愛依斯電力 (AES) 2006 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the AES second-quarter financial results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

It is now my pleasure to turn the floor over to your host, Mr. Scott Cunningham. Sir, you may begin your conference.

Thanks, and good morning, everyone. Joining me today as our principal speakers are Paul Hanrahan, President and Chief Executive Officer, and Victoria Harker, Executive Vice President and Chief Financial Officer.

The press release and the financial review presentation we'll refer to today is available on our website at AES.com, together with an updated investor presentation. Included in the financial review presentation are usually financial commentary, as well as the updated financial guidance, which is also included in our earnings press release.

Certain statements regarding our business operations and strategies may constitute forward-looking statements as defined by the SEC. Such statements are not historical facts, but are predictions about the future which inherently involve risks and uncertainties. These risks and uncertainties could cause our actual results to differ from those contained in the forward-looking statements.

In addition, AES disclaims any obligation to update any forward-looking statement to reflect events or circumstances after the date hereof. We urge investors to read our descriptions and discussions of these risks that are contained under Item 1A, Risk Factors, in our 2005 Form 10-K, as well as our other SEC filings.

Also, please note that definitions and reconciliations for all of the non-GAAP measures we will refer to today are included in the financial review presentation as well.

This morning, Victoria will go over our second-quarter performance and our updated financial guidance. Paul then has some comments on the state of the business.

Please turn to page 3 of the presentation, and with that, I will turn the call over to Victoria.

Thanks, Scott, and good morning, everyone. We are pleased to report a solid second quarter with strong financial improvements across many aspects of our business. As in last quarter, favorable pricing and volume trends again contributed to earnings that were more than double those reported last year. Quarter-over-quarter comparisons also benefited by $0.06 per share, due to certain items in Brazil that were impacted only the second quarter of 2005. In addition, key financial metrics such as free cash flow and return on invested capital remained on target.

Before I discuss the financial highlights, though, I would like to point out the second-quarter and prior-period results have been revised to reflect the decision to sell two of our smaller businesses, resulting in discontinued operations accounting treatment for those subsidiaries. I will discuss those in more detail in a few minutes.

Overall, revenue and gross margin showed strong strength in the quarter, driven by higher prices in all segments and higher volume, principally in our contract generation businesses, as well as favorable foreign currency rates. Specifically, of the 15% increase in revenue growth, 4% was attributable to favorable currency impacts, with a small contribution from the full consolidation of Itabo and full commercial operations of Buffalo Gap.

In addition, sales of excess emission allowances were $2 million lower than the second quarter of 2005 as higher sales in Europe were more than offset by lower sales in New York. This followed significant sales of emission allowances in the first quarter and is consistent with our comments last quarter on our expectations for the year.

Year over year, gross margin increased 75% and improved 10.4 percentage points to 30.3%. Please keep in mind that nearly half of the dollar improvement is attributable to the $192 million receivables reserve expense in Brazil that was recorded in the second quarter of 2005 and is part of the $0.06 EPS impact I mentioned earlier.

G&A costs increased, as previously projected, $14 million in the quarter, primarily due to higher corporate staffing costs and a higher level of business development activity worldwide. Interest expense decreased 7% in the quarter, reflecting reduced debt balances and marked-to-market gains on interest rate derivatives, partially offset by unfavorable foreign currency effects.

As a reminder, about 80% of our debt has fixed rates or has been swapped, thereby minimizing our exposure to interest rate fluctuations. In addition, the mix of debt denominations also provide a natural hedge to rising rates in some parts of the world.

Net other income and expense decreased $116 million from the prior period. A favorable reversal of a $70 million business tax accrual in Brazil was included in the second quarter of 2005. The second quarter of 2006 also included expenses of $20 million for liquidated damages related to the previously disclosed delays at our Cartagena power plant under construction in Spain.

Our effective tax rate in the quarter was 22% compared to 43% during the same period last year. Several significant factors contributed to the lower tax rate in the quarter. The first was the release of a $43 million valuation allowance of Eletropaulo in Brazil related to a deferred tax asset on certain pension obligations. Keep in mind that only about a third of this benefit flows to earnings, reflecting our ownership interest in Eletropaulo. The majority of the benefit goes to minority interest.

The second factor was a decrease in tax expense on unrealized foreign currency gains associated with U.S. dollar-denominated debt held at certain Latin American subsidiaries.

The third benefit was a decrease in U.S. taxes on distributions from certain international subsidiaries due to recent changes in U.S. tax law, which was retroactive to January 2006.

Minority interest expense increased significantly in the quarter, primarily due to higher after-tax earnings in Brazil. The comparison with the second quarter of 2005 was impacted by the receivables reserve expense in Brazil, which reduced minority interest expense in that period.

Weighted average shares outstanding were slightly higher in the quarter, due primarily to compensation-related share issuances. Our trust preferred securities were not dilutive in the second quarter, but were dilutive on a year-to-date basis for the first six months of 2006 as a result of first-quarter shares outstanding.

