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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 June 30, 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 and
Six Months Ended June 30, 2003 and 2002 ......................... 1
Condensed Consolidated Balance Sheets, as of June 30, 2003
and December 31, 2002 ........................................... 2
Condensed Consolidated Statement of Changes in Member's Capital
for the Period from December 31, 2002 through June 30, 2003 ..... 3
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 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 ...... 22
Item 4. CONTROLS AND PRODECURES ......................................... 22
PART II. OTHER INFORMATION ............................................... 22
Item 1. LEGAL PROCEEDINGS ............................................... 22
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ....................... 22
Item 3. DEFAULTS UPON SENIOR SECURITIES ................................. 22
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............. 22
Item 5. OTHER INFORMATION ............................................... 23
Item 6. EXHIBITS AND REPORTS ON FORM 8-K ................................ 24
Signatures ................................................................. 25
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION
Condensed Consolidated Statements of Operations,
Three and Six Months Ended June 30, 2003 and 2002
(dollars in thousands)
Three Months Six Months
Ended Ended
June 30 June 30
----------------------- -----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
OPERATING REVENUES
Energy ............................... $ 15,747 $ -- $ 26,768 $ --
OPERATING EXPENSES
Fuel costs ................................ -- -- (635)
Fuel conversion volume expense ....... (1,603) -- (3,206) --
Corporate management fees ............ (399) -- (798) --
Other operating expenses ............. (2,074) -- (3,609) --
Depreciation expense ................. (2,883) -- (5,779) --
Taxes and insurance .................. (663) (1,177)
General and administrative costs ..... (44) (134) (109) (156)
--------- --------- --------- ---------
Total operating expenses ......... (7,666) (134) (15,313) (156)
--------- --------- --------- ---------
Operating income (loss) .............. 8,081 (134) 11,455 (156)
--------- --------- --------- ---------
OTHER INCOME (EXPENSE)
Interest income ...................... 67 36 145 61
Other income ......................... 610 -- 1,213 --
Interest expense ..................... (8,492) (183) (17,106) (264)
Other expense ........................ (255) -- (506) --
--------- --------- --------- ---------
Total other income (expense) ..... (8,070) (147) (16,254) (203)
--------- --------- --------- ---------
NET INCOME (LOSS) .......................... $ 11 $ (281) $ (4,799) $ (359)
========= ========= ========= =========
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,
June 30, 2003 and December 31, 2002
(dollars in thousands, except share amounts)
June 30, December 31,
2003 2002
---------- ----------
ASSETS:
Current Assets:
Cash .............................................................................. $ 61 $ 23
Restricted cash at cost, which approximates market value .......................... 26,923 7,749
Receivables ....................................................................... 12,739 8,442
Receivable from affiliate ......................................................... 360 309
Prepaid expenses .................................................................. 1,355 230
---------- ----------
Total current assets ......................................................... 41,438 16,753
Land .............................................................................. 4,240 4,240
Construction in progress .......................................................... -- 344
Property, plant, and equipment - net of accumulated depreciation of $10,217 and
$4,438, respectively ........................................................... 402,481 406,815
Deferred financing costs - net of accumulated amortization of $2,518 and $2,315,
respectively ................................................................... 15,984 16,390
Spare parts inventory ............................................................. 10,500 10,500
Other assets ...................................................................... 54 141
---------- ----------
Total assets ................................................................. $ 474,697 $ 455,183
========== ==========
LIABILITIES AND MEMBER'S CAPITAL:
Current Liabilities:
Accounts payable .................................................................. $ 976 $ 1,175
Accrued liabilities ............................................................... 1,039 1,516
Accrued interest .................................................................. 2,797 2,804
Payable to affiliate .............................................................. 75 18
Bonds payable - current portion ................................................... 6,070 6,219
Notes payable ..................................................................... 1,130 --
Other current liabilities ......................................................... 38,000 10,000
---------- ----------
Total current liabilities .................................................... 50,087 21,732
Bonds payable - non current portion ............................................... 374,578 375,361
Liabilities under spare parts agreement ........................................... 6,066 9,325
---------- ----------
Total liabilities ............................................................ $ 430,731 $ 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 .................................................................. (12,770) (7,971)
---------- ----------
Total member's capital ....................................................... 43,966 48,765
---------- ----------
Total liabilities and member's capital ................................... $ 474,697 $ 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
