UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

Commission file number 333-40478

 

AES RED OAK, L.L.C.

(Exact name of registrant as specified in its charter)

 

Delaware		54-1889658
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
832 Red Oak Lane, Sayreville, NJ		08872
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code:  (732) 238-1462

 

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 whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o   No ý

 

Registrant is a wholly owned subsidiary of The AES Corporation.  Registrant meets the conditions set forth in General Instruction H(I)(a) and (b) of Form 10-Q and is filing the Quarterly Report on form 10-Q with the reduced disclosure format authorized by General Instruction II.

 

 

AES RED OAK, L.L.C.

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.	CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
	Condensed Consolidated Statements of Operations, Three and Six Months Ended June 30, 2004 and 2003
	Condensed Consolidated Balance Sheets, as of June 30, 2004 and December 31, 2003
	Condensed Consolidated Statement of Changes in Member’s Capital  for the Period from December 31, 2003 through June 30, 2004
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003
	Notes to Condensed Consolidated Financial Statements
Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 4.	CONTROLS AND PROCEDURES
PART II.	OTHER INFORMATION
Item 1.	LEGAL PROCEEDINGS
Item 5.	OTHER INFORMATION
Item 6.	EXHIBITS AND REPORTS ON FORM 8-K
Signatures

 

 

PART I. FINANCIAL INFORMATION

 

Item 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

AES RED OAK, L.L.C. AND SUBSIDIARY

AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION

Condensed Consolidated Statements of Operations,

Three and Six Months Ended June 30, 2004 and 2003

(Unaudited)

(dollars in thousands)

 

		Three Months Ended June 30						Six Months Ended June 30
		2004			2003			2004			2003
OPERATING REVENUES
Energy		$	17,915		$	15,747		$	29,543		$	26,768
OPERATING EXPENSES
Fuel costs		50			—			373			635
Fuel conversion volume expense		1,566			1,603			2,595			3,206
Corporate operator fees		408			399			816			798
Other operating expenses		3,469			1,798			5,737			3,151
Depreciation expense		2,974			2,883			5,825			5,779
Taxes and insurance		748			663			1,496			1,177
General and administrative costs		311			320			488			567
Total operating expenses		9,526			7,666			17,330			15,313
Operating income		8,389			8,081			12,213			11,455
OTHER INCOME (EXPENSE)
Interest income		58			67			119			145
Other income-interim rebates		—			610			—			1,213
Interest expense		(8,471		)	(8,492		)	(16,949		)	(17,106		)
Other expense-letter of credit fees		(257		)	(255		)	(518		)	(506		)
Total other (expense)		(8,670		)	(8,070		)	(17,348		)	(16,254		)
NET (LOSS) INCOME		$	(281	)	$	11		$	(5,135	)	$	(4,799	)

 

See notes to condensed consolidated financial statements.

 

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AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION
Condensed Consolidated Balance Sheets,
June 30, 2004 and December 31, 2003
(Unaudited)
(dollars in thousands, except share amounts)

 

		(Unaudited) June 30, 2004			December 31, 2003
ASSETS:
Current Assets:
Cash		$	22		$	38
Restricted cash at cost, which approximates market value		28,423			34,837
Trade receivable		8,842			4,070
Receivable from affiliate		16			51
Prepaid and other current assets		1,489			628
Total current assets		38,792			39,624
Land		4,240			4,240
Property, plant, and equipment – net of accumulated depreciation of $21,655 and $15,830, respectively		404,177			408,963
Deferred financing costs – net of accumulated amortization of $3,534 and $3,128, respectively		15,171			15,577
Other assets		580			219
Total assets		$	462,960		$	468,623
LIABILITIES AND MEMBER’S CAPITAL:
Current Liabilities:
Accounts payable		$	2,746		$	398
Accrued liabilities		1,701			956
Accrued interest		2,754			2,759
Liabilities under spare parts agreement-current portion		630			4,520
Payable to affiliate		297			131
Bonds payable-current portion		5,206			5,230
Notes payable		768			—
Williams Energy prepayment		35,000			35,000
Total current liabilities		49,102			48,994
Bonds payable		369,372			370,132
Liabilities under spare parts agreement and other		2,091			2,017
Total liabilities		$	420,565		$	421,143
Member’s capital:
Common stock, $1 par value-10 shares authorized, none issued or outstanding		$	—		$	—
Contributed capital		56,825			56,775
Member’s deficit		(14,430		)	(9,295		)
Total member’s capital		42,395			47,480
Total liabilities and member’s capital		$	462,960		$	468,623

 

See notes to condensed consolidated financial statements.