In the presentation, you'll find that we've summarized the drivers of earnings from a quarter-over-quarter standpoint and on a pretax consolidated basis. Higher gross margin was the largest driver, contributing about $0.30, due to a combination of price, volume and currency. Reduced interest expense contributed about $0.05 to the quarter-over-quarter improvement as well. Higher G&A and other expense were the main factors for the $0.09 offset for items between gross margin and income before tax and minority interest. Finally, higher income taxes, minority interest and number of shares outstanding offset gains by $0.14.

In summary, diluted earnings per share from continuing operations increased $0.18. For reference, this is $0.12 net of the $0.06 per share impact of the receivables reserve expense and tax reversal in the prior period. Overall, we estimate that foreign currency translation impacts represented very little impact on either diluted earnings per share from continuing operations or on an adjusted earnings per share basis.

Here are some additional highlights from the second quarter that are worth noting. Net cash provided by the operating activities increased 32% to $434 million. This was a result of higher net income, partially offset by higher cash taxes paid in the quarter and higher working capital requirements as a result of business expansion.

Depreciation and amortization expense from continuing operations was $239 million versus $222 million in the prior-year quarter, reflecting higher spending on capital projects, as previously discussed.

Free cash flow for the quarter remained strong at $243 million and was $61 million higher than last year, due to higher net cash from operating activities, partially offset by higher maintenance capital expenditures. Maintenance capital expenditures increased by $45 million to $191 million, due primarily to spending on environmental projects. About 18% of those expenditures related to major environmental projects at IPL and Greenwich in New York, both of which will have a positive economic return for the Company as well.

Gross capital expenditures were $170 million in the quarter. Approximately 55% of these expenditures related to projects under construction, principally our Cartagena project in Spain and our Maritza East 1 project in Bulgaria. All the capital expenditures for Cartagena were funded from non-recourse financings and equity that was previously contributed. Capital spending for Maritza was funded approximately 70% from non-recourse financings and 30% from AES.

Our purchase of an additional 25% interest in Itabo for $23 million using non-recourse financing was included in the acquisitions category. Our purchase of a 9.9% interest in AgCert for $52 million was also reported in the quarter as a payment for long-term available-for-sale securities.

Return on invested capital increased 590 basis points in the quarter to 13.2% for the 12 months ended June 2006. The improvement was primarily due to lower effective tax rate and higher net operating profit, offset slightly by higher average invested capital. Subsidiary cash distributions to the parent were on track for the quarter at $177 million, consistent with the expected timing of distributions and in line with our overall target of $1 billion for the year.

During the quarter, we also continued to make good progress on our credit improvement goals at the parent and at the subsidiaries. Moody's upgraded Gener in Chile two notches to Ba1 and Chivor in Colombia one notch to Ba3. Last week, Moody's also upgraded Tiete in Brazil two notches to B1 and also upgraded IPL one notch to Baa1. At the parent, our goal remains strong BB and Ba ratings, and we continue to target coverage ratios in the range of 4.5 to 5.0 for recourse debt relative to subsidiary distributions and 2.0 to 2.5 for subsidiary distributions as a multiple of parent interest expense.

Actual performance over the last 12 months for these ratios was well within range at 5.2 and 2.2, respectively, and was unchanged from the first quarter. Parent liquidity also remains strong at $645 million.

In keeping with this, last Friday, AES Eastern Energy closed a five-year, $350 million letter of credit facility which will be used primarily to support credit obligations related to our risk management strategies in New York. This will free up parent liquidity, as Eastern Energy will no longer require AES letters of credit to support hedging activities. This is another example of our ongoing efforts to maximize the corporate capital structure while allowing subsidiaries financial flexibility.

Let me take just a moment now to talk about a few extraordinary items that impacted the quarter. As a result of changes in operational focus, we removed two subsidiaries from our ongoing financial reporting in the quarter -- Eden, one of our regulated utilities in Argentina, and Indian Queens, the competitive supply business in the UK. Both businesses were classified as discontinued operations held for sale, and we expect the transactions to close in the second half of the year.

An assessment of impairment for these businesses resulted in no material loss or gain recorded for Indian Queens, while the Eden impairment was partially offset by earnings for the two businesses in the period. In total, we recorded a $63 million charge for these two businesses in the second quarter.

In addition, we also recorded an extraordinary gain of $21 million after tax relating to our purchase of an additional 25% interest in Itabo, a power generation business located in the Dominican Republic, for approximately $23 million. This is a result of the benefit of a lower than fair value purchase price generating negative goodwill. U.S. GAAP requires the allocation of negative goodwill as a pro rata reduction to eligible non-current assets. As a result of allocating this negative goodwill, our 25% interest in non-current assets was reduced to zero, and we recognized an extraordinary gain of $21 million.

Let's now turn to second-quarter operating performance by business segment. Before I begin, let me remind you that our geographic segments have been slightly revised this quarter to reflect the updated regional management structure that we announced last quarter. As a result, our Middle East businesses are now included in the Asia and Middle East region, and our Kazakhstan businesses are now included in our Europe and Africa region.

