**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.**

(Exactname 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’stelephone 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 (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days. Yes ý  No o

 

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

 

Registrant is a wholly owned subsidiary of The AESCorporation.  Registrant meets theconditions set forth in General Instruction H(I)(a) and (b) of Form 10-Q and isfiling the Quarterly Report on form 10-Q with the reduced disclosure formatauthorized by General Instruction II.

 

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**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 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** | ** **                                                                                                                                       | ** ** |
| ** **     | ** **                                                                                                                                       | ** ** |
| ** **     | ** **                                                                                                                                       | ** ** |

 

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**PART I. FINANCIAL INFORMATION**

 

**Item 1.   CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARYOF THE AES CORPORATION**

** Condensed Consolidated Statements ofOperations,**

**Threeand Nine Months Ended September 30, 2004 and 2003**

**(Unaudited)**

***(dollars inthousands)***

 
| ** **                               | ** ** | **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 condensedconsolidated financial statements.

 

 

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**                AESRED OAK, L.L.C. AND SUBSIDIARYAN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATIONCondensed Consolidated BalanceSheets,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 condensedconsolidated financial statements.

 

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARYOF THE AES CORPORATION**

**CondensedConsolidated Statement of Changes in Member’s Capital (Deficit)**

**Period fromDecember 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 condensedconsolidated financial statements.

 

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARYOF THE AES CORPORATION**

**CondensedConsolidated Statements of Cash Flows for the Nine Months Ended**

**September30, 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 condensedconsolidated financial statements.

 

4

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

**AN INDIRECT, WHOLLY OWNEDSUBSIDIARY OF THE AES CORPORATION**

**Notes toCondensed Consolidated Financial Statements**

 

**1.            ORGANIZATION**

 

AES Red Oak, L.L.C. (the “Company”) wasformed on September 13, 1998, in the State of Delaware, to develop, construct,own and operate an 832-megawatt (MW) gas-fired, combined cycle electricgenerating facility (the “Facility”) in the Borough of Sayreville, MiddlesexCounty, New Jersey. The Company was considered dormant until March 15, 2000(hereinafter, inception), at which time it consummated a project financing andcertain related agreements. On March 15, 2000, the Company issued $384 millionin senior secured bonds for the purpose of providing financing for theconstruction of the Facility and to fund, through the construction period,interest payments to the bondholders. In late September 2000, the Companyconsummated an exchange offer whereby the holders of the senior secured bondsexchanged their privately placed senior secured bonds for registered seniorsecured bonds.

The Facility consists of three Westinghouse501 FD combustion turbines, three unfired heat recovery steam generators, andone multicylinder steam turbine. The Facility produces and sells electricity,as well as provides fuel conversion and ancillary services, solely to WilliamsPower Company, Inc., (“Williams Energy”), formerly Williams Energy Marketing& Trading Company, under a 20-year Fuel Conversion Services, Capacity andAncillary Services Purchase Agreement (the “Power Purchase Agreement”).  The term of the Power Purchase Agreement istwenty years from the last day of the month in which commercial operationcommenced, which was September 2002.  TheCompany reached provisional acceptance on August 11, 2002, risk transfer onAugust 13, 2002, and took the position that the Facility was commerciallyavailable on September 1, 2002.  WilliamsEnergy disputed the September 1, 2002, commercial operation date and informedthe Company that it recognized commercial availability of the facility as ofSeptember 28, 2002.  On November 4, 2003,a settlement was reached and a commercial operation date of September 28, 2002was agreed upon.

The Company is a wholly owned subsidiary ofAES Red Oak, Inc. (“Red Oak”), which is a wholly-owned subsidiary of The AESCorporation (“AES”). Red Oak has no assets other than its ownership interestsin the Company and AES Sayreville, L.L.C. Red Oak has no operations and is notexpected to have any operations. Red Oak’s only income is distributions (ifany) it receives from the Company and AES Sayreville, L.L.C.