 

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AES RED OAK, L.L.C. AND SUBSIDIARY

AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION

Condensed Consolidated Statement of Changes in Member’s Capital (Deficit)

Period from December 31, 2003 through June 30, 2004

(dollars in thousands)

(Unaudited)

 

		Common Stock					Additional Paid-in Capital			Accumulated Deficit			Total
		Shares		Amount
BALANCE DECEMBER 31, 2003		—		$	—		$	56,775		$	(9,295	)	$	47,480
Contributed Capital							50						50
Net loss		—		—			—			(5,135		)	(5,135		)
BALANCE JUNE 30, 2004		—		$	—		$	56,825		$	(14,430	)	$	42,395

 

See notes to condensed consolidated financial statements.

 

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AES RED OAK, L.L.C. AND SUBSIDIARY

AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION

Condensed Consolidated Statements of Cash Flows for the Six Months Ended

June 30, 2004 and 2003

(dollars in thousands)

(Unaudited)

 

		Six months Ended June 30
		2004			2003
OPERATING ACTIVITIES:
Net loss		$	(5,135	)	$	(4,799	)
Amortization of deferred financing costs		406			406
Depreciation		5,825			5,778
Change in:
Trade receivable		(4,772		)	(4,297		)
Receivable from affiliate		35			(51		)
Prepaid expenses		(93		)	(1,125		)
Other assets		(361		)	87
Accounts payable		2,348			(199		)
Accrued liabilities		745			(259		)
Accrued interest		(5		)	(7		)
Payable to affiliates		166			57
Net cash used in operating activities		$	(841	)	$	(4,409	)
INVESTING ACTIVITIES:
Payments for capital additions		(1,039		)	(1,359		)
Payments under long-term spare parts agreement		(3,816		)	(218		)
Restricted cash		6,414			(19,174		)
Net cash provided by (used in) investing activities		$	1,559		$	(20,751	)
FINANCING ACTIVITIES:
Payment of principal on bonds payable		(784		)	(932		)
Securities from Williams under power purchase agreement		—			26,130
Contribution from parent		50			—
Net cash (used in) provided by financing activities
		$	(734	)	$	25,198
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		$	(16	)	$	38
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		38			23
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	22		$	61
SUPPLEMENTAL DISCLOSURE:
Interest paid		$	16,548		$	16,699

 

See notes to condensed consolidated financial statements.

 

4

 

AES RED OAK, L.L.C. AND SUBSIDIARY

AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION

Notes to Condensed Consolidated Financial Statements

 

1.             ORGANIZATION

 

AES Red Oak, L.L.C. (the “Company”) was formed on September 13, 1998, in the State of Delaware, to develop, construct, own and operate an 832-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 Power Company, Inc., (“Williams Energy”), formerly Williams Energy Marketing & Trading Company, 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.

 

The Company is a wholly owned subsidiary of AES Red Oak, Inc. (“Red Oak”), which is a wholly-owned subsidiary of The AES Corporation (“AES”). Red Oak has no assets other than its ownership interests in the Company and AES Sayreville, L.L.C. Red Oak has no operations and is not expected to have any operations. Red Oak’s only income is distributions (if any) it receives from the Company and AES Sayreville, L.L.C.

 

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 unaudited quarterly and annual audited reports with the Securities and Exchange Commission under the Securities Exchange Act of 1934, which are publicly available, but which do not constitute a part of, and are not incorporated into, this Form 10-Q.

 

The Company owns all of the equity interests in AES Red Oak Urban Renewal Corporation (“AES URC”), which was organized as an urban renewal corporation under New Jersey Law. As an urban renewal corporation under New Jersey law, portions of the Facility were designated as redevelopment areas in order to provide certain real estate tax and development benefits to the Facility. AES URC has no operations outside of its activities in connection with the Facility.

