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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
/_/ TRANSITION REPORT PURSUANT OR TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 333-40478
AES RED OAK, L.L.C.
(Exact name of registrant as specified in its charter)
Delaware 54-1889658
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
832 Red Oak Lane, Sayreville, NJ 08872
(732) 238-1462
(Address of principal executive offices, zip code)
(Telephone number, Including Area Code)
Registrant is a wholly owned subsidiary of The AES Corporation.
Registrant meets the conditions set forth in General Instruction H(I)(a) and
(b) of Form 10-Q and is filing the Quarterly Report on form 10-Q with the
reduced disclosure format authorized by General Instruction H.
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No /_/
Indicate by check mark whether registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes /_/ No /X/
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AES RED OAK, L.L.C.
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION .......................................... 1
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) ........ 1
Condensed Consolidated Statements of Operations, Three
Months Ended March 31, 2003 and 2002 ......................... 1
Condensed Consolidated Balance Sheets, as of March 31, 2003
and December 31, 2002 ........................................ 2
Condensed Consolidated Statement of Changes in Member's
Capital (Deficit) for the Period from December 31, 2002
through March 31, 2003 ....................................... 3
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2003 and 2002 ................... 4
Notes to Condensed Consolidated Financial Statements ........... 5
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ............................ 13
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ..... 21
Item 4. CONTROLS AND PROCEDURES ........................................ 21
PART II. OTHER INFORMATION .............................................. 21
Item 1. LEGAL PROCEEDINGS .............................................. 21
Item 2. CHANGES IN SECURTIES AND USE OF PROCEEDS ....................... 21
Item 3. DEFAULTS UPON SENIOR SECURITIES ................................ 21
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............ 21
Item 5. OTHER INFORMATION .............................................. 22
Item 6. EXHIBITS AND REPORTS ON FORM 8-K ............................... 23
Signatures ................................................................. 24
Certifications ............................................................. 25
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDERECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION
Condensed Consolidated Statements of Operations,
Three Months Ended March 31, 2003 and 2002
(dollars in thousands)
Three Months
Ended
March 31
----------------------
2003 2002
----------------------
OPERATING REVENUES
Energy.................................... $ 11,021 $ --
OPERATING EXPENSES
Fuel costs................................ (635) --
Fuel conversion volume rebate............. (1,603) --
Corporate management fees................. (399) --
Other operating expenses.................. (2,049) --
Depreciation expense...................... (2,896) --
General and administrative costs......... (63) (22)
-------- --------
Total operating expenses.............. (7,645) (22)
-------- --------
Operating income (loss)................... 3,376 (22)
-------- --------
OTHER INCOME (EXPENSE)
Interest income........................... $ 77 $ 25
Other income.............................. 603 --
Interest expense.......................... (8,614) (81)
Other expense............................. (251) --
-------- --------
Total other income (expense).......... (8,185) (56)
-------- --------
NET LOSS....................................... $(4,809) $ (78)
======== ========
See notes to condensed consolidated financial statements.
1
AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION
Condensed Consolidated Balance Sheets,
March 31, 2003 and December 31, 2002
(dollars in thousands, except share amounts)
March 31, December 31,
2003 2002
------------ ----------------
ASSETS:
Current Assets:
Cash................................................................................ $ 29 $ 23
Restricted cash at cost, which approximates market value............................ 29,308 7,749
Receivables......................................................................... 8,293 8,442
Receivable from affiliate........................................................... 343 309
Prepaid expenses.................................................................... 293 230
------------ ------------
Total current assets........................................................... 38,266 16,753
Land................................................................................ 4,240 4,240
Construction in progress............................................................ -- 344
Property, plant, and equipment - net of accumulated depreciation of $7,334 and
$4,438, respectively............................................................. 405,277 406,815
Deferred financing costs - net of accumulated amortization of $2,518 and $2,315,
respectively..................................................................... 16,187 16,390
Spare parts inventory............................................................... 10,500 10,500
Other assets........................................................................ 172 141
------------ ------------
Total assets................................................................... $ 474,642 $ 455,183
============ ============
LIABILITIES AND MEMBER'S CAPITAL:
Current Liabilities:
Accounts payable.................................................................... $ 831 $ 1,175
Accrued liabilities................................................................. 1,613 1,516
Accrued interest.................................................................... 2,804 2,804
Payable to affiliate................................................................ -- 18
Bonds payable-current portion....................................................... 6,144 6,219
Other current liabilities........................................................... 35,000 10,000
------------ ------------
Total current liabilities...................................................... 46,392 21,732
Bonds payable - non current portion................................................. 374,969 375,361
Liabilities under spare parts agreement............................................. 9,325 9,325
------------ ------------
Total liabilities.............................................................. $ 430,686 $ 406,418
============ ============
Member's capital:
Common stock, $1 par value-10 shares authorized, none issued or outstanding......... $ -- $ --
Contributed capital................................................................. 56,736 56,736
Member's deficit.................................................................... (12,780) (7,971)
------------ ------------
Total member's capital ........................................................ 43,956 48,765
------------ ------------
Total liabilities and member's capital..................................... $ 474,642 $ 455,183
============ ============
See notes to condensed consolidated financial statements.
2
AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION
Condensed Consolidated Statement of Changes in Member's Capital (Deficit)
Period from December 31, 2002 through March 31, 2003
(dollars in thousands)
Common Stock
------------------
Additional
Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ---------- ----------- -------
BALANCE DECEMBER 31, 2002.................................. -- $-- $56,736 $(7,971) $48,765
------ ------ ---------- ----------- -------
Contributed capital........................................ -- -- -- -- --
Net loss................................................... -- -- -- (4,809) (4,809)
------ ------ ---------- ----------- -------
BALANCE March 31, 2003..................................... -- $-- $56,736 $(12,780) $43,956
====== ====== ========== =========== =======
See notes to condensed consolidated financial statements.
3
AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2003 and 2002
(dollars in thousands)
Three months
Ended
March 31
--------------------------
2003 2002
------------- -----------
OPERATING ACTIVITIES:
Net income (loss)................................................................................... $ (4,809) $ (78)
Amortization of deferred financing costs............................................................ 203 204
Depreciation........................................................................................ 2,896 --
Change in:
Accrued liabilities................................................................................. 97 173
Receivables......................................................................................... 149 --
Receivable -- from affiliate........................................................................ (34) 1,748
Other assets........................................................................................ (31) --
Payable to affiliate................................................................................ (18) (1,573)
Prepaid expenses.................................................................................... (63) --
Accounts payable.................................................................................... (344) 116
--------- ---------
Net cash (used in) provided by operating activities................................................. $ (1,954) $ 590
========= =========
INVESTING ACTIVITIES:
Payments for construction in progress............................................................... -- (15,061)
Retainage payable................................................................................... -- (28,453)
Purchases of property, plant, and equipment......................................................... (1,014)
Restricted cash..................................................................................... (21,559) 196
--------- ---------
Net cash used in investing activities............................................................... $(22,573) $(43,318)
========= =========
FINANCING ACTIVITIES:
Payment of principal on bonds payable............................................................... (467) --
Other liabilities................................................................................... 25,000 --
Contribution from parent............................................................................ -- 42,700
--------- ---------
Net cash provided by financing activities........................................................... $ 24,533 $ 42,700
========= =========
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............................................... $ 6 $ (28)
========= =========
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD...................................................... $ 23 $ 48
CASH AND CASH EQUIVALENTS, END OF PERIOD............................................................ $ 29 $ 20
========= =========
SUPPLEMENTAL DISCLOSURE:
Interest paid (net of amounts capitalized).......................................................... $ 8,614 $ 81
========= =========
Transfer of construction in progress to property, plant and equipment .............................. $ 344 $ --
========= =========
See notes to condensed consolidated financial statements.