Period from December 31, 2002 through June 30, 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 .................... -- -- -- (4,799) (4,799)
-------- -------- -------- -------- --------
BALANCE June 30, 2003 ....... -- $ -- $ 56,736 $(12,770) $ 43,966
======== ======== ======== ======== ========
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 Six Months Ended
June 30, 2003 and 2002
(dollars in thousands)
Six months
Ended
June 30
---------------------
2003 2002
-------- --------
OPERATING ACTIVITIES:
Net income (loss) ...................................... $ (4,799) $ (78)
Amortization of deferred financing costs ............... 406 204
Depreciation ........................................... 5,778 --
Change in:
Accrued liabilities .................................... (484) 173
Accounts receivable -- trade ........................... (4,297) --
Accounts receivable -- from affiliates ................ (51) 1,748
Other assets ........................................... 87 --
Payable to affiliates .................................. 57 (1,573)
Prepaid expenses ....................................... (1,125) --
Accounts payable ....................................... (199) 116
-------- --------
Net cash (used in) provided by operating activities .... $ (4,627) $ 590
======== ========
INVESTING ACTIVITIES:
Payments for construction in progress .................. -- (15,061)
Retainage payable ...................................... -- (28,453)
Purchases of property, plant, and equipment ............ (1,359) --
Restricted cash ........................................ (19,174) 196
-------- --------
Net cash used in investing activities .................. $(20,533) $(43,318)
======== ========
FINANCING ACTIVITIES:
Payment of principal on bonds payable .................. (932) --
Other liabilities ...................................... 26,130 --
Contribution from parent ............................... -- 42,700
-------- --------
Net cash provided in financing activities ............. $ 25,198 $ 42,700
======== ========
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .. $ 38 $ (28)
======== ========
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ......... 23 48
CASH AND CASH EQUIVALENTS, END OF PERIOD ............... $ 61 $ 20
======== ========
SUPPLEMENTAL DISCLOSURE:
Interest paid (net of amounts capitalized) ............. $ 16,699 $ 81
======== ========
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 fourth quarter of 2003 or first quarter
of 2004.
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 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. AES
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 include 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 for the three
and six months and cash flows for six months ended June 30, 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 and six 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. Annual principal repayments on the
Bonds are scheduled as follows:
6
Year Annual Payment
---- --------------
2003 (remaining subsequent to June 30, 2003)...... $5.2 million
2004.............................................. $5.2 million
2005.............................................. $5.1 million
2006.............................................. $7.1 million
2007.............................................. $6.1 million
Thereafter........................................ $351.9 million
--------------
Total............................................. $380.6 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 the scheduled principal payment of
approximately $466,000 in May 2003 on the 2019 bonds.
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 (see Note 5). 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
the dispute regarding the commercial operation date and disputes over the
proper interpretation of certain provisions of the Power Purchase Agreement
with respect to 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 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 its 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 the 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 $10 million 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 and $111,000 of heat rate penalties 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 fourth quarter of 2003 or first quarter of 2004.
Construction Agreement - The Company entered into an Agreement for
Engineering, Procurement and Construction (EPC) 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 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.
9
Under the construction agreement, in lieu of the Company's retainage,
Raytheon is entitled to post a letter of credit in the amount of the then
current retainage. As of June 30, 2003, Raytheon had provided a letter of
credit of approximately $30.8 million. The Company may draw on this letter of
credit in the event that Raytheon fails to pay the Company any amount owed to
it under the construction agreement. As of July 31, 2003 the Company had drawn
$447,000 on this letter of credit.
As discussed in Note 1, provisional 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.
Raytheon gave notice of final acceptance on July 22, 2003 based on its July 8,
2003 performance test. On July 31, 2003, the Company received a letter from the
project's independent engineer stating that it could not support Raytheon's
claim of final acceptance and it did not consider the July 8, 2003 performance
test valid. In making this assessment, the independent engineer cited, among
other reasons, (i) modifications made to certain equipment in performance of
the July 8 performance test which would adversely impact the operations of the
plant and other pieces of equipment and (ii) Raytheon's failure to comply with
guaranteed emissions limits. On August 1, 2003, the Company rejected Raytheon's
claim of final acceptance. This rejection was based upon Raytheon's failure to
meet the conditions for final acceptance provided for in the EPC contract. On
August 7, 2003, the Company received a response from Raytheon in which Raytheon
claims that the Company's rejection of the final acceptance is invalid and
improper. The Company is currently considering its options for resolving this
dispute.