 

2.             BASIS OF PRESENTATION

 

In the Company’s opinion, all adjustments necessary for a fair presentation of the unaudited results of operations for the interim periods presented herein are included. All such adjustments include accruals of a normal and recurring nature. Certain reclassifications have been made to prior-period amounts to conform to the 2004 presentation. The results of operations for the three and six-month periods presented herein are not necessarily indicative of the results of operations to be expected for the full year or future periods.

 

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The Company generates energy revenues under the Power Purchase Agreement with Williams Energy. During the 20-year term of the agreement, the Company expects to sell capacity and electric energy produced by the Facility, as well as ancillary services and fuel conversion services. Under the Power Purchase Agreement, the Company also generates revenues from meeting (1) base electrical output guarantees and (2) heat rate rebates through efficient electrical output. Revenues from the sales of electric energy and capacity are recorded based on output delivered and capacity provided at rates as specified under contract terms. Revenues for ancillary and other services are recorded when the services are rendered.

 

Upon its expiration, or in the event that the Power Purchase Agreement is terminated prior to its 20-year term or Williams Energy otherwise fails to perform, the Company would seek to generate energy revenues from the sale of electric energy and capacity into the merchant market or under new short or long-term power purchase or similar agreements. Due to recent declines in Pennsylvania-New Jersey-Maryland (“PJM”) power pool prices, however, the Company would expect that even if successful in finding alternate revenue sources, any such alternate revenues would be substantially below the amounts that would have been otherwise payable by Williams Energy pursuant to the Power Purchase Agreement. There can be no assurances as to whether such efforts would be successful.

 

These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles (“GAAP”) for complete financial statements. The accompanying  condensed consolidated financial statements are unaudited and they should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

3.             BONDS PAYABLE

 

On March 15, 2000, the Company issued $384 million in senior secured bonds for the purpose of providing financing for the construction of the Facility and to fund, through the construction period, interest payments to the bondholders. In September 2000, the Company consummated an exchange offer whereby the holders of the senior secured bonds exchanged their privately placed senior secured bonds for registered senior secured bonds.

 

The senior secured bonds were issued in two series: 8.54% senior secured bonds due 2019 (the “2019 Bonds”) in an aggregate principal amount of $224 million and 9.20% senior secured bonds due 2029 (the “2029 Bonds”) in an aggregate principal amount of $160 million. Principal repayment of the 2019 Bonds commenced with the quarterly payment on August 31, 2002. Annual principal repayments on the Bonds are scheduled as follows:

 

Year		Annual Payment
2004 (remaining subsequent to June 30, 2004)		$	4.4 million
2005		$	5.1 million
2006		$	7.1 million
2007		$	6.1 million
2008		$	8.1 million
Thereafter		$	343.8 million
Total		$	374.6 million

 

Principal repayment dates on the 2019 Bonds are February 28, May 31, August 31, and November 30 of each year, with the final payment due November 30, 2019. Quarterly principal repayments commenced on August 31, 2002. Quarterly principal repayment of the 2029 Bonds does not commence until February 28, 2019. The company made the scheduled principal payment of approximately $392,000 in May 2004 on the 2019 bonds.

 

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4.             CONCENTRATION OF CREDIT RISK IN WILLIAMS ENERGY AND AFFILIATES

 

Williams Energy is currently the Company’s sole customer for purchases of capacity, ancillary services, and energy and its sole source for fuel.  Williams Energy’s payments under the Power Purchase Agreement are expected to provide all of the Company’s operating revenues during the term of the Power Purchase Agreement.  It is unlikely that the Company would be able to find another purchaser or fuel source with 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 gauranty were initially capped at an amount equal to approximately $510 million.  Beginning on January 1 of the first full year after the commercial operation date, this guarantee 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 June 30, 2004, the gauranty was capped at $506.6 million.

 

The minimum capacity payments provided for under the Power Purchase Agreement have been the Company’s primary source of operating revenues, representing $62.0 million of 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.  The Company currently anticipates 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.  The Company also believes 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, will be sufficient to fund operating expenses and debt service costs.

