Washington, D.C. 20549

 

 

FORM 10-K

(Mark One)

 

Commission file number:  333-40478

AES RED OAK, L.L.C.

(Exact name of registrant as specified in its charter)

 

 

 

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 ý No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10K.  ý

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes o No ý

 

As of June 30, 2003, the last business day of the registrant’s most recently completed second fiscal quarter, and as of March 15, 2004, there was one membership interest in AES Red Oak, LLC outstanding, which was held by AES Red Oak, Inc., the Company’s parent and a wholly-owned subsidiary of The AES Corporation.

 

All of the Registrant’s equity securities are indirectly owned by The AES Corporation.  Registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Form 10-K with the reduced disclosure format authorized by General Instruction I of Form 10-K.

 

DOCUMENTS INCORPORATED BY REFERENCE

None

 

 

TABLE OF CONTENTS

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
PART I
ITEM 1.	BUSINESS
ITEM 2.	PROPERTIES
ITEM 3.	LEGAL PROCEEDINGS
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5.	MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
ITEM 6.	SELECTED FINANCIAL DATA
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A.	CONTROLS AND PROCEDURES
PART III
ITEM 10.	DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11.	EXECUTIVE COMPENSATION
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 14.	PRINCIPAL ACCOUNTING FEES AND SERVICES
PART IV
ITEM 15.	EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
SIGNATURES

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Some of the statements in this Form 10-K, 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-K 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 of the facility, 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:

 

•      unexpected problems relating to the performance of the facility,

 

•      the financial condition of third parties on which we depend, including in particular, Williams Power Company, Inc., (“Williams Energy”), formerly Williams Energy Marketing & Trading Company, as 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 (the “Power Purchase Agreement”), and The Williams Companies, Inc., as the guarantor of Williams Energy’s performance under the Power Purchase Agreement,

 

•      delays in, or disputes over, the final completion of our facility,

 

•      continued performance by Williams Energy (as guaranteed by The Williams Companies, Inc.) under the Power Purchase Agreement,

 

•      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,

 

•      our ability to find a replacement power purchaser on favorable or reasonable terms, if necessary,

 

•      an adequate merchant market after the expiration, or in the event of a termination, of the Power Purchase Agreement,

 

•      capital shortfalls and access to additional capital on reasonable terms, or in the event that the Power Purchase Agreement is terminated,

 

•      the possibility that Williams Energy will not request that we run or “dispatch” the facility as provided under the Power Purchase Agreement,

 

•      inadequate insurance coverage,

 

•      unexpected expenses or lower than expected revenues,

 

•      environmental and regulatory compliance,

 

•      terrorists acts and adverse reactions to United States anti-terrorism activities, and

 

•      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.

 

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PART I

 

ITEM 1.

BUSINESS

 

General

 

We are a Delaware limited liability company formed on September 13, 1998, to develop, construct, own, lease, operate and maintain a gas-fired electric generating power plant in the Borough of Sayreville, Middlesex County, New Jersey and manage the production of electric generating capacity, ancillary services and energy at our facility. We reached provisional acceptance on August 11, 2002, risk transfer on August 13, 2002, and took the position that we were commercially available on September 1, 2002.  Williams Energy disputed the September 1, 2002 commercial operation date and informed us that it recognized commercial availability of the facility as of September 28, 2002.  On November 4, 2003, a settlement was reached and a commercial operation date of September 28, 2002 was agreed upon.  See Item 3 “Legal Proceedings”.  Since our commercial operation date, our sole business is the ownership, leasing and operation of the project.

 

Our facility was initially designed, engineered, procured and constructed for us by Washington Group International, Inc. (“WGI”) (as the successor contractor) on a fixed-price, turnkey basis. On May 14, 2001, WGI filed a plan of reorganization along with voluntary petitions to restructure under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Nevada in Reno (the “Bankruptcy Court”). As a result of WGI’s bankruptcy filing, on June 20, 2001 we made a demand on the Raytheon Company (“Raytheon”) to perform its obligations under a guarantee which Raytheon had given us of WGI’s performance obligations under the construction agreement and Raytheon became responsible for the construction of our facility.  As discussed above, 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, we 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 demonstrate compliance with guaranteed emissions limits.  On August 1, 2003, we 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 Engineering, Procurement and Construction Services Agreement (“EPC contract”). On August 7, 2003, we received a response from Raytheon in which Raytheon claims that our rejection of the final acceptance is invalid and improper.  The Company is currently considering its options for resolving this dispute.  See “Summary of Principal Agreements – Construction Agreement”.

 

Siemens Westinghouse Power Corporation provides combustion turbine maintenance services and spare parts with respect to the turbines for our facility under a maintenance services agreement for an initial term of 16 years from the date of execution of the agreement or after the twelfth scheduled outage for a turbine, whichever occurs first, unless we exercise our right to cancel the agreement after the first major outage of the turbines at approximately the sixth year of operation of the facility.

 

AES Sayreville, L.L.C., a wholly owned subsidiary of AES Red Oak, Inc., our direct corporate parent, provides development, construction management and operations and maintenance services for our operating facility under the operations agreement. We act as construction agent for our affiliate, AES Red Oak Urban Renewal Corporation (“AES URC”), for the development and construction of part of the facility under a construction agency agreement. We own the land on which our facility is located, and lease part of the facility from AES URC with an option to purchase.

 

We have entered into a Power Purchase Agreement for a term of 20 years under which Williams Energy has committed to purchase all of the net capacity, fuel conversion and ancillary services of our facility. Net capacity is the maximum amount of electricity generated by our facility net of electricity used at our facility. Fuel conversion services consist of the combustion of natural gas in order to generate electric energy. Ancillary services consist of services necessary to support the transmission of capacity and energy. Williams Energy is obligated to supply us with all natural gas necessary to provide net capacity, fuel conversion services and ancillary services under the Power Purchase Agreement. During the term of the Power Purchase Agreement, substantially all of our operating

 

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revenues will be derived from payments made under the Power Purchase Agreement. Under certain limited circumstances described herein, Williams Energy has the right to terminate the Power Purchase Agreement.

 

Organizational Structure

 

All of the equity interests in our company are owned by AES Red Oak, Inc., a wholly owned subsidiary of The AES Corporation.  The AES Corporation is a leading global power company, with 2003 sales of $8.4 billion. AES delivers 45,000 megawatts of electricity to customers in 27 countries through 116 power facilities and 17 distribution companies. Its 30,000 people are committed to operational excellence and meeting the world’s growing power needs. Approximately 26% of AES’s revenues come from businesses in North America, 18% from the Caribbean, 39% from South America, 11% from Europe and Africa, and 6% from Asia.

 

AES Red Oak, Inc. currently has no operations outside of its activities in connection with our project and does not anticipate undertaking any unrelated operations. AES Red Oak, Inc. also owns all of the equity interests in AES Sayreville, L.L.C., (“AES Sayreville”) which provides development, construction management, and operations and maintenance services to us. AES Sayreville has no operations outside of its activities in connection with our project. AES Red Oak, Inc. has no assets other than its membership interests in us and AES Sayreville. The AES Corporation supplies AES Sayreville with personnel and services necessary to carry out its obligations to us.

 

We also own all of the equity interests in AES URC, which was organized as an urban renewal corporation under New Jersey law so that portions of our project can be designated as redevelopment areas or projects in order to provide certain real estate tax and development benefits for our project. AES URC has no operations outside of its activities in connection with our project.

 

The AES Corporation is a public company and is subject to the informational requirements of the Securities Exchange Act of 1934 and, in accordance therewith, files reports, proxy statements and other information, including financial reports, with the SEC, which are not incorporated into and do not form a part of this Form 10-K.

 

The following organizational chart illustrates the relationship among us, AES Red Oak, Inc., AES Sayreville, The AES Corporation, and AES URC:

 

 

Our principal executive offices are located at 832 Red Oak Lane, Sayreville, NJ 08872. Our telephone number is (732) 238-1462.

 

Energy Revenues

 

As mentioned above, 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

 

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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-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 current 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 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.

 

After the plant reached provisional acceptance, we elected to confirm reliability for up to 19 days before binding with Williams Energy.  Beginning August 13, 2002 (the date of risk transfer) through August 31, 2002, we operated the facility as a merchant plant with electric revenues sold to Williams Energy, in its capacity as our Pennsylvania-New Jersey-Maryland (“PJM”) account representative, at spot market prices and bought gas from Williams Energy at spot market prices. Additionally, during September 2002, we made net electric energy available to Williams Energy during times other than receiving 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.  We recognized merchant revenues of approximately $.2 million and $11.1 million for the years ended December 31, 2003 and 2002, respectively.  Related fuel expenses were approximately $.9 million and $6.9 million for the years ended December 31, 2003 and 2002, respectively.

 

Competition

 

Under the Power Purchase Agreement, Williams Energy is required to purchase all of our facility’s capacity and energy for an initial term of 20 years. Therefore, during the term of the Power Purchase Agreement, competition from other capacity and energy providers will become an issue only if the Power Purchase Agreement is terminated or not performed in accordance with its terms. Following the term of the Power Purchase Agreement, we anticipate selling our facility’s net capacity, ancillary services and energy under a new Power Purchase Agreement or into the PJM power pool market. At that time, we will face competition from other generating facilities selling into the PJM power pool market including, possibly, other facilities owned by The AES Corporation or its affiliates.

 

Employees

 

We are a Delaware limited liability company and have no employees other than our 7 officers.  Our officers receive no compensation for the services they provide to us or for any transactions between us and our affiliates. Under the operations agreement, AES Sayreville has managed the development and construction of and now operates and maintains our facility. The direct labor personnel and the plant operations management are employees of The AES Corporation provided to AES Sayreville under a services agreement.  As of December 31, 2003, The AES Corporation provided 27 employees to work at our facility.

 

Insurance

 

As owner of our site and lessee and owner of the facility, we maintain a comprehensive insurance program as required under our various project contracts and the indenture governing our senior secured bonds and underwritten by recognized insurance companies. Among other insurance policies, we also maintain commercial general liability insurance, permanent property insurance for full replacement value of the facility and business interruption insurance covering at least 18 months of gross revenues less variable operating expenses. We have obtained title insurance in an amount equal to the principal amount of the bonds.

 

AES Sayreville, as operator of our facility, maintains, among other insurance policies, workers’ compensation insurance (or evidence of self-insurance), if required, and comprehensive automobile bodily injury and property damage liability insurance.

 

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Permits And Regulatory Approvals

 

AES Sayreville, as operator of our facility, and us, as owner and lessee of our facility, must comply with numerous federal, state and local regulatory requirements including environmental requirements in the operation of our facility.

 

On November 4, 1999, we received a certification from the Federal Energy Regulatory Commission (“FERC”) that we are an exempt wholesale generator. Certification as an exempt wholesale generator exempts us from regulation under the Public Utility Holding Company Act of 1935. We will maintain this status so long as we continue to make only wholesale sales of electricity, which we intend to do. Prior to commercial operation, we filed the Power Purchase Agreement with FERC and requested approval for the rates contained therein. On June 22, 2001, we received FERC approval at those rates. We may also need to obtain FERC approval for sales of electricity at market-based rates after the Power Purchase Agreement is no longer in effect.

 

On January 28, 2000, we received our Prevention of Significant Deterioration Permit, or “air permit,” from the New Jersey Department of Environmental Protection. The appeal period in respect of the air permit expired on February 28, 2000, and no appeal was filed. The air permit requires that our facility be constructed in a manner that will allow it to meet specified limitations on emissions of air pollutants. Under the construction agreement, originally WGI and now Raytheon, as project guarantor, are required to construct our facility to meet these requirements.  The required emission standards were met upon provisional acceptance and commercial operation and no additional modification is currently needed.

 

We are subject to a number of statutory and regulatory standards and required approvals relating to energy, labor and environmental laws.  The necessary environmental permits for the commencement of construction and operation of our facility have been obtained.

 

Summary of Principal Project Contracts

 

While we believe that the following summaries contain the material terms of the principal project contracts, such summaries may not include all of the provisions of each agreement that each individual investor may feel is important. These summaries do not restate each agreement discussed herein and exclude certain definitions and complex legal terminology that may be contained in each relevant agreement. You should carefully read each agreement discussed herein, each of which is filed as an exhibit to this Form 10- K.

 

Power Purchase Agreement

 

We entered into a Fuel Conversion Services, Capacity and Ancillary Services Purchase Agreement, dated as of September 17, 1999, with Williams Energy, for the sale to Williams Energy of all of the electric energy and unforced capacity produced by our facility as well as ancillary services and fuel conversion services.

 

Term

 

The Power Purchase Agreement extends for 20 years from the first contract anniversary date, which is the last day of the month in which commercial operation occurred (September 30, 2002).

 

Upon notice from Williams Energy no later than 90 days prior to the end of the initial term of the Power Purchase Agreement, the term of the Power Purchase Agreement may be extended by Williams Energy for up to a total of 24 months for each hour of the initial term during which we are unable to deliver energy or ancillary services because of an event of force majeure (other than an inability of the Company to obtain natural gas to operate the facility) that occurs after the commercial operation date.

 

Under the Power Purchase Agreement, the commercial operation date was required to occur by December 31, 2001, however the Company had the right to extend the commercial operation date until June 30, 2002 by invoking its right to a free extension option which was available under the Power Purchase Agreement if certain conditions were met.  The Company exercised its right to extend the commercial operation date from December 31, 2001 to June 30, 2002, as granted under the free extension option. In addition, the Company had the right under the Power Purchase Agreement to again extend the commercial operation date from June 30, 2002 to June 30, 2003 (the “Second Paid Extension Option”), upon written notification to Williams Energy no later than May 21, 2002 (which

 

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represented an agreed upon extension from the original April 30, 2002 notification deadline), by paying Williams Energy (i) an amount equal to the lesser of any actual damages Williams Energy suffered or incurred after June 30, 2002, as a result of Williams Energy’s reliance upon delivery by such date, to the extent said damages could not be mitigated fully, or $3.0 million and (ii) certain amounts of liquidated damages as calculated pursuant to the Power Purchase Agreement.  On May 21, 2002, the Company exercised the Second Paid Extension Option.  As a result of these extensions, we paid liquidated damages to Williams Energy at the rate of $11,000 per day for the period beginning on July 1, 2002 and ending on August 31, 2002, which amounted to $682,000.  As a result of the dispute over the commercial operation date, we also paid liquidated damages to Williams Energy at the rate of $22,000 per day for the period beginning on September 1, 2002 and ending on September 27, 2002, which amounted to $594,000.  This issue was resolved as part of the arbitration settlement with Williams. During the period of the Second Paid Extension Option, we continued to collect liquidated damages through August 10, 2002 from Raytheon under the construction agreement in the amount of $108,000 per day.  As of August 2002, we had received $14 million in liquidated damages from Raytheon under the construction agreement.  We did not receive any liquidated damages under the construction agreement in 2003.

 

Williams Energy is currently our sole customer for purchases of capacity, ancillary services, and energy and our sole source for fuel.  Williams Energy’s payments under the Power Purchase Agreement are expected to provide all of our operating revenues during the term of the Power Purchase Agreement.  It is unlikely that we 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 adverse impact on our operations.

 

Purchase and Sale of Capacity

 

During the term of the Power Purchase Agreement, we will perform for Williams Energy on an exclusive basis, and Williams Energy will purchase and pay for fuel conversion services. Fuel conversion services include the operation of our facility by us to combust natural gas delivered by Williams Energy in order to generate and deliver energy or to provide ancillary services. We will sell and make available to Williams Energy on an exclusive basis, and Williams Energy will purchase and pay for, our facility’s net capacity and ability to generate electric energy. We may not sell, without the consent of Williams Energy in its sole discretion, capacity generated on the site but not from our facility.

 

Fuel Conversion and Other Services

 

Williams Energy must deliver or cause to be delivered to us at the natural gas delivery point on an exclusive basis all quantities of natural gas required by us to:

 

•      generate net electric energy and/or ancillary services;

 

•      perform start-ups;

 

•      perform shutdowns; and

 

•      operate our facility during any period other than a start-up, shutdown or dispatch period for any reason.

 

Williams Energy at all times retains title to the natural gas delivered to us except that when our facility is operated during any period other than a start-up, shutdown or dispatch period title is transferred to us at the natural gas delivery point.

 

Williams Energy is solely responsible for all costs and expenses related to the supply and transportation of natural gas to the natural gas delivery point. We are responsible for all costs and expenses related to the transportation, gathering or taxation of natural gas or its use or possession at and after the natural gas delivery point.

 

Upon the expiration of the Power Purchase Agreement or any termination of the Power Purchase Agreement as the result of Williams Energy’s default thereunder, we will have the right to purchase the gas interconnection facilities from Williams Energy, or if Williams Energy does not own the gas interconnection facilities, Williams Energy will assign to us all of its rights to transportation services using the gas interconnection facilities.

 

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Pricing and Payments

 

For each month of the term after the commercial operation date, Williams Energy must pay us for our facility’s net capacity, successful start-ups and associated shutdowns, ancillary services and fuel conversion services at the applicable rates set forth in the Power Purchase Agreement. Each monthly payment by Williams Energy consists of a total fixed payment, a variable operations and maintenance payment and an energy exercise fee. The total fixed payment, which is payable regardless of facility dispatch by Williams Energy but is subject to adjustment based on facility availability, is calculated by multiplying an unforced capacity rate for each contract year by the temperature adjusted unforced capacity in the billing month and adding to that the product of the fuel conversion option demand charge and the average facility capacity for that month. The total fixed payment is anticipated to be sufficient to cover our debt service and fixed operating and maintenance costs and to provide us a return on equity. The variable operations and maintenance payment is intended to cover our variable operating and maintenance costs and escalates annually based on an escalation index set forth in the Power Purchase Agreement. The energy exercise fee is intended to compensate us for each successful start-up. We may receive heat rate bonuses or be required to pay heat rate penalties.

 

Prior to the commercial operation date, and during some facility tests thereafter, we purchased natural gas from Williams Energy. Williams Energy sold us the natural gas at prices specified in the Power Purchase Agreement, and we sold to Williams Energy at the electric delivery point any net electric energy produced during the periods at the hourly integrated market clearing marginal price for electric energy at the location where it was delivered or received, calculated pursuant to the terms of the operating agreement of PJM Interconnection, LLC, which is the independent system operator that operates the transmission system to which our facility interconnects. We are solely responsible for any fines or penalties resulting from the delivery of the net electric energy at the electric delivery point when the delivery is made without the authorization of PJM, Jersey Central Power, which is the host utility, or FERC. We have not incurred any such fine or penalty to date.

 

Williams Energy is entitled to an annual fuel conversion volume rebate if its dispatch of our facility exceeds specified levels and monthly non-dispatch payments if, under some circumstances, our facility does not deliver, in whole or in part, the requested net electric energy requested by Williams Energy. All fuel conversion volume rebate payments and non-dispatch payments must be made to Williams Energy after debt service and certain other payments but prior to any distribution to holders of equity interests in our company. Fuel conversion volume rebate payments and any non-dispatch payments owed to Williams Energy and not paid when due will be paid, together with interest thereon, when funds become available to us at the priority level described above. A separate reserve account must be maintained by us and our lenders and we must deposit to that account on a monthly basis, from our cash flow, any applicable and unpaid non-dispatch payment plus a ratable amount of the maximum fuel conversion volume rebate amount that Williams Energy may have earned. Amounts held in that reserve account will be used to pay, to the extent owed, the fuel conversion volume rebate and non-dispatch payments.

 

Required Authorizations

 

During the term of the Power Purchase Agreement, we must, at our own cost and expense, obtain as and when required all approvals, permits, licenses and other authorizations from governmental authorities as may be required for us to operate and maintain our facility, the interconnection facilities and protective gas apparatus and to perform our obligations under the Power Purchase Agreement.  We plan to obtain all additional governmental approvals, permits, licenses and authorizations as may be required with respect to our facility as soon as practicable.

 

Interconnection and Metering Equipment

 

At our sole cost and expense, we designed, constructed and installed and currently maintain the GPU interconnection facilities and protective gas apparatus needed to generate and deliver net electric energy and/or ancillary services to the electric delivery point in order to fulfill our obligations under the Power Purchase Agreement, including all interconnection facilities and protective gas apparatus that are located at the switchyards and/or substations at our facility. Our facility, interconnection facilities and protective gas apparatus have been designed, constructed and completed in a good and workmanlike manner and in accordance with accepted electrical practices (with respect to our facility and interconnection facilities) or in accordance with standard gas industry practices (with respect to protective gas apparatus), so that the expected useful life of our facility, the interconnection facilities and protective gas apparatus will be not less than the term of the Power Purchase Agreement.

 

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Public Service Electric and Gas (“PSE&G”), under contract with Williams Energy, has installed the natural gas interconnection facilities and natural gas metering equipment to our satisfaction.  PSE&G has also installed gas metering equipment although we are currently involved in a dispute with Williams Energy over the location of such equipment.  All electric metering equipment and gas metering equipment, whether owned by us or by a third party, must be operated, maintained and tested in accordance with accepted electrical practices, in the case of the electric metering equipment, and in accordance with applicable industry standards, in the case of the gas metering equipment. Except under limited circumstances, we may not enter into any modification or amendment of the interconnection agreement with Jersey Central Power without the prior written consent of Williams Energy.

 

As of December 31, 2002, all electrical interconnection and metering equipment had been installed and accepted by Jersey Central Power See “Interconnection Agreement - Jersey Central Power’s Obligations”.

