AES RED OAK LLC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the quarterly period ended September 30, 2004

o	TRANSITION REPORT PURSUANT OR TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 333-40478

AES RED OAK, L.L.C.

(Exact name of registrant as specified in its charter)

Delaware		54-1889658
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

832 Red Oak Lane, Sayreville, NJ (Address of principal executive offices)		08872 (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.

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 Nine Months Ended September 30, 2004 and 2003

(Unaudited)

(dollars in thousands)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
OPERATING REVENUES
Energy.	$	27,904		$	25,799		$	57,447		$	52,567

OPERATING EXPENSES
Fuel conversion volume expense	1,632			1,618			4,227			4,824
Corporate operator fees	411			402			1,227			1,200
Other operating expenses	3,242			2,871			9,352			6,657
Depreciation expense	2,989			2,830			8,814			8,609
Taxes and insurance	748			644			2,244			1,821
General and administrative costs	213			209			701			776
Total operating expenses	9,235			8,574			26,565			23,887
Operating income	18,669			17,225			30,882			28,680

OTHER INCOME (EXPENSE)
Interest income	158			57			277			202
Other income-interim rebates	—			202			—			1,415
Interest expense	(8,259		)	(8,371		)	(24,802		)	(25,071		)
Amortization of Deferred Financing Costs	(204		)	(204		)	(610		)	(610		)
Other expense-letter of credit fees	(240		)	(255		)	(758		)	(761		)
Total other (expense)	(8,545		)	(8,571		)	(25,893		)	(24,825		)

NET INCOME	$	10,124		$	8,654		$	4,989		$	3,855

See notes to condensed consolidated financial statements.

AES RED OAK, L.L.C. AND SUBSIDIARY
AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION
Condensed Consolidated Balance Sheets,
September 30, 2004 and December 31, 2003

(Unaudited)
(dollars in thousands, except share amounts)

	September 30, 2004			December 31, 2003
ASSETS:

Current Assets:
Cash	$	4		$	38
Restricted cash at cost, which approximates market value	39,624			34,837
Trade receivable	9,936			4,070
Receivable from affiliate	28			51
Prepaid and other current assets	1,055			628
Total current assets	50,647			39,624

Land	4,240			4,240
Property, plant, and equipment — net of accumulated depreciation of $24,644 and $15,830, respectively	401,598			408,963
Deferred financing costs — net of accumulated amortization of $3,738 and $3,128, respectively	14,967			15,577
Other assets.	606			219
Total assets	$	472,058		$	468,623

LIABILITIES AND MEMBER’S CAPITAL:

Current Liabilities:
Accounts payable	$	371		$	398
Accrued liabilities	1,514			956
Accrued interest	2,738			2,759
Liabilities under spare parts agreement—current portion	1,517			4,520
Payable to affiliate	300			131
Bonds payable-current portion	5,139			5,230
Notes payable	305			—
Payable to Raytheon	30,302			—
Payable to Williams	10,000			35,000
Total current liabilities	52,186			48,994
Bonds payable	367,216			370,132
Liabilities under spare parts agreement and other	114			2,017
Total liabilities	$	419,516		$	421,143

Member’s capital:
Common stock, $1 par value-10 shares authorized, none issued or outstanding	$	—		$	—
Contributed capital	56,848			56,775
Member’s deficit	(4,306		)	(9,295		)
Total member’s capital	52,542			47,480
Total liabilities and member’s capital	$	472,058		$	468,623

See notes to condensed consolidated financial statements.

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 September 30, 2004

(dollars in thousands)

(Unaudited)

	Common Stock
	Shares	Amount		Additional Paid-in Capital		Accumulated Deficit			Total
BALANCE DECEMBER 31, 2003	—	$	—	$	56,775	$	(9,295	)	$	47,480

Contributed Capital				73					73
Net Income	—	—		—		4,989			4,989

BALANCE SEPTEMBER 30, 2004	—	$	—	$	56,848	$	(4,306	)	$	52,542

See notes to condensed consolidated financial statements.

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 Nine Months Ended

September 30, 2004 and 2003

(dollars in thousands)

(Unaudited)

	Nine months Ended September 30,
	2004			2003
OPERATING ACTIVITIES:
Net income	$	4,989		$	3,855
Amortization of deferred financing costs	610			610
Depreciation	8,814			8,609

Change in:
Trade receivable	(5,866		)	(4,380		)
Receivable from affiliate	23			64
Prepaid insurance and related note payable, net	(122		)	7
Other assets	(387		)	(76		)
Accounts payable	(27		)	(162		)
Accrued liabilities	558			(329		)
Accrued interest	(21		)	—
Payable to affiliates	169			362
Net cash provided by operating activities	$	8,740		$	8,560

