation is conditioned on a future event. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Uncertainty about the timing and/or method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. This interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective for fiscal years ending after December 15, 2005. Management is currently evaluating the effect that adoption of FIN 47 will have on the Companys financial position and results of operations.
In our previously filed Form 10-K, for the year ended December 31, 2004, management reported that a material weakness existed in its internal controls over financial reporting related to accounting for income taxes. Specifically, the Company lacked effective controls for the proper reconciliation of the components of its foreign subsidiaries income tax assets and liabilities to related consolidated balance sheet accounts.
After examining certain historical purchase transactions from 1999 2002 and reviewing the reconciliations of detailed historical income tax return records to reported book/income tax differences, various accounting errors were identified. As a result of these initial findings, on July 27, 2005 the Company announced that it would restate its previously filed financial statements. Management also expanded the scope of the review to include the composition of other material current and deferred income tax related balances including those recorded by, or on behalf of, our domestic subsidiaries and the parent company. As a result of this expanded review, additional non-tax items also were identified and corrected. A discussion of both income tax and non-tax adjustments follows.
The errors identified from the income tax review can be categorized into three types of deferred tax issues. Details regarding material findings associated with each issue are provided below:
1. Deferred income tax adjustments associated with foreign acquisitions and restructurings
La Electricidad de Caracas (EDC)
The most significant deferred income tax restatement adjustment related to the purchase of a majority interest in EDC, a private integrated utility in Venezuela in June, 2000. At that time, a deferred income tax liability was recorded representing the difference between the non-inflation indexed income tax basis and the resulting adjusted purchase basis (assigned carrying value) of fixed assets. However, Venezuelan income tax provisions allow for the indexing of EDCs non-monetary assets and equity, as a result of inflation. This indexing created an additional layer of tax basis that should have been included as part of the acquisition income tax basis at the time of the acquisition.
In addition, several other purchase accounting adjustments were recorded to correctly account for the treatment of deferred charges and the fair value applied to an equity investment held by EDC at the time of acquisition. The recording of the deferred income tax asset related to indexation and the other noted
adjustments affected the allocation of the excess fair value over cost (commonly referred to as negative goodwill) to non-monetary assets.
Eletropaulo Metropolitana Electricidade de Sao Paulo S.A. (Eletropaulo)
At the time of the acquisition of Eletropaulo, a regulated utility located in Brazil, the Company did not record certain deferred income taxes on the difference between the tax basis of land and the related book basis which was adjusted to fair value under acquisition accounting guidelines. The correction of this error resulted in the recording of additional deferred income tax liabilities at the initial date of consolidation in February 2002. This increase in deferred income tax liability increased the original goodwill calculated as the excess purchase price over the fair value of assets and liabilities. As a further result, this adjustment also increased goodwill impairment expense subsequently recognized in 2002.
Brasiliana Energia, S.A. (Brasiliana)
In January, 2004 the Company entered into a debt restructuring transaction with the Brazilian National Bank for Economic and Social Development (BNDES), whereby BNDES received a 54% economic interest in our Brazil distribution business and two generating facilities in exchange for the cancellation of $863 million of debt and accrued interest owed by AES Elpa and AES Transgas, holding companies for the Brazilian operations. After the Company made a cash payment of $90 million, the remaining indebtedness of $510 million, was re-profiled at a 9% stated interest rate with extended maturities. This exchange was accounted for as a modification of debt. The terms of the agreement state that penalty interest as of December 31, 2004 of $194 million would be cancelled in the future ratably as the principal of the new $510 million debentures are paid within the stated timeframes. This treatment gave rise to a deferred income tax liability. As a result of the income tax review, it was determined that a deferred income tax liability should have been recorded for $194 million of penalty interest anticipated to be forgiven in the future. To correct this error, the additional deferred income tax liability was recorded as part of the stock issued for debt restructuring transaction, with the following impacts:
· A deferred income tax liability at Brasiliana (the new parent company of the restructured entities), was recorded as of January, 2004. This deferred liability is also subject to foreign currency remeasurement in each subsequent reporting period.
· Debt modification calculations were adjusted to include the fair value of the increased income tax expense due to the forgiveness of debt compared to the book value of debt remaining. The resulting impact reduced the debt discount and decreased the effective interest rate. This adjustment did not change our conclusion regarding the accounting treatment of the transaction as a modification of debt.
These adjustments also impacted the amounts recorded to reflect the BNDES debt restructuring described above. This impact is described below in the Other Non Income Tax Adjustments section.