 

Operation and Dispatch

 

Our facility and the interconnection facilities must be operated in accordance with accepted electrical practices and applicable requirements and guidelines of Jersey Central Power pursuant to the interconnection agreement. The protective gas apparatus must be operated in accordance with standard gas industry practices. If there is a conflict between the terms and conditions of the Power Purchase Agreement and Jersey Central Power requirements, the Jersey Central Power requirements control.

 

We must operate our facility in parallel with Jersey Central Power’s electrical system in accordance with the interconnection agreement. When dispatched by Williams Energy, we must operate our facility and each unit thereof with automatic regulation equipment in service.

 

The Power Purchase Agreement acknowledges that Jersey Central Power has the right to require us to disconnect our facility from its electrical system, or otherwise curtail, interrupt or reduce deliveries of net electric energy, in accordance with the terms of the interconnection agreement. If our facility has been disconnected for these reasons, Williams Energy will continue to be obligated to make total fixed payments for at least 24 hours after the occurrence of disconnection of our facility by Jersey Central Power.

 

We must use commercially reasonable efforts to correct promptly any condition at our facility which necessitates the disconnection of our facility from Jersey Central Power’s electrical system or the reduction, curtailment or interruption of electrical output of our facility.

 

Williams Energy has the exclusive right to use the net electric energy and ancillary services and to schedule the operation of our facility or a unit thereof in accordance with the provisions of the Power Purchase Agreement; however, the scheduling must be consistent with the design limitations of our facility, applicable law, regulations and permits, and the agreements and the manuals of PJM.

 

Williams Energy and our company must perform each of our respective obligations in a manner that avoids the creation of cashout obligations or imbalance penalties imposed by the natural gas transporter. Williams Energy must try to minimize any imbalance charges under a transporter’s tariff and thereafter we will be responsible for imbalance charges levied by the natural gas transporter to the extent that the charges result from: (i) an imbalance caused by us greater than the allocable tolerance in the transporter’s tariff or (ii) our failure to promptly notify Williams Energy of a change in the operation of our facility that would cause any imbalance.

 

Force Majeure

 

A party will be excused from performing its obligations under the Power Purchase Agreement and will not be liable for damages or otherwise to the other party if and to the extent the party declares that it is unable to perform or is prevented from performing an obligation under the Power Purchase Agreement by a force majeure condition, except for any obligations and/or liabilities under the Power Purchase Agreement to pay money, which will not be excused, and except to the extent an obligation accrues prior to the occurrence or existence of a force majeure condition as long as:

 

•      the party declaring its inability to perform by virtue of force majeure, as promptly as practicable after the occurrence of the force majeure condition, but in no event later than 5 days thereafter, gives the other party written notice describing, in detail, the nature, extent and expected duration of the force majeure condition;

 

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•      the suspension of performance is of no greater scope and of no longer duration than is reasonably required by the force majeure condition;

 

•      the party declaring force majeure uses all commercially reasonable efforts to remedy its inability to perform; and

 

•      as soon as the party declaring force majeure is able to resume performance of its obligations excused as a result of the force majeure condition, it must give prompt written notification thereof to the other party.

 

Irrespective of whether the force majeure condition is declared by Williams Energy or us, the time period of a force majeure will be excluded from the calculation of all payments under the Power Purchase Agreement and Williams Energy will be under no obligation to pay us any of the payments described in the Power Purchase Agreement. If Williams Energy declares a force majeure, however, it will continue to pay us only the applicable monthly total fixed payment as described in the Power Purchase Agreement until the earlier of (i) the termination of the force majeure condition or (ii) the termination of the Power Purchase Agreement. Furthermore, if a force majeure is declared by us due to an action or inaction of Jersey Central Power that prevents us from delivering net electric energy to the electric delivery point, Williams Energy will continue to pay the applicable portion of the total fixed payment for the first 24 hours of the period.

 

Notwithstanding anything to the contrary contained in the Power Purchase Agreement, except as may expressly be provided in the Power Purchase Agreement, the term force majeure will not include or excuse a party’s performance in the following circumstances:

 

•      Any reduction, curtailment or interruption of generation or operation of our facility, or of the ability of Williams Energy to accept or transmit net electric energy, whether in whole or in part, which reduction, curtailment or interruption is caused by or arises from the acts or omissions of any third party providing services or supplies to the party claiming force majeure, including any vendor or supplier to either party of materials, equipment, supplies or services, or any inability of Jersey Central Power to deliver net electric energy to Williams Energy, unless, and then only to the extent that, any act or omission would itself be excused under the Power Purchase Agreement as a force majeure;

 

•      Any outage, whether or not due to our fault or negligence, attributable to a defect or inadequacy in the manufacture, design or installation of our facility that prevents, curtails, interrupts or reduces the ability of our facility to generate net electric energy or our ability to perform our obligations under the Power Purchase Agreement;

 

•      To the extent that the party claiming force majeure failed to prevent or remedy the force majeure condition by taking all commercially reasonable acts (short of litigation, if the remedy requires litigation) and, except as otherwise provided in the Power Purchase Agreement, failed to resume performance under the Power Purchase Agreement with reasonable dispatch after the termination of the force majeure condition;

 

•      To the extent that the claiming party’s failure to perform was caused by lack of funds;

 

•      To the extent Williams Energy is unable to perform due to a shortage of natural gas supply not caused by an event of force majeure; or

 

•      Because of an increase or decrease in the market price of electric energy/capacity or natural gas or because it is uneconomic for the party to perform its obligations under the Power Purchase Agreement.

 

Neither party will be required to settle any strike, walkout, lockout or other labor dispute on terms which, in the sole judgment of the party involved in the dispute, are contrary to its interest.

 

Williams Energy will have the right to terminate the Power Purchase Agreement if we have declared a force majeure and the effect of said force majeure has not been fully corrected or alleviated within 18 months after the date said force majeure was declared. Williams Energy, however, will not have the right to terminate the Power Purchase Agreement if (i) the force majeure was caused by Williams Energy or (ii) the force majeure event does not prevent or materially limit Williams Energy’s ability to sell our facility net capacity into or through the PJM power pool market or to a third party.

 

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Events of Default; Termination; Remedies

 

The following will constitute events of default under the Power Purchase Agreement:

 

•      breach of any term or condition of the Power Purchase Agreement, including, but not limited to, (i) any failure to maintain or to renew any security, (ii) any breach of a representation, warranty or covenant or (iii) failure of either party to make a required payment to the other party;

 

•      our facility is not available to provide fuel conversion services or ancillary services to Williams Energy during any period of 180 consecutive days after the occurrence of the commercial operation date, except as may be excused by force majeure or the absence of available natural gas, or if non-availability is caused by an act or failure to act by Williams Energy where the action is required by the Power Purchase Agreement;

 

•      we sell or supply net electric energy, ancillary services or capacity from our facility, or agree to do the same, to any person or entity other than Williams Energy, without the prior approval of Williams Energy;

 

•      our failure for 30 consecutive days to perform regular and required maintenance, testing or inspection of the interconnection facilities, our facility and/or other electric equipment and facilities where the failure is material;

 

•      our failure for 30 consecutive days to correct or resolve a material violation of any code, regulation and/or statute applicable to the construction, installation, operation or maintenance of our facility, the interconnection facilities, protective gas apparatus or any other electric equipment and facilities required to be constructed and operated under the Power Purchase Agreement when the violation impairs our continued ability to perform its obligations under the Power Purchase Agreement;

 

•      involuntary bankruptcy or insolvency of either party that continues for more than 60 days;

 

•      voluntary bankruptcy or insolvency by either party;

 

•      any modifications, alterations or other changes to our facility by or on our behalf which prevent us from fulfilling, or materially diminish our ability to fulfill, its obligations, duties, rights and responsibilities under the Power Purchase Agreement and which after reasonable notice and opportunity to cure, are not corrected;

 

•      there will be outstanding for more than 60 days any unsatisfied final, non-appealable judgment against us in an amount exceeding $500,000, unless the existence of the unsatisfied judgment will not materially affect our ability to perform its obligations under the Power Purchase Agreement; and

 

•      The AES Corporation will cease to own, directly or indirectly, beneficially and of record, at least 50 percent of the equity interests in our company, or will cease to possess the power to direct or cause the direction of our company’s management or policies, or any person, other than The AES Corporation or an affiliate, authorized to act as a power marketer by FERC or any affiliate of the person will own, directly or indirectly, beneficially or of record, any of the equity interests in our company.

 

Upon the occurrence of any event of default, other than a bankruptcy-related event of default, for which no notice will be required or opportunity to cure permitted, the party not in default, to the extent the party has actual knowledge of the occurrence of the event of default, will give prompt written notice of the default to the defaulting party. The notice will set forth, in reasonable detail, the nature of the default and, where known and applicable, the steps necessary to cure the default. The defaulting party will have 30 days, two business days in the case of a default related to the breach of a representation, warranty or covenant, following receipt of the notice either to cure the default or commence in good faith all the steps as are necessary and appropriate to cure the default if the default cannot be completely cured within the 30-day period.

 

If the defaulting party fails to cure the default or take the steps as provided under the preceding paragraph, and immediately upon the occurrence of insolvency or the filing of a voluntary petition for bankruptcy, the Power Purchase Agreement may be terminated by the non-defaulting party, without any liability or responsibility whatsoever, by written notice to the party in default thereof. The Power Purchase Agreement will then terminate and

 

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the non-defaulting party may exercise all rights and remedies as are available to it to recover damages caused by the default, seek specific performance or exercise other rights and remedies that it may have in equity or at law.

 

Security

 

The Power Purchase Agreement requires us to provide $30 million of financial security for our performance and payment obligations prior to commercial operation and $10 million of financial security for our performance and payment obligations subsequent to the commercial operation date.  We may, at any time at our option, elect to either provide the financial security in the form of a guaranty of The AES Corporation or in the form of a single letter of credit, satisfactory to Williams Energy in form and substance, upon which Williams Energy may draw as specified in the Power Purchase Agreement.  If the financial security contains an expiration date, either express or implied, we will renew the financial security not later than 10 days prior to the expiration date and will provide written notice of the renewal to Williams Energy at the same time. If we fail to renew the financial security as set forth above, Williams Energy is entitled to demand and receive payment thereunder on or after three days after written notice of the failure is provided to us, and the amount drawn will be deposited in an interest-bearing escrow account.

 

The letter of credit referred to above must be issued by a financial institution that at all times during the term of the letter of credit meets and maintains the following criteria: (i) a U.S. or foreign bank rated “C” or better by Thompson Bankwatch; or (ii) a U.S. or foreign bank, surety company or financial institution whose senior debt has the rating listed below by two of the three rating agencies: Standard & Poor’s: “A-” or better; Moody’s: “A3” or better; Duff & Phelps: “A-” or better.  If the bank, surety company or financial institution fails to maintain the ratings criteria, then upon 30 days’ written notice from Williams Energy, we are required to obtain equivalent security from another bank, surety company or financial institution meeting the above stated criteria.

 

In order to satisfy this obligation, prior to the commercial operation date we provided a $30 million letter of credit which was reduced to $10 million on the commercial operation date.  This letter of credit will remain in effect during the term of the Power Purchase Agreement.

 

The payment obligations of The Williams Companies, Inc. under the guaranty were originally 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 reduced semiannually by a fixed amount which is based on the amortization of the company’s senior secured bonds during the applicable semiannual period.  As of December 31, 2003 the guarantee was capped at $507.6 million.  Pursuant to Section 18.3 of the Power Purchase Agreement, in the event that Standard & Poors 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, The Williams Companies, Inc.’s long term senior unsecured debt has been rated below investment grade since 2002 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 provide the Company (a) a prepayment of $10 million within five business days after execution of the Letter Agreement (the “Prepayment”); (b) 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 Power Purchase Agreement 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 either now or in the future or any other terms set forth in the Letter Agreement is not intended to 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 guarantee 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.

 

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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 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 the 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 and or all of its contractual rights and remedies as set forth in the Power Purchase Agreement, including, but not limited to, drawing 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 us on January 6, 2003 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. regain 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 above.  As of March 15, 2004, we had cash balances of approximately $33.5 million.  See “Item 7-Managements Discussion and Analysis of Financial Condition and Results of Operations -Liquidity and Capital Resources”.

 

Assignment

 

Generally, a party to the Power Purchase Agreement may not assign, transfer, pledge or otherwise encumber or dispose of any rights, duties, interests or obligations thereunder without the prior written consent of the other party except that (i) Williams Energy may, upon reasonable advance notice to us, assign its rights, duties and obligations under the Power Purchase Agreement to any of its affiliates or any other entity, provided that such affiliate or other entity’s long term unsecured debt at such time is rated investment grade by Standard & Poor’s and Moody’s or such affiliate or other entity’s obligations under the Power Purchase Agreement are guaranteed by an affiliate whose long-term unsecured debt at such time is rated investment grade by Standard & Poor’s and Moody’s and such assignee agrees to be bound by all of the terms and conditions on the Power Purchase Agreement to the same extent as Williams Energy, (ii) we may, upon reasonable advance notice to Williams Energy, assign the Power Purchase Agreement and any of our rights, interests, duties or obligations thereunder as collateral security to any Lender so long as the assignee agrees to be bound by all of the terms and conditions of the Power Purchase Agreement to the same extent as we are in the event that such lender exercises its rights under such assignment and (iii) we may assign any of our rights, duties and obligations under the Power Purchase Agreement to any affiliate provided such affiliate assumes in writing all of our obligations under the Power Purchase Agreement and the guaranty of our performance as required by the Power Purchase Agreement remains in effect.

 

Construction Agreement

 

We entered into an Agreement for Engineering, Procurement and Construction Services, dated as of October 15, 1999, with WGI (as the successor contractor) under which WGI was required to perform services in connection with 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

 

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separately, the “services”) for our facility. Under a Guaranty in our favor, effective as of October 15, 1999, all of WGI’s obligations under the construction agreement are irrevocably and unconditionally guaranteed by Raytheon.

 

WGI filed for bankruptcy on May 14, 2001, however construction of the facility continued through a series of cooperative agreements executed by us, WGI and Raytheon. On November 9, 2001, the Bankruptcy Court approved WGI’s rejection of the construction agreement and the execution of the PCA by WGI and Raytheon. Additionally, on November 21, 2001, we and Raytheon entered into the Owner/Guarantor Supplemental Agreement pursuant to which (i) Raytheon and we acknowledged that, notwithstanding the rejection of the construction agreement by WGI, Raytheon would cause the project to be completed in accordance with the terms of the construction agreement pursuant to Raytheon’s performance guaranty obligations, and the construction agreement will have continuing applicability insofar as it defines (x) the obligations owed to us by Raytheon under its guaranty and (y) our obligations to Raytheon arising from the performance of those obligations, (ii) Raytheon (or their designees) was designated as our agent for purposes of administering the subcontracts and vendor contracts assigned by WGI to us, (iii) all future payments by us would be paid in accordance with the terms of the construction agreement directly to Raytheon, and (iv) Raytheon would indemnify us with respect to any claims arising out of the subcontracts and vendor contracts assumed by us.

 

Provisional acceptance of the facility was achieved on August 11, 2002 when we entered into a settlement agreement with Raytheon.  In return for provisional acceptance, Raytheon agreed to perform work identified in the punch list provided as part of the agreement.  Raytheon was also required to pay a $5 million settlement fee, minus outstanding milestones and change-orders for a net payment to the Company for $2.37 million, which it paid in 2002.  Raytheon must perform certain agreed upon completion items in order to obtain final acceptance.  See “Completion and Acceptance of our Project – Final Acceptance”.

 

Raytheon Services and Other Obligations

 

Raytheon must complete our project by performing or causing to be performed all of the agreed upon services. The services have included: engineering and design; construction and construction management; providing us design documents, instruction manuals, a project procedures manual and quality assurance plan; procurement of all materials, equipment and supplies and all contractor and subcontractor labor and manufacturing and related services; providing a spare parts list; providing all labor and personnel; obtaining all applicable permits; performing inspection, expediting, quality surveillance and traffic services; transporting, shipping, receiving and marshaling all materials, equipment and supplies and other items; providing storage for all materials, supplies and equipment and procurement or disposal of all soil and gravel (including remediation and disposal of specific hazardous materials); providing for design, construction and installation of electrical interconnection facilities (including electric metering equipment, automatic regulation equipment, protective apparatus and control system equipment) and reviewing other utility interconnections to our facility (including gas and water pipelines); performing performance tests; providing for start-up and initial operation functions; providing specified spare parts, waste disposal services, chemicals, consumables and utilities.

 

The services have also included: training our personnel prior to provisional acceptance; providing us and our designee with access to the site; obtaining additional necessary real estate rights; cleaning-up and waste disposal (including hazardous materials brought to the site by Raytheon or the subcontractors); submitting a project schedule and progress reports; paying of contractor taxes; making employee identification and security arrangements; protecting adjoining utilities and public and private lands from damage; paying appropriate royalties and license fees; providing final releases and waivers to us; posting collateral or providing other assurances if major subcontractors fail to furnish final waivers; maintaining labor relations and project labor agreements; providing further assurances; coordinating with other contractors; and causing Raytheon to execute and deliver the related guaranty.

 

As mentioned above, provisional acceptance was granted by us on August 11, 2002.  Raytheon must perform certain agreed upon completion items in order to obtain final acceptance.  See “Completion and Acceptance of our Project – Final Acceptance”.

 

Construction and Start-Up

 

Raytheon must perform certain services in accordance with prudent utility practices, generally accepted standards of professional care, skill, diligence and competence applicable to engineering, construction and project

 

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management practices, all applicable laws, all applicable permits, the real estate rights, the quality assurance plan, the electrical interconnection requirements, the environmental requirements and safety precautions set forth in the construction agreement, and all of the requirements necessary to maintain the warranties granted by the subcontractors under the construction agreement. Raytheon must perform the services in accordance with our project schedule and is obligated to cause:

 

•      each construction progress milestone to be achieved on or prior to the applicable construction progress milestone date; and

 

•      final acceptance of our facility on or before the guaranteed final acceptance date (see “Completion and Acceptance of Our Project – Final Acceptance “).  Raytheon must perform the services so that our facility, when operated in accordance with the instruction manual and the Power Purchase Agreement operating requirements as of provisional acceptance and final acceptance, will comply with all applicable laws and applicable permits, the electrical interconnection requirements and the guaranteed emissions limits in accordance with the completed performance test requirements.

 

Contract Price and Payment

 

The adjusted contract price may either be paid in installments in accordance with the payment and milestone schedule or be prepaid as described in the collateral agency agreement. Initially, the adjusted contract price was prepaid in the amount of $295.7 million ($288.6 million of which was paid at closing), which included base scope changes through March 15, 2000. The contract price may be adjusted as a result of scope changes. The prepayment funds were backed by a prepayment letter of credit in our favor. However, under the construction agreement, the bankruptcy filing by WGI on May 14, 2001 constituted an event of default under the construction agreement. Accordingly, we requested that the full available amount of such letter of credit be drawn upon and deposited in the construction account held by the collateral agent. The collateral agent made such drawing on May 4, 2001 in the amount of $95.8 million, which was the then outstanding amount of the prepayment letter of credit as it had been reduced by WGI’s achievement of construction milestones under the construction agreement. Subsequent to the termination of the prepayment arrangements with WGI, payments to WGI for achievement of construction milestones as specified in the construction agreement were made in accordance with the terms of the construction agreement.

 

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 in the amount of 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. On March 4, 2002, Raytheon provided us with a letter of credit in the amount of $29.5 million (which amount represented the outstanding amount of retainage under the construction agreement on the date the letter of credit was posted) and we paid Raytheon the amount of the retainage.  Raytheon has subsequently increased the amount of the letter of credit in proportion to the amounts which would otherwise be retained by us and we have paid Raytheon the corresponding amount of this retainage.  As of December 31, 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 December 31, 2003 and December 31, 2002, we had drawn $544,000 and $96,000 on this letter of credit, respectively, for interim rebates which Raytheon then resumed paying until their notice of Final Acceptance on July 22, 2003.

 

We are currently in discussions with Raytheon as to when the performance testing required for final acceptance will occur.  See “Completion and Acceptance of Our Project – Final Acceptance.”

 

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Our Services

 

Our responsibilities include: designating a representative for our project; furnishing Raytheon access to the site; securing specified real estate rights; providing specified start-up personnel; furnishing specified spare parts, water disposal services and consumables; providing permanent utilities for the start-up, testing and operation of our facility; providing raw and potable water arrangements; providing fuel supply arrangements; providing electrical interconnection facilities arrangements; furnishing approvals; administering third-party contracts; causing The AES Corporation to provide a pre-financial closing guaranty.

 

If we fail to meet any of our obligations under the construction agreement, then, to the extent that Raytheon was reasonably delayed in the performance of the services as a direct result thereof, an equitable adjustment to one or more of the contract price, the guaranteed completion dates, the construction progress milestone dates, the payment and milestone schedule and our project schedule, and, as appropriate, the other provisions of the construction agreement that may be affected thereby, will be made by agreement between us and Raytheon.

 

Completion and Acceptance of Our Project

 

Mechanical Completion

 

Mechanical completion was achieved on August 13, 2002.

 

Performance Tests and Power Purchase Agreement Output Tests

 

Once mechanical completion was achieved, Raytheon was required to perform certain performance tests in accordance with criteria set forth in the construction agreement. Raytheon gave us notice of the performance tests, we arranged for the disposition of output during start-up and testing and Raytheon declared these performance tests complete since during the tests the operation of our facility complied with applicable laws, applicable permits, Guaranteed Emissions Limits and other required standards.  Although the performance test met the levels required for the commencement of commercial operations, they did not meet the levels guaranteed by Raytheon under the construction agreement.  Therefore, as provided by the construction agreement, Raytheon had been paying us interim rebates until their notice of final acceptance date of July 22, 2003, but we contend that these amounts should continue to be paid until the final acceptance date, which we contend has not yet occurred. Based on our interpretation of the contract, we expect that on the final acceptance date additional performance tests will be performed and if specified levels of heat rate and output are not met, Raytheon will be required to pay us a final lump-sum payment which will be based on the amount of the deficiency. Raytheon disputes our position since they contend that the final acceptance date has already occurred (See “Final Acceptance”).