INVESTING ACTIVITIES:
Payments for capital additions	(1,449		)	(1,265		)
Payments under long-term spare parts agreement	(4,906		)	(1,334		)
Restricted cash	(4,787		)	(27,389		)

Net cash used in investing activities	$	(11,142	)	$	(29,988	)

FINANCING ACTIVITIES:
Payment of principal on bonds payable	(3,007		)	(3,575		)
Securities from Williams under power purchase agreement	(25,000		)	25,000
Proceeds from Raytheon letter of credit under EPC agreement	30,302			—
Contribution from parent	73			—

Net cash provided by financing activities	$	2,368		$	21,425

NET DECREASE IN CASH AND CASH EQUIVALENTS	$	(34	)	$	(3	)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	38			23
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	4		$	20

SUPPLEMENTAL DISCLOSURE:
Interest paid	$	24,823		$	25,202

See notes to condensed consolidated financial statements.

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. 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 nine-month periods presented herein are not necessarily indicative of the results of operations to be expected for the full year or future periods.

The Company generates energy revenues under the Power Purchase Agreement with Williams Energy.

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

Upon its expiration, or in the event that the Power Purchase Agreement is terminated prior to its 20-year term or Williams Energy otherwise fails to perform, the Company would seek to generate energy revenues from the sale of electric energy and capacity into the merchant market or under new short or long-term power purchase or similar agreements. Due to recent declines in 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. Annual principal repayments on the Bonds are scheduled as follows:

Year	Annual Payment
2004 (subsequent to September 30, 2004)	$	2.2 million
2005	$	5.1 million
2006	$	7.1 million
2007	$	6.1 million
2008	$	8.1 million
Thereafter	$	343.8 million
Total	$	372.4 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 $2.2 million in August 2004 on the 2019 bonds.

4. CONCENTRATION OF CREDIT RISK IN WILLIAMS ENERGY AND AFFILIATES

Williams Energy is currently the Company’s sole customer for purchases of capacity, ancillary services, and energy and its sole source for fuel. Williams Energy’s payments under the Power Purchase Agreement are expected to provide all of the Company’s operating revenues during the term of the Power Purchase Agreement. 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 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 September 30, 2004, the guarantee 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 $51.0 million of total revenues of $57.4 million for the nine months ended September 30, 2004 and $49.6 million of total revenues of $52.6 million for the nine months ended September 30, 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 Facility’s utilization factor for the nine months ended September 30, 2004 was approximately 28% as compared to approximately 16% for the same period in 2003. The utilization factor is the percentage of hours dispatched of the total available hours of the facility. The Company currently anticipates that the plant will be dispatched in future periods to similar degrees. 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 operations began. As part of the arbitration settlement with Williams Energy, described below, the Company recognizes September 28, 2002 as the commercial operation 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 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 $1.2 million 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 and Reimbursement Agreement) 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 and Reimbursement Agreement 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 September 30, 2004, the guarantee 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.

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 elected to have the $10 million Prepayment included as part of the alternative credit support. On September 24, 2004, Williams Energy posted a letter of credit and the Company returned the $25 million of alternative credit support.

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 (the “EPC agreement”) 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 EPC 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.

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.

On August 26, 2004, the Company drew down approximately $30.3 million under a letter of credit posted by Raytheon pursuant to the terms of the EPC Agreement. Prior to this date, the Company had drawn $544,000 on this letter of credit. The Company believes that Raytheon substantially breached the EPC Agreement, due, among other things, to the Facility’s failure to achieve compliance with certain performance tests, and Raytheon’s failure to complete other services under the EPC Agreement and certain amendments thereto, including a Settlement Agreement dated August 6, 2002, that purported to resolve disputes over whether Raytheon had achieved Mechanical Completion and Provisional Acceptance. As a result, the Company claims that Raytheon’s breaches have caused damages in excess of the amount of the letter of credit. Raytheon disputes these claims and has failed and refused to pay costs and damages to the Company despite the Company’s demands for such payment.

On August 27, 2004, Raytheon filed a construction lien claim for $30,963,662 in Middlesex County against the real property and improvements owned by the Company under the New Jersey Construction Lien Law. Among other things, Raytheon claims therein that the draw of the Letter of Credit represents a debt to Raytheon owed by the Company.

On October 28, 2004, AES Red Oak, L.L.C. received a complaint filed by Raytheon in the State of New York. In the complaint, Raytheon is seeking to recover $30.3 million, which represents the amount Red Oak drew down on the letter of credit on August 26, 2004, and also to recover up to $110 million of net expense Raytheon claims to have incurred in good faith under the governing guaranty and construction agreements. Red Oak’s management believes the complaint to be without merit and intends to defend against it vigorously. The Company has recorded the $30.3 million as a current liability, but has not accrued any additional amounts with respect to Raytheon’s claims.