Other Acquisition Related Income Tax Adjustments
As a result of the comprehensive review of income tax accounting, certain other adjustments were made to correct errors identified at other subsidiaries, primarily related to recording of deferred income taxes arising from the step up of acquired assets to fair value and/or from other purchase accounting items. These adjustments increased or decreased fixed assets or concession assets and as a result impacted depreciation or amortization charges recorded within the Companys statements of operations.
2. Foreign currency remeasurement of deferred income tax balances where the U.S. dollar is the functional currency at certain subsidiaries
The functional currency for certain of the Companys foreign subsidiaries is the U.S. dollar. After reviewing the income tax balances for certain of the Companys U.S. dollar entities in Venezuela, Brazil, Chile, Colombia, Dominican Republic, Argentina and Mexico, the Company discovered that deferred income taxes were remeasured from local currency to the U.S. dollar using the historical exchange rate
versus the current exchange rate as prescribed by Statement of Financial Accounting Standard (SFAS) No. 52, Foreign Currency Translation and SFAS No. 109, Accounting for Income Taxes, starting in the year of acquisition or formation. In addition, as noted above, certain additional deferred tax amounts were recorded in these entities, which also required remeasurementthe largest of which was the additional deferred tax asset related to the EDC purchase accounting indexation adjustment described above.
3. Reconciliation of income tax returns to U.S. GAAP income tax balances
The remediation plan involved a detailed review of current and temporary differences identified through an analysis of local income tax return filings. The completion of this review also required the Company to fully evaluate adjustments which had been previously recorded in consolidation, but which should have been recorded at a subsidiary level where the appropriate analysis of the tax jurisdiction could be made. This process led to the identification of errors that accounted for the remainder of the deferred income tax entries.
Establishment of Deferred Tax Liability for Brazilian Unrealized Foreign Currency GainsCertain of the Companys Brazilian subsidiaries have designated the U.S. dollar as the functional currency for accounting purposes. For Brazilian tax purposes, these companies have elected to treat these exchange gains or losses as taxable or deductible only when cash payments are made. The Company did not record deferred assets or liabilities related to the unrealized gains and losses that occur on an interim basis related to its U.S. dollar denominated debt. Under U.S. GAAP, these increases/decreases in deferred liabilities/assets are permanent differences that are recorded as an adjustment to tax expense.
Establishment of a U.S. Liability Related to Brazilian Deferred Tax AssetsOne of the Companys Brazilian subsidiaries, Sul, which has designated its functional currency as the Brazilian real, has generated deferred tax assets mainly related to net operating losses, unrealized tax losses on foreign currency transactions and certain other taxable temporary differences. A restructuring transaction was undertaken in relation to this subsidiary in July 2002. At the time of this restructuring, the Company should have recorded a reduction to the deferred tax assets for the U.S. income tax liability associated with the future projected Brazilian taxable income.
Establishment of Other Valuation AllowancesThe Company determined that certain valuation allowances should have been provided at various subsidiaries in Chile, Colombia, Brazil and Argentina related to deferred tax assets recorded primarily related to net operating loss carryforwards. Under U.S. GAAP, the Company is required to assess its ability to utilize deferred tax assets under a more likely than not standard and provide a valuation allowance to the extent the asset or any part of it does not meet this test. As part of the deferred tax review, the Company determined that these deferred tax assets were unlikely to be utilized in full or in part, based on information available in these historical periods and consequently did not meet the more likely than not standard.
Other Tax Expense ItemsThe Company undertook a detailed comparison of the tax returns filed to accounting records in a majority of the countries in which we operate and identified certain other adjustments related to this reconciliation. Most significantly, these adjustments included the following:
· non-deductibility of certain holding company interest and goodwill;
· capitalized interest on tax holiday projects;
· treatment of certain foreign investment tax credits;
· reconciliation of other deferred tax balances; and
· changes in pre-tax book income related to other non-tax restatement adjustments.
Other Non-Income Tax Adjustments
Other non-income tax accounting errors were also identified as part of the Companys review of certain other historical transactions. The Company has concluded that the reasons for these errors primarily related to the lack of sufficient control and documentation procedures in 2002 and prior years
related to certain consolidation and foreign currency translation processes. Significant non-income tax errors are described below:
AES acquired 56% of SONEL located in Cameroon in July, 2001. Since that time, AES SONEL experienced a high degree of turnover of its senior accounting personnel. SONELs accounting systems required a significant degree of manual intervention including the conversion of local GAAP financial statements into U.S. GAAP.