4
AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION
Notes to Condensed Consolidated Financial Statements
1. ORGANIZATION
AES Red Oak, L.L.C. (the "Company") was formed on September 13, 1998, in
the State of Delaware, to develop, construct, own and operate an 830-megawatt
(MW) gas-fired, combined cycle electric generating facility (the "Facility") in
the Borough of Sayreville, Middlesex County, New Jersey. The Company was
considered dormant until March 15, 2000 (hereinafter, "inception"), at which
time it consummated a project financing and certain related agreements. On
March 15, 2000, the Company issued $384 million in senior secured bonds for the
purpose of providing financing for the construction of the Facility and to
fund, through the construction period, interest payments to the bondholders
(see Note 3). In late September 2000, the Company consummated an exchange offer
whereby the holders of the senior secured bonds exchanged their privately
placed senior secured bonds for registered senior secured bonds.
The Facility, consists of three Westinghouse 501 FD combustion turbines,
three unfired heat recovery steam generators, and one multicylinder steam
turbine. The Facility produces and sells electricity, as well as provides fuel
conversion and ancillary services, solely to Williams Energy Marketing &
Trading Company ("Williams Energy") under a 20-year Fuel Conversion Services,
Capacity and Ancillary Services Purchase Agreement (the "Power Purchase
Agreement" or "PPA"). The term of the PPA is twenty years from the last day of
the month in which commercial operation commenced, which was September 2002.
The Company reached provisional acceptance on August 11, 2002, risk transfer on
August 13, 2002, and reached commercial availability on September 1, 2002.
Williams Energy has disputed the September 1, 2002 commercial operation date
and has informed the Company that it recognizes the commercial availability of
the Facility as of September 28, 2002. The Company expects to settle the
dispute through arbitration during the second quarter of 2003.
After the Facility reached provisional acceptance, the Company elected to
confirm reliability for up to 19 days before binding with Williams Energy.
Beginning August 13, 2002 (the risk transfer date) through August 31, 2002, the
Company operated the Facility as a merchant plant with electric revenues sold
to Williams Energy, in its capacity as the Company's PJM account
representative, at spot market prices and bought gas from Williams Energy at
spot market prices. Additionally, during September 2002, the Company made net
electric energy available to Williams Energy during times when it had not
received a Williams Energy dispatch notice. This net electric energy is
referred to as "other sales of energy" in the Power Purchase Agreement and is
sold at the local marginal price commonly referred to as spot market energy.
Gas required for this energy generation was purchased from Williams Energy at
spot market prices.
The Company is a wholly owned subsidiary of AES Red Oak, Inc. ("Red Oak"),
which is a wholly-owned subsidiary of The AES Corporation ("AES"). Red Oak has
no assets other than its ownership interests in the Company and AES Sayreville,
L.L.C.. Red Oak has no operations and is not expected to have any operations.
Red Oak's only income is distributions (if any) it receives from the Company
and AES Sayreville, L.L.C. Pursuant to an equity subscription agreement, Red
Oak agreed to contribute up to approximately $55.75 million to the Company to
fund construction after the bond proceeds were fully utilized. All $55.75
million has been contributed. The Company does not have access to additional
liquidity pursuant to this agreement as Red Oak has fulfilled its funding
obligations thereunder. The equity that Red Oak provided to the Company was
provided to Red Oak by AES, which owns all of the equity interests in Red Oak.
AES files quarterly and annual audited reports with the Securities and Exchange
Commission under the Securities Exchange Act of 1934, which are publicly
available, but which do not constitute a part of, and are not incorporated
into, this Form 10-Q.
The Company owns all of the equity interests in AES Red Oak Urban Renewal
Corporation ("AES URC"), which was organized as an urban renewal corporation
under New Jersey Law. As an urban renewal corporation under New Jersey law,
portions of the Facility can be designated as redevelopment areas in order to
provide certain real estate tax and development benefits to the Facility. URC
has no operations outside of its activities in connection with the Facility.
5
2. BASIS OF PRESENTATION
In the Company's opinion, all adjustments necessary for a fair
presentation of the unaudited results of operations for the interim periods
presented herein are included. All such adjustments are accruals of a normal
and recurring nature. Prior to the August 13, 2002 date of risk transfer, the
Facility was under construction, and the Company was a development stage
company. Accordingly, the results of operations and cash flows for the three
months ended March 31, 2003 and 2002 are not comparable. Undue reliance should
not be placed upon a period-by-period comparison. The results of operations for
the three month periods presented herein are not necessarily indicative of the
results of operations to be expected for the full year or future periods.
The Company generates energy revenues under the Power Purchase Agreement
with Williams Energy. During the 20-year term of the agreement, the Company
expects to sell capacity and electric energy produced by the Facility, as well
as ancillary services and fuel conversion services. Under the Power Purchase
Agreement, the Company also generates revenues from meeting (1) base electrical
output guarantees and (2) heat rate rebates through efficient electrical
output. Revenues from the sales of electric energy and capacity are recorded
based on output delivered and capacity provided at rates as specified under
contract terms. Revenues for ancillary and other services are recorded when the
services are rendered.
Upon its expiration, or in the event that the Power Purchase Agreement is
terminated prior to its 20-year term or Williams Energy otherwise fails to
perform, the Company would seek to generate energy revenues from the sale of
electric energy and capacity into the merchant market or under new short or
long-term power purchase or similar agreements. Due to recent declines in pool
prices, however, the Company would expect that even if it were successful in
finding alternate revenue sources, any such alternate revenues would be
substantially below the amounts that would have been otherwise payable pursuant
to the Power Purchase Agreement. There can be no assurances as to whether such
efforts would be successful.
These financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q and
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles ("GAAP") for
complete financial statements. The accompanying condensed consolidated
financial statements are unaudited and they should be read in conjunction with
the audited financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002.
3. BONDS PAYABLE
On March 15, 2000, the Company issued $384 million in senior secured bonds
for the purpose of providing financing for the construction of the Facility and
to fund, through the construction period, interest payments to the bondholders.
In September 2000, the Company consummated an exchange offer whereby the
holders of the senior secured bonds exchanged their privately placed senior
secured bonds for registered senior secured bonds.
The senior secured bonds were issued in two series: 8.54% senior secured
bonds due 2019 (the "2019 Bonds") in an aggregate principal amount of $224
million and 9.20% senior secured bonds due 2029 (the "2029 Bonds") in an
aggregate principal amount of $160 million. Principal repayment of the 2019
Bonds commenced with the quarterly payment on August 31, 2002. Annual principal
repayments on the Bonds are scheduled as follows:
6
Year Annual Payment
---- --------------
2003 (remaining subsequent to March 31, 2003)......... $5.7 million
2004.................................................. $5.2 million
2005.................................................. $5.1 million
2006.................................................. $7.1 million
2007.................................................. $6.1 million
Thereafter............................................ $351.9 million
--------------
Total.................................................. $381.1 million
==============
Principal repayment dates on the 2019 Bonds are February 28, May 31,
August 31, and November 30 of each year, with the final payment due November
30, 2019. Quarterly principal repayments commenced on August 31, 2002.
Quarterly principal repayment of the 2029 Bonds does not commence until
February 28, 2019. The Company made a principal payment of approximately
$466,000 in February 2003.
4. CONCENTRATION OF CREDIT RISK IN WILLIAMS ENERGY AND AFFILIATES
Williams Energy is currently the Company's sole customer for purchases of
capacity, ancillary services, and energy and its sole source for fuel. Williams
Energy's payments under the Power Purchase Agreement are expected to provide
all of the Company's operating revenues during the term of the Power Purchase
Agreement. It is unlikely that the Company would be able to find another
purchaser or fuel source on similar terms for its Facility if Williams Energy
were not performing under the Power Purchase Agreement. Any material failure by
Williams Energy to make capacity and fuel conversion payments or to supply fuel
under the Power Purchase Agreement would have a severe impact on the Company's
operations. The payment obligations of Williams Energy under the Power Purchase
Agreement are guaranteed by The Williams Companies, Inc. The payment
obligations of The Williams Companies, Inc. under the guaranty are capped at an
amount equal to approximately $510 million. Beginning on January 1 of the first
full year after the commercial operation date, this guaranty cap is to be
reduced semiannually by a fixed amount which is based on the amortization of
the company's senior secured bonds during the applicable semiannual period.