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 September 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. On August 19, 2004, AES secured a performance bond for $539,493 relating to the tree replacement and other site improvements. This bond replaces the previous letter of credit 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.

8. SUBSEQUENT EVENTS

The lawsuit naming the Company as a defendant on or about October 27, 2004, is disclosed in footnote 6, “Commitment and Contingencies” in the litigation section.

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. The Company has based these forward-looking statements on our current expectations and projections about future events based upon our knowledge of facts as of the date of this Form 10-Q and our assumptions about future events.

All statements other than of historical facts included herein, including those regarding market trends, our financial position, business strategy, projected plans and objectives of management for future operations 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. The Company was 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.

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, the Company became 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 more often in the nine months ended September 30, 2004, than in 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.

Net cash provided by operating activities was $8.7 million for the nine months ended September 30, 2004 and $8.6 million for the nine months ended September 30, 2003. The Facility’s utilization factor for the nine months ended September 30, 2004, was approximately 28% as compared to approximately 16% for the same period in 2003. The Company currently anticipates that the plant will be dispatched in future periods to similar degrees. 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 has 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 the Company. Since The Williams Companies, Inc. debt rating fell below investment grade in 2002, Williams Energy had provided us with $35 million of cash as alternate credit support, which included a $10 million Prepayment. On September 24, 2004, Williams Energy posted a letter of credit and the Company returned $25 million of alternative 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 alternative credit support , the Company either will be required to return the $10 million Prepayment or Williams Energy will 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, providing a substitute guarantee of investment grade rating, posting of alternative credit support or at the beginning of calendar year 20, whichever comes first. In the event the Company regains investment grade status, the Company will also have access to funds from our $2.5 million working capital agreement. As of November 5, 2004, the Company had cash balances of approximately $48 million. In the event that the Company is required to return the $10 million prepayment to Williams Energy, the Company believes that it would use all or a portion of its current cash balances and cash generated from future operations, with any remaining balance deducted from the monthly amounts due to the Company 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 September 30, 2004, $372 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 2029 Bonds does not commence until February 28, 2019. The Company has 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 the Company fails 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 September 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 and represents the amount potentially due if there is a failure of the Company to take action regarding the plan. This irrevocable standby letter of credit had an expiration date of June 30, 2004, but was automatically extended for another one-year period.

For the nine months ended September 30, 2004, the Company incurred costs related to capital additions of approximately $1.4 million, including general improvements of the Facility, EPC related costs and planned maintenance outages. The Company expects to incur approximately $0.2 million of such costs for the remainder of 2004.

Raytheon disputes these claims and has failed and refused to pay costs and damages to the Company despite the Company’s demands for such payment.

On October 28, 2004, AES Red Oak, L.L.C. received a complaint filed by Raytheon in the State of New York. In the complaint, Raytheon is seeking to recover $30,3 million, which represents the amount Red Oak drew down on the letter of credit on August 26, 2004, and also to recover up to $110 million of net expense Raytheon claims to have incurred in good faith under the governing guaranty and construction agreements. Red Oak’s management believes the complaint to be without merit and intends to defend against it vigorously. The Company has recorded the $30.3 million as a current liability, but has not accrued any additional amounts with respect to Raytheon’s claims.

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 the Company was required to seek alternate purchasers of our power in the event of a default of Williams Energy, even if the Company was 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 the Company does 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 nine months ended September 30, 2004 and 2003.

Energy Revenues

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 electric energy and capacity produced by the Facility, as well as ancillary 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.

Upon its expiration, or in the event that the Power Purchase Agreement is terminated prior to its 20-year term, 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 PJM power pool prices, however, the Company would expect that even if the Company was successful in finding alternate revenue sources, any such alternate revenues would be substantially below the amounts that would have been otherwise payable pursuant to the Power Purchase Agreement. There can be no assurances as to whether such efforts would be successful.

Operating Expenses

Under an agreement with AES Sayreville, L.L.C., a wholly owned subsidiary of AES Red Oak, Inc. (“Red Oak”), which is a wholly-owned subsidiary of The AES Corporation (“AES”), the Company is 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 EPC agreement, 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 nine-month period ended September 30, 2004, for electrical output and heat rate rebates. As of September 30, 2004, Raytheon owed approximately $65,000 in rebates for amounts invoiced in 2003.

Recent and New Accounting Pronouncements

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. The Facility’s utilization factor for the nine months ended September 30, 2004, was approximately 28% as compared to approximately 16% for the same period in 2003. Accordingly, the minimum capacity payments have been our primary source of operating revenues.