As you know, our regulated utilities are most heavily influenced by changes in electricity demand, tariff adjustments and foreign currency. Since I've already mentioned the positive foreign currency impacts in the quarter, I will now touch on the effects of demand shifts and tariff changes.

Demand increased in most of our international utilities during the quarter, reflecting continued economic growth in the regions overall. Demand was somewhat lower at IPL in the U.S., due to the lower number of extremely hot and cold days in the period.

Likewise, the average tariff received was higher than the year-ago quarter at all the distribution companies. During the second quarter, we received an increase in the tariff at Sul of 6.2% as part of the normal annual adjustment process. Eletropaulo received its corresponding increase of 11.5% in July. Edelap in Argentina also received a tariff increase in July. At IPL, we continue to pass through higher fuel and purchased energy costs through the quarterly fuel adjustment charge process. So overall, the businesses are actively managing tariff achievement to improve both their top and bottom lines.

By contrast, the results of our contract generation businesses are most heavily influenced by contract pricing, the addition of new capacity, their fixed cost requirements, and in some periods, foreign currency. In the second quarter, the most significant price benefit was in Chile, principally due to higher node prices resulting from the change in regulations made there last year.

In addition to the contributions of Itabo and Buffalo Gap, existing businesses in Brazil, Chile and Sri Lanka also benefited from higher volumes in the quarter. Higher maintenance costs in the U.S. were offset by gains elsewhere.

Our competitive supply businesses are also influenced by pricing, volume, and in some periods, sales of excess emission allowances. In the second quarter, favorable pricing contributed to improve results, most significantly in New York, Argentina and Kazakhstan. We also experienced higher volumes in New York and Kazakhstan in the quarter.

In Panama, we completed the first phase of output upgrades at two plants, resulting in 6 megawatts increase of incremental capacity. Sales of excess emission allowances decreased $19 million, primarily due to lower sales in New York, where we sold $7 million of SOx and NOx allowances in the quarter versus $27 million in the prior-year period. Again, these businesses continue to assess market pricing and future business requirements to maximize the impact of allowances to their bottom lines.

I'd now like to turn to our outlook for the remainder of 2006. As described in the presentation and in our press release, we now expect both higher revenues and operating results for the remainder of the year. We have increased our guidance for diluted earnings per share from continuing operations to $1.05 from $0.96 previously and have also raised our adjusted earnings per share guidance to $1.01 from $0.97. We have also reaffirmed our cash flow guidance for the year.

As I mentioned in last quarter's call, the quarterly profile of our financial results is changing somewhat versus historical patterns. There are several factors driving this change -- one, the timing of emissions sales; two, increased business development activity; three, investment of our financial infrastructure; four, shifts in the business mix, which impacts both taxes and minority interest; five, tougher foreign currency comparisons; and six, portfolio management activities.

Those factors are causing shifts in the quarterly timing of profit, outpacing previous trends and seasonality. These factors are as relevant to our forecast today as they were three months ago. Let me discuss what has changed during this quarter as it relates to our expectations for second-half results.

The first change in second-half EPS is our expectation for the effective tax rate, where we see a higher effective tax rate in the second half than we had previously assumed. We still expect a full-year effective tax rate in the mid-30% range compared to a year-to-date rate of 27%. However, our second-quarter rate was lower than expected, implying a higher projected effective tax rate for the second half of the year. The tax rate of 27% was materially impacted by the discrete items I previously mentioned, as well as the tax-free sale of Kingston in the first quarter.

As book income increases throughout the year, the effect of these discrete items on the effective tax rate will diminish. As always, our actual effective tax rate is also impacted by the mix of pretax income and subsidiary distribution.

The second driver is the trajectory of our business development spending, which we still expect will cost $0.08 to earnings for the year. However, we have only seen about $0.03 of this transpire so far this year. We are continuing to ramp up our development activities around the world to execute on our promising pipeline of projects. And Paul will touch more on these opportunities in his remarks.

I also want to mention that our updated guidance does not include the proposed restructuring of Brasiliana Energia in Brazil. You will recall that we announced this in May. If successful, we expect to fully repay holding company debt to BNDES, the National Development Bank in Brazil, and refinance the balance of the debt within the holding company structure.

We see significant value in completing this debt restructuring. If we were to proceed with the restructuring as planned, it could result in a potential [CPA] writeoff in the range of 350 to $500 million and will likely have a dilutive effect on recurring earnings after the restructuring is completed. We believe that the restructuring makes a lot of sense, but we do want investors to be aware of the potential earnings impact.

Before I turn the call over to Paul, I'd also like to briefly update you on our progress with regard to financial development and controls. We continue to place a top priority on strengthening our financial infrastructure across the globe in support of ongoing Sarbanes-Oxley 404 compliance while building a world-class finance organization.

Remediation of the material weaknesses that were identified in our 2005 10-K continues to be our priority and is a joint effort between the finance organization and the business leadership. I am pleased to note that this effort is progressing quickly and effectively. We're also rapidly adding required staffing, providing technical training and implementing systems and process improvements where necessary. We continue to report progress against the material weaknesses remediation plans, along with efforts to strengthen the finance infrastructure, to both our external auditors and audit committee on a monthly basis.