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 June 30, 2003, the Company has
received approximately $10.5 million in rotable spare parts under this
agreement. This amount is recorded as spare parts inventory and a long-term
liability in the accompanying balance sheets. 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. For financial reporting purposes the payments made to
Siemens Westinghouse are netted with the liabilities under the spare-parts
agreement in the accompanying balance sheet.
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 June 30, 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
10
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 June 30, 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.
Land Development Plan - The Company entered into an agreement with the
Borough of Sayreville by which the Company will develop and implement a plan to
replace trees which were removed during clearing of the site. The Land
Development Plan is required for final site approval. The estimated cost of the
plan is approximately $425,000. The Company is in the process of selecting a
contractor to perform the service and no payments have been made as of June 30,
2003. On July 23, 2003, the project was secured by a letter of credit issued by
Union Bank of California for $425,000 with the Borough of Sayreville as the
beneficiary. This irrevocable standby letter of credit currently has an
expiration date of June 30, 2004 and represents the amount potentially due if
there is a failure of AES Red Oak, LLC to take action regarding the plan.
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
11
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 fourth quarter of 2003 or first quarter of 2004.. 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 (PPA) 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 delays in or disputes over final completion of our Facility;
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 was historically 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. We plan to finance any remaining
costs related to the facility with operation revenues and any additional
interim rebates that may be received from Raytheon.
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 fourth
quarter of 2003 or first quarter of 2004. 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. Since May 5, 2003,
Williams Energy has requested that we run the Facility or "dispatch" the
Facility. From September 28, 2002 to May 4, 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 and six months ended June 30, 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 period from August 11, 2002 until the date of the next
performance test, which we refer to as the interim period, 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 initial 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 approximately $2,941 per day since August 14,
2002.
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 June 30, 2003, we have invoiced Raytheon
approximately $610,082 in electrical output and heat rate rebates. As of June
30, 2003, Raytheon has paid in full the rebates invoiced.
Raytheon gave notice of Final Acceptance on July 22, 2003 based on its
July 8, 2003 performance test. On July 31, 2003, the Company received a letter
from the project's independent engineer stating that it could not support
Raytheon's claim of final acceptance and it did not consider the July 8, 2003
performance test valid. In making this assessment, the independent engineer
cited, among other reasons, (i) modifications made to certain equipment in
performance of the July 8 performance test which would adversely impact the
operations of the plant and other pieces of equipment and (ii) Raytheon's
failure to comply with guaranteed emissions limits. On August 1, 2003, the
Company rejected Raytheon's claim of final acceptance. This rejection was based
upon Raytheon's failure to meet the conditions for final acceptance provided
for in the EPC contract. On August 7, 2003, the Company received a response
from Raytheon in which Raytheon
15
claims that the Company's rejection of the final acceptance is invalid and
improper. The Company is currently considering its options for resolving this
dispute.
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.
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.
16
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 fourth quarter of 2003 or first quarter of 2004. 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.
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 in September 2002. 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 and six months ended June 30, 2003 and 2002 are not comparable.
For the Three Months Ended June 30, 2003 and 2002
Operating revenues for the three months ended June 30, 2003 were
approximately $15.8 million. This amount consists of capacity sales under the
Power Purchase Agreement.
Operating expenses for the three months ended June 30, 2003 were
approximately $7.7 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.
The were no operating revenues or significant operating expenses for the
three months ended June 30, 2002, as the Facility was not operational.
General and administrative costs for the three months ended June 30, 2003
were $44,000 compared to $134,000 for the three months ended June 30, 2002.
These costs did not directly relate to construction and are included as
expenses in the statement of operations. The decrease is due to initial plant
startup costs in 2002.
Fuel Conversion Volume expense for the three months ended June 30, 2003
were $1.6 million compared to $0 for the comparable period for the prior
calendar year. Fuel Conversion Volume expense represent a charge paid to
Williams Energy under the Power Purchase Agreement based upon utilization of
the Facility. The increase is due to the Facility being constructed and not in
operation in second quarter of 2002.
Total other income (expense) for the three months ended June 30, 2003 and
2002 was $(8.1) million and ($147,000), respectively, and is primarily
comprised of other income and expense, interest expense 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 bank
fees relating to our debt service letter of credit and reimbursement agreement
and power purchase agreement letter of credit and reimbursement agreement.