For the Three Months Ended September 30, 2004 and 2003

Operating revenues for the three months ended September 30, 2004, were approximately $27.9 million compared to $25.8 million for the three months ended September 30, 2003. Revenue in the current three-month period was higher primarily due to increased dispatch periods by Williams, a higher unforced capacity rating than in the prior year period and an availability bonus earned from Williams in the current three-month period.

Fuel conversion volume expense for each of the three-month periods ended September 30, 2004, and September 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.

Other operating expenses for the three months ended September 30, 2004, were approximately $3.2 million compared to $2.9 million for the three months ended September 30, 2003. The increase in other operating expenses was primarily due to maintenance costs incurred in July 2004 and increased facility dispatch in 2004.

Taxes and insurance expense for the three months ended September 30, 2004, was approximately $0.7 million compared to $0.6 million for the comparable period of the prior year. A higher level of local property tax was initiated in the third quarter of 2003.

Total other income (expense) for the three months ended September 30, 2004 and 2003 was $(8.5) million and $(8.6) million, respectively, and was primarily comprised of interest expense, interest income, interim rebates and letter of credit fees. Interest income was $0.1 million higher during the current three-month period, as compared to the same period in 2003. This increase was related to higher interest rates and higher average cash balances. Interim rebates were received by the Company from the EPC contractor for underperformance of the Facility in the prior year period. 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.

For the Nine Months Ended September 30, 2004 and 2003

Operating revenues for the nine months ended September 30, 2004, were approximately $57.4 million compared to $52.6 million for the comparable period of the prior year. Revenue in the current nine-month period was higher primarily due to increased dispatch periods by Williams, a higher unforced capacity rating than in the prior year period and an availability bonus earned from Williams in the current year.

Fuel Conversion Volume expense for the nine months ended September 30, 2004, was $4.2 million

compared to $4.8 million for the comparable period of the prior 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 was 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 of September 28, 2002. 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.

Other operating expenses for the nine months ended September 30, 2004, were approximately $9.4 million compared to $6.7 million for the nine months ended September 30, 2003. The increase in other operating expenses was primarily due to costs related to two planned combustion inspection maintenance outages and increased Facility dispatch in 2004.

Taxes and insurance expense for the nine months ended September 30, 2004, was approximately $2.2 million compared to $1.8 million for the comparable period of the prior year. A higher level of local property tax was initiated in the third quarter of 2003.

Total other income (expense) for the nine months ended September 30, 2004 and 2003 was $(25.9) million and $(24.8) million respectively, and was 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 nine months ended September 30, 2004, compared to the nine months ended September 30, 2003 was primarily due to interim rebates that were received in the prior year period. Interest income was $0.1 million higher during the current year-to-date period, as compared to the same period last year. This increase was related to higher interest rates and higher average cash balances.

Concentration of Credit Risk

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 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 September 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 — The Company prepares its financial statements in accordance with accounting principles generally accepted in the United States of America. As such, the Company is required to make certain estimates, judgments and assumptions that it believes 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 the Company believes are most critical to understanding and evaluating its reported financial results include the following: Revenue Recognition, Property, Plant and Equipment and Contingencies.

Restricted Cash —- The Company has recorded the drawdown on the Raytheon letter of credit and the Prepayment from Williams Energy as restricted cash. The proceeds from the Raytheon letter of credit are deposited in the construction account. The Prepayment from Williams Energy, which the Company is entitled to use for operations as needed, is deposited in the revenue account.

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, 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. 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, 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 declines in PJM power pool prices, however, the Company would expect that even if it was 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	September 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	—	13,469
Plant	35	363,277
Subtotal	35	426,242
Accumulated Depreciation		(24,644		)
Property, Plant and Equipment, net		$	401,598

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 September 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 September 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 the Company has 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 third quarter ended September 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, the Company has made and will continue to make changes from time to time in our internal controls over financial reporting.

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

See Note 6 to our condensed consolidated financial statements.

Item 5. OTHER INFORMATION

None.

PART I.	FINANCIAL INFORMATION
Item 1.	CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
	Condensed Consolidated Statements of Operations, Three and Nine Months Ended September 30, 2004 and 2003
	Condensed Consolidated Balance Sheets, as of September 30, 2004 and December 31,2003
	Condensed Consolidated Statement of Changes in Member’s Capital for the Period from December 31, 2003 through September 30, 2004
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003
	Notes to Condensed Consolidated Financial Statements
Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND 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

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

	AES RED OAK, L.L.C.

Date: November 11, 2004	By:	/s/ A.W. BERGERON
		A.W. Bergeron
		President

Date: November 11, 2004	By:	/s/ PAM STRUNK
		Pam Strunk
		Chief Financial Officer

Date: November 11, 2004	By:	/s/ THOMAS P. KEATING
		Thomas P. Keating
		Principal Accounting Officer