The Company's dependence upon The Williams Companies, Inc. and its
affiliates under the Power Purchase Agreement exposes the Company to possible
loss of revenues and fuel supply, which in turn, could negatively impact its
cash flow and financial condition and may result in a default on its senior
secured bonds. There can be no assurances as to the Company's ability to
generate sufficient cash flow to cover operating expenses or its debt service
obligations in the absence of a long-term power purchase agreement with
Williams Energy.
5. POWER PURCHASE AGREEMENT
The Company and Williams Energy have entered into a Power Purchase
Agreement for the sale of all capacity produced by the Facility, as well as
ancillary services and fuel conversion services. Under the PPA, Williams Energy
has the obligation to deliver, on an exclusive basis, all quantities of natural
gas and fuel oil required by the Facility to generate electricity or ancillary
services, to start-up or shut-down the plant, and to operate the Facility
during any period other than a start-up, shut-down, or required dispatch by
Williams Energy for any reason.
The term of the PPA is 20 years from the first contract anniversary date,
which is the last day of the month in which commercial availability occurs. The
Company recognizes September 1, 2002 as the commercial availability date.
However, the date of commercial availability is in dispute and Williams Energy
recognizes September 28, 2002 as the commercial availability date.
7
The Company has entered into arbitration with Williams Energy to resolve
certain disputes regarding the date of commercial operation and the proper
interpretation of certain provisions of the Power Purchase Agreement relating
to the amounts claimed by the Company to be payable by Williams Energy under
the Power Purchase Agreement (see Note 6).
Public Service Electric and Gas constructed, on behalf of Williams Energy,
all natural gas interconnection facilities necessary for the delivery of
natural gas to the Company's natural gas delivery point. This includes metering
equipment, valves and piping. Upon the expiration of the PPA or termination of
the PPA, the Company has the right to purchase the natural gas interconnection
facilities from Williams.
The Company has provided Williams Energy a letter of credit (the "PPA
Letter of Credit") in an amount of $10 million to support the Company's
obligations under the Power Purchase Agreement. The repayment obligations with
respect to any drawings under the PPA Letter of Credit are a senior debt
obligation of the Company.
The payment obligations of Williams Energy under the PPA are guaranteed by
The Williams Companies, Inc. The payment obligations of The Williams Companies,
Inc. under the guaranty are capped at an amount equal to approximately $510
million. Beginning on January 1 of the first full year after the commercial
operation date, this guaranty cap is to be reduced semiannually by a fixed
amount which is based on the amortization of our senior secured bonds during
the applicable semiannual period.
Pursuant to Section 18.3 of the Power Purchase Agreement, in the event
that Standard & Poor's "(S&P)" or Moody's rates the long-term senior unsecured
debt of The Williams Companies, Inc. lower than investment grade, The Williams
Companies, Inc. is required to supplement The Williams Companies, Inc.
guarantee with additional alternative security that is acceptable to the
Company within 90 days after the loss of such investment grade rating.
According to published sources, on July 23, 2002, S&P lowered the long-term
senior unsecured debt rating of The Williams Companies, Inc. to "BB" from
"BBB-" and further lowered such rating to "B" on July 25, 2002. According to
published sources, on July 24, 2002, Moody's lowered the long-term senior
unsecured debt rating of The Williams Companies, Inc. to "B1" from "Baa3" and
further lowered such rating on November 22, 2002 to "Caa1." Accordingly, The
Williams Companies, Inc.'s long term senior unsecured debt is currently rated
below investment grade by both S&P and Moody's.
Due to the downgrade of The Williams Companies, Inc. to below investment
grade, the Company and Williams Energy entered into a letter agreement dated
November 7, 2002 (the "Letter Agreement"), under which Williams Energy agreed
to (a) provide the Company a prepayment of $10 million within five business
days after execution of the Letter Agreement (the "Prepayment"); (b) provide
the Company alternative credit support equal to $35 million on or before
January 6, 2003 in any of the following forms (i) cash, (ii) letter(s) of
credit with the Company as the sole beneficiary substantially in the form of
the PPA Letter of Credit, unless mutually agreed to otherwise, or (iii) a
direct obligation of the United States Government delivered to a custodial
securities account as designated by the Company with a maturity of not more
than three years; and (c) replenish any portion of the alternative credit
support that is drawn, reduced, cashed, or redeemed, at any time, with an equal
amount of alternative credit support. In the Letter Agreement, the Company and
Williams Energy acknowledged that the posting of such alternative credit
support and Williams Energy's agreement and performance of the requirements of
(a), (b), and (c) as set forth in the immediately preceding sentence, would be
in full satisfaction of Williams Energy's obligations contained in Section 18.3
of the Power Purchase Agreement. In the Letter Agreement, the Company and
Williams Energy expressly agreed that the posting of the Prepayment or any
alternative credit support at any time or any other terms set forth in the
Letter Agreement, were not intended, and did not modify, alter, or amend in any
way, the terms and conditions or relieve The Williams Company, Inc. from any
obligations it has under its guaranty of the payment obligations of Williams
Energy under the Power Purchase Agreement. The guaranty remains in full force
and effect, and the Company retains all of its rights and remedies provided by
that guaranty.
Under the terms of the Letter Agreement, the Company is obligated to
return the Prepayment to Williams Energy upon the earlier of (i) The Williams
Companies, Inc. regaining its investment grade rating
8
or Williams Energy providing a substitute guaranty of investment grade rating;
(ii) the beginning of Contract Year 20; or (iii) the posting of alternative
credit support by Williams Energy as set forth below. In the case of items (i)
and (iii) above, except to the extent, in the case of item (iii), Williams
Energy elects to have all or a portion of the Prepayment make up a combination
of the alternative credit support required to be posted pursuant to Section
18.3(b) of the Power Purchase Agreement, Williams Energy shall have the right
to recoup the Prepayment by set-off of any and all amounts owing to the Company
under the Power Purchase Agreement beginning no earlier than June in the
calendar year after the occurrence of item (i) or (iii) and continuing
thereafter until the Prepayment has been fully recovered. In the case of item
(ii) above, Williams Energy shall have the right to immediately set-off all
amounts owing to the Company under the Power Purchase Agreement after the
occurrence of item (ii) and continuing thereafter until the Prepayment has been
fully recovered. Except to the extent Williams Energy elects to include the
Prepayment as part of the alternative credit support, the amount of alternative
credit support posted by Williams Energy pursuant to the Letter Agreement shall
be initially reduced by the amount of the Prepayment, and Williams Energy shall
thereafter increase the alternative credit support proportionately as Williams
Energy recoups the Prepayment set-off on the payment due date of amounts owing
to the Company.
If the Company does not return the Prepayment to Williams Energy as set
forth in the preceding paragraph, then the Company shall be considered in
default under the Letter Agreement and Williams Energy shall be entitled to
enforce any or all of its contractual rights and remedies as set forth in the
Power Purchase Agreement, including, but not limited to its right to draw on
the Letter of Credit previously posted by the Company in favor of Williams
Energy.
Williams Energy made the Prepayment on November 14, 2002 and provided an
additional $25 million of cash to the Company on January 6, 2003 as the
alternative credit support. As allowed by the Letter Agreement, Williams has
elected to have the $10 million Prepayment included as part of the alternative
credit support. In the event that Williams regains and maintains its investment
grade status, provides a substitute guaranty of investment grade rating, or
posts a letter of credit, the Company will be required to return the $35
million alternative credit support to Williams Energy in accordance with the
terms of the Letter Agreement as described above.