The equity that Red Oak provided to theCompany was provided to Red Oak by AES, which owns all of the equity interestsin Red Oak. AES files unaudited quarterly and annual audited reports with theSecurities and Exchange Commission under the Securities Exchange Act of 1934,which are publicly available, but which do not constitute a part of, and arenot incorporated into, this Form 10-Q.

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

**2.            BASIS OF PRESENTATION**

 

                In the Company’sopinion, all adjustments necessary for a fair presentation of the unauditedresults of operations for the interim periods presented herein are included.All such adjustments include accruals of a normal and recurring nature. Certainreclassifications have been made to prior-period amounts to conform to the 2004presentation. The results of operations for the three and nine-month periodspresented herein are not necessarily indicative of the results of operations tobe expected for the full year or future periods.

 

                TheCompany generates energy revenues under the Power Purchase Agreement withWilliams Energy. 

 

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During the 20-year term of the agreement, the Companyexpects to sell capacity and electric energy produced by the Facility, as wellas ancillary services and fuel conversion services. Under the Power PurchaseAgreement, the Company also generates revenues from meeting (1) baseelectrical output guarantees and (2) heat rate rebates through efficientelectrical output. Revenues from the sales of electric energy and capacity arerecorded based on output delivered and capacity provided at rates as specifiedunder contract terms. Revenues for ancillary and other services are recordedwhen the services are rendered.

 

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

 

                Thesefinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information and with the instructions to Form 10-Q andRegulation S-X. Accordingly, they do not include all of the informationand footnotes required by generally accepted accounting principles (“GAAP”) forcomplete financial statements. The accompanying condensed consolidated financial statements are unaudited and theyshould be read in conjunction with the audited financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2003.

 

**3.             BONDS PAYABLE**

                OnMarch 15, 2000, the Company issued $384 million in senior securedbonds for the purpose of providing financing for the construction of theFacility and to fund, through the construction period, interest payments to thebondholders. In September 2000, the Company consummated an exchange offerwhereby the holders of the senior secured bonds exchanged their privatelyplaced senior secured bonds for registered senior secured bonds.

 

                Thesenior secured bonds were issued in two series: 8.54% senior secured bonds due2019 (the “2019 Bonds”) in an aggregate principal amount of $224 millionand 9.20% senior secured bonds due 2029 (the “2029 Bonds”) in an aggregateprincipal amount of $160 million. Annual principal repayments on the Bondsare 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 the2019 Bonds are February 28, May 31, August 31, andNovember 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 untilFebruary 28, 2019. The company made the scheduled principal payment ofapproximately $2.2 million in August 2004 on the 2019 bonds.

 

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**4.**               **CONCENTRATIONOF CREDIT RISK IN WILLIAMS ENERGY AND AFFILIATES**

 

      WilliamsEnergy 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 PowerPurchase Agreement are expected to provide all of the Company’s operatingrevenues during the term of the Power Purchase Agreement.  It is unlikely that the Company would be ableto find another purchaser or fuel source with similar terms for its Facility ifWilliams Energy were not performing under the Power Purchase Agreement.  Any material failure by Williams Energy tomake capacity and fuel conversion payments or to supply fuel under the PowerPurchase Agreement would have a severe impact on the Company’s operations, andmay result in a default on the Company’s debt. The payment obligations of Williams Energy under the Power PurchaseAgreement are guaranteed by The Williams Companies, Inc.  The payment obligations of The WilliamsCompanies, Inc. under the guarantee were initially capped at an amount equal toapproximately $510 million.  Beginning onJanuary 1 of the first full year after the commercial operation date, this guaranteecap is to be reduced semiannually by a fixed amount which is based on theamortization of our senior secured bonds during the applicable semiannualperiod. As of September 30, 2004, the guarantee was capped at $506.6 million.

 

The minimum capacity payments provided forunder the Power Purchase Agreement have been the Company’s primary source ofoperating revenues, representing $51.0million of total revenues of $57.4 million for the nine months ended September30, 2004 and $49.6 million of total revenues of $52.6 million for thenine months ended September 30, 2003. The minimum cash flow from Williams underthe power purchase agreement is approximately $3.8 million per month forOctober through May and $7.9 million per month from June through September.