Finally, I would also like to call your attention to the 2005 AES Fact Book, which will be available on our website under Investor Resources after this call. The Fact Book contains financial and operational information that we hope will be a convenient resource to the investment community.

I would now like to turn the call over to Paul.

Thanks, Victoria, and good morning, everyone. This morning, I'd like to give you an update on our portfolio management and restructuring activities, as well as the progress on the growth front.

First, portfolio management. Last quarter, I mentioned our sale of shares in Gener, our Chilean generation company, and the sale of our interest in the Canadian plant. I'd like to now update you on further progress we have made in the second quarter.

In June, we announced we had reached an agreement with the Brazilian National Development Bank, BNDES, to retain ownership with Sul, one of our distribution companies in the southern part of Brazil. The terms of the agreement included three elements -- one, termination of the Sul option; two, a $15 million payment from AES to BNDES; and three, contribution of our 100% interest in Infoenergy, which is a small commercial energy trading company, to Brasiliana Energia, the company that we jointly own with BNDES. We are in the process now of delivering legal opinions required by the bank under their standard procedures and expect the transaction to close in the third quarter. We are pleased to work with BNDES to constructively resolve these issues.

EDC in Venezuela recently completed public offerings of new shares in Venezuela and also listed on the LATIBEX, an international market in Spain for Latin American companies, that is denominated in euros. While the dollar amount of the offerings was relatively small, these were positive steps towards broadening the shareholder base of EDC. Increasing the public float also provides an option for accessing the local capital markets to finance future capital projects in Venezuela.

As Victoria mentioned, we are in the process of selling two businesses -- Eden, one of our distribution companies in Argentina, and Indian Queens, a 140 megawatt competitive supply plant in the UK which basically provides power to balance the market. These transactions have not yet been finalized, so I can't provide extensive details. But I can give you some insights into our rationale for selling these businesses.

The sale of Eden is one of the last steps in the restructuring of our Argentina businesses. The debt of a holding company which owns our interest in Eden and Edes has been in default since the maxi-devaluation of the Argentine peso in 2002 and the subsequent freezing of distribution terms by the government. The sale of Eden will result in a cancellation of all the holding company debt and leave Edes properly capitalized and well-positioned to benefit from the improved regulatory environment and strong local demand for electricity. We expect this transaction to close in the second half, pending approval by the government agencies in Argentina.

Following the default on the debt of Indian Queens in the third quarter of 2005, we initiated a bid process to assess the current market value of the business and a potential sale. We're now in negotiations to sell this business to a third party and believe it's probable that the sale will close this year.

So far this year, portfolio management transactions have generated over $200 million in cash to the parent, which can be used to support growth investment in those areas where we have a greater strategic interest and also for further debt reduction.

In addition to potential sales of all or a portion of our investment in an existing business, a part of our portfolio management process involves identifying businesses that are undervalued and increasing our investment in them. We saw one such opportunity in May, when we increased our ownership by acquiring an additional 25% interest in Itabo for $23 million and funded this with non-recourse financing. Itabo is a base-load coal and diesel-fired plant in a country where the new government has been making progress in restructuring the electricity sector. We now control Itabo, which will allow us to restructure the operations to improve performance and to consolidate its results.

Next, I'd like to give you an update on the new investment progress and also the updates on our development pipeline. During the quarter, one of our wind projects achieved full commercial operations. This was Buffalo Gap, a 121 megawatt project in Texas. We also announced another wind acquisition that will close in the third quarter, 54 megawatts of wind assets in Tehachapi, California.

In addition, as part of our plan to grow our alternative energy business, we established a joint venture in the area of climate change, which involves creating and selling greenhouse gas offsets, called AES AgriVerde, which is our partnership with AgCert.

We are continuing to ramp up our business development activities. We have a pipeline of approximately 100 development projects in 30 countries at various stages of development. Although we found the market to be very competitive for certain assets, we continue to find attractive opportunities in those cases where we are expanding on the platform of an existing site or a business position in a country and in the more difficult greenfield development opportunities and in the alternative energy field.

I'd like to highlight a few development milestones that we have achieved since our first-quarter conference call. We began the construction of Maritza East 1, our 670 megawatt lignite-fired project in Bulgaria, in May. This project is a good example of our traditional contracted generation model. It has a 15-year contract with the National Utility of Bulgaria, along with a matching 15-year lignite supply agreement with nearby coal mines. Non-recourse financing funds about 70% of this project and our equity contribution is going in over the construction period. This capacity is very badly needed in the country and will help diversify the Bulgarian economy away from imported gas.

We also made progress on an earlier-staged project in North America. Our bid on a proposed 184 megawatt coal and biomass plant in British Columbia was recently accepted by the purchaser, BC Hydro. We are encouraged by the progress on this project, but there are still many significant milestones ahead, such as signing the PPA and the EPC contracts, as well as obtaining the permits and the financing.