6. COMMITMENTS AND CONTINGENCIES
Williams Energy Arbitration - As discussed in Note 5, the Company has
entered into arbitration with Williams Energy to resolve certain disputes
regarding the date of commercial operation and the proper interpretation of
certain provisions of the Power Purchase Agreement relating to the amounts
claimed by the Company to be payable by Williams Energy. Williams Energy has
withheld or offset from amounts invoiced by the Company amounts that Williams
Energy believes were improperly invoiced based on Williams Energy's
interpretation of the Power Purchase Agreement. The arbitration relates to
disputed amounts of approximately $7.6 million, which includes a $594,000
payment extension option dispute and a $7.0 million commercial operation start
date dispute. The Company is also disputing $392,000 of merchant price and gas
testing charges with Williams Energy although this is not currently part of the
arbitration. While the Company believes that its interpretation of the Power
Purchase Agreement is correct, the Company cannot predict the outcome of these
matters. The Company expects to resolve the disputes in the second quarter of
2003.
Construction Agreement - The Company entered into an Agreement for
Engineering, Procurement and Construction services, dated as of October 15,
1999, between the Company and WGI (as the successor contractor), as amended for
the design, engineering, procurement, site preparation and clearing, civil
works, construction, start-up, training and testing and to provide all
materials and equipment (excluding operational spare parts), machinery, tools,
construction fuels, chemicals and utilities, labor, transportation,
administration and other services and items (collectively and separately, the
"services") of the Facility. Under a guaranty in the Company's favor, effective
as of October 15, 1999, all of the WGI's obligations under the construction
agreement are irrevocably and unconditionally guaranteed by Raytheon. In 2001,
as a result of WGI's bankruptcy filing, the Company made a demand on Raytheon to
perform its obligations under the Raytheon guarantee and WGI, Raytheon and the
Company entered into agreements pursuant to which Raytheon became responsible
for the construction of the Facility. As discussed in Note 1, provisional
9
acceptance has been granted and the Facility has commenced commercial
operations, however, Raytheon must perform certain agreed upon completion items
in order to obtain final acceptance. On March 8, 2003, the Company entered into
a letter agreement with Raytheon pursuant to which the Company granted Raytheon
an extension of the guaranteed final acceptance date from April 1, 2003 to June
30, 2003.
Maintenance Services - Pursuant to a maintenance services agreement dated
December 5, 1999, Siemens Westinghouse is to provide the Company with specific
combustion turbine maintenance services and spare parts for twelve maintenance
periods or until December 8, 2015. As of March 31, 2003, the Company has
received approximately $10.5 million in rotable spare parts under this
agreement. The fees assessed by Siemens Westinghouse will be based on the
number of Equivalent Base Load Hours accumulated by the applicable Combustion
Turbine as adjusted for inflation. These fees are capitalized to the Facility
when paid and expensed as maintenance occurs. This amount is recorded as spare
parts inventory and a long-term liability in the accompanying balance sheets.
For financial reporting purposes, the payments made to Siemens Westinghouse are
netted with the liabilities under the spare-parts agreement in the accompanying
balance sheets.
Water Supply and Water Supply Pipeline - The Company has entered into a
contract with the Borough of Sayreville (the "Borough") by which the Borough
will provide untreated water to the Company. The contract has a term of 30
years with an option to extend for up to four additional five-year terms. The
Company is contractually committed to a minimum annual payment of $300,000.
The Borough of Sayreville is in the final stages of completion and
approval of the Lagoon Water Pipeline, Lagoon Pumping Station, and Sayreville
Interconnection Number 2. The Company is responsible for selection of a
contractor and for payment of all costs. The pipeline construction has been
completed. The construction contract for the Pumping Station was awarded and is
completed. Start up and commissioning of this system started May 1, 2002. The
cost of the pipeline and pumping station are estimated to be approximately
$678,000 and $1.64 million, respectively. The Company has paid the pipeline
project in full, and as of March 31, 2003, had paid approximately $1.6 million
towards the pumping station.
Interconnection Agreement (GPU) - The Company has entered into an
interconnection agreement with Jersey Central Power & Light Company d/b/a GPU
Energy ("GPU") to transmit the electricity generated by the Facility to the
transmission grid so that it may be sold as prescribed under the PPA. The
agreement is in effect for the life of the Facility, yet may be terminated by
mutual consent of both GPU and the Company under certain circumstances as
detailed in the agreement. Costs associated with the agreement are based on
electricity transmitted via GPU at a variable price and the PJM
(Pennsylvania/New Jersey/Maryland) Tariff as charged by GPU, which is comprised
of both service cost and asset recovery cost, as determined by GPU and approved
by the Federal Energy Regulatory Committee. On June 22, 2001, FERC approved the
Company's Market - Based Tariff petition. The Company has been importing
electricity from the transmission system to support commissioning of the
Facility since July 2001 and the interconnection facilities have exported power
to the transmission system since that time.
Interconnection Installation Agreement (GPU) - The Company entered into an
interconnection agreement with GPU on April 27, 1999 to design, furnish install
and own certain facilities required to interconnect the Company with the
transmission system. Under the terms of this agreement, GPU will provide all
labor, supervision, materials and equipment necessary to perform the
interconnection installation. The cost of these interconnection facilities is
approximately $5.3 million. The Company had paid $5.1 million to GPU for these
facilities as of March 31, 2003.
Interconnection Services Agreement (PJM) - The Company entered into an
interconnection agreement with the Independent System Operator ("ISO") of the
PJM Control Area on December 24, 2001, as required under the PJM Open Access
Transmission Tariff. This agreement includes specifications for each generating
unit that will be interconnected to the Transmission System, confirms Capacity
Interconnection Rights and includes the Company's agreement to abide by all
rules and procedures pertaining to generation in the PJM Control Area.
10
7. NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 143, entitled "Accounting for Asset
Retirement Obligations." This standard is effective for fiscal years beginning
after June 15, 2002 and provides accounting requirements for asset retirement
obligations associated with long-lived assets. Under the Statement, the asset
retirement obligation is recorded at fair value in the period in which it is
incurred by increasing the carrying amount of the related long-lived asset. The
liability is accreted to its present value in each subsequent period and the
capitalized cost is depreciated over the useful life of the related asset. The
adoption of this standard did not have a material effect on the Company's
financial statements.
In April 2002, the FASB issued SFAS No. 145, entitled "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the current requirement that gains and
losses on debt extinguishment must be classified as extraordinary items in the
income statement. Instead, such gains and losses will be classified as
extraordinary items only if they are deemed to be unusual and infrequent, in
accordance with the current GAAP criteria for extraordinary classification. In
addition, SFAS No. 145 eliminates an inconsistency in lease accounting by
requiring that modifications of capital leases that result in reclassification
as operating leases be accounted for consistent with sale-leaseback accounting
rules. The statement also contains other nonsubstantive corrections to
authoritative accounting literature. The changes related to debt extinguishment
will be effective for fiscal years beginning after May 15, 2002, and the
changes related to lease accounting will be effective for transactions
occurring after May 15, 2002. The adoption of this standard did not have a
material effect on the Company's financial statements.
In June 2002, the FASB issued SFAS No. 146, entitled "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force ("EITF") Issue No. 94-3. The
Company will adopt the provisions of SFAS No. 146 for restructuring activities
initiated after December 31, 2002. SFAS No. 146 requires that the liability for
costs associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF Issue No. 94-3, a liability for an exit cost
was recognized at the date of a company's commitment to an exit plan. SFAS No.
146 also establishes that the liability should initially be measured and
recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of
recognizing future restructuring costs as well as the amount recognized. The
adoption of this standard did not have a material effect on the Company's
financial statements.