During 2003, the Company’s first full year ofoperations, net cash provided by operating activities was $14.8 million.  The Facility’s utilization factor for thenine months ended September 30, 2004 was approximately 28% as compared toapproximately 16% for the same period in 2003. The utilization factor is thepercentage of hours dispatched of the total available hours of the facility.The Company currently anticipates that the plant will be dispatched in futureperiods to similar degrees. The Company also believes that cash flows from the saleof electricity and/or minimum capacity payments under the Power PurchaseAgreement, and funds available to be drawn under the debt service reserveletter of credit or the power purchase letter of credit, will be sufficient tofund operating expenses and debt service costs.

The Company’s dependence upon The WilliamsCompanies, Inc. and its affiliates under the Power Purchase Agreement exposesthe Company to possible loss of revenues and fuel supply, which in turn, couldnegatively impact its cash flow and financial condition and may result in adefault on its senior secured bonds. There can be no assurances as to the Company’s ability to generatesufficient cash flow to cover operating expenses or its debt serviceobligations in the absence of a long-term power purchase agreement withWilliams Energy.

 

**5.            POWER PURCHASE AGREEMENT**

 

The Company and WilliamsEnergy have entered into a Power Purchase Agreement for the sale of allcapacity produced by the Facility, as well as ancillary services and fuel conversionservices. Under the Power Purchase Agreement, Williams Energy has theobligation to deliver, on an exclusive basis, all quantities of natural gasrequired by the Facility to generate electricity or ancillary services, tostart-up or shut-down the plant, and to operate the Facility during any periodother than a start-up, shut-down, or required dispatch by Williams Energy forany reason. The term of the Power Purchase Agreement is 20 years from the firstcontract anniversary date, which is the last day of the month in whichcommercial operations began.  As part ofthe arbitration settlement with Williams Energy, described below, the Companyrecognizes September 28, 2002 as the commercial operation date.

The Company entered intoarbitration with Williams Energy to resolve certain disputes regarding the dateof commercial operation and the proper interpretation of certain provisions ofthe Power Purchase Agreement relating to the amounts claimed by the Company tobe payable by Williams Energy.  WilliamsEnergy has 

 

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withheldor offset from amounts invoiced by the Company amounts that Williams Energybelieves were improperly invoiced based on Williams Energy’s interpretation ofthe Power Purchase Agreement.  Thearbitration related to disputed amounts of approximately $7.6 million, whichincluded a $594,000 payment extension option dispute and a $7 millioncommercial operation start date dispute. On November 4, 2003, the Company andWilliams 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 fromOctober 2002 to the payment date, and the commercial operation date was agreedto be September 28, 2002. The related revenue had been substantially recordedin September 2002, with the remaining amount recorded in the fourth quarter of2003.   This payment settled all paymentobligations between the parties for the month of September 2002 with respect tothe commercial operation date under the Power Purchase Agreement.  From the Company’s perspective, the cashpayment had the economic effect of recognizing a commercial operation dateprior to September 28, 2002. The Company is also currently disputing approximately$1.2 million of merchant price, testing gas and other charges with WilliamsEnergy that the Company contends is owed by Williams Energy. This was not partof the above arbitration.

The Company providedWilliams Energy a letter of credit (Power Purchase Agreement Letter of Creditand Reimbursement Agreement) in the amount of $30 million to support specificpayment obligations should the Facility not achieve commercial operation by thedate required under the Power Purchase Agreement. Upon the commencement ofcommercial operations in September 2002, the stated amount of that letter ofcredit was reduced to $10 million. The repayment obligations with respect toany drawings under the Power Purchase Agreement Letter of Credit andReimbursement Agreement are a senior debt obligation of the Company.