 

Provisional Acceptance

 

Provisional acceptance was achieved on August 11, 2002 and risk transfer occurred on August 13, 2002 when:

 

•      Raytheon caused a completed performance test in which our facility demonstrated an average net electrical output of 95% (or higher) of the electrical output guarantee and 105% (or lower) of the gas-based heat rate guarantee; and

 

•      our facility achieved the requirements of mechanical completion.

 

The independent engineer and we were satisfied that the provisional acceptance requirements had been met and delivered to Raytheon a provisional acceptance certificate on August 11, 2002.  We took possession and control of our facility and we are now solely responsible for the operation and maintenance of the facility although Raytheon continues to have reasonable access to our facility to complete the services.

 

Final Acceptance

 

Final acceptance will be achieved when:

 

•      Raytheon has caused a completed performance test in accordance with the construction agreement to be concluded in which our facility demonstrates during the performance test an average net electrical output of 100% (or higher) of the electrical output guarantee and 100% (or lower) of the heat rate guarantee;

 

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•      our facility has achieved, and continues to satisfy the requirements for the achievement of, mechanical completion;

 

•      the reliability guarantee has been achieved under the construction agreement; and

 

•      Raytheon has completed performance of the services except for (i) punch list items and (ii) services that are required by the terms of the construction agreement to be completed after the achievement of final acceptance, such as Raytheon’s warranty obligations.

 

The reliability guarantee will have been achieved if and only if our facility demonstrates an average equivalent availability of not less than 95% while operating over a period of at least 30 consecutive days in accordance with applicable laws, applicable permits, the electrical interconnection requirements, the Power Purchase Agreement operating requirements, the guaranteed emissions limits, the instruction manual and the Power Purchase Agreement.

 

At any time after provisional acceptance of our facility has been achieved, Raytheon may, after exhausting all reasonable repair and replacement alternatives in order to achieve the applicable performance guarantees for final acceptance, and so long as that the reliability guarantee will have been achieved, give to us notice of its intention to elect to declare final acceptance. In that event, Raytheon may elect to use the results of the most recent eligible completed performance test for the purpose of determining our facility’s level of achievement of the performance guarantees.  Final acceptance will be deemed effective as of the last to occur of (i) the date of our receipt of the declaration and report of the final completed performance test, or, as applicable, the most recent completed performance test and (ii) the effective date of the achievement of the reliability guarantee.

 

If on or before the guaranteed final acceptance date (i) our facility has achieved provisional acceptance and (ii) the reliability guarantee has been achieved, then final acceptance of our facility will be deemed to occur on the guaranteed final acceptance date.

 

The guaranteed final acceptance date was originally required to occur 13.5 months after the guaranteed provisional acceptance date as defined under the construction agreement, but on March 8, 2003 we entered into a letter agreement with Raytheon pursuant to which we agreed to extend the guaranteed final acceptance date to June 30, 2003.  Raytheon gave notice of Final Acceptance on July 22, 2003 based on its July 8, 2003 performance test.  On July 31, 2003, we 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 demonstrate compliance with guaranteed emissions limits.  On August 1, 2003, we 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, we received a response from Raytheon in which Raytheon claims that the Company’s rejection of the final acceptance is invalid and improper.  We are currently considering its options for resolving this dispute. At any time, by giving notice to Raytheon, we in our sole discretion may elect to effect final acceptance, in which case final acceptance will be deemed effective as of the date of the notice, and Raytheon will have no liability to us for any amounts thereafter arising as performance guarantee payments, other than any interim period rebates that arose prior to the election by us, for failure of our facility to achieve any or all of the performance guarantees applicable thereto.

 

Project Completion

 

Project completion will be achieved under the construction agreement when:

 

•      Final acceptance of our facility will have occurred and the performance guarantees with respect to our facility will have been achieved (or in lieu of achievement of the performance guarantees, applicable rebates under the construction agreement will have been paid, or we will have elected final acceptance);

 

•      The reliability guarantee will have been achieved;

 

•      Raytheon will have demonstrated during the completed performance test that the operation of our facility does not exceed the guaranteed emissions limits;

 

•      The requirements for achieving mechanical completion of our facility will continue to be met;

 

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•      The punch list items will have been completed in accordance with the construction agreement; and

 

•      Raytheon will have performed all of the services, other than those services, such as Raytheon’s warranty obligations, which by their nature are intended to be performed after project completion.

 

When Raytheon believes that it has achieved project completion, it will deliver to us a notice of project completion. If Raytheon is satisfied that the final acceptance requirements have been met, we will deliver to Raytheon a project completion certificate. If reasonable cause exists for doing so, we will notify Raytheon in writing that project completion has not been achieved, stating the reasons therefore. If our project completion has not been achieved as so determined by us, Raytheon will promptly take the action or perform the additional services as will achieve project completion and will issue to us another notice of project completion. The procedure will be repeated as necessary until project completion is achieved.

 

Raytheon will be obligated to achieve project completion within 90 days after final acceptance of our facility. If Raytheon does not achieve our project completion on or before our project completion deadline or if we determine that Raytheon is not proceeding with all due diligence to complete the services in order to achieve project completion by the deadline, we may retain another contractor to complete the work at contractor’s expense.

 

As a result of our ongoing disagreement with Raytheon regarding final acceptance, project completion has not yet occurred.

 

Price Rebate for Failure to Meet Guarantees

 

Completion Dates

 

Raytheon guaranteed that (i) provisional acceptance or final acceptance of our facility will be achieved on or before the guaranteed provisional acceptance date and (ii) final acceptance of our facility will be achieved on or before the guaranteed final acceptance date.

 

If neither provisional acceptance nor final acceptance of our facility occurred by the date that is 50 days after the guaranteed provisional acceptance date, Raytheon was obligated to pay us $108,000 per day as liquidated damages, for each day provisional acceptance or final acceptance is later than the guaranteed provisional acceptance date. The aggregate amount of such payments that Raytheon is obligated to make is limited to 13% of the adjusted contract price (approximately $40 million). Since neither provisional nor final acceptance had occurred within 50 days of the guaranteed provisional acceptance date of February 14, 2002, Raytheon began to pay us scheduled late completion payments beginning on April 6, 2002 and ending on August 10, 2002 (the day prior to the provisional acceptance date).  A total of $14 million in liquidated damages was received in 2002, and no amounts were received in 2003.

 

Pursuant to the construction agreement, if neither provisional acceptance nor final acceptance of our facility occurred on or before the date that was 90 days after the guaranteed provisional acceptance date, Raytheon was required to submit for approval by us and the independent engineer a plan to accelerate the performance of the services as necessary in order to achieve final acceptance of our facility by the guaranteed final acceptance date. Raytheon submitted the required plan which was subsequently approved by us and the independent engineer.

 

Performance Guarantees

 

Electrical Output

 

Under the construction contract, if the average net electrical output of our facility at provisional acceptance or interim acceptance, whichever is the earlier to occur, is less than the electrical output guarantee, then Raytheon must pay us, as a rebate and not as liquidated damages, for each day during the interim period, an amount equal to $0.22 per day for each kilowatt by which the average net electrical output is 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 charge for this amount has been calculated at $2,941.40 per day. Raytheon had been paying us this amount until their notice of final acceptance date of July 22, 2003, but we are disputing this claim of final acceptance and contend that these amounts should continue to be paid until the final acceptance date (See “Final Acceptance”).

 

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Upon final acceptance, if the average net electrical output of our facility during the completed performance test is less than the electrical output 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 minus any interim rebates paid or to be paid by Raytheon.

 

Heat Rate Guarantees

 

If the average net heat rate of our facility at provisional acceptance or interim acceptance, if having occurred before final acceptance, exceeds the heat rate guarantee, then Raytheon must 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 is greater than the heat rate guarantee.

 

Upon final acceptance, if the net heat rate of our facility during the completed performance test exceeds the heat rate guarantee, then Raytheon will pay us, as a rebate, a lump sum amount equal to $110,000 for each BTU/KwH by which the measured heat rate is greater than the heat rate guarantee minus any interim rebates paid or to be paid by Raytheon.

 

For the year ended December 31, 2003, we have invoiced Raytheon approximately $1.42 million in electrical output and heat rate rebates.  As of December 31, 2003, Raytheon owed approximately $65,000 in rebates.  This amount is reflected in accounts receivable-other at December 31, 2003.

 

Liability and Damages

 

Limitation of Liability

 

In no event will Raytheon’s liability (i) for provisional acceptance late completion payments exceed an amount equal to 13% of the contract price, (ii) for performance guarantee payments arising from the electrical output guarantee exceed in the aggregate an amount equal to 10% of the contract price, (iii) for performance guarantee payments arising from the heat rate guarantee exceed in the aggregate 15% of the contract price and (iv) for all provisional acceptance late completion payments and performance guarantee payments exceed an amount equal to 34% of the contract price.

 

Consequential Damages

 

Neither party nor any of its contractors, subcontractors or other agents providing equipment, material or services for our project will be liable for any indirect, incidental, special or consequential loss or damage of any type.

 

Aggregate Liability of Contractor

 

The total aggregate liability of Raytheon and any of its subcontractors, including, without limitation, liabilities described above, to us will not in any event exceed an amount equal to the contract price for liability due to events occurring before the provisional acceptance date or 40% of the contract price for liability due to events occurring after the provisional acceptance date; however, the limitation of liability will not apply to obligations to remove liens or to make indemnification payments.

 

Warranties and Guarantees

 

Raytheon warrants and guarantees that during the applicable warranty period:

 

•      all machinery, equipment, materials, systems, supplies and other items comprising our project will be new and of first-rate quality which satisfies utility-grade standards and in accordance with prudent utility practices and the specifications set forth in the construction agreement, suitable for the use in generating electric energy and capacity under the climatic and normal operating conditions and free from defective workmanship or materials;

 

•      it will perform all of its design, construction, engineering and other services in accordance with the construction agreement;

 

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•      our project and its components are free from all defects caused by errors or omissions in engineering and design, as determined by reference to prudent utility practices, and comply with all applicable laws, all applicable permits, the electrical interconnection requirements, the Power Purchase Agreement operating requirements and the guaranteed emissions limits; and

 

•      the completed project performs its intended functions of generating electric energy and capacity as a complete, integrated operating system as contemplated in the construction agreement.

 

If we notify Raytheon within 30 days after the expiration of the applicable warranty period of any defects or deficiencies discovered during the applicable warranty period, Raytheon will promptly reperform any of the services at its own expense to correct any errors, omissions, defects or deficiencies and, in the case of defective or otherwise deficient machinery, equipment, materials, systems supplies or other items, replace or repair the same at its own expense. Raytheon warrants and guarantees that, to the extent we have made all payments then due to Raytheon, title to our facility and all work, materials, supplies and equipment will pass to us free and clear of all liens, other than any permitted liens. Other than the warranties and guarantees provided in the construction agreement there are no other warranties of any kind, whether statutory, express or implied relating to the services.

 

Upon notification from us no later than 30 days after the expiration of the applicable warranty period of any defects or deficiencies in our project or any component thereof, we will, subject to the provisions of the construction agreement, make our facility or the subject equipment available to Raytheon for Raytheon to re-perform, replace or, at Raytheon’s option, repair the same at Raytheon expense so that it is in compliance with the standards warranted and guaranteed, all in accordance with the construction agreement.

 

Force Majeure

 

Force Majeure Event

 

A force majeure event will mean any act or event that prevents the affected party from performing its obligations, other than the payment of money, under the construction agreement or complying with any conditions required to be complied with under the construction agreement if the act or event is beyond the reasonable control of and not the fault of the affected party and the party has been unable by the exercise of due diligence to overcome or mitigate the effects of the act or event. Force majeure events include, but are not limited to, acts of declared or undeclared war, sabotage, landslides, revolution, terrorism, flood, tidal wave, hurricane, lightning, earthquake, fire, explosion, civil disturbance, insurrection or riot, act of God or the public enemy, action, including unreasonable delay or failure to act, of a court or public authority, or strikes or other labor disputes of a regional or national character that are not limited to only the employees of Raytheon or its subcontractors and that are not due to the breach of a labor contract or applicable law by the party claiming force majeure or any of its subcontractors. Force majeure events do not include (i) acts or omissions of Raytheon or any subcontractors, except as expressly provided in the foregoing sentence, (ii) late delivery of materials or equipment, except to the extent caused by a force majeure event, and (iii) economic hardship.

 

Excused Performance

 

If either party is rendered wholly or partly unable to perform its obligations because of a force majeure event, that party will be excused from whatever performance is affected by the force majeure event to the extent so affected so long as:

 

•      the non-performing party gives the other party prompt notice describing the particulars of the occurrence;

 

•      the suspension of performance is of no greater scope and of no longer duration than is reasonably required by the force majeure event;

 

•      the non-performing party exercises all reasonable efforts to mitigate or limit damages to the other party;

 

•      the non-performing party uses its best efforts to continue to perform its obligations under the construction agreement and to correct or cure the event or condition excusing performance; and

 

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•      when the non-performing party is able to resume performance of its obligations, that party will give the other party written notice to that effect and will promptly resume performance under the construction agreement.

 

Scope Changes

 

We may order scope changes to the services, in which event one or more of the contract price, the construction progress milestone dates, the guaranteed completion dates, the payment and milestone schedule, our project schedule and the performance guarantees will be adjusted accordingly, if necessary. All scope changes will be authorized by a scope change order and only we or our representative may issue scope change orders.

 

As soon as Raytheon becomes aware of any circumstances which Raytheon has reason to believe may necessitate a scope change, Raytheon will issue to us a scope change order notice at Raytheon’s expense. If we desire to make a scope change, in response to a scope change order notice or otherwise, we will submit a scope change order request to Raytheon. Raytheon will promptly review the scope change order request and notify us in writing of the options for implementing the proposed scope change and the effect, if any, each option would have on the contract price, the guaranteed completion dates, the construction progress milestone dates, the payment and milestone schedule, our project schedule and the performance guarantees.

 

No scope change order will be issued and no adjustment of the contract price, the guaranteed completion dates, the construction progress milestone dates, the payment and milestone schedule, our project schedule or the performance guarantees will be made in connection with any correction of errors, omission, deficiencies, or improper or defective work on the part of Raytheon or any subcontractors in the performance of the services. Changes due to changes in applicable laws or applicable permits occurring after the date of the construction agreement will be treated as scope changes.

 

Effect of Force Majeure Event

 

If and to the extent that any force majeure events affect Raytheon’s ability to meet the guaranteed completion dates, or the construction progress milestone dates, an equitable adjustment in one or more of the dates, the payment and milestone schedule and our project schedule will be made by agreement of us and Raytheon. No adjustment to the performance guarantees and, except as otherwise expressly set forth below, the contract price will be made as a result of a force majeure event. If Raytheon is delayed in the performance of the services by a force majeure event, then:

 

•      to the extent that the delay(s) are, in the aggregate, 60 days or less, Raytheon will absorb all of its costs and expenses resulting from said delay(s); and

 

•      to the extent that the delay(s) are, in the aggregate, more than 60 days, Raytheon will be reimbursed by us for those incremental costs and expenses resulting from said delay(s) which are incurred by Raytheon after said 60-day period.

 

Price Change

 

An increase or decrease in the contract price, if any, resulting from a scope change requested by us or made under the construction contract will be determined by mutual agreement of the parties.

 

Continued Performance Pending Resolution of Disputes

 

Notwithstanding any dispute regarding the amount of any increase or decrease in Raytheon’s costs with respect to a scope change, Raytheon will proceed with the performance of the scope change promptly following our execution of the corresponding scope change order.

 

Hazardous Materials

 

If hazardous materials were not identified in an environmental site assessment report delivered by us to Raytheon prior to the commencement date and were not brought onto the site by Raytheon or any of its subcontractors, then Raytheon will be entitled to a scope change under the construction agreement.

 

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Risk of Loss

 

Since the risk transfer date with respect to our facility, we bear all risk of loss and full responsibility for repair, replacement or reconstruction with respect to any loss, damage or destruction to our facility.

 

Termination

 

Termination for our Convenience

 

We may for our convenience terminate any part of the services or all remaining services at any time upon 30 days’ prior written notice to Raytheon specifying the part of the services to be terminated and the effective date of termination. We may elect to suspend completion of all or any part of the services upon 10 days’ prior written notice to Raytheon, or, in emergency situations, upon prior notice as circumstances permit.

 

Termination by Raytheon

 

If we fail to pay to Raytheon any payment and the failure continues for 30 days, then (i) Raytheon may suspend its performance of the services upon 10 days’ prior written notice to us, which suspension may continue until the time as the payment, plus accrued interest thereon, is paid to Raytheon, and/or (ii) if the payment has not been made prior to the commencement of a suspension by Raytheon under clause (i) above, Raytheon may terminate the construction agreement upon 60 days’ prior written notice to us; however, the termination will not become effective if the payment, plus accrued interest thereon, is made to Raytheon prior to the end of the notice period. If the suspension occurs, an equitable adjustment to one or more of the contract price, the guaranteed completion dates, the construction progress milestone dates, the payment and milestone schedule and our project schedule, and, as appropriate, the other provisions of the construction agreement that may be affected thereby, will be made by agreement between us and Raytheon. If we have suspended completion of all or any part of the services in accordance with the construction agreement for a period in excess of 365 days in the aggregate, Raytheon may, at its option, at any time thereafter so long as the suspension continues, give written notice to us that Raytheon desires to terminate the construction agreement. Unless we order Raytheon to resume performance of the suspended services within 15 days of the receipt of the notice from Raytheon, the suspended services will be deemed to have been terminated by us for our convenience. If the occurrence of one or more force majeure events prevents Raytheon from performing the services for a period in the aggregate of 720 days, either party may, at its option, give written notice to the other party of its desire to terminate the construction agreement.

 

Consequences of Termination

 

•      Upon any termination, we may, so long as the termination is pursuant to any default Raytheon will have been paid all amounts due and owing to it under the construction agreement, which will not be deemed to constitute a waiver by Raytheon of any rights to payment it may have as a result of a non-default related termination in the event of a termination pursuant to a default, at our option elect to have itself, or our designee, which may include any other affiliate or any third-party purchaser, (i) assume responsibility for and take title to and possession of our project and any or all work, materials or equipment remaining at the site and (ii) succeed automatically, without the necessity of any further action by Raytheon, to the interests of Raytheon in any or all items procured by Raytheon for our project and in any and all contracts and subcontracts entered into between Raytheon and any subcontractor with respect to the equipment specified in the construction agreement, and with respect to any or all other subcontractors selected by us which are materially necessary to the timely completion of our project, Raytheon will use all reasonable efforts to enable us, or our designee, to succeed to Raytheon’s interests thereunder.

 

•      If any termination occurs, we may, without prejudice to any other right or remedy it may have, at its option, finish the services by whatever method we may deem expedient.

 

Surviving Obligations

 

Termination of the construction agreement (i) will not relieve either party of any obligation with respect to the confidentiality of the other party’s information, (ii) will not relieve either party of any obligation which expressly or by implication survives termination of the construction agreement and (iii) except as otherwise provided in any provision of the construction agreement expressly limiting the liability of either party, will not relieve either party of any obligations or liabilities for loss or damage to the other party arising out of or caused by acts or omissions of the

 

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party prior to the effectiveness of the termination or arising out of the termination, and will not relieve Raytheon of its obligations as to portions of the services already performed or as to obligations assumed by Raytheon or us prior to the date of termination.

 

Default and Remedies

 

Raytheon’s Default

 

Raytheon’s events of default include: voluntary bankruptcy or insolvency; involuntary bankruptcy or insolvency; materially adverse misleading or false representation or warranty; improper assignment; failure to maintain required insurance; failure to comply with applicable laws or applicable permits; cessation or abandonment of the performance of services; termination or repudiation of, or default under the related construction contract guaranty; failure to supply sufficient skilled workers or suitable material or equipment; failure to make payment when due for labor, equipment or materials; non-occurrence of either provisional acceptance or final acceptance within 90 days after the guaranteed provisional acceptance date, non-occurrence of construction progress milestones and failure proceed under a remediation plan within 90 days after the non-occurrence; and failure to remedy non-performance or non-observance of any provision in the construction agreement.

 

Our Rights and Remedies

 

If Raytheon is in default of its obligations, we will have any or all of the following rights and remedies, in addition to any other rights and remedies that may be available to us under the construction agreement or at law or in equity, and Raytheon will have the following obligations:

 

•      We may, without prejudice to any other right or remedy we may have under the construction agreement or at law or in equity, terminate the construction agreement in whole or in part immediately upon delivery of notice to Raytheon. In case of the partial termination, the parties will mutually agree upon a scope change order to make equitable adjustments, including the reduction and/or deletion of obligations of the parties commensurate with the reduced scope Raytheon will have after taking into account the partial termination, to one or more of the guaranteed completion dates, the construction progress milestone dates, the contract price, the payment and milestone schedule, our project schedule, the performance guarantees and the other provisions of the construction agreement which may be affected thereby, as appropriate. If the parties are unable to reach mutual agreement as to said scope change order and the dispute resolution procedures set forth in the construction agreement are invoked, the procedures will give due consideration to customary terms and conditions under which Raytheon has entered subcontracts with third party prime contractors covering services substantially similar to those services which are not being terminated.