In April 2003, the FASB issued Statement No. 149, Amendment of Statement
133 on Derivative Instruments and Hedging Activities ("SFAS No. 149"). SFAS No.
149 amends and clarifies the accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. The amendments set
forth in SFAS No. 149 require that contracts with comparable characteristics be
accounted for similarly. In particular, this statement clarifies under what
circumstances a contract with an initial net investment meets the
characteristics of a derivative according to SFAS No. 133 and when a derivative
contains a financing component that warrants special reporting in the statement
of cash flows. In addition, the statement amends the definition of an
underlying to conform it to language used in FASB Interpretation No. 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, and amends certain other
existing pronouncements.
The requirements of SFAS No. 149 are effective for contracts entered into
or modified after June 30, 2003 and for hedging relationships designated after
June 30, 2003. The provisions of the statement that relate to SFAS No. 133
Implementation Issues that have been effective for fiscal quarters that began
prior to June 15, 2003, should continue to be applied in accordance with their
respective effective dates. The Company is currently evaluating the impacts, if
any, of SFAS No. 149 on its consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". This interpretation establishes new
disclosure requirements for all guarantees, but the measurement criteria are
applicable to
11
guarantees issued and modified after December 31, 2002. The adoption of this
interpretation did not have any immediate material effect on the Company's
financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities". This interpretation is effective immediately for
all enterprises with variable interests in variable interest entities created
after January 31, 2003. FIN 46 provisions must be applied to variable interests
in variable interest entities created before February 1, 2003 from the
beginning of the third quarter of 2003. If an entity is determined to be a
variable interest entity, it must be consolidated by the enterprise that
absorbs the majority of the entity's expected losses if they occur and/or
receives a majority of the entity's expected residual returns if they occur. If
significant variable interests are held in a variable interest entity, the
company must disclose the nature, purpose, size and activity of the variable
interest entity and the company's maximum exposure to loss as a result of its
involvement with the variable interest entity in all financial statements
issued after January 31, 2003. The adoption of this interpretation did not have
any material effect on the Company's financial statements.
12
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Cautionary Note Regarding Forward-Looking Statements
Some of the statements in this Form 10-Q, as well as statements made by us
in periodic press releases and other public communications, constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Certain, but not necessarily all, of such
forward- looking statements can be identified by the use of forward-looking
terminology, such as "believes," "estimates," "plans," "projects," "expects,"
"may," "will," "should," "approximately," or "anticipates" or the negative
thereof or other variations thereof or comparable terminology or by discussion
of strategies, each of which involves risks and uncertainties. We have based
these forward-looking statements on our current expectations and projections
about future events based upon our knowledge of facts as of the date of this
Form 10-Q and our assumptions about future events.
All statements other than of historical facts included herein, including
those regarding market trends, our financial position, business strategy,
projected plans, and objectives of management for future operations, are
forward-looking statements. Such forward-looking statements involve known and
unknown risks, uncertainties, and other factors outside of our control that may
cause our actual results or performance to be materially different from any
future results, performance or achievements expressed or implied by the
forward-looking statements. These risks, uncertainties, and other factors
include, among others, the following:
o unexpected problems relating to the performance of the Facility;
o the financial condition of third parties on which we depend,
including in particular Williams Energy, as the fuel supplier under
the Power Purchase Agreement we entered into with Williams Energy for
the sale of all electric energy and capacity produced by the
Facility, as well as ancillary and fuel conversion services, and The
Williams Companies Inc, as the guarantor of Williams Energy's
performance under the Power Purchase Agreement;
o the continued performance of Williams Energy (as guaranteed by The
Williams Companies, Inc.) under the Power Purchase Agreement;
o the ability of The Williams Companies, Inc. or its affiliates to
avoid a default under the Power Purchase Agreement by continuing to
maintain or provide adequate security to supplement their guarantee
of Williams Energy's performance under the Power Purchase Agreement;
o our ability to find a replacement power purchaser on favorable or
reasonable terms, if necessary;
o the outcome of our pending arbitration with Williams Energy;
o an adequate merchant market after the expiration, or in the event of
termination, of the Power Purchase Agreement;
o capital shortfalls and access to additional capital on reasonable
terms, or in the event that the Power Purchase Agreement is
terminated;
o the possibility that Williams Energy will not request that we run or
"dispatch" the Facility as provided under the Power Purchase
Agreement;
o inadequate insurance coverage;
13
o unexpected expenses or lower than expected revenues;
o environmental and regulatory compliance;
o terrorist acts and adverse reactions to United States anti-terrorism
activities; and
o the additional factors that are unknown to us or beyond our control.
We have no obligation to publicly update or revise any forward-looking
statement, whether as a result of new information, future events, or otherwise.
General
We are a Delaware limited liability company formed on September 13, 1998
to develop, construct, own, operate and maintain our Facility. We were dormant
until March 15, 2000, the date of the sale of our senior secured bonds. We
obtained $384 million of project financing from the sale of the senior secured
bonds. In late September 2000, we consummated an exchange offer whereby the
holders of our senior secured bonds exchanged their privately placed senior
secured bonds for registered senior secured bonds. The total cost of the
construction of our Facility is estimated to be approximately $454 million,
which has and will continue to be financed by the proceeds from our sale of the
senior secured bonds, equity contributions, operating revenues and the amount
of liquidated damages received from Raytheon through August 10, 2002, under the
Construction Agreement, as described below.
The facility reached provisional acceptance on August 11, 2002, risk
transfer on August 13, 2002, and became commercially available under the Power
Purchase Agreement on September 1, 2002. Williams Energy has disputed the
September 1, 2002 commercial operation date and has informed the Company that
it recognizes commercial availability of the Facility as of September 28, 2002.
The Company expects to settle the dispute through arbitration during the second
quarter of 2003. See "Part II- Item 1 - Legal Proceedings".
Since achieving commercial operations, under the Power Purchase Agreement
with Williams Energy, we are eligible to receive variable operations and
maintenance payments, total fixed payments, energy exercise fee payments (each
as defined in the Power Purchase Agreement) and other payments for the delivery
of fuel conversion, capacity and ancillary services. Although Williams Energy
has requested that we run the Facility or "dispatch" the Facility in May 2003,
from September 28, 2002 to May 2003 Williams Energy did not request that we run
the Facility or "dispatch" the facility to a significant degree and the minimum
capacity payments provided for under the Power Purchase Agreement were our
primary source of operating revenues. We have used these operating revenues,
together with interim rebates received from Raytheon under the construction
agreement, interest income from the investment of a portion of the proceeds
from the sale of the senior secured bonds and the $10 million Prepayment from
Williams Energy to fund our generation expenses and other operations and
maintenance expenses.
The following discussion presents certain financial information for the
three months ended March 31, 2003 and 2002.
Energy Revenues
We generate energy revenues under the Power Purchase Agreement with
Williams Energy. During the 20-year term of the agreement, we expect to sell
electric energy and capacity produced by the facility, as well as ancillary and
fuel conversion services. Under the Power Purchase Agreement, we also generate
revenues from meeting (1) base electrical output guarantees and (2) heat rate
rebates through efficient electrical output.
Upon its expiration, or in the event that the Power Purchase Agreement is
terminated prior to its 20-
14
year term, we would seek to generate energy revenues from the sale of electric
energy and capacity into the merchant market or under new short- or long-term
power purchase or similar agreements. Due to recent declines in pool prices,
however, we would expect that even if we were successful in finding alternate
revenue sources, any such alternate revenues would be substantially below the
amounts that would have been otherwise payable pursuant to the Power Purchase
Agreement. There can be no assurances as to whether such efforts would be
successful.
Operating Expenses
Under an agreement with AES Sayreville, L.L.C., we are required to
reimburse all operator costs on a monthly basis. Operator costs generally
consist of all direct costs and overhead associated with running the Facility.