The payment obligationsof Williams Energy under the Power Purchase Agreement are guaranteed by TheWilliams Companies, Inc.  The paymentobligations of The Williams Companies, Inc. under the guarantee were initiallycapped at an amount equal to approximately $510 million.  Beginning on January 1 of the first full yearafter the commercial operation date, this guarantee cap is to be reducedsemiannually by a fixed amount which is based on the amortization of our seniorsecured bonds during the applicable semiannual period. As of September 30,2004, the guarantee was capped at $506.6 million.

Pursuant to Section 18.3of the Power Purchase Agreement, in the event that Standard & Poors orMoody’s rates the long-term senior unsecured debt of The Williams Companies,Inc. lower than investment grade, The Williams Companies, Inc. is required tosupplement The Williams Companies, Inc. guarantee with additional alternativesecurity that is acceptable to the Company within 90 days after the loss ofsuch investment grade rating.  Accordingto published sources, The Williams Companies, Inc.’s long term senior unsecureddebt has been rated below investment grade since 2002 by both S&P and Moody’s.

Due to the downgrade ofThe Williams Companies, Inc. to below investment grade, the Company andWilliams Energy entered into a letter agreement dated November 7, 2002 (the “LetterAgreement”), under which Williams Energy agreed to provide the Company (a) aprepayment of $10 million within five business days after execution of theLetter 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 beneficiarysubstantially in the form of the Power Purchase Agreement Letter of Credit,unless mutually agreed to otherwise, or (iii) a direct obligation of the UnitedStates Government delivered to a custodial securities account as designated bythe Company with a maturity of not more than three years; and (c) replenish anyportion of the alternative credit support that is drawn, reduced, cashed, orredeemed, at any time, with an equal amount of alternative credit support.  In the Letter Agreement, the Company andWilliams Energy acknowledged that the posting of such alternative creditsupport and Williams Energy’s agreement and performance of the requirements of(a), (b), and (c), as set forth in the immediately preceding sentence, would bein full satisfaction of Williams Energy’s obligations contained in Section 18.3of the Power Purchase Agreement.  In theLetter Agreement, the Company and Williams Energy expressly agreed that theposting of the Prepayment or any alternative credit support either now or inthe future or any other terms set forth in the Letter Agreement is not intendedto and did not modify, alter, or amend in any way, the terms and conditions orrelieve The Williams Company, Inc. from any obligations it has under itsguarantee of the payment obligations of Williams Energy under the PowerPurchase Agreement.  The guaranteeremains in full force and effect and the Company retains all of its rights andremedies provided by that guarantee.

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Under the terms of theLetter Agreement, the Company is obligated to return the Prepayment to WilliamsEnergy upon the earlier of (i) The Williams Companies, Inc. regaining itsinvestment grade rating or Williams Energy providing a substitute guarantee ofinvestment grade rating; (ii) the beginning of Contract Year 20; or (iii) theposting of alternative credit support by Williams Energy as set forthbelow.  In the case of items (i) and(iii) above, except to the extent, in the case of item (iii), Williams Energyelects to have all or a portion of the Prepayment make up a combination of thealternative credit support required to be posted pursuant to Section 18.3(b) ofthe Power Purchase Agreement, Williams Energy shall have the right to recoupthe Prepayment by set-off of any and all amounts owing to the Company under thePower Purchase Agreement beginning no earlier than the June in the calendaryear after the occurrence of item (i) or (iii) and continuing thereafter untilthe Prepayment has been fully recovered. In the case of item (ii) above, Williams Energy shall have the right toimmediately set-off all amounts owing to the Company under the Power PurchaseAgreement after the occurrence of item (ii) and continuing thereafter until thePrepayment has been fully recovered. Except to the extent Williams Energy elects to include the Prepayment aspart of the alternative credit support, the amount of alternative creditsupport posted by Williams Energy pursuant to the Letter Agreement shall beinitially reduced by the amount of the Prepayment, and Williams Energy shallthereafter increase the alternative credit support proportionately as WilliamsEnergy recoups the Prepayment set-off on the payment due date of amounts owingto the Company.