As I mentioned earlier, we are particularly pleased about the progress we are making in our alternative energy efforts, which make up about one-third of our current pipeline. Last month, we announced our acquisition of a majority interest in a UK-based wind development company, with 640 megawatts of wind projects under development throughout Scotland.

The UK has very favorable regulations for development of renewable generation projects. This acquisition brings our total pipeline of wind projects at various stages of development to over 2600 megawatts. In the area of climate change, the leadership team is now in place for AES AgriVerde. They have begun executing on our plan to achieve annual production of 20 million tons of greenhouse emission reductions by 2012.

As you can see, we are slowly building a pipeline of quality projects for growth going forward, and combining this with our continued emphasis on managing the performance of our existing business as well, we are building a company with good and long-term growth potential.

Thanks for your attention today. I will now turn the call over to our operator for the question-and-answer portion of this call.

(OPERATOR INSTRUCTIONS). Elizabeth Parrella, Merrill Lynch.

I was hoping to ask two questions, actually. One for Paul -- can you just give us a little bit more of an update on the status of the proposed restructuring of your Eletropaulo ownership and the related holdco debt?

I can't say too much about it right now because we have actually filed for an application to sell shares of Transgas, the company that owns the shares of Eletropaulo, which is jointly owned by AES and BNDES under the Brasiliana Energia company. But basically, the concept is that we repay debt, BNDES debt, by selling their shares. And whether or not that transaction goes forward will depend on many things -- whether we get the approvals, the final pricing that might result -- a number of factors. But that is about all I can say for right now.

And just a follow-up. Looking at your guidance slides with respect particularly to the 2008 outlook, it looks like the gross margin that you are targeting for 2008 is pretty similar to the revised gross margin guidance for 2006. Yet the EPS that you are forecasting looks like it would be higher in 2008, as well as the cash from operations.

Just wondering if you can talk about the drivers that you see below the gross margin line? I wouldn't think interest expense necessarily would be lower. But what are the drivers that result in higher EPS and higher cash flow despite kind of a flattish growth margin outlook over the next two years?

Elizabeth, this is Scott. Let me try to respond to that. You're right, some of it is related to the assumptions that we are making in the 2008 scenario on the use of free cash flow. You will recall that scenario basically is just funding projects that had been announced a couple of years ago. So in that scenario, we do generate some free cash flow, paying down debt. So interest expense benefit below gross margin is relevant.

We have also made some assumptions there, obviously, on the currency scenario that is going to be applying. In terms of the differences between the cash flow growth when we announced the revised cash flow guidance, which was higher than we had originally provided a couple of years ago, we pointed both to the impact of the higher net income assumptions that we were making, as well as the fact that we saw, because of the growth program that was in progress, the higher depreciation and amortization, which is an add-back in the cash flow calculation. Those are the major factors.

Elizabeth, the other thing I will say is that we will be updating our guidance looking out forward by the end of the year. And I think we will be able to provide more insights into it at that time.

When you say updating the guidance, do you mean beyond, say, 2006, meaning as far out potentially as 2008?

Yes, we have said we would go out -- longer-term guidance by the end of the year, we'd come out with -- refresh that, just because it has been in existence for some time.

Lasan Johong, RBC Capital.

Wonderful quarter. I have a question similarly along the lines of what was just asked on the '06 guidance. I am a little puzzled -- gross margin is going up and business segment income before minority is also going up and the cash flow guidance is staying flat. Is that due to some form of an increased minority interest expense? I'm not sure why that is -- why gross margin goes up and cash flow stays flat.

Well, I think it is predominately related to some non-cash or what would be non-cash items in the gross margin numbers or the GAAP accounting numbers. One good example would be, for example, taxes -- we've seen increased cash taxes, but at the same time we've seen a reduced tax rate according to GAAP income.

So I think there are a number of items like that that are causing -- essentially, our cash flow numbers are coming in as expected and we see an improvement in the GAAP income and the adjusted income -- adjusted earnings per share. And that is why we are raising the guidance. But the cash looks like it is pretty much on track as we had expected.

So it's all accounting related?

Yes.

And tax.

Simply put, yes.

Then on the -- still of the -- Eletropaulo shares, are you guys going to record a gain or loss on those? Or can you not comment yet?

I don't think we are compared to comment at this point, just given the note that Paul made relative to our registration. We will obviously do that once we clear that period.

Just generally speaking, Paul, do you see an acceleration in the project pipeline, meaning do you see more and more projects coming on faster and faster? Or do you think that is kind of petering out and slowing down a little bit?

It's probably -- it is improving a little bit. I think as we -- we started out a couple years ago thinking there would be some good acquisition opportunities. But I think as we looked around the market, aside from some of the more complex ones that required good operating skills or some other skills that we have, those became fairly competitively priced.