 

The Company’s dependence upon The Williams Companies, Inc. and its affiliates under the Power Purchase Agreement exposes the Company to possible loss of revenues and fuel supply, which in turn, could negatively impact its cash flow and financial condition and may result in a default on its senior secured bonds.  There can be no assurances as to the Company’s ability to generate sufficient cash flow to cover operating expenses or its debt service obligations in the absence of a long-term power purchase agreement with Williams Energy.

 

5.             POWER PURCHASE AGREEMENT

 

The Company and Williams Energy have entered into a Power Purchase Agreement for the sale of all capacity produced by the Facility, as well as ancillary services and fuel conversion services. Under the Power Purchase Agreement, Williams Energy has the obligation to deliver, on an exclusive basis, all quantities of natural gas 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 occurred.  As part of the arbitration settlement with Williams Energy, described below, the Company recognizes September 28, 2002 as the commercial availability date.

 

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

 

7

 

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 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 the Company 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 settled 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 had the economic effect of recognizing a commercial operation date prior to September 28, 2002. The Company is also currently disputing approximately $800,000 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.

 

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 guarantee were initially capped at an amount equal to approximately $510 million.  Beginning on January 1 of the first full year after the commercial operation date, this guarantee 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 June 30, 2004 the guaranty was capped at $506.6 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 guarantee remains in full force and effect and the Company retains all of its rights and remedies provided by that guarantee.

 

8

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 guarantee 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 guarantee of investment grade rating, or posts a letter of credit, the Company will be required to return the $35 million alternative credit support to Williams Energy in accordance with the terms of the Letter Agreement as described above.

 

6.             COMMITMENTS AND CONTINGENCIES

 

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 guarantee 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 June 30, 2004, Raytheon had provided a letter of credit of approximately $30.8 million.  The Company may draw on this letter of credit in the event that Raytheon fails to pay us any amount owed to us under the construction agreement.  As of June 30, 2004, the Company had drawn $544,000 on this letter of credit for interim rebates which Raytheon then resumed paying until their notice of Final Acceptance.

 

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.

 

9

 

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.

 

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 June 30, 2004.  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 had an expiration date of June 30, 2004, but was automatically extended for another one-year period, and represents the amount potentially due if there is a failure of AES Red Oak, LLC to take action regarding the plan.

 

7.             NEW ACCOUNTING PRONOUNCEMENTS

 

In 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 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) did not have a material effect on our financial position, results of operations, or cash flows.

 

Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Cautionary Note Regarding Forward-Looking Statements

 

Some of the statements in this Form 10-Q, as well as statements made by us in periodic press releases and other public communications, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Certain, but not necessarily all, of such forward-looking statements can be identified by the use of forward-looking terminology, such as “believes,” “estimates,” “plans,” “projects,” “expects,” “may,” “will,” “should,” “approximately,” or “anticipates” or the negative thereof or other variations thereof or comparable terminology, or by discussion of strategies, each of which involves risks and uncertainties. We have based these forward-looking statements on our current

 

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expectations and projections about future events based upon our knowledge of facts as of the date of this Form 10-Q and our assumptions about future events.

 

All statements other than of historical facts included herein, including those regarding market trends, our financial position, business strategy, projected plans and objectives of management for future operations 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 degree to which Williams Energy requests that we run or “dispatch” the Facility, including the possibility that Williams Energy will not request that we run or “dispatch” the Facility at all,

 

•                  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 undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

 

General

 

We are a Delaware limited liability company formed on September 13, 1998 to develop, construct, own, operate and maintain our Facility. We were dormant until March 15, 2000, the date of the sale of our senior

 

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secured bonds. We obtained $384 million of project financing from the sale of the senior secured bonds.

 

We reached provisional acceptance on August 11, 2002, risk transfer on August 13, 2002, and in a settlement with Williams Energy reached on November 4, 2003, a commercial operation date of September 28, 2002 was agreed upon.

 

Liquidity and Capital Resources

 

Since achieving commercial operations under the Power Purchase Agreement with Williams Energy, we are eligible to receive variable operations and maintenance payments, total fixed payments, energy exercise fee payments (each as defined in the Power Purchase Agreement) and other payments for the delivery of fuel conversion, capacity and ancillary services.  We have been dispatched by Williams Energy on a more regular basis in the second quarter of 2004, as compared to the same period last year, but can provide no assurance that this will continue.  If the Facility is not dispatched, our operating revenues will consist of minimum capacity payments under the Power Purchase Agreement.