If the Company does notreturn the Prepayment to Williams Energy as set forth in the precedingparagraph, then the Company shall be considered in default under the LetterAgreement and Williams Energy shall be entitled to enforce any and or all ofits contractual rights and remedies as set forth in the Power PurchaseAgreement, including, but not limited to, drawing on the Letter of Creditpreviously posted by the Company in favor of Williams Energy.

Williams Energy made thePrepayment on November 14, 2002 and provided an additional $25 million of cashto the Company on January 6, 2003 as the alternative credit support.  As allowed by the Letter Agreement, Williamselected to have the $10 million Prepayment included as part of the alternativecredit support. On September 24, 2004, Williams Energy posted a letter ofcredit and the Company returned the $25 million of alternative credit support.

 

**6.****                                         ****COMMITMENTS AND CONTINGENCIES**

 

*Construction Agreement* - The Company entered intoan Agreement for Engineering, Procurement and Construction (EPC) services,dated as of October 15, 1999, between the Company and WGI (as the successorcontractor), 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 otherservices and items (collectively and separately, the “services”) of theFacility. 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 andunconditionally guaranteed by Raytheon. In 2001, as a result of WGI’s bankruptcyfiling, the Company made a demand on Raytheon to perform its obligations underthe Raytheon guarantee and WGI, Raytheon and the Company entered intoagreements pursuant to which Raytheon became responsible for the constructionof the Facility*.*

 

Provisional acceptance has been granted and the Facility has commencedcommercial operations, however, Raytheon must perform certain agreed uponcompletion items in order to obtain final acceptance. Raytheon gave notice ofFinal Acceptance on July 22, 2003 based on its July 8, 2003 performancetest.  On July 31, 2003, the Companyreceived a letter from the project’s independent engineer stating that it couldnot support Raytheon’s claim of final acceptance and it did not consider theJuly 8, 2003 performance test valid.  Inmaking this assessment, the independent engineer cited, among other reasons,(i) modifications made to certain equipment in performance of the July 8performance test which would adversely impact the operations of the plant andother pieces of equipment and (ii) Raytheon’s failure to demonstrate compliancewith guaranteed emissions limits.  OnAugust 1, 2003, the Company rejected Raytheon’s claim of final acceptance.  This rejection was based upon Raytheon’sfailure to meet the conditions for final acceptance provided for in the EPCcontract. On August 7, 2003, the Company received a response from Raytheon in

 

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whichRaytheon claims that the Company’s rejection of the final acceptance is invalidand improper.

 

On August 26, 2004, the Company drew down approximately $30.3 millionunder a letter of credit posted by Raytheon pursuant to the terms of the EPCAgreement. Prior to this date, the Company had drawn $544,000 on this letter ofcredit. The Company believes that Raytheon substantially breached the EPCAgreement, due, among other things, to the Facility’s failure to achievecompliance with certain performance tests, and Raytheon’s failure to completeother services under the EPC Agreement and certain amendments thereto,including a Settlement Agreement dated August 6, 2002, that purported toresolve disputes over whether Raytheon had achieved Mechanical Completion andProvisional Acceptance. As a result, the Company claims that Raytheon’s breacheshave caused damages in excess of the amount of the letter of credit. Raytheondisputes these claims and has failed and refused to pay costs and damages tothe 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 improvementsowned by the Company under the New Jersey Construction Lien Law.  Amongother things, Raytheon claims therein that the draw of the Letter of Credit representsa debt to Raytheon owed by the Company.

 

On October 28, 2004, AES Red Oak, L.L.C. received a complaint filed byRaytheon in the State of New York. In the complaint, Raytheon is seeking torecover $30.3 million, which represents the amount Red Oak drew down on theletter of credit on August 26, 2004, and also to recover up to $110 million of netexpense Raytheon claims to have incurred in good faith under the governingguaranty and construction agreements. Red Oak’s management believes thecomplaint to be without merit and intends to defend against it vigorously. TheCompany has recorded the $30.3 million as a current liability, but has notaccrued any additional amounts with respect to Raytheon’s claims.