 

•      If requested by us, Raytheon must withdraw from the site, must assign to us such of contractor’s subcontracts, to the extent permitted therein, as we may request, and must remove the materials, equipment, tools and instruments used by, and any debris and waste materials generated by, Raytheon in the performance of the Services as we may direct, and we, without incurring any liability to Raytheon, other than the obligation to return to Raytheon at the completion of our project the materials that are not consumed or incorporated into our project, solely on an “as is, where is” basis without any representation or warranty of any kind whatsoever, may take possession of any and all designs, drawings, materials, equipment, tools, instruments, purchase orders, schedules and facilities of Raytheon at the site that we deem necessary to complete the services.

 

Assignment

 

The parties shall have no right to assign or delegate any of their respective rights or obligations under the construction agreement either voluntarily or involuntarily or by operation of law, except that we may, without Raytheon’s approval, assign any or all of its rights under the construction agreement (a) as collateral security to the financing parties and (b) to any transferee of our project or a substantial portion of our project so long as such assignee has financial and operational capabilities that are either substantially similar to ours at the time or otherwise are such that the assignment could not reasonably be expected to have a material adverse effect on Raytheon’s rights and obligations under the construction agreement.

 

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Maintenance Services Agreement

 

We have entered into the Maintenance Program Parts, Shop Repairs and Scheduled Outage Technical Field (“TFA”) Assistance Services Contract, dated as of December 8, 1999, with Siemens Westinghouse by which Siemens Westinghouse will provide us with, among other things, combustion turbine parts, shop repairs and scheduled outage technical field assistance services.  The fees assessed by Siemens Westinghouse will be based on the number of Equivalent Base Load Hours (EBH) or Equivalent Starts, accumulated by the applicable Combustion Turbine as adjusted for inflation. The Company has received approximately $10.8 million in rotable spare parts under this agreement.  This amount is recorded as Spare Parts Inventory, under Property, Plant and Equipment, and the remaining amount owed as current and long-term liabilities in the accompanying balance sheets.

 

The maintenance services agreement became effective on the date of execution and unless terminated early, will terminate upon completion of shop repairs performed by Siemens Westinghouse following the twelfth scheduled outage of the applicable combustion turbine or sixteen years from the date of execution, whichever occurs first, unless we exercise our right to terminate the agreement after the first major outage of the turbines, which will be approximately the eighth year of operation of the facility.

 

Scope of Work

 

During the term of the maintenance services agreement, and in accordance with the scheduled outage plan, Siemens Westinghouse is required to do the following:

 

•      deliver the type and quantity of new program parts for installation of the combustion turbine;

 

•      repair/refurbish program parts and equipment for the combustion turbine;

 

•      provide miscellaneous hardware;

 

•      provide us with material safety data sheets for all hazardous materials Siemens Westinghouse intends to bring/use on the site;

 

•      provide the services of a maintenance program engineer to manage the combustion turbine maintenance program;

 

•      provide technical field assistance, or TFA Services, which involves advice and consultation for the disassembly, inspection and assembly of various equipment; and

 

•      remove and reinstall insulation as required to complete inspections.

 

We are responsible for, among other things:

 

•      storing and maintaining parts, materials and tools to be used in or on the combustion turbine;

 

•      maintaining and operating the combustion turbine consistently with the warranty conditions;

 

•      ensuring that our operator and maintenance personnel are properly trained;

 

•      transporting program parts in need of repair/refurbishing; and

 

•      providing Siemens Westinghouse, on a monthly basis, with the number of equivalent starts and the number of equivalent base load hours (“EBHs”) incurred by each combustion turbine.

 

In October of 2003, we performed our first scheduled combustor inspection outage. The costs for repairs and other charges to expense were approximately $.75 million and the costs relating to the new parts and installation were approximately $2.8 million.

 

We and Siemens Westinghouse will continue to jointly develop the scheduled outage plan. The scheduled outage plan will be consistent with the terms and conditions of the Power Purchase Agreement.

 

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Early Replacement

 

If it is determined that due to normal wear and tear a program part(s) for the combustion turbine has failed or will not last until the next scheduled outage, and the part has to be repaired before the scheduled replacement period, Siemens Westinghouse will replace the program part by moving up a new program part which is otherwise scheduled to be delivered at a later date. The contract price for the replacement will not be affected if the replacement date is less than or equal to one year earlier than the scheduled outage during which the program part was scheduled to be replaced. If the actual replacement date for a program part is more than one year earlier than the scheduled outage at which point the program part was scheduled to be replaced, the early replacement will result in an adjustment to the payment schedule. Siemens Westinghouse has the final decision with regard to the replacement or refurbishment associated with any program part. If we dispute Siemens Westinghouse’s decision, we may seek to resolve the dispute in accordance with the dispute resolution procedures discussed below.

 

Parts Life Credit

 

After applicable warranty periods set forth in the maintenance services agreement and the construction agreement, Siemens Westinghouse will provide a parts life credit if a program part requires replacement due to normal wear and tear prior to meeting its expected useful life. Siemens Westinghouse has the final decision with regard to actual parts life and the degree of repair or refurbishment associated with any program parts. The parts life credit will be calculated in terms of EBHs and Equivalent Starts. The price of the replacement part will be adjusted for inflation. If we dispute Siemens Westinghouse’s decision, we may seek to resolve the dispute in accordance with the dispute resolution procedures discussed below.

 

Contract Price and Payment Terms

 

Siemens Westinghouse will invoice us monthly and payments are then due within 25 days. The fees assessed by Siemens Westinghouse will be based on the number of EBHs or equivalent starts accumulated by the applicable combustion turbine as adjusted for changes in the consumer price index. The contract price will be the aggregate number of fees as adjusted plus any additional payment amount mutually agreed to by the parties under a change order.

 

Unscheduled Outages and Unscheduled Outage Work

 

If during the term of the maintenance services agreement an unscheduled outage occurs resulting from (i) the non-conformity of new program parts; (ii) the failing of a shop repair; (iii) a program part requiring replacement due to normal wear and tear prior to achieving its expected life in terms of EBHs or equivalent starts; or (iv) the failure of a service, performed by Siemens Westinghouse, we will hire Siemens Westinghouse, to the extent not supplied by Siemens Westinghouse as a warranty remedy under Siemens Westinghouse’s warranties under the maintenance services agreement, to supply any additional parts, miscellaneous hardware, shop repairs and TFA Services under a change order. We will be entitled to any applicable parts life credit with respect to program parts as well as a discount for TFA Services. If the unscheduled outage occurs within a specified number of EBHs of a scheduled outage and it was anticipated that the additional parts, miscellaneous hardware, shop repairs and TFA Services to be used in the unscheduled outage were to be used during the upcoming scheduled outage, the upcoming scheduled outage will be moved up in time to become the unscheduled outage/moved-up scheduled outage. We will not be required to pay any additional money for the program parts, miscellaneous hardware, shop repairs and TFA Services.

 

If any program parts are delivered by Siemens Westinghouse within 15 days of receipt of the change order, we will pay to Siemens Westinghouse the price for the program part set forth in the maintenance services agreement plus a specified percentage.

 

Any program part delivered after 30 days of the change order will cost us the price set forth in the maintenance services agreement minus a specified percentage.

 

The remedies set forth in the maintenance services agreement, and discounts on any TFA Services purchased by us from Siemens Westinghouse will constitute Siemens Westinghouse’s sole liability and our exclusive remedies for unscheduled outages whether our claims are based in contract, in tort, or otherwise. If Siemens Westinghouse fails to send a TFA Services representative by the end of the second day following written receipt of the unscheduled

 

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outage, we may hire another qualified person, at its cost, to perform the work. If the hired party proceeds to disassemble the combustion turbine to determine the case of the unscheduled outage and Siemens Westinghouse still has not provided personnel to assist with the inspection, we can elect to terminate the maintenance services agreement on the basis that Siemens Westinghouse has failed to perform a material obligation.

 

Changes in Operating Restrictions

 

The maintenance services agreement requires that each combustion turbine will be operated in accordance with the requirements of the Power Purchase Agreement and prudent utility practices, with 8,000 EBH/year and 250 Equivalent Starts per year by using natural gas fuel or liquid fuel and water. Should the actual operations differ from these operating parameters which causes a scheduled outage to be planned/performed earlier or later than as expected, then, under a change order, an adjustment in the scope, schedule, and price will be made.

 

Warranties

 

Siemens Westinghouse warrants that the new program parts, miscellaneous hardware and any shop repairs will conform to standards of design, materials and workmanship consistent with generally accepted practices of the electric utility industry. The warranty period with respect to program parts, hardware and shop repair is until the earlier of one year from the date of installation of the original program part or hardware, a specific number of starts or fired hours after installation of the program parts and hardware, or three years from the date of delivery of the original program part, hardware, and in the case of shop repair, three years from completion of the work. Warranties on the program parts and hardware will not expire more than one year after the conclusion of the maintenance services agreement. Siemens Westinghouse will repair or replace any program part or hardware, at its cost, if notified of any failure or non-conformity of the program part or hardware during the warranty period.

 

Siemens Westinghouse also warrants that the services of its personnel and technical information transmitted will be competent and consistent with prudent utility practices and the services will comply in all material respects with laws and will be free from defects in workmanship for a period of one year from the date of completion of that item of services. The warranties on the services will expire no later than one year after the termination or end of the term of the maintenance services agreement.

 

In addition, Siemens Westinghouse warrants that any program part removed during a scheduled outage and delivered by us to the designated facility for repair will be repaired and delivered by Siemens Westinghouse within 26 weeks. If Siemens Westinghouse does not deliver the program part within this time frame or does not provide a new program part in lieu of the program part being shop repaired and an outage occurs which requires such a program part, Siemens Westinghouse will pay us liquidated damages for each day the program part is not repaired and delivered the aggregate of which liquidated damage payments will not exceed a maximum annual cap. If upon reaching the maximum cap on aggregate liquidated damages, Siemens Westinghouse still has not repaired and delivered the program part, we may elect to terminate the maintenance services agreement because Siemens Westinghouse will be considered to have failed to perform its material obligations.

 

Except for the express warranties set forth in the maintenance services agreement, Siemens Westinghouse makes no other warranties or representations of any kind. No implied statutory warranty of merchantability or fitness for a particular purpose applies.

 

The warranties provided by Siemens Westinghouse are conditioned upon (i) our receipt, handling, storage, operation and maintenance of our project, including any program parts and miscellaneous hardware, being done in accordance with the terms of the combustion turbine instruction manuals; (ii) operation of the combustion turbine in accordance with the terms of the maintenance services agreement; (iii) repair of accidental damage done consistently with the equipment manufacturer’s recommendations; (iv) our providing Siemens Westinghouse with access to the site to perform its services under the maintenance services agreement; and (v) hiring Siemens Westinghouse to provide TFA Services, program parts, shop repairs and miscellaneous hardware required to dissemble, repair and reassemble the combustion turbine.

 

Termination

 

We may terminate the maintenance services agreement if (i) specific bankruptcy events affecting Siemens Westinghouse occur; (ii) Siemens Westinghouse fails to perform or observe in any material respect any provision in

 

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the maintenance services agreement and fails to (a) promptly commence to cure and diligently pursue the cure of the failure or (b) remedy the failure within 45 days after Siemens Westinghouse receives written notice of the failure; (iii) we terminate the construction agreement due to Raytheon’s default thereunder or due to our inability to obtain construction financing or environmental operating permits; or (iv) Raytheon terminates the construction agreement for any reason other than our default thereunder. Notwithstanding the foregoing, we may terminate the maintenance services agreement at any time for convenience following the completion of the first major outage of both combustion turbine generators. In addition, the maintenance services agreement will automatically terminate if (i) we terminate the construction agreement for reasons other than (a) the default of Raytheon and (b) our inability to obtain permits for our project or (ii) Raytheon terminates the construction agreement for our default thereunder. If such termination occurs, Siemens Westinghouse will discontinue any work or services being performed and continue to protect our property. Siemens Westinghouse will transfer title to us and deliver any new program parts and miscellaneous hardware already purchased by us. We will pay Siemens Westinghouse those amounts owed at the time of termination.

 

Siemens Westinghouse may also terminate the maintenance services agreement if: (i) we fail to make payments or (ii) specific bankruptcy events affecting us occur. Siemens Westinghouse cannot terminate the maintenance services agreement if we pay outstanding amounts due within 90 days. Upon termination, Siemens Westinghouse will stop all work, place no additional orders, protect our property and deliver the property to us upon our instructions. Siemens Westinghouse will be entitled to payment for work performed up until its termination of the maintenance services agreement, and to all outstanding fees and reasonable costs associated with the termination.

 

Limitation of Liability

 

Each party agrees that, except to the extent liquidated damages provided in the maintenance services agreement are so considered, neither Siemens Westinghouse, nor its suppliers, nor will we under any circumstances be liable for: any indirect, special, incidental or consequential loss or damage whatsoever; damage to or loss of property or equipment; loss of profits or revenues; loss of use of material, equipment or power system; increased costs of any kind, including but not limited to capital cost, fuel cost and cost of purchased or replacement power, or claims of our customers.

 

We agree that the remedies provided in the maintenance services agreement are exclusive and that under no circumstances will the total aggregate liability of Siemens Westinghouse during a given year exceed 100% of the contract price payable to Siemens Westinghouse for that given year under the maintenance services agreement. We further agree that under no circumstances will the total aggregate liability of Siemens Westinghouse for liquidated damages during a given year exceed a specified percentage of the contract price payable to Siemens Westinghouse for that given year under the maintenance services agreement. We further agree that under no circumstances will the total aggregate liability of Siemens Westinghouse exceed a specified percentage of the contract price payable to Siemens Westinghouse under the maintenance services agreement.

 

Force Majeure

 

Neither party will be liable for failure to perform any obligation or delay in performance, excluding payment, to the extent the failure or delay is caused by any act or event beyond the reasonable control of the affected party or Siemens Westinghouse’s suppliers; so long as the act or event is deemed to be a force majeure and is not the fault or the result of negligence of the affected party and the party has been unable by exercise of reasonable diligence to overcome or mitigate the effects of the act or event. Force majeure includes: any act of God; act of civil or military authority; act of war whether declared or undeclared; act, including delay, failure to act, or priority, of any governmental authority; civil disturbance; insurrection or riot; sabotage; fire; inclement weather conditions; earthquake; flood; strikes, work stoppages, or other labor difficulties of a regional or national character which are not limited to only the employees of Siemens Westinghouse or its subcontractors or suppliers and which are not due to the breach of an applicable labor contract by the party claiming force majeure; embargo; fuel or energy shortage; delay or accident in shipping or transportation to the extent attributable to another force majeure; changes in laws which substantially prevent a party from complying with its obligations in conformity with its requirements under the maintenance services agreement or failure or delay beyond its reasonable control in obtaining necessary manufacturing facilities, labor, or materials from usual sources to the extent attributable to another force majeure; or failure of any principal contractor to provide equipment to the extent attributable to another force majeure. Force majeure will not include: (i) economic hardship, (ii) changes in market conditions or (iii) except due to an event of force majeure, late delivery of program parts or other equipment.

 

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If a delay in performance is excusable due to a force majeure, the date of delivery or time for performance of the work will be extended by a period of time reasonably necessary to overcome the effect of the force majeure and if the force majeure lasts for a period longer than 30 days and the delay directly increases Siemens Westinghouse’s costs or expenses, we, after reviewing Siemens Westinghouse’s additional direct costs and expenses, will reimburse Siemens Westinghouse for its reasonable additional direct costs and expenses incurred after 30 days from the beginning of the force majeure resulting from said delay.

 

Environmental Compliance

 

Siemens Westinghouse will indemnify us from any fines, penalties, expense, loss or liability, including the costs of clean-up, incurred by us as a result of (i) Siemens Westinghouse’s failure to meet its obligations under the maintenance services agreement or (ii) any spills of hazardous waste or oil, petroleum or petroleum products to the environment which are attributable to and occur during Siemens Westinghouse’s performance, or the performance of its contractors or subcontractors, of the workscope obligations at the site under the maintenance services agreement.

 

We will indemnify Siemens Westinghouse from any fines, penalties, expense, loss or liability incurred by Siemens Westinghouse as a result of our failure to meet our obligations under the maintenance services agreement. We will have no responsibility or liability with regard to any hazardous waste or oil, petroleum or petroleum products which were spilled by Siemens Westinghouse, or any other of its contractors or subcontractors performing workscope obligations at the site.

 

Fleetwide Issue Notification

 

During the term of this agreement, if Siemens Westinghouse becomes aware of a fleetwide issue involving the Siemens Westinghouse 501F Combustion Turbine which may have a deleterious effect on our combustion turbines, Siemens Westinghouse will, within a reasonable time of becoming aware of the fleetwide issues, notify us thereof, and if the fleetwide issue requires an additional repair or replacement of a program part or miscellaneous hardware to be performed, the additional repair or replacement will be performed in accordance with the provisions of the maintenance services agreement.

 

Interconnection Agreement

 

We have entered into a Generation Facility Transmission Interconnection Agreement, dated as of April 27, 1999 with Jersey Central Power, for the installation, operation and maintenance of the facilities necessary to interconnect our facility to Jersey Central Power’s transmission system. Under the interconnection agreement, we and Jersey Central Power will construct, own, operate and maintain the interconnection facilities. We are responsible for all of the costs of construction, operation and maintenance of the interconnection facilities, including those owned by Jersey Central Power. We have 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.  At December 31, 2002, the interconnection facilities and protective gas apparatus needed to generate and deliver net electric and/or ancillary services to the electric delivery point had been completed as required under the Power Purchase Agreement.

 

Company Market-Based Tariff Petition

 

FERC approval of our company market-based tariff petition was received on June 22, 2001.

 

Jersey Central Power’s Obligations

 

We have entered into an interconnection installation agreement, by which Jersey Central Power has installed, at our cost and expense, the Jersey Central Power interconnection facilities. The Jersey Central Power interconnection facilities, together with the facilities that we have installed, are necessary to allow the interconnection of our facility with the transmission system of Jersey Central Power. The Jersey Central Power interconnection facilities which include, but are not limited to, certain substation protective relaying equipment and two 230 kV 2-cycle circuit breakers, are owned, maintained and operated by Jersey Central Power, at our cost and expense. The remainder of the interconnection facilities have been installed and are owned, maintained and operated by us.

 

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Jersey Central Power has completed the installation of the Jersey Central Power interconnection facilities necessary to permit us to meet our construction agreement requirement to energize the switch yard and commence commissioning of our facility.  We have 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.  The cost of these interconnection facilities was approximately $5.1 million, and is included on the balance sheet as property, plant and equipment.

 

Our Obligations

 

We have installed and own, operate and maintain a portion of the interconnection facilities, including, but not limited to, a 230 kV switchyard, including generator step up transformers, instrument transformers, revenue metering, power circuit breakers, control and protective relay panels, supervisory control and data acquisition equipment, and protective relaying equipment.

 

We are obligated to give prior notice to Jersey Central Power before undertaking any additions, modifications or replacements to our facility or our interconnection facilities that will increase the generating capacity of our facility or could reasonably be expected to affect the transmission system, the Jersey Central Power Interconnection Facilities or the operation of our facility. We must reimburse Jersey Central Power for all costs incurred by Jersey Central Power associated with any modifications, additions or replacements that it must make to the transmission system or the Jersey Central Power Interconnection Facilities, as reasonably required by Jersey Central Power, in connection with our proposed addition, modification or replacement at our facility. We are obligated to modify its portion of the interconnection facilities as may be required to conform to changes in good utility practice or as required by PJM Interconnection, L.L.C., which is the independent system operator that operates the transmission system to which our facility will be interconnected.

 

We are obligated to keep our facility insured against loss or damage in accordance with the minimum coverages specified in the Interconnection Agreement.

 

Operation and Maintenance of Interconnection Facilities

 

The parties are obligated to operate and maintain their respective portions of the interconnection facilities in accordance with good utility practices and the requirements and guidelines of PJM and Jersey Central Power.

 

Jersey Central Power will have the right to disconnect our facility from its transmission system and/or curtail, interrupt or reduce the output of our facility when operation of our facility or the interconnection facilities adversely affects the quality of service rendered by Jersey Central Power or interferes with the safe and reliable operation of its transmission system or the regional transmission system. Jersey Central Power, however, is obligated to use reasonable efforts to minimize any disconnection, curtailment, interruption or reduction in output.

 

In accordance with good utility practice, Jersey Central Power may remove the interconnection facilities from service as necessary to perform maintenance or testing or to install or replace equipment on the interconnection facilities or the transmission system. Jersey Central Power is obligated to use due diligence to restore the interconnection facilities to service as promptly as practicable.

 

In addition, if we fail to operate, maintain, administer, or insure our facility or its portion of the interconnection facilities, Jersey Central Power may, following 30 days notice and opportunity to cure the failure, disconnect our facility from the transmission system.

 

Revenue Metering

 

Revenue meters, which are part of the interconnection facilities, will be installed to measure the transfer of electrical energy between the parties at the point of interconnection. The revenue meters have been installed at our expense and will be owned, maintained and repaired by Jersey Central Power, also at our expense. Jersey Central Power has provided, at our expense, telemetering equipment which has been installed by us, to retrieve certain information. The revenue meters are to be tested at least once every two years, or more frequently at our request. Any revenue meter found to be inaccurate by greater than 1% is to be adjusted, repaired or replaced.

 

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Land Rights and Access

 

We have granted to Jersey Central Power the right of reasonable access and all necessary rights of way, easements, and licenses as Jersey Central Power may require to install, operate, maintain, replace and remove the revenue meters and other portions of the Jersey Central Power Interconnection Facilities.