 

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 calendar year 2003, and $27.0 million of our total revenues of $29.5 million for the first six months of 2004. 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.  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, will be sufficient to fund our operating expenses and debt service costs.

 

We have 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.

 

Due to the downgrade of The Williams Companies, Inc.’s debt to below investment grade, the Williams Companies, Inc. is required to supplement The Williams Companies, Inc. guarantee with additional alternative security that is acceptable to us.  Since The Williams Companies, Inc. debt rating fell below investment grade in 2002, Williams Energy has provided us with $35 million of cash as alternate credit support.  In the event that the Williams Companies, Inc. regains and maintains its investment grade status, provides a substitute guarantee 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. In the event we regain investment grade status, we will also have access to funds from our $2.5 million working capital agreement.  As of August 5, 2004, we had cash balances of approximately $33.0 million.  In the event that we are 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.

 

As of June 30, 2004, $375 million aggregate principal amount of senior secured bonds, issued in two tranches, were outstanding.  Quarterly principal repayments on the 2019 Bonds commenced on August 31, 2002 and are due on May 31, August 31, and November 30 of each year.  Quarterly principal repayment of the

 

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2029 Bonds does not commence until February 28, 2019.  We have provided the collateral agent with a debt service reserve letter of credit in an initial stated amount of $22.0 million which the collateral agent may draw upon if we fail to meet our obligations under the senior secured bonds.

 

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 March 31, 2004.  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 had an expiration date of June 30, 2004, but was automatically extended for another one-year period, and represents the amount potentially due if there is a failure of the Company to take action regarding the plan.

 

It is anticipated that we will incur costs related to capital additions of approximately $1.5 million in 2004, including general improvements of the Facility, EPC related costs and planned maintenance outages.

 

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 payments that would otherwise be retained.  As of June 30, 2004, 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 June 30, 2004 we have drawn $544,000 on this letter of credit.

 

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 PJM power 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.

 

The following discussion presents certain financial information for the three and six months ended June 30, 2004 and 2003.

 

Energy Revenues

 

We generate energy revenues under the Power Purchase Agreement with Williams Energy. During the 20-year term of the agreement, we expect to sell electric energy and capacity produced by the Facility, as well as ancillary and fuel conversion services. Under the Power Purchase Agreement, we also generate revenues from meeting (1) base electrical output guarantees and (2) heat rate rebates through efficient electrical output.

 

Upon its expiration, or in the event that the Power Purchase Agreement is terminated prior to its 20-year term, we would seek to generate energy revenues from the sale of electric energy and capacity into the merchant market or under new short or long-term power purchase or similar agreements. Due to recent declines in PJM power pool prices, however, we would expect that even if we were successful in finding alternate revenue sources, any such alternate revenues would be substantially below the amounts that would have been otherwise payable pursuant to the Power Purchase Agreement. There can be no assurances as to whether such efforts would be successful.

 

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Operating Expenses

 

Under an agreement with AES Sayreville, L.L.C., a wholly owned subsidiary of AES Red Oak, Inc. (“Red Oak”), which is a wholly-owned subsidiary of The AES Corporation (“AES”), we are required to reimburse all operator costs on a monthly basis. Operator costs generally consist of all direct costs and overhead associated with running the Facility. Additionally, an operator fee of approximately $400,000, subject to annual adjustment, is payable on each bond payment date.

 

Performance Guarantees

 

Electrical Output

 

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 paid 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.

 

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.

 

The Company has not invoiced Raytheon for the six-month period ended June 30, 2004 for electrical output and heat rate rebates. As of June 30, 2004, Raytheon owed approximately $65,000 in rebates for amounts invoiced in 2003.

 

Recent and 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

 

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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 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) did not have a material effect on our financial position, results of operations, or cash flows.