17
We had net income of $11,000 for the three months ended June 30, 2003
compared to a net loss of ($281,000) for the three months ended June 30, 2002.
For the Six Months Ended June 30, 2003 and 2002
Operating revenues for the three months ended June 30, 2003 were
approximately $26.8 million. This amount consists of revenue generated in a PJM
capacity test in the amount of $169,000 in February 2003 and capacity sales
under the Power Purchase Agreement.
Operating expenses for the three months ended June 30, 2003 were
approximately $15.3 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
six months ended June 30, 2002 as the Facility was not operational.
General and administrative costs for the six months ended June 30, 2003
were $109,000 compared to $156,000 for the six months ended June 30, 2002.
These costs did not directly relate to construction and are included as
expenses in the statement of operations. The decrease is due to initial startup
costs in 2002.
Fuel Conversion Volume costs for the six months ended June 30, 2003 were
$3.2 million compared to $0 for the comparable period for the prior calendar
year. Fuel Conversion Volume expense 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
second quarter of 2002.
Total other income (expense) for the six months ended June 30, 2003 and
2002 was $(16.3) million and $(203,000) respectively, and is comprised of other
income and expense, interest expense 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 bank fees 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 six months ended June 30, 2003
compared to a net loss of $359,000 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. From September 2002 to May 4, 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. Williams Energy has requested that we run the Facility or "dispatch"
the Facility since May 5, 2003. 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.
18
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 described in
Note 5 to our Condensed Consolidated Financial Statements. As of July 31, 2003,
we had cash balances of approximately $33.3 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. The Company has provided
Williams Energy with the PPA Letter of Credit in the amount of $10 million that
may be utilized if necessary to fund obligations as they become due. 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 June 30, 2003, $380.6 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 June 30, 2003, we had capital commitments of $657,000 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, $114,000 related to a road modification project and
$425,000 related to the Land Development Plan.
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 June 30, 2003, Raytheon had provided a letter of
credit of approximately $30.8 million. We may draw on this letter of credit in
the event that Raytheon fails to pay us any amount owed to us under the
construction agreement. As of June 30, 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
19
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 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.
20
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:
June 30, 2003
Description of Asset Depreciable Life (000's)
- --------------------------------------- ---------------- ------------
Buildings............................... 35 $ 1,721
Vehicles................................ 5 96
Computers............................... 6 667
Furniture and Fixtures.................. 10 466
CTG Parts............................... 9-36 44,150
Gas Heaters............................. 35 1,093
Inventory............................... NA 1,005
Plant................................... 35 353,283
------------
$ 402,481
============
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 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 fourth quarter of 2003 or first quarter of 2004. 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 and $111,000 of heat rate penalties 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.
21
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable pursuant to General Instruction H of Form 10-Q.
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
(the "Exchange Act") Rules 13a-15e and 15d - 15(e)) as of the end of the
fiscal quarter ended June 30, 2003, have concluded that our disclosure controls
and procedures are effective based on their evaluation of these controls and
procedures as required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
Changes in internal control over financial reporting. There were no
changes in our internal control over financial reporting identified in
connection with the evaluation required by paragraph (d) of the Exchange Act
Rules 13a-15 or 15d-15 that occurred during the three months ended June 30,
2003 that have materially affected or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
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 fourth quarter of 2003 or first quarter of
2004. 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 and $111,000 of heat rate penalties
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.
22
Item 5. OTHER INFORMATION
None.
23
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certification of principal executive officer required by Rule 13a
- 14(a) or 15d-14(a) of the Exchange Act.
31.2 Certification of principal financial officer required by Rule 13a
- 14(a) or 15d-14(a) of the Exchange Act.
32.1 Certification of principal executive officer and principal
financial officer required by Rule 13a - 14(b) or 15d - 14(d) of
the Exchange Act.
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended
June 30, 2003.
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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: August 14, 2003 By: /s/ A.W. BERGERON
----------------------------------
A.W. Bergeron
President
Date: August 14, 2003 By: /s/ PAM STRUNK
----------------------------------
Pam Strunk
Chief Financial Officer
Date: August 14, 2003 By: /s/ WILLIAM R. BAYKOWSKI
----------------------------------
William R. Baykowski
Principal Accounting Officer
25