 

Force Majeure

 

If either party is delayed in or prevented from performing or carrying out its obligations under the interconnection agreement by reason of force majeure, the party will not be liable to the other party for or on account of any loss, damage, injury or expense resulting from or arising out of the delay or prevention; however, the party encountering the delay or prevention will use due diligence to remove the cause or causes thereof.

 

Default

 

The events of default under the interconnection agreement are:

 

•      breach of a material term or condition and uncured failure to provide a required schedule, report or notice;

 

•      failure or refusal of a party to permit the representatives of the other party access to maintenance records, or its interconnection facilities or protective apparatus;

 

•      appointment by a court of a receiver or liquidator or trustee that is not discharged within 60 days, issuance by a court of a decree adjudicating a party as bankrupt or insolvent or sequestering a substantial part of its property that has not been discharged within 60 days after its entry, or filing of a petition to declare a party bankrupt or to reorganize a party under the Federal Bankruptcy Code or similar state statute that has not been dismissed within 60 days;

 

•      voluntary filing by a party of a petition in bankruptcy or consent to the filing of a bankruptcy or reorganization petition, an assignment for the benefit of creditors, an admission by a party in writing of its inability to pay its debts as they come due, or consent to the appointment of a receiver, trustee, or liquidator of a party or any part of its property; and

 

•      failure to provide the other party with reasonable written assurance of the party’s ability to perform any of the material duties and responsibilities under the interconnection agreement within 60 days of a reasonable request for the assurance.

 

Upon an event of default, the non-defaulting party may give notice of the event of default to the defaulting party. The defaulting party will have 60 days following the receipt of the notice to cure the default or to commence in good faith the steps necessary to cure a default that cannot be cured within that 60-day period. If the defaulting party fails to cure its default within 60 days or fails to take the steps necessary to cure a default that cannot be cured within a 60-day period, the non-defaulting party will have the right to terminate the interconnection agreement.

 

Jersey Central Power will have the right to operate and/or to purchase specific equipment, facilities and appurtenances from us that are necessary for Jersey Central Power to operate and maintain its transmission system if (i) we commence bankruptcy proceedings or petitions for the appointment of a trustee or other custodian, liquidator, or receiver; (ii) a court issues a decree for relief of our company or appoints a trustee or other custodian, liquidator, or receiver for our company or a substantial part of our assets and the decree is not dismissed within 60 days or (iii) we cease operation for 30 consecutive days without having an assignee, successor, or transferee in place.

 

Operations Agreement and Services Agreement

 

We entered into a Development and Operations Services Agreement (the “Operations Agreement”), dated as of March 10, 2000, with AES Sayreville under which AES Sayreville is providing, operating and maintenance services for our facility for a period of 32 years. Under the Operations Agreement, AES Sayreville is responsible for, among other things, preparing plans and budgets related to start-up and commercial operation of our facility, providing qualified operating personnel, making repairs, purchasing consumables and spare parts (not otherwise provided under the maintenance services agreement) and providing other services as needed according to industry standards.

 

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AES Sayreville is compensated for its maintenance and operation services on a cost basis, and it also receives certain management fees which it passes on to The AES Corporation.  For the years ended December 31, 2003 and 2002, we paid AES Sayreville a total of $5.3 million and $4.4 million, respectively, for their services.

 

Under a services agreement between AES Sayreville and The AES Corporation, The AES Corporation has and continues to provide to AES Sayreville all of the personnel and services necessary for AES Sayreville to comply with its obligations under the operations agreement.

 

Water Supply Agreement

 

We have entered into a Water Supply Agreement dated as of December 22, 1999 with the Borough of Sayreville under which the Borough will provide untreated water to our facility.

 

Supply of Untreated Water

 

Untreated Water Supply

 

The Borough of Sayreville is in the final stages of approval of the Lagoon Water Pipeline, Lagoon Pumping Station, and Sayreville Interconnection Number 2.  The Company was 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.  Startup and commissioning of this system started May 1, 2002.  Subsequent to the completion of the Lagoon Pumping Station and the Lagoon Water Pipeline, the Borough has made available to our facility a supply of untreated water from the South River that is up to 4.6 million gallons per day and 1.53 billion gallons per year.  The Borough must use reasonable efforts to maintain the Lagoon’s water level at an elevation of 29 feet, but during periods when water cannot be drawn from the South River, the Lagoon’s water level must not be drawn to elevations below 20 feet. During periods when either the Lagoon’s water level is below 20 feet and water cannot be drawn from the South River or when water from the Lagoon is needed to ensure a supply of treated water to Borough treated water customers, the Borough must supply our facility with water drawn from the Duhernal acquifer and transported through the Duhernal water pipeline.

 

Compensation

 

The cost of the pipeline and pumping station was approximately $678,000 and $1.71 million, respectively.  The Company has paid the pipeline and pumping station projects in full, and as of December 31, 2003. In addition to the amounts discussed in the preceding paragraph, we paid the Borough an initial payment of $150,000 from the bond proceeds, which was credited to our account and is being used to offset the cost of untreated water purchased during our project’s start-up and testing phase and during the first year of operation.  If the Borough incurs additional costs from Middlesex Water Company as a result of the Borough providing us with Duhernal Water, we also must pay the Borough for those additional costs. We must pay the Borough monthly for all untreated water delivered to the point of delivery during the prior month. The base rate for untreated water supplied from the South River is $216 per million gallons, which includes $53 per million gallons to cover operations, maintenance and administrative costs and $163 per million gallons to cover past infrastructure costs. The operations and maintenance rate will be escalated in accordance with the percentage changes in water rates that are applicable to other Borough water customers. The base rate for untreated water delivered from the Duhernal acquifer is $932 per million gallons which includes $785 to cover the operations, maintenance and administrative costs and $147 to cover acquisition costs. The operations and maintenance portion of the base rate for water delivered from the Duhernal acquifer is also subject to escalation in accordance with the percentage changes in water rates that are applicable to other Borough water customers.

 

With respect to each contract year there is a minimum bill amount, which is initially $300,000 per year. One-twelfth of the minimum bill amount must be paid each month. The minimum bill amount is adjusted as follows:

 

•      For the first contract year it is reduced by the amount of the initial payment;

 

•      it is reduced by an amount equal to the product of (x) the quantity of untreated water that would have been delivered but for service interruptions by the Borough and (y) the rate for untreated water delivered from the South River; and

 

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•      starting with 8th contract year and with six months’ prior written notice, we have the right to reduce the minimum bill amount for any contract year by reducing the annual quantity of water to be provided by up to 15%. Starting with the 21st contract year we may reduce the annual quantity to be delivered without limit.

 

Service Interruptions

 

In the event that there is an interruption in the delivery of untreated water attributable to a break in the infrastructure, the Borough will provide a shortfall notice and the Borough and we will agree on the best way to repair the infrastructure and restore service. If the Borough fails to restore service within a reasonable period of time, we may, at our expense, contract with contractors reasonably approved by the Borough to remedy the interruption.

 

Infrastructure and Real Estate Rights—The Lagoon Water Pipeline, Lagoon Pumping Station and Sayreville Interconnection Number 2

 

The Borough has designed, at our expense, the Lagoon Water Pipeline, Lagoon Pumping Station and Sayreville Interconnection Number 2 in conformance with standard water system practice. The Borough was responsible for obtaining, at our expense, all necessary government approvals. The Borough and we have cooperated to obtain, at our expense, the real estate rights necessary for the construction, operation and maintenance of the Lagoon Water Pipeline, Lagoon Pumping Station and Sayreville Interconnection Number 2. The Borough was not required to exercise its power of eminent domain to obtain the necessary real estate rights. We obtained easement rights from two adjacent property owners and the Borough of Sayreville. We also obtained permission from the New Jersey State House Commission to cross property designated as “Green Acres” by the New Jersey Department of Protection. Upon completion and testing of the Lagoon Water Pipeline, Lagoon Pumping Station and Sayreville Interconnection Number 2, we executed, without being compensated by the Borough, the documents necessary to evidence the Borough’s ownership of those facilities in November 2003.

 

Operation and Maintenance of Infrastructure

 

The Borough will operate and maintain all infrastructure necessary to supply the untreated water to the project boundary. We will reimburse the Borough for its associated maintenance and replacement costs.

 

The Borough will own and maintain metering equipment to measure the delivery of untreated water from each source to the point of delivery and will transmit a signal of the measurements to the Borough, which uses the information to compile billing invoices. At least once every five years, or more often if requested by either party, we must test the metering equipment. If the tests reveal that the metering equipment is inaccurate, the equipment must be recalibrated or replaced and a billing adjustment may be made.

 

Infrastructure Studies and Additions

 

We pay for the actual cost, subject to a mutually agreed upon cap, of infrastructure studies to determine the costs and benefits of (i) installing a new pipeline and (ii) improving the existing South River intake structure. We will have the right to pay for the upgrades, improvements and/or new infrastructure that may be identified as necessary or desirable by the studies in exchange for the benefits allowed with their implementation. Other water users that benefit from the improvements will pay a pro-rata portion of the costs of the improvements.

 

If the Borough or we reasonably determines that capital improvements to the infrastructure are required, the party will notify the other party and the parties will meet in good faith to determine the scope of the capital improvements. We will pay for our costs and expenses arising from the capital improvements as well as those of the Borough. If we damage either infrastructure or capital improvements, we will restore the damaged portions thereof or pay the Borough to restore the damaged portions.

 

Land Development Plan

 

We entered into an agreement with the Borough of Sayreville by which we will develop and implement a plan to replace trees which were removed during clearing of the Facility site.  The Land Development Plan is required for final site approval.   The estimated cost of the plan is approximately $425,000.  We are in the process of selecting a contractor to perform the service and no payments have been made as of December 31, 2003.  On July 23, 2003, the

 

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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.

 

Additional Obligations of the Parties

 

Additional Obligations of the Borough

 

The Borough must use its best efforts to either (i) amend its existing permit, which limits pumping from the Lagoons to 1,000,000 gallons of water per day or (ii) obtain or change any other permits necessary to allow it to meet its obligations under the water supply agreement. The Borough must provide us with written invoices by not later than the 15th of each month. The amounts due under the invoices are due within 30 days of receipt. The Borough must provide us and the financing parties with escorted access to any infrastructure or other property owned by the Borough to which we or the financing parties reasonably request access.

 

Our Additional Obligations

 

We must provide the Borough with notice of any violation by the Borough of applicable government approvals related to the delivery of untreated water. Not later than the 15th day of each month, we must provide the Borough with a detailed invoice listing any amounts due to us under the water supply agreement.

 

Force Majeure

 

If either party is unable to carry out any obligation under the water supply agreement due to an event of force majeure, the water supply agreement will remain in effect but the obligation will be suspended for the period necessitated by the force majeure, as long as:

 

•      the affected party gives the other party written notice within 48 hours of the occurrence of the force majeure;

 

•      the suspension of performance is of no greater scope and no longer than required by the force majeure; and

 

•      the non-performing party uses its best efforts to remedy its inability to perform.

 

Term

 

The water supply agreement has a term of 30 years with an option to extend for up to four additional five year terms. The agreement may be terminated by us and by the Borough under some circumstances including; (i) our failure to deliver a commencement notice on or prior to December 31, 2003; (ii) the occurrence of a bankruptcy event affecting the other party; and (iii) failure of a party to perform a material obligation within the time contemplated and the continuation of the failure for a period of 30 days or more.

 

ITEM 2.

PROPERTIES

 

Our principal property is the project site, on which our facility is located, which we own. The site is located in the Borough of Sayreville, Middlesex County, New Jersey on an approximately 62-acre parcel of land. We have access, utility and construction easements and licenses across neighboring property. We have title insurance in connection with our property rights.

 

Under our financing documents, our rights and interests in our property are encumbered by mortgages, security agreements, collateral assignments and pledges for the benefit of our bondholders and other senior creditors.

 

Our facility consists of an approximately 830 megawatt (net) gas-fired combined cycle electric generating facility. Our facility was designed, engineered, procured and constructed for us by WGI and Raytheon, as successor guarantor, under a fixed-price, turnkey construction agreement.  Among other components, our facility uses three Siemens Westinghouse model 501F combustion turbines, three heat recovery steam generators and one multicylinder steam turbine. Under a maintenance services agreement, Siemens Westinghouse is providing us with specific combustion turbine maintenance services and spare parts in respect of each combustion turbine until sixteen

 

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years after execution of the agreement or the twelfth planned outage of the combustion turbine, whichever is earlier, unless we exercise our right to cancel the agreement after the first major outage of the combustion turbines which will be after approximately the sixth year of operation of the facility. Under the Power Purchase Agreement, Williams Energy or its affiliates is supplying the fuel necessary to allow us to provide capacity, fuel conversion and ancillary services to Williams Energy. AES Sayreville has provided development, construction management, and operations and maintenance services for our facility under an operations agreement. We have provided installation, operation and maintenance of facilities necessary to interconnect our facility to Jersey Central Power’s transmission system under an interconnection agreement.

 

ITEM 3.

LEGAL PROCEEDINGS

 

On November 4, 2003, the Company and Williams Energy, through arbitration, settled a dispute regarding the date of commercial operation and the proper interpretation of certain provisions of the Power Purchase Agreement relating to amounts we claimed were payable by Williams Energy. The arbitration related to disputed amounts of approximately $7.6 million, which included a $594,000 payment extension dispute and a $7 million commercial operation start date dispute.  Under the settlement, Williams made a cash payment to us of $4,050,153 on November 14, 2003, which included $225,055 of interest from October 2002 to the payment date, and the Commercial Operation Date was deemed to be September 28, 2002.  The related revenue had been substantially recorded in 2002, with the remaining amount recorded in the fourth quarter of 2003.This payment settles all payment obligations between the parties for the month of September 2002 with respect to the Commercial Operation Date under the Power Purchase Agreement.  From our perspective, the cash payment has the economic effect of recognizing a Commercial Operation Date prior to of September 28, 2002. We are currently disputing $802,000 of merchant price, testing gas and other charges with Williams Energy that we contend Williams Energy owes to us. These charges were not part of the arbitration discussed above.

 

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

Not applicable pursuant to General Instruction I of the Form 10-K.

 

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PART II

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

 

There is no market for our equity interests. All of our member interests are owned by our parent, AES Red Oak, Inc., a wholly owned subsidiary of The AES Corporation.  On December 22, 2003, we declared and paid a $1.05 million dividend to AES Red Oak, Inc.

 

ITEM 6.

SELECTED FINANCIAL DATA

 

Not applicable pursuant to General Instruction I of the Form 10-K.

 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

The following discussion and analysis should be read in conjunction with our financial statements and the notes thereto included elsewhere in this annual report. The following discussion involves forward-looking statements. Our actual results may differ significantly from the results suggested by these forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements.”

 

General

 

We were 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. The total cost of the construction of our facility was approximately $450 million, which was 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. 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 Company reached provisional acceptance on August 11, 2002, risk transfer on August 13, 2002, and took the position that we were commercially available on September 1, 2002.  Williams Energy disputed the September 1, 2002, commercial operation date and informed the Company that it recognized commercial availability of the facility as of September 28, 2002.  On November 4, 2003, a settlement was reached and a commercial operation date of September 28, 2002 was agreed upon.  See “Item 3 – 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 minimum capacity 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.  During 2003 the PJM market, into which our facility’s generation is distributed, experienced a general decline in the amount paid for electricity. There was also a marked increase in the cost of natural gas. As a result, Williams Energy dispatched our facility on a very limited basis. During 2003, our facility was called on to generate only 14% of the year. Accordingly, the minimum capacity payments have been our primary source of operating revenues, representing $62.0 million of our total revenues of $64.2 million for the twelve months ended December 31, 2003.

 

Based upon current market conditions and projections from Williams Energy, we anticipate a comparable dispatch level in 2004.  In the event that these market conditions do not improve, and Williams Energy does not dispatch our facility at all in 2004, we believe that the fixed capacity payments are sufficient to meet the cash demands of our business, but we will require the additional revenue from such fuel conversion services to be profitable.

 

We are concerned that Williams Energy will not dispatch our facility in a manner that will increase our profitability. As a result, our management is researching ways to enhance our facility’s performance. We believe that any savings in starting the facility or improved performance will also benefit Williams Energy, with the result that Williams Energy may find it more economically feasible to dispatch our facility.

 

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The following discussion presents certain financial information for the years ended December 31, 2003, 2002 and 2001.

 

Equity Contributions

 

Under an equity subscription agreement, AES Red Oak, Inc. agreed to contribute up to approximately $56.7 million to us to fund project costs.  As of December 31, 2002 all $56.7 million had been contributed.  The Equity that AES Red Oak Inc. provided to us was provided to it by The AES Corporation.

 

Results of Operations

 

The first full year of operation in 2003 yielded a net loss of $0.3 million.  We commenced commercial operations in August 2002 and had a net loss for the year ended December 31, 2002 of $3.0 million.  For the year ended December 31, 2001, non-capitalizable costs and net interest expense resulted in a net loss of approximately $2.0 million.  At December 31, 2003, 2002 and 2001, these net losses resulted in earnings in excess (deficiency) of fixed charges of approximately $1.9 million, $(23.1) million and $(32.3) million, respectively. Due to our commencement of operations in August 2002, these results of operations may not be comparable with the results of operations during future periods.

 

Operating revenues for the year ended December 31, 2003 were approximately $64.2 million, as compared with $26.2 million for the partial year of operations ended December 31, 2002.  Revenues from September 2002 through December 2003 consist of capacity sales and ancillary services under the Power Purchase Agreement. Revenues for the period of August and part of September 2002 consisted of merchant revenue.  These amounts include fixed payments of $62.0 million and $15.2 million for the twelve month periods ending December 31, 2003 and 2002, respectively. The remaining amount of revenue relates to variable revenue which we receive when dispatched, and merchant revenue we earned prior to our commercial operation date in September 2002. We have no control over when the facility is dispatched, as that decision is made by Williams Energy based on several factors including market conditions.

 

Operating expenses were $30.9 million for the twelve months ended December 31, 2003, which represents the first full year of operations. These costs are largely of a recurring nature and are discussed below. Operating expenses for the twelve month period ending December 31, 2002 were $16.8 million, representing a partial year of operations.

 

Fuel purchased from Williams Energy during the period of merchant operations and testing was $0.9 million for the year ended December 31, 2003, as compared to $6.9 million for the year ended December 31, 2002. We purchased more fuel in 2002 in connection with the merchant operations we conducted in the period prior to the commercial operation date.

 

The fuel conversion volume rebate was $5.8 million for the year ended December 31, 2003 as compared to $1.6 million for the partial year of operations in the twelve months ended December 31, 2002. This cost represents payments to Williams and is based upon a twelve month facility utilization factor.

 

Corporate management fees were $1.6 million for the twelve months ended December 31, 2003 as compared to $0.6 million for the partial year of operations in the twelve month period ended December 31, 2002. Corporate management fees are charged on a monthly basis based on a fixed amount which is adjusted annually for inflation.

 

Other operating expenses, which represent the reimbursement of operating and maintenance expenses paid to AES Sayreville, L.L.C., were $7.2 million for the year ended December 31, 2003 as compared to $2.0 million for the partial year of operations in the twelve months ended December 31, 2002.

 

Depreciation expense was $11.4 million for the year ended December 31, 2003 as compared to $4.4 million for the partial year of operations in the twelve months ended December 31, 2002.

 

General and administrative costs for the years ended December 31, 2003, 2002 and 2001, were $4.0 million, $1.2 million, and $68,000, respectively. These costs did not directly relate to construction and are included as expenses in the Statements of Operations. The increase of general and administrative costs in the year ended December 31, 2003 compared to the year ended December 31, 2002 reflects a full year of operations in the current year and less than five months in the prior year period. The increase of general and administrative costs in the year

 

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ended December 31, 2002 compared to the year ended December 31, 2001 reflects the start of operations in August 2002.

 

There were no operating revenues or operating expenses, other than general and administrative costs, for the year ended December 31, 2001, as the facility was not operational.

 

Total other income (expense) for the years ended December 31, 2003, 2002 and 2001 was approximately $(33.6) million, $(12.5) million, and $(1.9) million, respectively, and is comprised of other income and expense, liquidated damages received and paid and interest income and expense.

 

Other income for the years ended December 31, 2003 and December 31, 2002 was approximately $1,427,000 and $957,000, respectively.  These amounts consist of interim rebates received from Raytheon under the construction agreement as a result of their failure to meet heat rate and output performance guarantees.  We did not recognize any other income in the year ended December 31, 2001, since no interim rebates were due under the construction agreement.

 

Other expense for the year ended December 31, 2003 and 2002 was approximately $1.0 million and $0.4 million, respectively.  These amounts consist of fees paid to Dresdner Bank pursuant to our debt service reserve letter of credit and reimbursement agreement and power purchase agreement letter of credit and reimbursement agreement.  See “Liquidity and Capital Resources” for a description of these letters of credit.  These fees were higher in 2003 than in 2002, because the fees related to these letters of credit were capitalized as part of the facility costs prior to the commencement of commercial operations.

 

For the year ended December 31, 2002, we recognized revenue of $1.8 million for liquidated damages received from Raytheon for late completion payments and a construction related outage in November 2002.  This revenue was recognized after the commercial operation date. We did not recognize revenue related to any liquidated damages in the year ended December 31, 2001 since no liquidated damages were due under the construction agreement.