 

Results of Operations

 

Under the Power Purchase Agreement with Williams Energy, we are eligible to receive variable operations and maintenance payments, total fixed payments, energy exercise fees (each as defined in the Power Purchase Agreement) and other payments for the delivery of fuel conversion, capacity and ancillary services.  We were dispatched by Williams Energy for two days in the quarter ended March 31, 2004 and during most peak periods in the quarter ended June 30, 2004, as compared to the same period for the prior year, and were called to generate only 14% during the 2003 calendar year. Accordingly, the minimum capacity payments have been our primary source of operating revenues.

 

For the Three Months Ended June 30, 2004 and 2003

 

Operating revenues for the three months ended June 30, 2004 were approximately $17.9 million compared to $15.7 million for the three months ended June 30, 2003.   Revenue in the current three-month period was higher primarily due to increased dispatch periods by Williams and a higher unforced capacity rating than in the prior year period.

 

Other operating expenses for the three months ended June 30, 2004 were approximately $3.5 million compared to $1.8 million from the three months ended June 30, 2003. The increase in other operating expenses is primarily due to costs related to a combustion inspection in June 2004 and increased Facility dispatch in 2004.

 

Fuel conversion volume expense for each of the three-month periods ended June 30, 2004 and June 30, 2003 was $1.6 million. Fuel conversion volume expense represents a charge paid to Williams Energy under the Power Purchase Agreement based upon utilization of the Facility.

 

Total other income (expense) for the three months ended June 30, 2004 and 2003 was $(8.7) million and ($8.1) million, respectively, and is primarily comprised of interest expense, interest income, interim rebates and letter of credit fees.  Interim rebates are received by the Company from the EPC contractor for underperformance of the Facility.  Letter of credit fees relate to our debt service letter of credit and reimbursement agreement and power purchase agreement letter of credit and reimbursement agreement.  The increase in other expense for the three months ended June 30, 2004 compared to the three months ended June 30, 2003 is primarily due to interim rebates that were received in the prior year period.

 

We had a net loss of $281,000 for the three months ended June 30, 2004 compared to a net income of $11,000 for the three months ended June 30, 2003.

 

For the Six Months Ended June 30, 2004 and 2003

 

Operating revenues for the six months ended June 30, 2004 were approximately $29.5 million compared to $26.8 million for the comparable period of the prior year. Revenue in the current six-month period was higher primarily due to increased dispatch periods by Williams and a higher unforced capacity

 

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rating than in the prior year period.

 

Other operating expenses for the six months ended June 30, 2004 were approximately $5.7 million compared to $3.2 million from the six months ended June 30, 2003. The increase in other operating expenses is primarily due to costs related to two planned combustion inspections and increased Facility dispatch in 2004.

 

Fuel Conversion Volume expense for the six months ended June 30, 2004 were $2.6 million compared to $3.2 million for the comparable period for the prior calendar year. Fuel Conversion Volume expense represents a charge paid to Williams Energy under the Power Purchase Agreement based upon utilization of the Facility. The decrease is due to the Facility not operating over a certain dispatch level for the last twelve months, which is a factor in the determination of this cost under the Power Purchase Agreement. The factor applied in the prior-year period was fixed for the first twelve-month period commencing with the Commercial Operation Date. To the extent that our utilization exceeds 20% for the prior twelve month period, this expense may rise back up to the 2003 level in future periods.

 

Total other income (expense) for the six months ended June 30, 2004 and 2003 was $(17.3) million and $(16.3) million respectively, and is primarily comprised of interest expense, interest income, interim rebates from the EPC contractor and letter of credit fees.  The increase in other expense for the six months ended June 30, 2004 compared to the six months ended June 30, 2003 is primarily due to interim rebates that were received in the prior year period.

 

Concentration of Credit Risk

 

Williams Energy is currently our 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 our 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 our operations, and may result in a default on the our 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 guarantee were initially capped at an amount equal to approximately $510 million.  Beginning on January 1 of the first full year after the commercial operation date, this guarantee 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 June 30, 2004, the guarantee was capped at $506.6 million.

 

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 our 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.

 

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.

 

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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 accordingly, based on the probability that they will be realized.

 

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 declines in PJM power 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 by Williams Energy pursuant to the Power Purchase Agreement.  There can be no assurances as to whether such efforts would be successful.