So what we are seeing is, as I mentioned, the platform extensions that we have for our existing businesses, a lot of good opportunities there, like the extension of the Greenwich and Westover facilities, which are basically putting on environmental controls to allow us to operate those facilities longer, extending the life of the deepwater facility, putting in -- where we have other facilities, maybe expanding those facilities. I think those are going to be great opportunities, but they will take some time to develop.

The other is the greenfield development opportunities, the BC Hydro bid being a good example, where we've got the experience in developing greenfield coal plants; not many other people do. We are seeing opportunities there.

And then, the other one which I think has probably got the most potential for us, we think is the most exciting part of the portfolio, is the alternative energy area, which is being led by Bill Luraschi's Corporate Development Group. And I think there, we are just seeing a lot of very interesting opportunities, like the climate change business that we've started with AES AgriVerde, where we are selling CO2 or greenhouse gas offsets. We see that as being an attractive market and something where it fits very well with our business and is helping us to not only mitigate our own potential exposure, but also profit from the opportunities to create these at a reasonable cost and then be able to sell them into the market.

Can I get one quick question in on Eden? It sounds like if I heard you correctly, Paul, you're going to use the sale of the proceeds of Eden to pay down the debt to cure the default? Is that how it works?

Yes, basically, what we are doing is we are swapping the asset with the lender. So in effect, we give up that asset with some equity value to retain the other asset with equity value. So just a way to clear out the holding company debt, yet wind up with an asset that is properly capitalized now and has some real equity value, but without having to worry about taking money out of our own pocket to pay down the debt. We figured that was a better way to do it.

I see. Very clever. Thank you.

Craig Shere, Calyon Securities.

Good quarter. So I want to try to understand -- Lasan asked a good clarifying question -- sounds like more accounting issues as far as your improving guidance. But it seems like we are really slamming the second half quite a bit -- I mean, on an adjusted basis, $1.01 would require second half of $0.29 in the second half versus last year, $0.83, and street consensus for this year in the second half at $0.45.

Is basically just the $0.06 from the business development costs and the difference in taxes and the other odds and ends -- is that all getting us to that much lower $0.29 second-half number? How conservative do you view that projection?

This is Victoria, Craig. I think the answer to that, obviously, is both of those items. We have at this point in the year no expectation that we will not fully utilize the full $0.08 in terms of the business development spending. And that goes along with the pipeline of projects that we are seeing the work go against. So I don't see us not hitting that number in the year unless we just run out of time.

On the tax point, we've spent a lot of time looking at that. And we had a number of first-half things that impacted the effective rate to the better -- the tax resale of Kingston, obviously, and the benefit of this new tax legislation that was a catch-up back to January of '06. So it sort of preternaturally depressed the tax rate in the first half. But we don't see any indication that the full-year forecast will be dramatically different, given the mix of businesses and where we see net income coming from.

So we are continuing to look at that, obviously, as we go forward. But we're not prepared to say that we see any major difference in terms of the full-year expectation based on the businesses as we see them coming into their forecast.

This is Paul. What I was going to say was, just to help you handicap this, whether there is some conservatism built in -- I would say there probably is, but prudently so, just because what we are finding is it's difficult to accurately predict the tax rate going forward, and that can have some movement in it, as well as foreign exchange rates. I think we look out and use the forward curves to determine what we think the exchange rates will be -- try not to take a view different than the markets.

But clearly, if the exchange rates turn out -- if the real and the peso and others turn out stronger than the forward curves, there could be some upside there in the numbers. So I would say it is slightly conservative, but intended just to reflect the fact that some of those things are going to have some movement in them, and that is why we've come out with the number we did.

And would the conservativism be simply accounting issues as what Lasan brought up? Or when it is all said and done, is it really affecting operations and cash flow potentially once we figure out what is going on with cash taxes and things like that?

I think the cash flow numbers are on track. They are as expected. So I think what is a little bit more difficult to predict is how the various factors that are influenced -- for example, our tax rate is influenced by where the earnings come from, by -- it can move depending on foreign exchange rates, other factors. You have to predict all those things and then work it through the process to figure out what does the effective tax rate look like on a GAAP basis.

I think what we do know is that we will see a ramp-up in development expenditures as we are developing these projects. But these are projects that we think are high quality and will result in projects we can close and add to the growth rates beyond 2008, for example.

Great. And last two questions -- any quick update on your LNG terminal projects? And finally, I understand that you don't want to comment on operations at Eletropaulo, but historically, you all have said that Brasiliana could upstream without dividend restrictions, 50 to 100 million plus, and subsidiary dividends to the AES parent annually.

Obviously, Eletropaulo, I believe, doesn't pay dividends, but the other subs in Brasiliana do. Would you feel comfortable reiterating that 50 to 100 million a year of parent cash flow could be freed up as a result of this restructuring?

Yes, let me just -- for the second question, let me just address that, but I'll have Bill Luraschi comment on Ocean Cay. But basically, because we have a registration process, we really can't comment on those issues with Eletropaulo. But I think you can go back and look at what we've said in the past, which was the intent of any kind of restructuring would be to allow us to dividend cash flow up to the parent. So that is the driving force behind this. But beyond that, I really can't comment on it because the registration statement, which is in place, we've just submitted.