Additionally, an operator fee of approximately $400,000, subject to annual
adjustment, is payable on each bond payment date.
Performance Guarantees
Electrical Output
Since the average net electrical output of the facility at provisional
acceptance was less than the electrical output guarantee, Raytheon Company
("Raytheon") is required to pay us, as a rebate and not as liquidated damages,
for each day during the interim period (the period from August 11, 2002 until
the date of the next performance test), an amount equal to $0.22 per day for
each kilowatt by which the average net electrical output was less than the
electrical output guarantee. During performance testing, our output was
calculated to be 13,370 kilowatts less than the electrical output guarantee.
Accordingly, our daily rebate charge to Raytheon for this amount has been
calculated at $2,941.40 per day.
Upon final acceptance, if the average net electrical output of our
facility during the completed performance test is less than the guarantee, then
Raytheon must pay us, as a bonus, an amount equal to $520 for each kilowatt by
which the average net electrical output is less than the guarantee.
Heat Rate Guarantees
Since the average net heat rate of our facility at provisional acceptance
exceeded the guaranteed amount, Raytheon is required to pay us, as a rebate and
not as liquidated damages, for each day during the interim period, an amount
equal to $46 per day for each BTU/KwH by which the measured net heat rate was
greater than the guaranteed amount.
Upon final acceptance, if the net heat rate of our facility during the
completed performance test exceeds the guaranteed amount, then Raytheon must
pay us, as a rebate, an amount equal to $110,000 for each BTU/KwH by which the
measured heat rate is greater than the natural gas-based heat rate guarantee.
For the three month period ended March 31, 2003, we have invoiced Raytheon
approximately $603,378 in electrical output and heat rate rebates. As of March
31, 2003, Raytheon has paid in full the rebates invoiced.
Recent and New Accounting Pronouncements
In July 2001, the FASB issued SFAS No. 143, entitled "Accounting for Asset
Retirement Obligations." This standard is effective for fiscal years beginning
after June 15, 2002 and provides accounting requirements for asset retirement
obligations associated with long-lived assets. Under the Statement, the asset
retirement obligation is recorded at fair value in the period in which it is
incurred by increasing the carrying amount of the related long-lived asset. The
liability is accreted to its present value in each subsequent period and the
capitalized cost is depreciated over the useful life of the related asset. The
adoption of this standard did not have a material effect on the Company's
financial statements.
15
In April 2002, the FASB issued SFAS No. 145, entitled "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the current requirement that gains and
losses on debt extinguishment must be classified as extraordinary items in the
income statement. Instead, such gains and losses will be classified as
extraordinary items only if they are deemed to be unusual and infrequent, in
accordance with the current GAAP criteria for extraordinary classification. In
addition, SFAS No. 145 eliminates an inconsistency in lease accounting by
requiring that modifications of capital leases that result in reclassification
as operating leases be accounted for consistent with sale-leaseback accounting
rules. The statement also contains other nonsubstantive corrections to
authoritative accounting literature. The changes related to debt extinguishment
will be effective for fiscal years beginning after May 15, 2002, and the
changes related to lease accounting will be effective for transactions
occurring after May 15, 2002. The adoption of this standard did not have a
material effect on the Company's financial statements.
In June 2002, the FASB issued SFAS No. 146, entitled "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force ("EITF") Issue No. 94-3. The
Company will adopt the provisions of SFAS No. 146 for restructuring activities
initiated after December 31, 2002. SFAS No. 146 requires that the liability for
costs associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF Issue No. 94-3, a liability for an exit cost
was recognized at the date of a company's commitment to an exit plan. SFAS No.
146 also establishes that the liability should initially be measured and
recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of
recognizing future restructuring costs as well as the amount recognized. The
adoption of this standard did not have a material effect on the Company's
financial statements.
In April 2003, the FASB issued Statement No. 149, Amendment of Statement
133 on Derivative Instruments and Hedging Activities ("SFAS No. 149"). SFAS No.
149 amends and clarifies the accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. The amendments set
forth in SFAS No. 149 require that contracts with comparable characteristics be
accounted for similarly. In particular, this statement clarifies under what
circumstances a contract with an initial net investment meets the
characteristics of a derivative according to SFAS No. 133 and when a derivative
contains a financing component that warrants special reporting in the statement
of cash flows. In addition, the statement amends the definition of an
underlying to conform it to language used in FASB Interpretation No. 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, and amends certain other
existing pronouncements.
The requirements of SFAS No. 149 are effective for contracts entered into
or modified after June 30, 2003 and for hedging relationships designated after
June 30, 2003. The provisions of the statement that relate to SFAS No. 133
Implementation Issues that have been effective for fiscal quarters that began
prior to June 15, 2003, should continue to be applied in accordance with their
respective effective dates. The Company is currently evaluating the impacts, if
any, of SFAS No. 149 on its consolidated financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". This interpretation establishes new
disclosure requirements for all guarantees, but the measurement criteria are
applicable to guarantees issued and modified after December 31, 2002. The
adoption of this interpretation did not have any immediate material effect on
the Company's financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities". This interpretation is effective immediately for
all enterprises with variable interests in variable interest entities created
after January 31, 2003. FIN 46 provisions must be applied to variable interests
in variable interest entities created before February 1, 2003 from the
beginning of the third quarter of 2003. If an entity is determined to be a
variable interest entity, it must be consolidated by the enterprise that
absorbs the majority of the entity's expected losses if they occur and/or
receives a majority of the entity's expected residual returns if they occur. If
significant variable interests are held in a variable interest entity, the
16
company must disclose the nature, purpose, size and activity of the variable
interest entity and the company's maximum exposure to loss as a result of its
involvement with the variable interest entity in all financial statements
issued after January 31, 2003. The adoption of this interpretation did not have
any material effect on the Company's financial statements.
Results of Operations
Our Facility reached provisional acceptance on August 11, 2002, risk
transfer on August 13, 2002 and reached commercial availability under the Power
Purchase Agreement on September 1, 2002. Williams Energy has disputed this
commercial operation date and has informed us that Williams Energy recognizes
the commercially availability of the Facility on September 28, 2002. We expect
to settle the dispute through arbitration during the second quarter of 2003.
Prior to August 13, 2002, the Facility was under construction, and we were a
development stage company. Accordingly, the results of operations, the
financial condition, and cash flows for the three months ended March 31, 2003
and 2002 are not comparable.
For the Three Months Ended March 31, 2003 and 2002
Operating revenues for the three months ended March 31, 2003 were
approximately $11.0 million. This amount consists of revenue generated in a PJM
capacity test in the amount of $169 thousand in February 2003 and capacity
sales under the Power Purchase Agreement.
Operating expenses for the three months ended March 31, 2003 were
approximately $7.6 million. Operating expenses consist of depreciation, fuel
conversion volume rebate (see below), management fees and reimbursable
operating and maintenance expenses paid to AES Sayreville, L.L.C., and gas
purchased from Williams Energy for the PJM capacity test in the amount of
$635,000 in February 2003.
There were no operating revenues or significant operating expenses for the
three months ended March 31, 2002, as the Facility was not operational.
General and administrative costs for the three months ended March 31, 2003
were $63,000 compared to $22,000 for the comparable period of the prior
calendar year. These costs did not directly relate to construction and are
included as expenses in the statement of operations. The increase is due to the
Facility being operational in the first quarter of 2003.
Fuel Conversion Volume Rebate costs for the three months ended March 31,
2003 were $1.6 million compared to $0 for the comparable period for the prior
calendar year. Fuel Conversion Volume Rebates represent a charge paid to
Williams Energy under the Power Purchase Agreement based upon utilization of
the Facility. The difference is due to the Facility being constructed and not
in operation in first quarter of 2002.