 

Property, Plant and Equipment —  Property, plant and equipment is recorded at cost and is depreciated over its useful life.  The estimated lives of our generation facilities range from five to thirty-six years.  A significant decrease in the estimated useful life of a material amount of our property, plant or equipment could have a material adverse impact on our operating results in the period in which the estimate is revised and in subsequent periods.  The depreciable lives of our property plant and equipment by category are as follows:

 

Description of Asset		Depreciable Life		June 30, 2004 (000’s)
Buildings		35		$	1,767
Vehicles		5		112
Computers		6		772
Furniture and Fixtures		10		515
Combustion Turbine Generator Parts		9-36		45,211
Gas Heaters		35		1,119
Spare Parts Inventory		—		13,370
Plant		35		362,966
Subtotal		35		425,832
Accumulated Depreciation				(21,655		)
Property, Plant and Equipment, net				$	404,177

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures.  We carried out an evaluation, under the supervision and with the participation of our management, including the chief executive officer (“CEO”) and chief financial officer (“CFO”), of the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15-d-15 (e) as required by paragraph (b) of the Exchange Act Rules 13a-15 or 15d-15) as of June 30, 2004.  The Company’s management, including the CEO and CFO, is engaged in a comprehensive effort to review, evaluate and improve our controls; however, management does not expect that our disclosure controls or our internal controls over financial reporting will prevent all errors and all fraud.  A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. 

 

Based upon the controls evaluation performed, the CEO and CFO have concluded that as of June 30, 2004, our disclosure controls and procedures were effective to provide reasonable assurance that material information relating to us and our consolidated subsidiaries is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

 

Changes in Internal Controls.  In the course of our evaluation of disclosure controls and procedures, management considered certain internal control areas in which we have made and are continuing to make changes to improve and enhance controls.  Based upon that evaluation, the CEO and CFO concluded that there were no changes in our internal controls over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the second quarter ended June 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

Compliance with Section 404 of the Sarbanes Oxley Act of 2002.  Beginning with the year ending December 31, 2005, Section 404 of the Sarbanes-Oxley Act of 2002 will require us to include an internal control report of management with our annual report on Form 10-K.  The internal control report must contain (1) a statement of management's responsibility for establishing and maintaining adequate internal controls over financial reporting for our Company, (2) a statement identifying the framework used by management to conduct the required evaluation of the effectiveness of our internal controls over financial reporting, (3) management's assessment of the effectiveness of our internal controls over financial reporting as of the end of our most recent fiscal year, including a statement as to whether or not our internal controls over financial reporting are effective, and (4) a statement that our independent auditors have issued an attestation report on management's assessment of our internal controls over financial reporting. 

 

Management developed a comprehensive plan in order to achieve compliance with Section 404 within the prescribed period and to review, evaluate and improve the design and effectiveness of our controls and procedures on an on-going basis.  The comprehensive compliance plan includes (1) documentation and assessment of the adequacy of our internal controls over financial reporting, (2) remediation of control weaknesses, (3) validation through testing that controls are functioning as documented and (4) implementation of a continuous reporting and improvement process for internal controls over financial reporting.  As a result of this initiative, we have made and will continue to make changes from time to time in our internal controls over financial reporting. 

 

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PART II. OTHER INFORMATION

 

Item 1. LEGAL PROCEEDINGS

 

See Note 6 to our condensed consolidated financial statements.

 

Item 5. OTHER INFORMATION

 

None.

 

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Item 6.  EXHIBITS AND REPORTS ON FORM 8-K

 

(a)          Exhibits

 

31.1		Certification by Chief Executive Officer Required by Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934
31.2		Certification by Chief Financial Officer Required by Rule 13a-14(a) or 15d— 14(a) of the Securities Exchange Act of 1934
32		Section 1350 Certifications

 

(b)          Reports on Form 8-K

 

The Company did not file any reports on Form 8-K during the quarter ended June 30, 2004.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	AES RED OAK, L.L.C.
Date: August 6, 2004	By:	/s/ A.W. BERGERON
		A.W. Bergeron
		President
Date: August 6, 2004	By:	/s/ PAM STRUNK
		Pam Strunk
		Chief Financial Officer
Date: August 6, 2004	By:	/s/ THOMAS P. KEATING
		Thomas P. Keating
		Principal Accounting Officer

 

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