Let me have Bill Luraschi, who heads up our Corporate Development Group, comment on Ocean Cay.

Thanks, Paul. There has been a flurry of articles recently in the Bahamas about progress on our LNG facility down there. We have been having discussions with the government on finalizing the heads of agreement. I don't think there's any material issues remaining.

However, given the history of this project, until we actually execute the heads of agreement, which is the last remaining step for us before we can go forward and finalize the commercial arrangements and begin construction, we wouldn't announce anything. So what I would say is, look for an announcement from us when that milestone is reached. And then we would expect to go forward with the project.

Do you all still believe that you wouldn't progress with that project by yourselves, but you'd have to look for an equity partner with more experience in that area?

I don't think that is true of how we think about it. We would be prepared to go forward with that project on our own.

We do have a partner in that project already, and I think we'd look at that in terms of, just in sources of capital, what is the most efficient way to raise capital. So Bill is right, I don't think we have any previous position other than to say if we can find attractive capital, low-cost capital, to fund it, we would do that. But it would really depend on -- I mean, our first priority will always be to bring on non-recourse project financing, and then we'd look at other sources of capital and whether they could optimize the value longer term.

Terran Miller, UBS.

A couple of clarification questions. When we look at the cash flow guidance, parent investment and capital expenditures, you have that going up about $250 million. Could you bridge that 250? And also, could you tie that in with previous guidance about debt reduction at the parent and asset sales, the proceeds? Are we supposed to expect lower debt reduction now with the increased parent investment in capital expenditures?

This is Victoria; I can take that. Essentially, the forecast remains the same in terms of the investments and maintenance capital with the addition of these additional announcements that we've made relative to alternate energy and AgCert. So that is obviously incremental to the previous baseline investment that we had discussed. So that, from a run rate perspective, we're not expecting any differences, but we added those incrementally to it.

In terms of debt reduction, and I will certainly let Paul comment as well, at this point we are looking at prioritizing our use of cash and investment in the business in both new opportunities in the pipeline, as well as expansions where they look to generate good returns. And we are managing to coverage ratios pretty well in line with what we had previously announced. So from my perspective, we are very comfortable with where we are from a leverage perspective. And we will just continue to look at where the best priority is from an investment perspective.

I think the way to think about it is, as Victoria said, it is not so much the debt reduction as it is getting to strong BB credit metrics. That is really where we want to be. And that can come from a number of different sources, in terms of whether we pay down debt or add good projects that can do that -- it would just depend on what opportunities are out there.

But I think we will look at the capital that is available and what is the best way to deploy it, which very likely could involve some additional debt paydown. I think, at least in my mind, that's still something we would likely do as opportunities present themselves. But the overriding objective really is to get to the strong BB credit metrics and to make sure we get there within a reasonable period of time.

So you are effectively going away from a dollar reduction goal in terms of debt and moving toward coverages and making specific ratios instead?

Yes, we started talking about that a few months ago, that that's really the intent. A dollar reduction of debt is a simple way to get there. And I think as we have cash flow available, that would be a good use of that cash to get us where we need to be. If we have some competing investment alternatives that we think are very attractive, then you look at what are the sources of cash, and whether it's going to be asset sales, it could be issuances of capital, it could be cash flow from the parent -- so we will look at all the different ways that we can reduce debt to get there. But that is the overall objective, is to get to strong BB.

And Victoria, do you have a cash interest number for the quarter? I guess we don't have the Q yet?

No, we will shortly -- the Q will be filed shortly.

Brian Russo, Broadwall Capital.

Could you list the projects added to the portfolio in 2006, and then the projects you expect to add to the portfolio in 2007?

You know, I've covered some of them in my comments. I think I am reluctant to do that right now, just because I don't have the complete list in front of me. And particularly with 2007, maybe, Scott, do you have some of those you could provide? But I just -- we may want to put out something later that would have more detail than that.

Brian, I can go over some of the specifics with you after the call. The 10-Q you'll see tomorrow, when the Q is filed, I'm sorry, we will be updating exactly what is in the defined pipeline of projects in engineering and construction -- there is nothing changed there since Maritza came onstream. We can talk a little later about some of the other projects, if you have specific questions.

And just on the 2600 megawatts in the wind generation subsidiary, are those like late-stage development projects or early-stage development projects?

I will have Bill Luraschi respond to that.

Both is the answer. Some we expect to bring on line next year, and then it goes out several years as far as the entire development pipeline.

Brian Chin, Citigroup.

I hate to beat a dead horse on the tax rate question, but just to clarify, in your '08 guidance, should we still be thinking about a mid-30% tax rate going forward? Or is there a different tax rate you guys had in mind?

Brian, this is Victoria. I think as Paul commented, we are better prepared closer to the end of the year to re-look at that. At this point, we don't see any significant driver differences in terms of the businesses and how they roll up in the five-year forecast. But we'll need to further clarify that as we get closer to the end of the year.

Annie Tsao, AllianceBernstein.