 

For the years ended December 31, 2003 and 2002, we expensed $.2 million and $1.8 million, respectively of liquidated damages paid to Williams Energy as a result of our extension of the commercial operation date and a construction related outage in November 2002.  This expense was recognized after the commercial operation date. We did not incur any liquidated damages for the year ended December 31, 2001.

 

Proceeds from the sale of the senior secured bonds were held in the construction account, pending application to construction costs, and were invested by the trustee. For the years ended December 31, 2003, 2002 and 2001, the interest income earned on these invested funds, the security collateral received from Williams Energy and other available funds was approximately $495,000, $125,000 and $1.7 million, respectively.  The $495,000 of interest income earned for the year ended December 31, 2003 included $225,055 of interest on amounts owed by, and paid as part of the arbitration settlement with, Williams Energy.  See “Item 3 – Legal Proceedings”. The amount of interest income earned on the proceeds from the senior secured bonds for the year ended December 31, 2002 compared to the year ended December 31, 2001 decreased as a result of a lower average balance in the construction account resulting from our use of the bond proceeds for construction of the facility.

 

Prior to our commencement of commercial operations in 2002, construction related interest costs incurred on the portion of the bond proceeds expended during the construction period were capitalized to Construction in Progress. For the years ended December 31, 2002 and 2001, capitalized construction related interest costs were approximately $20.9 million and $30.3 million, respectively.  On August 13, 2002, the risk transfer date, the balance of Construction in Progress was transferred to Property, Plant and Equipment.  For the years ended December 31, 2003, 2002 and 2001, interest costs incurred on the bond proceeds not spent on construction of our facility were approximately $34.2 million, $13.2 million and $3.6 million, respectively. The increase in interest expense for the year ended December 31, 2003 compared to the year ended December 31, 2002 is the result of expensing interest costs for a full year in 2003, compared to the capitalizing of construction-related interest for most of the year ended December 31, 2002. The increase in interest expense for the year ended December 31, 2002 compared to the year ended December 31, 2001 is a result of expensing interest costs incurred after the completion of construction, compared with a higher level of interest capitalized during construction in 2001.

 

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On August 13, 2002, the risk transfer date, the balance of construction in progress was transferred to Property, Plant and Equipment.  As of December 31, 2003, Property Plant and Equipment adjusted for depreciation was $409 million, which includes generation, building and office equipment.

 

Liquidity and Capital Resources

 

Sources and Uses of Cash

 

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 payments (each as defined in the Power Purchase Agreement) and other payments for the delivery of fuel conversion, capacity and ancillary services.  We currently anticipate being dispatched by Williams Energy beginning in April 2004 but can provide no assurance that this will occur.  If the facility is not dispatched, our operating revenues will consist of minimum capacity payments under the Power Purchase Agreement.  Any future operating revenues, including any minimum capacity payments received in the event that Williams Energy does not dispatch the facility, will be used to fund our generation expenses and other operations and maintenance expenses and to meet the obligations described below.

 

Since September 28, 2002, Williams Energy has not dispatched the facility to a significant degree, outside the peak summer months. The minimum capacity payments provided for under the Power Purchase Agreement have been our primary source of operating revenues, representing $62.0 million of our total revenues of $64.2 million in 2003.  The minimum cash flow from Williams under the power purchase agreement is approximately $3.8 million per month for October through May and $7.9 million per month from June through September.

 

During 2003, the Company’s first full year of operations, net cash provided by operating activities was $14.8 million, which included non-cash depreciation of $11.4 million, and amortization of $.8 million.  We currently anticipate that the plant will be dispatched in future periods to a similar degree as it was during 2003, that operating cash flow will be comparable to 2003 in 2004 and that operating cash requirements will be similar in 2004 and 2005 as they were during this first year of operation.  We also believe that cash flows from the sale of electricity and/or minimum capacity payments under the Power Purchase Agreement and 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 pay project costs, including ongoing expenses and principal and interest on our senior secured bonds as described below, fund costs of our commercial operations and pay fees and expenses in connection with the Power Purchase Agreement letter of credit (as described above).

 

We have provided the collateral agent with a debt service reserve letter of credit in an initial stated amount of $22.0 million. We have also provided Williams Energy a $10 million letter of credit under the Power Purchase Agreement, which we refer to as the power purchase letter of credit, to support specific payment obligations under the Power Purchase Agreement. The repayment obligations with respect to any drawings under the power purchase letter of credit are our senior debt obligation. The interest rate on these loans would be the sum of a) the higher of (i) the Federal Funds Rate plus .50% and (ii) the Agent’s prime rate and b) an applicable margin rate which is based upon the rating of our senior secured bonds. Since our senior secured bonds are currently rated below investment grade, our working capital facility is unavailable and we are required to pay higher fees for draws on any of our project support agreements.

 

As discussed below, in the event we are required to return the $35 million alternate credit support to Williams Energy we may also use a portion of operating revenues for this purpose.  Under the terms of the Letter 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 no earlier than the June in the calendar year after the occurrence of regaining its investment grade rating or the beginning of the twentieth year after the commercial operation date, whichever comes first (Note 7). In the event the Company regains its investment grade status, the Company will also have access to its $2.5 million working capital agreement (Note 6). 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.

 

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Debt Service

 

On March 15, 2000, we issued $384 million in senior secured bonds for the purpose of providing financing for the construction of the Facility and to the fund, through the construction period, interest payments to the bondholders.  In September 2000, we 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 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 on the 2019 Bonds commenced on August 31, 2002.  Annual principal repayments over the life of the 2019 Bonds range from 1.0799% of original principal amount or $2.4 million to 11.2819% of original principal amount or $25.3 million.  Quarterly principal repayment of the 2029 Bonds does not commence until February 28, 2019.

 

The annual interest and principal payments on the 2019 and 2029 Bonds are scheduled as follows:

 

 

We are current on debt payments through February 29, 2004.

 

We are prohibited from making any distributions unless we have required minimum balances in certain accounts and have met certain other conditions contained in the Indenture and the Collateral Agency and Intercreditor Agreement governing the senior secured bonds.

 

Maintenance Agreement

 

We have entered into the Maintenance Program Parts, Shop Repairs and Scheduled Outage TFA Services Contract, dated as of December 8, 1999, with Siemens Westinghouse by which Siemens Westinghouse will provide us with, among other things, combustion turbine parts, shop repairs and scheduled outage technical field assistance services.

 

The maintenance services agreement became effective on the date of execution and unless terminated early, will terminate upon completion of shop repairs performed by Siemens Westinghouse following the twelfth scheduled outage of the applicable combustion turbine or 16 years from the effective date of the contract, whichever occurs first.

 

The maintenance services agreement indicates that we will pay a fixed amount, adjusted for inflation, over the term of the agreement. The payments are based on a stated amount for each equivalent base load hour of the combustion turbines, but if a scheduled maintenance outage occurs prior to 8,000 equivalent base load hours being accumulated since the last scheduled maintenance outage for that turbine, the Company will be invoiced the remaining amount to equate to 8,000 hours. The total of these payments for the twelve months ended December 31, 2003 was approximately $2.8 million, which included a maintenance outage and related payment as the turbine was far short of the 8,000 hour level. Assuming the same dispatch hours and the performance of one maintenance outage, a comparable level of payments would be expected for the twelve months ended December 31, 2004.

 

Operations Agreement

 

We entered into a Development and Operations Services Agreement, dated as of March 1,2000, with AES Sayreville, L.L.C. by which AES Sayreville, L.L.C. is providing development and construction management services and, after the commercial operation date, operating and maintenance services for our facility for a period of

 

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32 years. Under the operations agreement, AES Sayreville, L.L.C is responsible for, among other things, preparing plans and budgets related to start-up and commercial operation of our facility, providing qualified operating personnel, making repairs, purchasing consumables and spare parts (not otherwise provided under the maintenance services agreement) and providing other services as needed according to industry standards. During fiscal year 2002, AES Sayreville, L.L.C was compensated for the services on a cost plus fixed-fee basis of $133,000 per month.  The fee is adjusted annually by the change in Gross Domestic Product, Implicit Price Deflator.  Total fees paid by us were $1.6 million for the year ended December 31, 2003.  Under the services agreement between AES Sayreville, L.L.C and The AES Corporation, The AES Corporation provides to AES Sayreville, L.L.C all of the personnel and services necessary for AES Sayreville, L.L.C to comply with its obligations under the operations agreement.

 

The following table is an estimate of management fees paid through the end of the contract, using an annual inflation rate of 2.7%:

 

Year		Fees
		(in thousands)
2004		$	1,639
2005		1,683
2006		1,729
2007		1,775
2008		1,823
2009 and thereafter		73,034
Total Payments		$	81,683

 

Other Commitments.

 

As discussed in “Item 1-Business-Power Purchase Agreement -Security” and Footnote 7 to the Consolidated Financial Statements, pursuant to Section 18.3 of the Power Purchase Agreement, in the event that Standard & Poors (“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 us.  Due to the downgrade of The Williams Companies, Inc. to below investment grade in 2002, Williams Energy has provided with $35 million cash as alternate 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. Under the terms of the Letter 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 no earlier than the June in the calendar year after the occurrence of regaining its investment grade rating or the beginning of calendar year 20, whichever comes first (Note 7). In the event the Company regains its investment grade status, the Company will also have access to its $2.5 million working capital agreement (Note 6).  As of December 31, 2003, the Company had cash balances of approximately $35 million.  In the event the Company is required to return the $35 million alternative credit support to Williams, we believe that we would use all or a portion of our current cash balances and cash generated from future operations, with any remaining balance deducted from the monthly amounts due to us from 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.

 

We have entered into an agreement with the Borough of Sayreville by which we will develop and implement a plan to replace trees which were removed during clearing of the Facility site.  The Land Development Plan is required for final site approval.   The estimated cost of the plan is approximately $425,000.  We are in the process of selecting a contractor to perform the service and no payments have been made as of December 31, 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.

 

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As of December 31, 2003, we also had a capital commitment of $114,000 related to a road modification project.  It is also anticipated that we will incur capital expenditures of approximately $400,000 in 2004 related to general improvements of the facility.

 

We have also entered into a contract with the Borough of Sayreville (the “Borough”) pursuant to which the Borough will provide untreated water to us. The contract has a term of 30 years with an option to extend for up to four additional five-year terms. We are contractually committed to a minimum annual payment of $300,000.

 

Under the construction agreement, we were entitled to retain certain amounts from each scheduled payment until after final acceptance by us of the facility unless Raytheon posted a letter of credit in the amount of amounts which would otherwise be retained.  As of December 31, 2003, Raytheon had provided a letter of credit of approximately $30.8 million and we had paid Raytheon for any amounts previously retained.  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 December 31, 2003 and December 31, 2002, we had drawn $544,000 and $96,000 on this letter of credit, respectively, for interim rebates which Raytheon had agreed to pay until their notice of Final Acceptance on July 22, 2003.

 

As discussed in Item 1–”Business–Construction Agreement–Completion and Acceptance of Our Project–Final Completion” we are currently disputing the final completion of the project with Raytheon.

 

Risks that May Impact Our Liquidity

 

Williams Energy is currently our sole customer for purchases of capacity, ancillary services, and energy and our sole source for fuel. Williams Energy’s payments under the Power Purchase Agreement are expected to provide all of our operating revenues during the term of the Power Purchase Agreement.

 

The payment obligations of the Williams Companies, Inc. under its guaranty of Williams Energy’s obligations under the Power Purchase Agreement were originally 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.  As of December 31, 2003, the guarantee was capped at $507.6 million.

 

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 provide the Company with a $10 million prepayment (the “Prepayment”) and certain additional collateral.  A description of the collateral that supports Williams Energy’s obligations under the Power Purchase Agreement is set forth under “Item 1-Business Power Purchase Agreement-Security” and Footnote 7 to our Consolidated Financial Statements”.

 

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 to our cash flow and financial condition which could result in a default on our senior secured bonds.  Due to the current 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.

 

In addition to the factors discussed above, and/or the other factors listed under the “Cautionary Note Regarding Forward-Looking Statements,” if we do not receive final rebates from Raytheon and/or the working capital agreement continues to be unavailable as a result of the ratings on our senior secured bonds, we could experience a negative impact on our cash flow and financial condition.

 

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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 receivable 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.

 

Recent and New Accounting Pronouncements

 

In July 2001, the Financial Accounting Standards Board  (“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 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 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 adoption of this standard did not have a material effect on the Company’s financial statements.

 

In May 2003, the FASB adopted SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of

 

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the first interim period beginning after June 15, 2003.  The adoption of this pronouncement will not have a material effect on our financial position, results of operations, or cash flows.

 

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 FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (“FIN No. 46”).  In October 2003, FASB Staff Position No. 46-6, “Effective Date of FIN No. 46, Consolidation of Variable Interest Entities” deferred the effective date of FIN No. 46 for variable interests held by a public entity in a variable interest entity (“VIE”) that was created or acquired before February 1, 2003 to the end of the first interim or annual period ending after December 15, 2003.  In December 2003, FASB issued FIN 46 (revised December 2003), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (“FIN 46(r)”), which clarified some requirements and incorporated several staff positions that the Company was already required to apply.  In addition, FIN 46(r) deferred the effective date for VIEs that were created or acquired before February 1, 2003 and were not considered special purpose entities (“SPEs”) prior to the issuance of the interpretation until the end of the first reporting period ending after March 15, 2004.  FIN 46(r) defines a VIE as (i) any entity in which the equity investors at risk in such entity do not have the characteristics of a controlling financial interest, or (ii) any entity that does not have sufficient equity at risk to finance its activities without additional subordinated financial support from other parties.  It requires the consolidation of the VIE by the primary beneficiary.  The adoption of FIN 46(r) requires the Company to include disclosures for non SPE VIEs created or acquired on or after February 1, 2003 in its condensed consolidated financial statements related to the total assets and the maximum exposure to loss resulting from the Company’s interests in VIEs.  The adoption of FIN 46(r) for VIEs created or acquired prior to February 1, 2003 that were considered SPEs prior to the issuance of the interpretation did not have a significant impact on the Company’s consolidated financial statements.  The Company has assessed the impact of the provisions of FIN 46(r) on its consolidated financial statements for VIEs created or acquired prior to February 1, 2003 that were not considered SPEs prior to the issuance of the interpretation, and does not believe that the impact will be material.

 

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. Amounts that are in dispute are reserved for accordingly, based on the probability that they will be realized.

 

Property, Plant and Equipment —  Property, plant and equipment is recorded at cost and is depreciated, after consideration for salvage value, 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:

 

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Description of Asset		Depreciable Life		December 31, 2003 ($000’s)
Buildings		35		$	1,767
Vehicles		5		112
Computers		6		772
Furniture and Fixtures		10		515
Combustion Turbine Generator Parts		9-36		45,367
Gas Heaters		35		1,119
Spare Parts Inventory		—		12,751
Plant		35		362,390
				$	424,793

 

Commitments and Contingencies– The Company had 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.  On November 4, 2003, the Company and Williams Energy settled this dispute.  The Company is also disputing $802,000 of merchant price, testing gas and other charges with Williams Energy that the Company contends is owed from Williams. This was not part of the above arbitration.

 

The Company’s facility was initially designed, engineered, procured and constructed for us by Washington Group International, Inc. (“WGI”) (as the successor contractor) on a fixed-price, turnkey basis. On May 14, 2001, WGI filed a plan of reorganization along with voluntary petitions to restructure under Chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the District of Nevada in Reno (the “Bankruptcy Court”). As a result of WGI’s bankruptcy filing, on June 20, 2001 we made a demand on the Raytheon Company (“Raytheon”) to perform its obligations under a guarantee which Raytheon had given us of WGI’s performance obligations under the construction agreement and Raytheon became responsible for the construction of our facility.  As discussed above, 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 demonstrate compliance 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.

 

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

We issued and have outstanding two series of bonds, registered under the Securities Act of 1933.  As of December 31, 2003, the aggregate outstanding principal amount of these bonds was $375.4 million.  We are not subject to interest rate risk as the interest rates associated with our outstanding indebtedness are fixed over the life of the bonds.

 

We currently have no other financial or derivative financial instruments. We do not believe that we face other material market risks requiring disclosure pursuant to Item 305 of Regulation S-K.

 

During 2003 the PJM market, into which our facility’s generation is distributed, experienced a general decline in the amount paid for electricity. This, in combination with a marked increase in the cost of natural gas, was a major factor in Williams’ decision to dispatch our facility on a very limited basis. Based upon current market conditions and projections from Williams, we anticipate a comparable dispatch level in 2004.  In the event that these market conditions do not improve, and Williams does not dispatch our facility at all in 2004, we believe that the

 

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fixed capacity payments are sufficient to meet the cash demands of our business, but we require the additional revenue from such fuel conversion services to be profitable.

 

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ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

 

AES Red Oak L.L.C. and Subsidiary
(An Indirect, Wholly Owned
Subsidiary Of The AES Corporation)

 

Index To Consolidated Financial Statements

 

Independent Auditors’ Report

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Changes in Member’s Capital

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

 

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INDEPENDENT AUDITORS’ REPORT

 

To the Member of
AES Red Oak, L.L.C. and Subsidiary:

 

We have audited the accompanying balance sheets of AES Red Oak, L.L.C. (an indirect wholly owned subsidiary of The AES Corporation) (the “Company”) as of December 31, 2003 and 2002 and the related statements of operations, changes in member’s capital and cash flows for the years ended December 31, 2003, 2002 and 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such financial statements present fairly, in all material respects, the financial position of AES Red Oak,  L.L.C., as of December 31, 2003 and 2002, and the results of its operations and its cash flows for the years ended December 31, 2003, 2002 and 2001, in conformity with accounting principles generally accepted in the United States of America.

 

As more fully discussed in Note 7, the Company’s dependence upon Williams Energy Marketing & Trading Company under the Power Purchase Agreement exposes the Company to possible loss of revenues and fuel supply. There can be no assurances as to the Company’s ability to generate sufficient cash flow to cover operating expenses or debt service obligations in the absence of a Power Purchase Agreement with Williams Energy Marketing & Trading Company and related guaranty by The Williams Companies, Inc. or their affiliates.

 

 

Deloitte & Touche LLP
McLean, Virginia
March 15, 2004

 

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AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION

 

Consolidated Balance Sheets,
December 31, 2003 and 2002
(dollars in thousands, except share amounts)

 

		2003			2002
ASSETS:
Current Assets:
Cash		$	38		$	23
Restricted cash at cost, which approximates market value		34,837			7,749
Receivables		4,070			8,442
Receivable from affiliate		51			309
Prepaid and other expenses		628			230
Total current assets		39,624			16,753
Land		4,240			4,240
Property, plant, and equipment – net of accumulated depreciation of $15,830 and $4,438, respectively		408,963			417,659
Deferred financing costs – net of accumulated amortization of $3,128 and $2,315, respectively		15,577			16,390
Other assets		219			141
Total assets		$	468,623		$	455,183
LIABILITIES AND MEMBER’S EQUITY
Current Liabilities:
Accounts payable		$	398		$	1,175
Accrued liabilities		956			1,516
Accrued interest		2,759			2,804
Liabilities under spare parts agreement – current portion		4,520			—
Payable to affiliate		131			18
Bond payable-current portion		5,230			6,219
Other current liabilities		35,000			10,000
Total current liabilities		48,994			21,732
Bonds payable		370,132			375,361
Liabilities under spare parts agreement and other		2,017			9,325
Total liabilities		$	421,143		$	406,418
Commitments and Contingencies (Note 8)
Member’s equity:
Common stock, $1 par value-10 shares authorized, none issued or outstanding		$	—		$	—
Contributed capital		56,775			56,736
Member’s deficit		(9,295		)	(7,971		)
Total member’s equity		47,480			48,765
Total liabilities and member’s equity		$	468,623		$	455,183

 

See notes to consolidated financial statements.

 

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AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION

 

Consolidated Statements of Operations,
years ended December 31, 2003,  2002 and  2001

(dollars in thousands)

 

		Year Ended December 31, 2003			Year Ended December 31, 2002			Year Ended December 31, 2001
OPERATING REVENUES
Energy		$	64,206		$	26,244		$	—
OPERATING EXPENSES
Fuel costs		906			6,898			—
Fuel conversion volume rebate		5,793			1,645			—
Corporate management fees		1,608			594			—
Other operating expenses		7,207			1,990			—
Depreciation expense		11,392			4,438			—
General administrative costs		4,002			1,237			68
Total operating expenses		30,908			16,802			68
Operating income (loss)		$	33,298		$	9,442		$	(68	)
OTHER INCOME (EXPENSE)
Interest income		$	495		$	125		$	1,655
Other income- interim rebates		1,427			957			—
Liquidated damages received		—			1,810			—
Interest expense		(34,232		)	(13,163		)	(3,592		)
Other expense - letter of credit fees		(1,013		)	(379		)	—
Liquidated damages paid		(249		)	(1,810		)	—
Total other income (expense)		(33,572		)	(12,460		)	(1,937		)
NET LOSS		$	(274	)	$	(3,018	)	$	(2,005	)

 

See notes to consolidated financial statements.

 

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AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION

 

Consolidated Statements of Changes in Member’s Capital,
years ended December 31, 2003,  2002 and  2001
(dollars in thousands)

 

		Common Stock					Contributed			Member’s			Member’s
		Shares		Amount			Capital			Deficit			Equity
BALANCE, DECEMBER 31, 2000		—		$	—		$			$	(948	)	$	(948	)
Contributed capital		—		—			986			—			986
Net loss		—		—			—			(2,005		)	(2,005		)
BALANCE, DECEMBER 31, 2001		—		$	—		$	986		$	(2,953	)	$	(1,967	)
Contributed capital		—		—			55,750			—			55,750
Dividends		—		—			—			(2,000		)	(2,000		)
Net loss		—		—			—			(3,018		)	(3,018		)
BALANCE, DECEMBER 31, 2002		—		$	—		$	56,736		$	(7,971	)	$	48,765
Contributed capital		—		—			39			—			39
Dividends		—		—			—			(1,050		)	(1,050		)
Net loss		—		—			—			(274		)	(274		)
BALANCE, DECEMBER 31, 2003		—		$	—		$	56,775		$	(9,295	)	$	47,480

 

See notes to consolidated financial statements.