During the Companys 2004 year-end process, the Company discovered errors in minority interest calculations that were corrected in the Companys restated financial statements as of and for the years ended December 31, 2003 and 2002 as filed with the Securities and Exchange Commission on Form 10-K on March 30, 2005. Subsequently, as part of the Corporate process to ensure the correct communication and documentation of the correction of the initial error at the subsidiary level, a comprehensive additional review of the preparation of the U.S. GAAP financial statements was performed and the following errors were identified:
· translation errors from local currency to U.S. dollar financial statements;
· the omission of certain purchase accounting adjustments related to the final valuation of our concession assets and recording of severance provisions from the U.S. GAAP financial statements; and
· incorrect treatment related to the accounting for dividends.
As a result of the income tax review performed at AES Elpa, one of the Companys Brazilian holding companies, the Company identified a long-term liability which had been recorded for Brazilian GAAP but which had been omitted from U.S. GAAP financial statements at the acquisition date. The proper recording of this liability at the acquisition date would have increased the opening balance of goodwill, which was subsequently impaired and thereby written off as of the end of December, 2002. The impact of this adjustment as of December 31, 2002, increased long term liabilities and increased goodwill impairment expense and prior retained earnings by the same combined amount. This long-term liability is accreted by an interest expense component on a monthly basis.
The Company determined that an error had been made in the initial accounting for a debt instrument which had been assumed at the date of purchase of Tiete, a generation company in Brazil, in 1999. The debt requires an annual adjustment to principal based on changes in the local rate of inflation. The Company accounted for this by using estimates of future inflation over the life of the debt and amortizing these adjustments as a component of interest expense over the term of the loan. These future inflation estimates were recorded on the balance sheet as a deferred financing cost within long-term assets. Periodically, adjustments were made to these estimates when the actual annual inflation calculations were charged to the principal balance. Subsequently, it was determined that inflation changes should be calculated and adjusted on a monthly basis through interest expense based on the rate of inflation in that month, regardless of how the actual cash payment would finally be determined.
SUL and Eletropaulo
The Company determined that an error had been made regarding the timing of the recognition of certain revenues recorded by its Brazilian utilities Eletropaulo and Sul. The tariff rates, as set by the Brazilian regulatory authority (ANEEL) provide that a percentage of a distributors revenue is added to the consumer tariff rate in return for the Companys future spending of these amounts on capital or operating expense projects approved by ANEEL for the express purpose of improving the efficiency of the electrical system. Eletropaulo and Sul had previously recognized the revenue related to this portion of the
tariff when billed, and recorded the future operating expense and capital project expenditures when incurred, since the expenditures were not considered pass through costs for purpose of a future tariff reset. However, under the guidance of SFAS 71 Accounting for the Effects of Certain Types of Regulation, Eletropaulo and Sul should have deferred this portion of revenue until such time that the related expenditures were incurred.
The correction of the error related to AES Elpa described above and other adjustments prior to January 2004 which impacted the net assets of Eletropaulo, Tiete and Uruguaiana, also impacted the recording of the Brazilian debt restructuring transaction with our lender, BNDES, as described earlier. The impact on the 2004 restated financials decreased the minority interest share allocated to BNDES and increased additional paid-in capital, a component of stockholders equity. The adjustment to additional paid-in capital was recorded in accordance with the Companys previously established accounting policy pertaining to gains or losses resulting from subsidiary sales of stock as permitted under SEC Staff Accounting Bulletin No. 51, Accounting for Sales of Stock by a Subsidiary.
Corporate Consolidation Accounting
During the restatement period, the Company undertook additional reviews of the consolidation process, including a review of consolidation journal entries to ascertain that appropriate supporting documentation existed and that current personnel who were performing the consolidation understood the basis for these entries. Several historical consolidation elimination adjustments were identified as errors which primarily affected deferred income taxes and other accumulated comprehensive income balances. The errors originated in years prior to 2002 and generally resulted from an inadequately controlled consolidation process including the elimination of investment accounts against subsidiary equity balances, general balancing controls related to the income statements and balance sheets submitted by our subsidiaries, and inadequate balance sheet reconciliations of consolidated deferred income tax accounts. The correcting entries resulted primarily in a decrease in deferred income tax liabilities and an increase in foreign currency translation, a component of other comprehensive income.