 

*Land Development Plan* — The Company entered intoan agreement with the Borough of Sayreville by which the Company will developand implement a plan to replace trees which were removed during clearing of theFacility site.  The Land Development Planis required for final site approval.  The estimated cost of the plan is approximately $425,000.  The Company is in the process of selecting acontractor to perform the service and no payments have been made as ofSeptember 30, 2004.  On July 23, 2003,the project was secured by a letter of credit issued by Union Bank ofCalifornia for $425,000 with the Borough of Sayreville as the beneficiary.  This irrevocable standby letter of credit hadan expiration date of June 30, 2004, but was automatically extended for anotherone-year period. On August 19, 2004, AES secured a performance bond for$539,493 relating to the tree replacement and other site improvements. Thisbond replaces the previous letter of credit and represents the amountpotentially due if there is a failure of AES Red Oak, LLC to take action regardingthe plan.

 

**7.            NEW ACCOUNTING PRONOUNCEMENTS**

 

In January 2003, the Financial Accounting Standards Board (“FASB”)issued FIN No. 46, Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51 (“FIN No. 46”).  In October 2003, FASB StaffPosition No. 46-6, “Effective Date of FIN No. 46, Consolidation of VariableInterest Entities” deferred the effective date of FIN No. 46 for variableinterests held by a public entity in a variable interest entity (“VIE”) thatwas created or acquired before February 1, 2003 to the end of the first interimor annual period ending after December 15, 2003.  In December 2003, FASBissued FIN 46 (revised December 2003), Consolidation of Variable InterestEntities, an Interpretation of ARB No. 51 (“FIN 46(R)”), which clarified somerequirements and incorporated several staff positions that the Company wasalready required to apply.  In addition, FIN 46(R) deferred the effectivedate for VIEs that were created or acquired before February 1, 2003 and werenot considered special purpose entities (“SPEs”) prior to the issuance of theinterpretation until the end of the first reporting period ending after March15, 2004.  FIN 46(R) defines a VIE as (i) any entity in which the equityinvestors at risk in such entity do not have the characteristics of acontrolling financial interest, or (ii) any entity that does not havesufficient equity at risk to finance its activities without additionalsubordinated financial support from other parties.  It requires the consolidationof the VIE by the primary beneficiary.  The adoption of FIN 46(R) requiresthe Company to include disclosures for non SPE VIEs created or acquired on orafter February 1, 2003 in its consolidated financial statements related to the total assets and themaximum 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 financialposition, results of operations, or cash flows.

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**8.            SUBSEQUENT EVENTS**

 

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

 

 

**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**Cautionary Note Regarding Forward-LookingStatements**

 

Some of the statements in this Form 10-Q, aswell as statements made by us in periodic press releases and other publiccommunications, constitute “forward-looking statements” within the meaning ofthe Private Securities Litigation Reform Act of 1995.  Certain, but not necessarily all, of suchforward-looking statements can be identified by the use of forward-lookingterminology, such as “believes,” “estimates,” “plans,” “projects,” “expects,” “may,”“will,” “should,” “approximately,” or “anticipates” or the negative thereof orother variations thereof or comparable terminology, or by discussion ofstrategies, each of which involves risks and uncertainties. The Company hasbased these forward-looking statements on our current expectations andprojections about future events based upon our knowledge of facts as of thedate of this Form 10-Q and our assumptions about future events.

All statements other than of historical factsincluded herein, including those regarding market trends, our financialposition, business strategy, projected plans and objectives of management forfuture operations of the Facility, are forward-looking statements. Suchforward-looking statements involve known and unknown risks, uncertainties andother factors outside of our control that may cause our actual results orperformance to be materially different from any future results, performance orachievements expressed or implied by the forward-looking statements. Theserisks, uncertainties and other factors include, among others, the following:

•                       unexpected problems relating to theperformance of the Facility,