Total other income (expense) for the three months ended March 31, 2003 and
2002 was $(8.2) million and $(56,000) respectively, and is comprised of other
income and expense and interest expense paid and interest income. Other income
consists of interim rebates received by the Company from the EPC contractor for
underperformance of the Facility. Other expense consists of fees paid to
Dresdner Bank pursuant to our debt service letter of credit and reimbursement
agreement and power purchase agreement letter of credit and reimbursement
agreement.
We had a net loss of $4.8 million for the three months ended March 31,
2003 compared to a net loss of $78,000 for the comparable period of the prior
year.
Liquidity and Capital Resources
Under the Power Purchase Agreement with Williams Energy we are eligible to
receive variable operations and maintenance payments, total fixed payments,
energy exercise payments (each as defined in the Power Purchase Agreement) and
other payments for the delivery of fuel conversion, capacity and ancillary
services. Although Williams Energy has requested that we run the Facility or
"dispatch" the
17
Facility in May 2003, from September 2002 to May 2003 Williams Energy did not
dispatch the Facility to a significant degree and the minimum capacity payments
provided for under the Power Purchase Agreement were our primary source of
operating revenues. We have used these operating revenues, together with
interim rebates received from Raytheon under the construction agreement,
interest income from the investment of a portion of the proceeds from the sale
of the senior secured bonds and the $10 million Prepayment from Williams Energy
to fund our generation expenses and other operations and maintenance expenses.
We have provided Williams Energy a $10 million letter of credit under the
Power Purchase Agreement, which we refer to as the PPA Letter of Credit, to
support our payment obligations under the Power Purchase Agreement. The
repayment obligations with respect to any drawings under the PPA Letter of
Credit are a senior debt obligation of the Company.
Due to the downgrade of The Williams Companies, Inc.'s debt to below
investment grade, the Company and Williams Energy entered into a Letter
Agreement dated November 7, 2002, under which Williams Energy agreed to provide
the Company with a $10 million Prepayment within five business days after
execution of the Letter Agreement and at least $25 million additional
collateral on January 6, 2003. Williams Energy made the $10 million Prepayment
on November 14, 2002 and provided an additional $25 million of cash to us as
alternative credit support. As allowed by the Letter Agreement, Williams Energy
has elected to have the $10 million Prepayment included as part of the
alternative credit support. In the event that the Williams Companies, Inc.
regains and maintains its investment grade status, provides a substitute
guaranty of Investment Grade rating, or posts a letter of credit, we will be
required to return the $35 million alternative credit support to Williams
Energy in accordance with the terms of the Letter Agreement. As of May 8, 2003,
we had cash balances of approximately $33 million. In the event we are required
to return the $35 million we believe that we would use all or a portion of our
current cash balances plus cash generated from future operations in order to
return the $35 million to Williams Energy. This belief is subject to certain
assumptions, risks and uncertainties, including those set forth above under the
caption "Cautionary Note Regarding Forward-Looking Statements" and there can be
no assurances that our operating revenues will generate sufficient cash.
As of March 31, 2003, $381.1 million aggregate principal amount of senior
secured bonds were outstanding. Quarterly principal repayments on the 2019
Bonds commenced on August 31, 2002 and are due on May 31, August 31, and
November 30 of each year. Quarterly principal repayment of the 2029 Bonds does
not commence until February 28, 2019. We have provided the collateral agent
with a debt service reserve letter of credit in an initial stated amount of
$22.0 million which the collateral agent may draw upon if we fail to meet our
obligations under the senior secured bonds.
As of March 31, 2003, we had capital commitments of $232,000 related to
major projects. This amount includes $118,000 in dispute with Jersey Central
Power regarding charges for costs related to the construction of the
interconnection facilities and $114,000 related to a road modification project.
Under the construction agreement, we are entitled to withhold from each
scheduled payment, other than the last milestone payment, 10% of the requested
payment until after final acceptance by us of the Facility unless, as discussed
below, Raytheon posts a letter of credit equal or greater than the amounts
which would otherwise be retained. Within 10 days after the final acceptance,
we are required to pay all retainage except for (a) 150% of the cost of
completing all punch list items and (b) the lesser of (i) 150% of the cost of
repairing or replacing any items that have already been repaired or replaced by
Raytheon and (ii) $1 million. Within 30 days after project completion, we are
required to pay the sum of the unpaid balance of the contract price, including
all retainage, less the amount indicated in (b) of the immediately proceeding
sentence. Within 30 days of the first anniversary of the earlier of provisional
acceptance or final acceptance, we are required, so long as project completion
has occurred, to pay all remaining retainage, if any.
Under the construction agreement, in lieu of our retaining these amounts,
Raytheon is entitled to post a letter of credit in the amount of the then
current retainage. As of March 31, 2003, Raytheon had provided a letter of
credit of approximately $30.8 million. We may draw on this letter of credit in
the
18
event that Raytheon fails to pay us any amount owed to us under the
construction agreement. As of March 31, 2003 we have drawn $447,000 on this
letter of credit.
We believe that (i) interim rebates paid and to be paid by Raytheon
through final acceptance, (ii) cash flows from the sale of electricity and/or
minimum capacity payments under the Power Purchase Agreement and (iii) funds
available to be drawn under the debt service reserve letter of credit or the
power purchase letter of credit (each as described above) will be sufficient to
(1) fund remaining construction costs at our facility and our commercial
operations, (2) pay fees and expenses in connection with the power purchase
agreement letter of credit (as described above) and (3) pay project costs,
including ongoing expenses and principal and interest on our senior secured
bonds as described above. As discussed above, in the event we are required to
return the alternate credit support we may also use a portion of operating
revenues for this purpose. After the Power Purchase Agreement expires, we plan
to depend on revenues generated from market sales of electricity. These beliefs
are subject to certain assumptions, risks and uncertainties, including those
set forth above under the caption "Cautionary Note Regarding Forward-Looking
Statements" and there can be no assurances.
Concentration of Credit Risk
Williams Energy is currently the Company's sole customer for purchases of
capacity, ancillary services, and energy and the Company's sole source for
fuel. Williams Energy's payments under the Power Purchase Agreement are
expected to provide all of the Company's operating revenues during the term of
the Power Purchase Agreement. It is unlikely that the Company would be able to
find another purchaser or fuel source on similar terms for the Facility if
Williams Energy were not performing under the Power Purchase Agreement. Any
material failure by Williams Energy to make capacity and fuel conversion
payments or to supply fuel under the Power Purchase Agreement would have a
severe impact on the Company's operations.
The payment obligations of the Williams Companies, Inc. under its guaranty
of Williams Energy's obligations under the Power Purchase Agreement are capped
at an amount equal to approximately $510 million. Beginning on January 1 of the
first full year after the commercial operation date, this guaranty cap is to be
reduced semiannually by a fixed amount which is based on the amortization of
our senior secured bonds during the applicable semiannual period.
Due to the downgrade of The Williams Companies, Inc. to below investment
grade, the Company and Williams Energy entered into a Letter Agreement dated
November 7, 2002 under which Williams Energy agreed to provide the Company with
a $10 million Prepayment and certain additional collateral. A description of
the collateral that supports Williams Energy's obligations under the Power
Purchase Agreement is set forth above under "Liquidity and Capital Resources".
Since we depend on Williams Energy for both revenues and fuel supply under
the Power Purchase Agreement, if Williams Energy were to terminate or default
under the Power Purchase Agreement, there would be a severe negative impact on
our cash flow and financial condition which could result in a default on our
senior secured bonds. Due to the recent decline in pool prices, we would expect
that if we were required to seek alternate purchasers of our power in the event
of a default of Williams Energy, even if we were successful in finding
alternate revenue sources, any such alternate revenue sources would be
substantially below the amounts that would have been otherwise payable pursuant
to the Power Purchase Agreement. There can be no assurance as to our ability to
generate sufficient cash flow to cover operating expenses or our debt service
obligations in the absence of a long-term power purchase agreement with
Williams Energy.