For the second quarter, when you talk about you have $0.30 higher gross margin primarily driven by price, currency and volume, can you kind of comment, going into the second half, where do you see that kind of debt, the trends for each one of those?

Well, I think as we look at -- the currency one is the most difficult to predict. What we do is we will look at the forward currency curves. And generally, if you look at a long-term foreign currency relative to dollar, they will generally have some devaluation built into them. But that has been proven to be not the case, as we have seen some, basically, is the dollar weakening. So that one is a tough one to call.

In terms of price and volume, the volume tends to -- the contract generation business tends to be fairly predictable and flat, sometimes declining a little bit. The regulated utility sector tends to grow in line with, for our businesses, slightly higher than GDP growth rates because of the developing economies. And when you mix that with, for example, IPL, you are probably getting something that is closer to the overall -- think of it as a global GDP growth rate. And prices there will tend to go up with inflation. So if you look at the drivers there, that is what you look at.

Probably the best thing to do is to look at the guidance we give, the long-term guidance for what is happening with gross margin. And we still think that is valid, and in terms of the long-term 2008 guidance. And as we mentioned, we are going to be updating that and refreshing it by the end of the year. I think we will provide more insights then based on where we see the long-term currency rates -- that will probably be the biggest driver that will require the most update, I think, at this point.

Second question -- if interest rates keep going up, what kind of impact would there be to AES as a whole, do you think?

What is our sensitivity on that, Scott?

Annie, it is Scott. We said earlier in the year, and we think it is still about right, that about a 100 basis point movement is a couple pennies, as Victoria mentioned, and we have about 80% of our debt as either fixed or swapped. And also keep in mind, two of our major currencies where we have local debt in Venezuela and Brazil, rates are actually coming down. So it's sort of a natural hedge against higher LIBOR and U.S. dollar rates. So we don't think it is a significant exposure.

Clark Orsky, KDP Investment Advisors.

Just wanted to ask about the new Eastern Energy facility. Did that close subsequent to quarter end -- the 300 million LOC facility?

Yes, it closed on Friday -- last Friday.

So does that mean at the parent now you have actually pro forma more liquidity because those LCs come off the parent revolver?

Yes, about 150 million.

And just one other question -- you called out the charge for Cartagena, I guess. Can you just update us on where that project stands?

Yes, Cartagena is still in construction. It had some construction delays primarily associated with the tunneling to get access to the water. There had to be a tunnel built which basically allowed the water pipeline to get to the source cooling water. And the civil engineering associated with that -- basically, when you get into it, you find out what kind of material is inside the mountain. And that turned out to be a little bit more complicated than thought.

That caused some delays. And as a result, we have been in negotiations with the contractor to speed up the construction, to have it completed by the end of the year. And as a result, as part of that negotiation, we then wound up taking a charge by essentially waiving some of the liquidated damages for that construction project to the contractor -- from the contractor.

So you expect it to be done by the end of the year now?

Yes.

Versus -- what was it? 3Q before? Is that what it--?

Yes, it has actually been delayed beyond that. I think originally, we had probably -- it was probably 2Q when we had expected that to be done at the very beginning. So it's slipped considerably.

Jeff Gildersleeve, Millennium Partners.

You mentioned the two issues affecting the tax rate in the first six months. It looks like around 20%. What were those two items?

In the first half?

Yes.

In the first quarter, we had the benefit of the tax resale of the Kingston property, which we had -- obviously flowed through, and then had a one-time benefit as well, as we had a change in legislation that occurred in the second quarter, which will have some recurring benefit over the next several years, but had a one-time six-month retroactive adjustment that took place in the second quarter. So both of those preternaturally depressed the first-half effective tax rate.

And then for the remainder of the year, we should assume mid-30%? Or will it be higher than that to get to an average of mid-30?

The latter. We are expecting a full-year number in the mid-30s. So by definition, just mathematically, given that the first half was lower than the second half, we are expecting, absent any changes in the mix of businesses, to be higher.

And then finally, you have '06 guidance out, and 2008. How should we be thinking about '07? Is that more a transition year as you gear up all these projects, or--?

No, we haven't given any '07 guidance yet. The longer-term guidance we will update, like I said, by the end of the year. And '07 guidance, we typically will give that in our first -- at the beginning of the year, we will give '07 guidance.

I'm just wondering -- was there a reason to give '08 versus '07? Is '08 a more meaningful year as far as all the projects coming on?

In '03, there was five-year guidance given. So what we are saying now is we will update that '03 guidance at the end of the year.

Yes, so it will be longer-term. It won't just go out through '08. We'll try and give longer-term guidance, so we'll help you gauge where we think we are heading.

This is Scott Cunningham. We appreciate very much -- I think we have run out of time here today. We appreciate everyone's attention. If you have any follow-up questions from investors, please don't hesitate to contact the Investor Relations team, and Robin Pence for any media inquiries. Thank you very much for participating in the AES call today. Goodbye.

Thank you. This does conclude today's AES teleconference. You may disconnect your lines at this time, and have a wonderful day.