 

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AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION

 

Consolidated Statements of Cash Flows, for the years
ended December 31, 2003,  2002 and  2001
(dollars in thousands)

 

		Year Ended December 31, 2003			Year Ended December 31, 2002			Year Ended December 31, 2001
OPERATING ACTIVITIES:
Net loss		$	(274	)	$	(3,018	)	$	(2,005	)
Amortization of deferred financing costs		813			853			816
Depreciation		11,392			4,438			—
Change in:
Accounts receivable – trade		4,372			(8,442		)	21
Receivable from affiliate		258			(184		)	(125		)
Prepaid expenses		(398		)	(230		)	—
Other assets		(78		)	(141		)	—
Accrued interest		(45		)	(17		)	—
Accrued liabilities		(560		)	1,454			(28		)
Payable to affiliate		113			(64		)	(2,423		)
Accounts payable		(777		)	293			578
Net cash provided by (used in) operating activities		$	14,816		$	(5,058	)	$	(3,166	)
INVESTING ACTIVITIES:
Payments for capital additions		(2,696		)	(24,029		)	(42,926		)
Payments under long term spare parts agreement		(2,788		)	(1,175		)	—
Change in:
Retention payable		—			(29,478		)	29,478
Restricted cash		(27,088		)	(1,688		)	15,734
Net cash (used in) provided by investing activities		$	(32,572	)	$	(56,370	)	$	2,286
FINANCING ACTIVITIES:
Payment of principal on bonds payable		(6,218		)	(2,420		)	—
Contribution from parent		39			55,750			986
Security proceeds from Williams under PPA		25,000			10,000			—
Dividends paid to parent		(1,050		)	(2,000		)	—
Net cash provided by financing activities		$	17,771		$	61,330		$	986
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		$	15		$	(98	)	$	106
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		$	23		$	121		$	15
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	38		$	23		$	121
SUPPLEMENTAL DISCLOSURE OF OTHER ACTIVITIES:
Interest paid (net of amounts capitalized)		$	33,537		$	8,437		$	—
Transfer of prepaid construction costs to construction in progress		$	—		$	—		$	31,840
Receipt of spare parts under long-term service agreement		$	289		$	10,500		$	—
Transfer of construction in progress to property, plant and equipment		$	344		$	411,597		$	—

 

See notes to consolidated financial statements.

 

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AES RED OAK L.L.C. AND SUBSIDIARY
AN INDIRECT WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001

 

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 6). 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”).  The term of the Power Purchase Agreement 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 took the position that the Facility was commercially available on September 1, 2002.  Williams Energy disputed the September 1, 2002, commercial operation date and informed the Company that it recognized commercial availability of the facility as of September 28, 2002.  On November 4, 2003, a settlement was reached and a commercial operation date of September 28, 2002 was agreed upon (see Note 7 ).

 

After the Facility reached provisional acceptance, the Company elected to confirm reliability for up to 19 days before binding with Williams Energy. As more fully described in Notes 3 and 7, 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. (see Note 9). 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 (see Note 6), Red Oak agreed to contribute up to approximately $56.7 million to the Company to fund construction after the bond proceeds have been fully utilized. As of December 31, 2002, all $56.7 million had been contributed, including the reclassification of a $986,000 payable to an affiliate (AES Corporation) to contributed capital in February 2001. This amount represented expenditures paid by the AES Corporation prior to March 15, 2000.

 

 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-K.

 

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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.

 

2.              OPERATIONS

 

During 2002, as further discussed in Note 7, the credit ratings of the long-term senior unsecured debt of The Williams Companies, Inc. were downgraded to below investment grade.  Since achieving commercial operations, under the Power Purchase Agreement with Williams Energy, the Company is 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 September 28, 2002, Williams Energy has not requested that the Company run the facility or “dispatch” the facility to a significant degree, outside the peak summer months. The minimum capacity payments provided for under the Power Purchase Agreement have been our primary source of operating revenues, representing $62.0 million of our total revenues of $64.2 million for the twelve months ended December 31, 2003.  The Company has used these operating revenues, together with interim rebates received from Raytheon under the construction agreement, interest income from the investment portion of the proceeds from the sale of the senior secured bonds and the $10 million Prepayment from Williams (Note 7) to fund its generation expenses, other operations and maintenance expenses and debt service costs.  As discussed in Note 7, in the event that The Williams  Companies, Inc. regains and maintains its investment grade status, Williams Energy 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 provided by Williams Energy in accordance with the terms of the Letter Agreement.

 

The Company currently anticipates being dispatched by Williams Energy beginning in April 2004 but can provide no assurance that this will occur.  In the event that the facility is not dispatched, the Company’s operating revenues will consist of minimum capacity payments under the Power Purchase Agreement.  The Company has also provided two letters of credit, the Power Purchase Agreement Letter of Credit ($10 million) and the debt service reserve letter of credit ($22 million) (Notes 6 and 7) that may be utilized if necessary to fund obligations as they become due.   In the event the Company regains its investment grade status, the Company will also have access to its $2.5 million working capital agreement (Note 6).

 

The Company currently believes that its sources of liquidity will be adequate to meet its needs through the end of 2004.  This belief is based on a number of assumptions, including but not limited to the continued performance and satisfactory financial condition of the third parties on which the Company depends, particularly Williams Energy as fuel supplier and purchaser of all electric energy and capacity produced by the facility as well as ancillary and fuel conversion services of the Company (as provided by  the Power Purchase Agreement) and The Williams Companies, Inc. as guarantor of Williams Energy’s performance under the Power Purchase Agreement.  Known and unknown risks, uncertainties and other factors outside the Company’s control may cause actual results to differ materially from its current expectations.  These risks, uncertainties and factors include but are not limited to risks and uncertainties related to the financial condition and continued performance of the third parties on which the Company depends, including Williams Energy and The Williams Companies and its affiliates, the possibility that the facility will not be dispatched to a significant degree, delays in or disputes over the completion of the facility, the possibility of unexpected problems related to the performance of the facility, the possibility of unexpected expenses or lower than expected revenues and additional factors that are unknown to the Company or beyond its control.

 

Since the Company depends 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 the Company’s cash flow and financial condition which could result in a default on its senior secured bonds.  Due to recent declines in pool prices, the Company would expect that if it were required to seek alternative purchasers of its power as a result of a default by Williams Energy that any such alternate revenues would be substantially below the amounts that would have been otherwise payable pursuant to the Power Purchase

 

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Agreement.  There can be no assurance 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.

 

3.              SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation - The consolidated financial statements include the accounts of the Company and AES URC, its wholly owned subsidiary. All intercompany transactions and balances have been eliminated in consolidation.

 

Cash and Cash Equivalents - The Company considers unrestricted cash on hand, deposits in banks, and investments with original maturities of three months or less to be cash and cash equivalents for the purpose of the statement of cash flows.

 

Restricted Cash and Investments - The Company is prohibited from making any distributions unless it has required minimum balances in certain accounts and has met certain other conditions contained in the Indenture and the Collateral Agency and Intercreditor Agreement governing the senior secured bonds. These minimum balances totaled $3.3 million at December 31, 2003. The $31.5 million balance of restricted cash consists of cash to be used to repay the Alternative Credit Support amount owed to Williams (See Note 7 - Power Purchase Agreement).  The Company had the required minimum balances and had met the required conditions when it made distributions of $1.05 million and $2.0 million to AES Red Oak, Inc. on December 31, 2003 and 2002, respectively.

 

Property, Plant and Equipment — Property, plant and equipment is recorded at cost.  Depreciation, after consideration of salvage value, is computed using the straight-line method over the estimated useful lives of the assets, which range from five to thirty-six years.  Maintenance and repairs are charged to expense as incurred.  The depreciable lives of our property, plant and equipment by category are as follows:

 

Description of Asset		Depreciable Life		December 31, 2003 (in thousands)
Buildings		35		$	1,767
Vehicles		5		112
Computers		6		772
Furniture and Fixtures		10		515
Combustion Turbine Generator Parts		9-36		45,367
Gas Heaters		35		1,119
Spare Parts Inventory		—		12,751
Plant		35		362,390
				$	424,793

 

Deferred Financing Costs - Financing costs are deferred and are being amortized using the straight-line method over the life of the bonds, which does not differ materially from the effective interest method of amortization.

 

Revenue Recognition —  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, revenues are generated 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

 

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agreements.  Due to recent declines in pool prices, however, the Company would expect that even being successful in finding alternate revenue sources, any such alternate revenues would be substantially below the amounts that would have been otherwise earned pursuant to the Power Purchase Agreement.

 

After the plant reached provisional acceptance, the Company elected to confirm reliability for up to 19 days before binding with Williams Energy.  Beginning August 13, 2002 (the date of risk transfer) through August 31, 2002, the Company operated the facility as a merchant plant and sold electric revenues to Williams Energy, in its capacity as our 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 recognized merchant revenues of approximately $11.1 million and fuel expenses of approximately $6.9 million for the year ended December 31, 2002.  These amounts are included within energy revenues and operating costs in the accompanying condensed consolidated statements of operations for the year ended December 31, 2002. Since September 28, 2002, Williams Energy has not requested that the Company run the facility or “dispatch” the facility to a significant degree. The minimum capacity payments provided for under the Power Purchase Agreement have been our primary source of operating revenues, representing $62.0 million of our total revenues of $64.2 million for the twelve months ended December 31, 2003.

 

Reclassifications – Certain reclassifications have been made to 2002 amounts to conform to the 2003 presentation.

 

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Income Taxes - The Company is a limited liability company and is treated as a disregarded entity for tax purposes. Therefore, it does not pay income taxes, and no provision for income taxes has been reflected in the accompanying financial statements.

 

Start-Up Costs - The Company follows AICPA Statement of Position (SOP) 98-5, Reporting on the Costs of Start-Up Activities, which requires that start-up and organizational costs be expensed as incurred. As such, no costs to which SOP 98-5 applies have been capitalized in the accompanying balance sheets.

 

Spare Parts Inventory – Spare parts inventory consists of rotable and other spare parts, primarily covered under the Maintenance Services Agreement discussed in Note 8.  Inventory is reported at cost and is included in Property, Plant and Equipment.  The liability for these spare parts is reflected as current and long-term liabilities in the accompanying balance sheets.

 

Recent Accounting Pronouncements - In July 2001, the Financial Accounting Standards Board  (“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 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

 

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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 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.

 

4.              CONCENTRATION OF CREDIT RISK IN WILLIAMS ENERGY AND ITS 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, and may result in a default on the Company’s debt.  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 our senior secured bonds during the applicable semiannual period (see Note 7).

 

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.              NEW ACCOUNTING PRONOUNCEMENTS

 

In January 2003, the Financial Accounting Standards Board  (“FASB”) issued FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (“FIN No. 46”).  In October 2003, FASB Staff Position No. 46-6, “Effective Date of FIN No. 46, Consolidation of Variable Interest Entities” deferred the effective date of FIN No. 46 for variable interests held by a public entity in a variable interest entity (“VIE”) that was created or acquired before February 1, 2003 to the end of the first interim or annual period ending after December 15, 2003.  In December 2003, FASB issued FIN 46 (revised December 2003), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (“FIN 46(r)”), which clarified some requirements and incorporated several staff positions that the Company was already required to apply.  In addition, FIN 46(r) deferred the effective date for VIEs that were created or acquired before February 1, 2003 and were not considered special purpose entities (“SPEs”) prior to the issuance of the interpretation until the end of the first reporting period ending after March 15, 2004.  FIN 46(r) defines a VIE as (i) any entity in which the equity investors at risk in such entity do not have the characteristics of a controlling financial interest, or (ii) any entity that does not have sufficient equity at risk to finance its activities without additional subordinated financial support from other parties.  It requires the consolidation of the VIE by the primary beneficiary.  The adoption of FIN 46(r) requires the Company to include disclosures for non SPE VIEs created or acquired on or after February 1, 2003 in its condensed consolidated financial statements related to the total assets and the maximum exposure to loss resulting from the Company’s

 

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interests in VIEs.  The adoption of FIN 46(r) for VIEs created or acquired prior to February 1, 2003 that were considered SPEs prior to the issuance of the interpretation did not have a significant impact on the Company’s consolidated financial statements.  The Company has assessed the impact of the provisions of FIN 46(r) on its consolidated financial statements for VIEs created or acquired prior to February 1, 2003 that were not considered SPEs prior to the issuance of the interpretation, and does not believe that the impact will be material.

 

In April 2003, the FASB issued Statement No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”  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 adoption of this standard did not have a material effect on the Company’s financial statements.

 

In May 2003, the FASB adopted SFAS No. 150, “Accounting for Certain Financial Instruments with characteristics of both Liabilities and Equity”.  This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  The adoption of this pronouncement will not have a material effect on our financial position, results of operations, or cash flows.

 

6.              BONDS PAYABLE

 

On March 15, 2000, the Company issued $224 million of 8.54% senior secured bonds due 2019 (“2019 Bonds”) and $160 million of 9.20% senior secured bonds due 2029 (2029 Bonds and together with the 2019 Bonds, the “Bonds”) to qualified institutional buyers and/or institutional accredited investors, pursuant to a transaction exempt from registration under the Securities and Exchange Act of 1933 (the Act) in accordance with Rule 144A of the Act. In late September 2000, the Company consummated an exchange offer whereby the holders of the Bonds exchanged their privately placed bonds for registered bonds. The net proceeds of the bonds (after deferred financing costs), approximately $365 million, were used to prepay WGI and other construction costs of the Plant and were also used, during the construction period, for interest payments to bondholders.

 

Future Maturities of Debt - Principal on the Bonds is payable quarterly in arrears.  Principal payments on the 2019 Bonds commenced on August 31, 2002. Quarterly principal repayment of the 2029 Bonds does not commence until February 28, 2019.  The final maturity date for the Bonds is November 30, 2019 and November 30, 2029, respectively.

 

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Interest & Principal Repayment Schedule:

 

 

Year		Interest			Principal
		(in thousands)
2004		$	33,113		$	5,230
2005		32,579			5,071
2006		32,111			7,101
2007		31,502			6,105
2008		31,020			8,122
2009 and thereafter		317,561			343,733
Total Payments		$	477,886		$	375,362

 

Optional Redemption - The Bonds are subject to optional redemption by the Company, in whole or in part, at any time at a redemption price equal to 100% of the principal amount plus accrued interest, together with a premium calculated using a discount rate equal to the interest rate on comparable U.S. Treasury securities plus 50 basis points.

 

Mandatory Redemption - The Bonds are subject to mandatory redemption by the Company, in whole or in part, at a redemption price equivalent to 100% of the principal amount plus accrued interest under certain situations pursuant to receiving insurance proceeds, eminent domain proceeds, liquidated damages under the construction agreement, or in certain instances in which payments are received under the Power Purchase Agreement if the Company terminates the Power Purchase Agreement as a result of a default by Williams.

 

Indenture - The Trust Indenture Agency (the Indenture) contains limitations on the Company incurring additional indebtedness, granting liens on the Company’s property, distributing equity and paying subordinated indebtedness issued by affiliates of the Company, entering into transactions with affiliates, amending, terminating or assigning any of the Company’s contracts and fundamental changes or disposition of assets.

 

Collateral for the Bonds consists of the Facility and related entities, all agreements relating to the operation of the project, the bank and investment accounts of the Company, and all ownership interests in the Company, as prescribed under the Indenture. The Company is also bound by a collateral agency agreement (the Collateral Agency Agreement) and an equity subscription agreement (the Equity Subscription Agreement).

 

Collateral Agency Agreement - The Collateral Agency Agreement requires the Company to fund or provide the funding or a letter of credit for a debt service reserve fund. The debt service reserve fund letter of credit was posted at financial closing in the amount of $22 million dollars. The amount required for funding the debt service reserve fund is equal to six months scheduled payments of principal and interest on the bonds.

 

Equity Subscription Agreement - The Company, along with Red Oak, entered into an Equity Subscription Agreement, pursuant to which Red Oak agreed to contribute up to approximately $56.7 million to the Company to fund project costs. As of December 31, 2002, Red Oak had contributed the entire $56.7 million to the Company, including the reclassification of a $986,000 payable to an affiliate (AES Corporation) to contributed capital in February 2001. The equity that Red Oak provided to the Company was provided by AES. The Company does not have access to additional liquidity pursuant to this agreement as Red Oak has fulfilled its funding obligations thereunder.

 

Covenants - The Indenture, Collateral Agency Agreement and Equity Subscription Agreement, contain specific covenants and requirements to be met by the Company.

 

Bond Ratings and Effect on Working Capital Agreement.  In connection with the initial financing of the Facility, the Company entered into a working capital agreement pursuant to which it could borrow up to $2.5 million from time to time for use in connection with the payment of operating and maintenance costs of the project.  The obligation of the banks that are party to the working capital agreement to extend loans to the Company under the working capital agreement is subject to, among others, the following conditions precedent:

 

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•                                          The Company’s senior secured bonds must be rated “BBB-”or higher by S&P and “Baa3” or higher by Moody’s;

 

•                                          no default or event of default under the working capital agreement shall have occurred and be continuing; and

 

•                                          no event has occurred and is continuing which could reasonably be expected to have a material adverse effect on the Company.

 

In an action related to the ratings downgrade of The Williams Companies, Inc and current market conditions. S&P lowered its ratings on the Company’s senior secured bonds to “B+” on December 10, 2003.  On November 11, 2002, Moody’s had lowered the ratings to “B2” with a negative outlook.   As a result of the Company’s senior secured bonds having a rating lower than “BBB-” by S&P and lower than “Baa3” by Moody’s, funds currently are not available to the Company under the working capital agreement and will not be available unless the ratings of the senior secured bonds of the Company satisfy the condition precedent contained in the working capital agreement.  Further, as a result of the bond ratings downgrades the Company must pay higher fees for draws on its project support agreements.  There can be no assurance that the ratings on the senior secured bonds of the Company will be increased or that the lenders will waive any of the conditions precedent set forth in the working capital agreement.

 

7.              POWER PURCHASE AGREEMENT

 

General.  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 Power Purchase Agreement, 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 Power Purchase Agreement is 20 years from the first contract anniversary date, which is the last day of the month in which commercial availability occurs.  As part of the arbitration settlement with Williams Energy, described below, the Company recognizes September 28, 2002 as the commercial availability date.

 

Under the Power Purchase Agreement, the commercial operation date was required to occur by December 31, 2001, however the Company had the right to extend the commercial operation date until June 30, 2002 by invoking its right to a free extension option which was available under the Power Purchase Agreement if certain conditions were met.  The Company exercised its right to extend the commercial operation date from December 31, 2001 to June 30, 2002, as granted under the free extension option. In addition, the Company had the right under the Power Purchase Agreement to again extend the commercial operation date (the Second Paid Extension Option) from June 30, 2002 to June 30, 2003, upon written notification to Williams Energy no later than May 21, 2002 (which represented an agreed upon extension from the original April 30, 2002 notification deadline), by paying Williams Energy (i) an amount equal to the lesser of any actual damages Williams Energy suffered or incurred after June 30, 2002, as a result of Williams Energy’s reliance upon delivery by such date, to the extent said damages cannot be mitigated fully, or $3.0 million and (ii) certain amount of liquidated damages as calculated pursuant to the Power Purchase Agreement.  On May  21, 2002, the Company exercised the Second Paid Extension Option.  As of December 31, 2002, the Company had paid liquidated damages to Williams Energy at the rate of $11,000 per day for the period beginning on July 1, 2002 and ending on August 31, 2002 which in aggregate amounted to $682,000.  The Company had also paid liquidated damages to Williams Energy at the rate of $22,000 per day for the period beginning on September 1, 2002, and ending on September 27, 2002 which in aggregate amounted to $594,000.  During the period of the Second Paid Extension Option, the Company continued to collect liquidated damages through August 10, 2002 from Raytheon under the construction agreement in the amount of $108,000 per day.  As of December 31, 2003, the Company had received $14 million in liquidated damages from Raytheon under the construction agreement.

 

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The Company 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 related to disputed amounts of approximately $7.6 million, which included a $594,000 payment extension option dispute and a $7.0 million commercial operation start date dispute. On November 4, 2003, the Company and Williams Energy settled this dispute.  Under the settlement, Williams made a cash payment to us of $4,050,153 on November 14, 2003, which included $225,055 of interest from October 2002 to the payment date, and the commercial operation date was agreed to be September 28, 2002. The related revenue had been substantially recorded in September 2002, with the remaining amount recorded in the fourth quarter of 2003.   This payment settles all payment obligations between the parties for the month of September 2002 with respect to the commercial operation date under the Power Purchase Agreement.  From the Company’s perspective, the cash payment has the economic effect of recognizing a commercial operation date prior to September 28, 2002. The Company is also disputing $802,000 of merchant price, testing gas and other charges with Williams Energy that the Company contends is owed by Williams Energy. This was not part of the above arbitration.

 

Guaranties.  The Company provided Williams Energy a letter of credit (Power Purchase Agreement Letter of Credit) in the amount of $30 million to support specific payment obligations should the Facility not achieve commercial operation by the date required under the Power Purchase Agreement. Upon the commencement of commercial operations in September 2002, the stated amount of that letter of credit was reduced to $10 million. The repayment obligations with respect to any drawings under the Power Purchase Agreement Letter of Credit are a senior debt obligation of the Company.