Business Strategy and Outlook
Our overall business strategy is to market and sell all of our net
capacity, fuel conversion and ancillary services to Williams Energy during the
20-year term of the Power Purchase Agreement. After expiration of the Power
Purchase Agreement, or in the event the Power Purchase Agreement is terminated
prior to its 20-year term or Williams Energy otherwise fails to perform, we
would seek to sell our Facility's
19
capacity, ancillary services and energy in the spot market or under a short or
long-term power purchase agreement or into the PJM power pool market. Due to
recent declines in pool prices, however, we would expect that even if we were
successful in finding alternate revenue sources, any such alternate revenues
would be substantially below the amounts that would have been otherwise payable
pursuant to the Power Purchase Agreement. There can be no assurances as to
whether such efforts would be successful.
We intend to cause our Facility to be managed, operated and maintained in
compliance with the project contracts and all applicable legal requirements.
Critical Accounting Policies
General -- We prepare our financial statements in accordance with
accounting principles generally accepted in the United States of America. As
such, we are required to make certain estimates, judgments and assumptions that
we believe are reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the periods presented. The significant accounting policies
which we believe are most critical to understanding and evaluating our reported
financial results include the following: Revenue Recognition, Property, Plant
and Equipment and Contingencies.
Revenue Recognition -- We generate energy revenues under the Power
Purchase Agreement with Williams Energy. During the 20-year term of the
agreement, we expect to sell capacity and electric energy produced by the
facility, as well as ancillary services and fuel conversion services. Under the
Power Purchase Agreement, we also generate revenues from meeting (1) base
electrical output guarantees and (2) heat rate rebates through efficient
electrical output. Revenues from the sales of electric energy and capacity are
recorded based on output delivered and capacity provided at rates as specified
under contract terms. Revenues for ancillary and other services are recorded
when the services are rendered.
Upon its expiration, or in the event that the Power Purchase Agreement is
terminated prior to its 20-year term or Williams Energy otherwise fails to
perform, we would seek to generate energy revenues from the sale of electric
energy and capacity into the merchant market or under new short- or long-term
power purchase or similar agreements. Due to recent declines in pool prices,
however, we would expect that even if we were successful in finding alternate
revenue sources, any such alternate revenues would be substantially below the
amounts that would have been otherwise payable pursuant to the Power Purchase
Agreement. There can be no assurances as to whether such efforts would be
successful.
Property, Plant and Equipment -- Property, plant and equipment is recorded
at cost and is depreciated over its useful life. The estimated lives of our
generation facilities range from five to thirty-six years. A significant
decrease in the estimated useful life of a material amount of our property,
plant or equipment could have a material adverse impact on our operating
results in the period in which the estimate is revised and in subsequent
periods. The depreciable lives of our property plant and equipment by category
are as follows:
March 31, 2003
Description of Asset Depreciable Life (000's)
- -------------------------------------- ---------------- ---------------
Buildings............................. 35 $ 1,733
Vehicles.............................. 5 101
Computers............................. 6 691
Furniture and Fixtures................ 10 477
CTG Parts............................. 9-36 44,639
Gas Heaters........................... 35 1,100
Plant................................. 35 356,536
--------------
$ 405,277
==============
Contingencies- On September 1, 2002, we notified Williams Energy of
availability and a date of commercial operation of September 1, 2002, as
described in the Power Purchase Agreement. Williams Energy has disputed a
commercial operation date of September 1, 2002 and has informed us that
Williams Energy recognizes the commercial availability of the facility as of
September 28, 2002. We have entered
20
into arbitration to settle the dispute over the commercial operation date and
the proper interpretation of certain provisions of the Power Purchase Agreement
and expect to resolve the arbitration during the second quarter of 2003. The
arbitration relates to disputed amounts of approximately $7.6 million, which
includes a $594,000 payment extension option dispute and a $7.0 million
commercial operation start date dispute. We are also disputing $392,000 of
merchant price and testing charges with Williams Energy although this is not
yet part of the arbitration. While we believe that our interpretation of the
Power Purchase Agreement is correct, we cannot predict the outcome of these
matters.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company believes that there have been no material changes in exposure
to market risks during the first quarter of 2003 compared with the exposure set
forth in the Company's Annual Report on Form 10-K for the year ended December
31, 2002.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. Our President and our
Chief Financial Officer, after evaluating the effectiveness of our "disclosure
controls and procedures" (as defined in the Securities Exchange Act of 1934
Rules 13a-14c and 15(d) - 14(c)) as of a date (the "Evaluation Date") within 90
days before the filing date of this quarterly report, have concluded that as of
the Evaluation Date, our disclosure controls and procedures were effective to
ensure that material information relating to us is recorded, processed,
summarized, and reported in a timely manner.
Changes in Internal Controls. Except as noted below, there were no
significant changes in our internal controls or, to our knowledge, in other
factors that could significantly affect such controls subsequent to the
Evaluation Date.
As part of our first quarter financial reporting process, management of
the Company, in consultation with the Company's independent accountants,
Deloitte & Touche, LLP, identified approximately $300,000 of costs (primarily
related to property) associated with our 2002 fiscal year that were paid in the
first quarter of 2003 and had not been accrued for as of December 31, 2002. We
have initiated the development and implementation of additional processes and
controls to address this issue. We do not believe that this matter has had or
will have a material effect on our financial position and results of
operations.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
We have entered into arbitration with Williams Energy to resolve certain
disputes regarding the date of commercial operation and the proper
interpretation of certain provisions of the Power Purchase Agreement relating
to amounts we claim are payable by Williams Energy. We recognize a commercial
operation date of September 1, 2002 (the date on which we notified Williams of
commercial availability) while Williams Energy currently recognizes a
commercial operation date of September 28, 2002, Williams Energy has withheld
or offset, from amounts invoiced by us, amounts that Williams Energy believes
were improperly invoiced by us based on Williams Energy's interpretation of the
Power Purchase Agreement. We have entered into arbitration to settle the
dispute over the commercial operation date and the proper interpretation of
certain provisions of the Power Purchase Agreement. We expect that the
arbitration will be resolved in the second quarter of 2003. The arbitration
relates to disputed amounts of approximately $7.6 million, which includes a
$594,000 payment extension option dispute and a $7.0 million commercial
operation start date dispute. We are also disputing $392,000 of merchant price
and testing gas charges with Williams Energy although this is not yet part of
the arbitration. While we believe that our interpretation of the Power Purchase
Agreement is correct, we cannot predict the outcome of these matters.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Not applicable pursuant to General Instruction H of Form 10-Q.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable pursuant to General Instruction H of Form 10-Q.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable pursuant to General Instruction H of Form 10-Q.
21
Item 5. OTHER INFORMATION
None.
22
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended
March 31, 2003.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AES RED OAK, L.L.C.
Date: May 15, 2003 By: /s/ A.W. BERGERON
-----------------------------------
A.W. Bergeron
President
Date: May 15, 2003 By: /s/ MICHAEL ROMANIW
-----------------------------------
Michael Romaniw
Chief Financial Officer
Date: May 15, 2003 By: /s/ WILLIAM R. BAYKOWSKI
-----------------------------------
William R. Baykowski
Principal Accounting Officer
24
CERTIFICATIONS
I, A.W. Bergeron, certify that:
1. I have reviewed this quarterly report on Form 10-Q of AES Red Oak, LLC;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ A.W. Bergeron
----------------------------------
A.W. Bergeron
President
25
I, Michael Romaniw, certify that:
1. I have reviewed this quarterly report on Form 10-Q of AES Red Oak, LLC;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were or not significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ Michael Romaniw
----------------------------------
Michael Romaniw
Chief Financial Officer
26
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act