As part of an ongoing balance sheet review process, it came to the Companys attention that several of its subsidiaries incorrectly included certain short-term investments as cash and cash equivalents in the balance sheet. The restatement impact was a decrease in cash and cash equivalents and an increase in short-term investments as of March 31, 2005 and December 31, 2004, respectively.
Cash Flow Reclassification
The Company includes components of the cash flows for its discontinued operations within the Consolidated Statements of Cash Flows (Cash Flow Statement) in operating, investing and financing activities. A separate line entitled Decrease in cash and cash equivalents of discontinued operations and businesses held for sale was previously presented on the face of Cash Flow Statement to reconcile back to the Companys cash balance on the face of the Consolidated Balance Sheets, which excludes cash from discontinued operations. As part of the restatement, the Company has changed its presentation to include the net change in cash balances for discontinued operations as a component of net cash from operating activities.
Other Immaterial Errors
Certain other immaterial errors were identified and corrected in the appropriate periods.
The following tables set forth the previously reported and restated amounts of selected items within the condensed consolidated balance sheets as of March 31, 2005 and December 31, 2004, within the condensed consolidated statements of operations and comprehensive income for the three months ended
March 31, 2005 and 2004, and within the condensed consolidated statements of cash flows for the three months ended March 31, 2005 and 2004.
Selected Balance Sheet Data: ($ in millions)
On July 4, 2005, the National Electric Energy Agency (ANEEL), an independent federal regulatory agency which has exclusive authority over the Brazilian power industry, concluded its assessment and determination of prior year tariff adjustments (the Tariff Reset) for Eletropaulo, a distribution company in Brazil included in the Large Utilities segment. The Tariff Reset includes an adjustment to the regulatory base rate and to the associated operating costs for services performed and costs incurred during the period July 2003 through June 2005. The Tariff Reset also includes an adjustment for the recovery of other costs
incurred during the period July 2004 through June 2005, not recovered in the 2004 tariff adjustment. The collection and recovery period for the Tariff Reset will be July 2005 through July 2006.
In accordance with SFAS No. 16, Prior Period Adjustments, the Company has accounted for and reported the adjustment of utility revenue under rate-making processes that relates to prior interim periods of the current fiscal year in its consolidated financial statements as follows:
· The portion of the Tariff Reset related to business activities for the period of July 2003 through December 2004 are included in the determination of net income for the three months ended March 31, 2005. The increase to revenues, gross margin, income from continuing operations, net income and diluted earnings per share for this portion of the Tariff Reset was $17 million, $31 million, $7 million, $7 million, and $0.01 per share, respectively.
· The portion of the Tariff Reset related to business activities for the period of January through March 2005 are included in the determination of net income for the three months ended March 31, 2005. The increase to revenues, gross margin, income from continuing operations, net income and diluted earnings per share for this portion of the Tariff Reset was $5 million, $8 million, $2 million, $2 million, and $0.00 per share, respectively.
The adjustment to the three months ended March 31, 2005 is required pursuant to SFAS No. 16 and is not an accounting error pursuant to Accounting Principles Board (APB) Opinion No. 20, Accounting Changes.
Inventory consists of the following (in millions):
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, after giving effect to stock splits, as applicable. Potential common stock, for purposes of determining diluted earnings per share, includes the effects of dilutive stock options, warrants, deferred compensation arrangements, and convertible securities. The effect of such potential common stock is computed using the treasury stock method or the if-converted method, as applicable.
The following table presents a reconciliation (in millions) of the numerators and denominators of the basic and diluted earnings per share computations for income from continuing operations. In the table below, income represents the numerator and shares represent the denominator:
There were approximately 8,609,769 and 27,024,582 options outstanding at March 31, 2005 and 2004, respectively, that were omitted from the earnings per share calculation because they were anti-dilutive. In addition, all convertible debentures were omitted from the earnings per share calculation because they were anti-dilutive.
The following table summarizes financial information (in millions) of the entities in which the Company has the ability to exercise significant influence but does not control, and that are accounted for using the equity method.
In accordance with APB 18, the Company discontinues the application of the equity method when an investment is reduced to zero and does not provide for additional losses when the Company does not guarantee the obligations of the investee, or is not otherwise committed to provide further financial support for the investee. The above table excludes income statement information for the Companys investments in which the Company has discontinued the application of the equity method. Furthermore, in accordance with APB 18, the Companys policy is to resume the application of the equity method if the investee subsequently reports net income only after the Companys share of that net income equals the share of net losses not recognized during the period the equity method was suspended.