 

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 our senior secured bonds during the applicable semiannual period.

 

Pursuant to Section 18.3 of the Power Purchase Agreement, in the event that Standard & Poors 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.  On May 23, 2003 S&P upgraded the rating to B+ with a negative outlook. On July 24, 2002, Moody’s lowered the long-term senior unsecured debt rating of The Williams Companies, Inc. “B1” from “Baa3.”  According to published sources, this rating was further lowered on November 22, 2002 to “Caa1” by Moody’s, but then upgraded to B3 on June 4, 2003. 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 provide the Company (a) a prepayment of $10 million within five business days after execution of the Letter Agreement (the “Prepayment”); (b) 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 Power Purchase Agreement 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

 

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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 either now or in the future or any other terms set forth in the Letter Agreement, was 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 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 the 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 and or all of its contractual rights and remedies as set forth in the Power Purchase Agreement, including, but not limited to, drawing 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.

 

8.              COMMITMENTS AND CONTINGENCIES

 

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.

 

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 December 31, 2003, Raytheon had provided a letter of credit of approximately $30.3 million.  The Company may draw on this letter of credit in the event that Raytheon

 

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fails to pay us any amount owed to us under the construction agreement.  As of December 31, 2003 and December 31, 2002, the Company had drawn $544,000 and $96,000 on this letter of credit, respectively, for interim rebates which Raytheon then resumed paying until their notice of Final Acceptance described below.

 

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 demonstrate compliance 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 December 31, 2003, the Company has received approximately $10.8 million in rotable spare parts under this agreement.  This amount is recorded as spare parts inventory, or as Property, Plant and Equipment when placed in service, and the remaining amount owed as current and long-term liabilities in the accompanying balance sheets.  The fees assessed by Siemens Westinghouse are based on the number of Equivalent Base Load Hours accumulated by the applicable Combustion Turbine as adjusted for inflation.  For financial reporting purposes the payments made to Siemens Westinghouse are treated as a reduction of the liabilities under the spare-parts agreement in the accompanying balance sheet, except for the portion that is considered maintenance expense when a scheduled outage occurs.

 

The maintenance services agreement became effective on the date of execution and unless terminated early, will terminate upon completion of shop repairs performed by Siemens Westinghouse following the twelfth scheduled outage of the applicable combustion turbine or sixteen years from the date of execution, whichever occurs first, unless the Company exercises its right to terminate the agreement after the first major outage of the turbines, which will be approximately the eighth year of operation of the facility.

 

Additionally, a significant monthly expenditure for payment of the Company’s long term service agreement with Siemens Westinghouse may be required, depending upon equivalent base hours. This agreement provides that the Company pay approximately $346 per gas turbine per equivalent base hour, with a true-up clause should an inspection outage be required based upon the number of equivalent starts. In the event the Company is not required to dispatch the facility, there is no charge for that month.

 

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.

 

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 Power Purchase Agreement. 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

 

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Federal Energy Regulatory Committee. 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 provided all labor, supervision, materials and equipment necessary to perform the interconnection installation. The cost of these interconnection facilities was approximately $5.1 million.

 

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 Facility 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 December 31, 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.

 

9.              RELATED PARTY TRANSACTIONS

 

Effective March 2000, the Company entered into a 32-year development and construction management agreement with AES Sayreville, L.L.C. (“Sayreville”), another wholly owned subsidiary of Red Oak, to provide certain support services required by the Company for the development and construction of the Facility. Under this agreement Sayreville has also provided operations management services for the Plant since the commencement of commercial operation. Minimum amounts payable under the contract during 2003 were $133,000 per month. Since commercial operation was achieved, payments for operations management services have been approximately $399,000 per quarter.

 

During the construction period, the construction management fees have been paid to Sayreville from the investment balances or from equity funding. For the years ended December 31, 2002 and 2001, $1 million, $1.5 million, in construction management fees were incurred and charged to construction in progress, respectively.  AES will continue to supply Sayreville with the personnel, operational and maintenance services necessary to carry out its obligations to the Company.

 

The Company had accounts receivable from affiliates of $51,000 and $309,000 as of December 31, 2003 and 2002, respectively.  The Company had accounts payable to its parent and affiliates of $131,000 and $18,000 as of December 31, 2003 and 2002, respectively.  Accounts receivable from affiliates generally represents charges for certain projects that the Company has paid for and invoiced to its affiliates.  Accounts payable to parent and affiliates represent general amounts owed to the Company’s parent and affiliates for shared services.

 

10.       FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The estimated fair values of the Company’s financial instruments have been determined using available market information. The estimates are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

 

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The fair value of the Company’s restricted investments approximates their carrying value. The Bonds had a carrying amount of $375.4 million and $381.6 million at December 31, 2003 and 2002, respectively.  The Bonds had a fair value of approximately $399 million and $261 million, respectively, at December 31, 2003 and 2002.

 

11.       SEGMENT INFORMATION

 

Under the provisions of Statement of Financial Accounting Standards No. 131, “Disclosure About Segments of an Enterprise and Related Information”, the Company’s business is expected to be operated as one reportable segment, with operating income or loss being the measure of performance evaluated by the chief operating decision maker. As described in Notes 1 and 6, the Company’s primary customer is Williams, which is expected to provide all of the revenues of the Company during the term of the Power Purchase Agreement.

 

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SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

 

The following table summarizes the unaudited quarterly statements of operations for the Company for 2001-2003.

 

		AES Red Oak, LLC
		Quarter Ended December 31, 2003			Quarter Ended September 30, 2003			Quarter Ended June 30, 2003			Quarter Ended March 31, 2003
		(dollars in thousands)
OPERATING REVENUES
Energy		$	11,639		$	25,799		$	15,747		$	11,021
OPERATING EXPENSES
Operating expenses		(5,976		)	(7,549		)	(6,689		)	(6,692		)
General and administrative costs		(1,047		)	(1,025		)	(977		)	(953		)
Total Operating Expense		(7,023		)	(8,574		)	(7,666		)	(7,645		)
OPERATING INCOME		4,616			17,225			8,081			3,376
OTHER INCOME/EXPENSE
Interest income		294			57			67			77
Interest expense		(8,551		)	(8,575		)	(8,492		)	(8,614		)
Liquated damages received		12			202			610			603
Other expense		(252		)	(255		)	(255		)	(251		)
Liquated damages paid		(249		)	—			—			—
Total Other Income/Expenses		(8,746		)	(8,571		)	(8,070		)	(8,185		)
NET INCOME (LOSS)		$	(4,130	)	$	8,654		$	11		$	(4,809	)

 

		AES Red Oak, LLC
		Quarter Ended December 31, 2002			Quarter Ended September 30, 2002			Quarter Ended June 30, 2002			Quarter Ended March 31, 2002
		(dollars in thousands)
OPERATING REVENUES
Energy		$	11,184		$	15,060		$	—		$	—
OPERATING EXPENSES
Operating expenses		(6,148		)	(9,417		)	—			—
General and administrative costs		(406		)	(675		)	(134		)	(22		)
Total Operating Expense		(6,554		)	(10,092		)	(134		)	(22		)
OPERATING INCOME		4,630			4,968			(134		)	(22		)
OTHER INCOME/EXPENSE
Interest income		30			34			36			25
Interest expense		(8,589		)	(4,310		)	(183		)	(81		)
Other income		618			339			—			—
Liquated damages received		1,810			—			—			—
Other expense		(379		)	—			—			—
Liquated damages paid		(1,810		)	—			—			—
Total Other Income/Expenses		(8,320		)	(3,937		)	(147		)	(56		)
NET INCOME (LOSS)		$	(3,690	)	$	1,031		$	(281	)	$	(78	)

 

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		AES Red Oak, LLC
		Quarter Ended December 31, 2001			Quarter Ended September 30, 2001			Quarter Ended June 30, 2001			Quarter Ended March 31, 2001
		(dollars in thousands)
OPERATING REVENUES
Energy		$	—		$	—		$	—		$	—
OPERATING EXPENSES
Operating expenses		—			—			—			—
General and administrative costs		(11		)	(35		)	(13		)	(9		)
Total Operating Expense		(11		)	(35		)	(13		)	(9		)
OPERATING INCOME		(11		)	(35		)	(13		)	(9		)
OTHER INCOME/EXPENSE
Interest income		250			543			602			260
Interest expense		(688		)	(1,326		)	(1,226		)	(352		)
Other income		—			—			—			—
Other expense		—			—			—			—
Total Other Income/Expenses		(438		)	(783		)	(624		)	(92		)
NET INCOME (LOSS)		$	(449	)	$	(818	)	$	(637	)	$	(101	)

 

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ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

 

ITEM 9A.

CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures  Under the direction of our Chief Executive Officer and Chief Financial Officer, we evaluated our disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-15(e) and 15d – 15(e)) required by paragraph (b) of Exchange Act Rules 13a – 15 or 15d – 15, and concluded that our disclosure controls and procedures were effective as of December 31, 2003.

 

Changes in Internal Controls  Based on management’s evaluation that was conducted during the fourth fiscal quarter under the direction of our Chief Executive Officer and Chief Financial Officer, we determined that there was no change in internal control over financial reporting during the quarter ended December 31, 2003 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.

 

PART III

 

ITEM 10.

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

 

Not applicable pursuant to General Instruction I of Form 10-K.

 

ITEM 11.

EXECUTIVE COMPENSATION

 

Not applicable pursuant to General Instruction I of the Form 10-K.

 

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

Not applicable pursuant to General Instruction I of the Form 10-K.

 

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

Not applicable pursuant to General Instruction I of the Form 10-K.

 

ITEM 14.

PRINCIPAL ACCOUNTING FEES AND SERVICES

 

 

The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant’s annual financial statements and review of the financial statements included in the registrant’s Form 10Q (17CFR249.308a) or services that or normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years were approximately $219,000 and $140,000 for the years ended December 31, 2003 and 2002, respectively.

 

The registrant’s board of directors serves as its audit committee. All audit and non-audit services to be provided to the registrant by its principal accountant are approved by the board of directors. No pre-approval policies are in place.

 

There were no other fees paid to the principal accountant for the years ended December 31, 2003 and 2002, respectively.

 

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PART IV

 

ITEM 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

 

 

a)     The following documents are filed as part of this report:

 

1.                                       Consolidated Financial Statements Filed:
Please refer to Item 8 - Consolidated Financial Statement and Supplementary Data.

 

2.                                       Consolidated Financial Statement Schedules Filed:
Please refer to Item 8 - Consolidated Financial Statement and Supplementary Data.

 

3.                                       Exhibits Filed:

 

Unless otherwise indicated, all exhibits to this Form 10-K are incorporated herein by reference from the identically numbered exhibit of AES Red Oak, L.L.C.’s Registration Statement of Form S-4 (333-40478).

 

Exhibit Number		Description
3		Amended and Restated Limited Liability Company Agreement, dated as of November 23, 1999, of AES Red Oak, L.L.C.
4.1(a)		Trust Indenture, dated as of March 1, 2000, by and among AES Red Oak, L.L.C., the Trustee and the Depositary Bank.
4.1(b)		First Supplemental Indenture, dated as of March 1, 2000, by and among AES Red Oak, L.L.C., the Trustee and the Depositary Bank.
4.2		Collateral Agency and Intercreditor Agreement, dated as of March 1, 2000, by and among AES Red Oak, L.L.C., the Trustee, the Collateral Agent, the Debt Service Reserve Letter of Credit Provider, the Power Purchase Agreement Letter of Credit Provider, the Working Capital Provider and the Depositary Bank.
4.3		Debt Service Reserve Letter of Credit and Reimbursement Agreement, dated as of March 1, 2000, by and among AES Red Oak, L.L.C., the Debt Service Reserve Letter of Credit Provider and the Banks named therein.
4.4		Power Purchase Agreement Letter of Credit and Reimbursement Agreement, dated as of March 1, 2000, by and among AES Red Oak, L.L.C., the Power Purchase Agreement Letter of Credit Provider and the Banks named therein.
4.5		Global Bond, dated March 15, 2000, evidencing 8.54% Senior Secured Bonds of AES Red Oak, L.L.C., Series A due 2019 in the principal amount of $224,000,000.
4.6		Global Bond, dated March 15, 2000, evidencing 9.20% Senior Secured Bonds of AES Red Oak, L.L.C., Series B due 2029 in the

 

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Exhibit Number		Description
		principal amount of $160,000,000.
4.7		Equity Subscription Agreement, dated as of March 1, 2000, by and among AES Red Oak, L.L.C., AES Red Oak, Inc. and the Collateral Agent.
4.8		Working Capital Agreement, dated as of March 1, 2000, by and among AES Red Oak, L.L.C., Working Capital Provider, and the Banks named therein.
4.9		Security Agreement, dated as of March 1, 2000, by and between AES Red Oak, L.L.C. and the Collateral Agent.
4.10		Pledge and Security Agreement, dated as of March 1, 2000, by and between AES Red Oak, Inc. and the Collateral Agent.
4.11		Pledge and Security Agreement, dated as of March 1, 2000, by and between AES Red Oak, L.L.C. and the Collateral Agent.
4.12		Consent to Assignment, dated as of March 1, 2000, by and between Williams Energy Marketing & Trading Company and the Collateral Agent, and consented to by AES Red Oak, L.L.C. (with respect to the Power Purchase Agreement).
4.13		Consent to Assignment, dated as of March 1, 2000, by and between The Williams Companies, Inc. and the Collateral Agent, and consented to by AES Red Oak, L.L.C. (with respect to the PPA Guaranty)
4.14		Consent to Assignment, dated as of March 1, 2000, by and between Raytheon Engineers & Constructors, Inc. and the Collateral Agent, and consented to by AES Red Oak, L.L.C. (with respect to the construction agreement).
4.15		Consent to Assignment, dated as of March 1, 2000, by and between Raytheon Company and the Collateral Agent, and consented to by AES Red Oak, L.L.C. (with respect to the EPC Guaranty).
4.16		Consent to Assignment, dated as of March 1, 2000, by and between Siemens Westinghouse Power Corporation and the Collateral Agent, and consented to by AES Red Oak, L.L.C. (with respect to the Maintenance Services Agreement).
4.17		Consent to Assignment, dated as of March 1, 2000, by and between AES Sayreville, L.L.C. and the Collateral Agent, and consented to by AES Red Oak, L.L.C. (with respect to the Development and Operations Services Agreement).
4.18		Consent to Assignment, dated as of March 1, 2000, by and between Jersey Central Power and Light Company d/b/a GPU Energy and the Collateral Agent, and consented to by AES Red

 

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Exhibit Number		Description
		Oak, L.L.C. (with respect to the Interconnection Agreement).
4.19		Consent to Assignment, dated as of March 1, 2000, by and between the Borough of Sayreville and the Collateral Agent, and consented to by AES Red Oak, L.L.C. (with respect to the Water Supply Agreement).
10.1		Fuel Conversion Services, Capacity and Ancillary Services Purchase Agreement, dated as of September 17, 1999, and Amendment No. 1, dated as of February 21, 2000, by and between AES Red Oak, L.L.C. and Williams Energy Marketing & Trading Company. (Portions of this exhibit have been omitted pursuant to a request for confidential treatment.)
10.2(a)		Agreement for Engineering, Procurement and Construction Services, dated as of October 15, 1999, and Amendment No. 1, dated as of February 23, 2000, by and between AES Red Oak, L.L.C. and Raytheon Engineers & Constructors, Inc. (Portions of this exhibit have been omitted pursuant to a request for confidential treatment.)
10.2(b)		EPC Contract Prepayment Coordination Agreement, dated as of March 14, 2000, between AES Red Oak, L.L.C. and Raytheon Engineers and Constructors, Inc. (Portions of this exhibit have been omitted pursuant to a request for confidential treatment.)
10.3		Guaranty, dated as of October 15, 1999, by Raytheon Company in favor of AES Red Oak, L.L.C. (Portions of this exhibit have been omitted pursuant to a request for confidential treatment.)
10.4		Maintenance Program Parts, Shop Repairs and Scheduled Outage TFA Services Contract, dated as of December 8, 1999, and Amendment No. 1, dated February 15, 2000, by and between AES Red Oak, L.L.C. and Siemens Westinghouse Power Corporation. (Portions of this exhibit have been omitted pursuant to a request for confidential treatment.)
10.5		Development and Operations Services Agreement, dated as of March 1, 2000, by and between AES Sayreville, L.L.C. and AES Red Oak, L.L.C.
10.7		Water Supply Agreement, dated as of December 22, 1999, by and between AES Red Oak, L.L.C. and the Borough of Sayreville.
10.8		General Facility Transmission Interconnection Agreement, dated as of April 27, 1999, by and between Jersey Central Power & Light Company d/b/a GPU Energy and AES Red Oak, L.L.C.
10.9		Mortgage, Security Agreement and Assignment of Leases and Income, dated as of March 1, 2000, by and between AES Red Oak, L.L.C. and the Mortgagee.

 

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Exhibit Number		Description
10.10		Assignment of Leases and Income, dated as of March 1, 2000, by and between AES Red Oak, L.L.C. and the Collateral Agent.
10.11		Financial Agreement, dated as of December 3, 1999, by and between AES Red Oak Urban Renewal Corporation and the Borough of Sayreville.
10.12		Promissory Note, dated as of March 15, 2000, of AES Red Oak Urban Renewal Corporation to AES Red Oak, L.L.C.
10.13		Ground Lease Agreement, dated as of March 1, 2000, by and between AES Red Oak, L.L.C. and AES Red Oak Urban Renewal Corporation.
10.14		Sublease Agreement, dated as of March 1, 2000, by and between AES Red Oak Urban Renewal Corporation and AES Red Oak, L.L.C.
10.15		Memorandum of Ground Lease, dated as of March 1, 2000, by and between AES Red Oak, L.L.C. and AES Red Oak Urban Renewal Corporation.
10.16		Memorandum of Sublease, dated as of March 1, 2000, by and between AES Red Oak Urban Renewal Corporation and AES Red Oak, L.L.C.
10.17		Construction Agency Agreement, dated as of March 1, 2000, by and between AES Red Oak Urban Renewal Corporation and AES Red Oak, L.L.C.
10.18		Leasehold Mortgage, Security Agreement and Assignment of Leases and Income, dated as of March 1, 2000, by and between AES Red Oak Urban Renewal Corporation and AES Red Oak, L.L.C.
10.19		Assignment of Mortgage, dated as of March 1, 2000, by AES Red Oak, L.L.C. in favor of the Collateral Agent.
10.20		URC Security Agreement, dated as of March 1, 2000, by and between AES Red Oak Urban Renewal Corporation and AES Red Oak, L.L.C.
10.21		Assignment of Leases and Income, dated as of March 1, 2000, by and between AES Red Oak Urban Renewal Corporation and AES Red Oak, L.L.C.
10.22		Assignment of Assignment of Leases and Income, dated as of March 1, 2000, by AES Red Oak, L.L.C. in favor of the Collateral Agent.
10.23		Guaranty, dated as of March 1, 2000, by The Williams Companies, Inc. in favor of AES Red Oak, L.L.C. (Power

 

71

 

Exhibit Number		Description
		Purchase Agreement Guaranty). (Portions of this exhibit have been omitted pursuant to a request for confidential treatment.)
10.24		Project Completion Agreement dates as of November 16, 2001, by and between Raytheon Company and Washington Group International, Inc. (incorporated herein by reference from Exhibit 10.1 to the Form 8-K filed on December 12, 2001, File No. 333-40478).
10.25		Owner/Guarantor Supplemental Agreement, dated as of November 21, 2001, by and among AES Red Oak, L.L.C. and Raytheon Company (incorporated herein by reference from Exhibit 10.2 to the Form 8-K filed on December 12, 2001, File No. 333-40478).
10.26**		Letter Agreement, dated November 7, 2002, between AES Red Oak, L.L.C. and Williams Energy Marketing & Trading Company.
10.27		Letter Agreement, dated March 5, 2003 between AES Red Oak, L.L.C. and Raytheon Company.
12*		Computation of Ratios of Earnings (Deficiency) to Fixed Charges.
21*		Subsidiary of the Registrant.
31*		Rule 13a-14(a)/15d-14(a) Certifications
32*		Section 1350 Certifications

 

* Filed herewith.

 

** Previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2002 and incorporated by reference herein.

 

b)             Reports on Form 8-K

 

No Current Reports on Form 8-K were filed by the registrant during the fourth quarter of the fiscal year ended December 31, 2003.

 

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Supplementary Information to be Furnished With Reports filed Pursuant to
Section 15(d) of the Act by Registrants Which Have Not Registered
Securities Pursuant to Section 12 of the Act.

 

No annual report or proxy materials have been sent to security holders during the fiscal year ended December 31, 2003. No annual report or proxy materials will be sent to security holders subsequent to the filing of this annual report on Form 10-K.

 

73

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.
		/s/ A.W. Bergeron
	By:	A.W. Bergeron
	Title:	President
		/s/ Pam Strunk
	By:	Pam Strunk
	Title:	Chief Financial Officer
		/s/ Thomas P. Keating
	By:	Thomas P. Keating
	Title:	Principal Accounting Officer

 

Date: March 15, 2004

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature			Title		Date
/s/ A. W Bergeron
A. W Bergeron			Director		March 15, 2004
/s/ Edward P. Convery
Edward P. Convery			Director		March 15, 2004
/s/ Dan  Rothaupt
Dan  Rothaupt			Director		March 15, 2004

 

74