•                       the financial condition of third parties onwhich we depend, including in particular, Williams Power Company, Inc., (“WilliamsEnergy”), formerly Williams Energy Marketing & Trading Company, as fuelsupplier under the power purchase agreement we entered into with WilliamsEnergy for the sale of all electric energy and capacity produced by theFacility, as well as ancillary and fuel conversion services (the “PowerPurchase Agreement”), and The Williams Companies, Inc., as the guarantor ofWilliams Energy’s performance under the Power Purchase Agreement,

•                       delays in, or disputes over, the finalcompletion of our Facility,

•                       continued performance by Williams Energy (asguaranteed 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 bycontinuing to maintain or provide adequate security to supplement theirguarantee of Williams Energy’s performance under the Power Purchase Agreement,

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

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

 

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•                     capital shortfalls and access to additionalcapital on reasonable terms, or in the event that the Power Purchase Agreementis terminated,

•                     the degree to which Williams Energy requeststhat we run or “dispatch” the Facility, including the possibility that WilliamsEnergy will not request that we run or “dispatch” the Facility at all,

•                     inadequate insurance coverage,

•                     unexpected expenses or lower than expectedrevenues,

•                     environmental and regulatory compliance,

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

•                     additional factors that are unknown to us orbeyond our control.

We undertake no obligation to publicly updateor revise any forward-looking statement, whether as a result of newinformation, 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 Companywas dormant until March 15, 2000, the date of the sale of our senior securedbonds. We obtained $384 million of project financing from the sale of thesenior secured bonds.

 

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

 

**Liquidity and Capital Resources**

 

Since achievingcommercial operations under the Power Purchase Agreement with Williams Energy,the Company became eligible to receive variable operations and maintenancepayments, total fixed payments, energy exercise fee payments (each as definedin the Power Purchase Agreement) and other payments for the delivery of fuelconversion, capacity and ancillary services. We have been dispatched by Williams Energy more often in the nine monthsended September 30, 2004, than in the same period last year, but can provide noassurance that this will continue.  Ifthe Facility is not dispatched, our operating revenues will consist of minimumcapacity payments under the Power Purchase Agreement.

The minimum capacitypayments provided for under the Power Purchase Agreement have been the Company’sprimary source of operating revenues, representing $51.0 million of totalrevenues of $57.4 million for the nine months ended September 30, 2004 and $49.6million of total revenues of $52.6 million for the nine months ended September30, 2003. The minimum cash flow fromWilliams under the power purchase agreement is approximately $3.8 million permonth for October through May and $7.9 million per month from June throughSeptember.

Net cash provided by operating activities was$8.7 million for the nine months ended September 30, 2004 and $8.6 million forthe nine months ended September 30, 2003. The Facility’s utilization factor for the nine months ended September30, 2004, was approximately 28% as compared to approximately 16% for the sameperiod in 2003. The Company currently anticipates that the plant will bedispatched in future periods to similar degrees. The Company also believes thatcash flows from the sale of electricity and/or minimum capacity payments underthe Power Purchase Agreement, and funds available to be drawn under the debtservice reserve letter of credit or the power purchase letter of credit, willbe sufficient to fund operating expenses and debt service costs.

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The Company has providedWilliams Energy a $10 million letter of credit under the Power PurchaseAgreement, which we refer to as the power purchase letter of credit, to supportspecific payment obligations under the Power Purchase Agreement. The repaymentobligations with respect to any drawings under the power purchase letter ofcredit are our senior debt obligation.

Due to the downgrade ofThe Williams Companies, Inc.’s debt to below investment grade, the WilliamsCompanies, Inc. is required to supplement The Williams Companies, Inc.guarantee with additional alternative security that is acceptable to theCompany.  Since The Williams Companies,Inc. debt rating fell below investment grade in 2002, Williams Energy hadprovided us with $35 million of cash as alternate credit support, whichincluded a $10 million Prepayment.  OnSeptember 24, 2004, Williams Energy posted a letter of credit and the Companyreturned $25 million of alternative credit support. In the event that TheWilliams Companies, Inc. regains and maintains its investment grade status,provides a substitute guarantee of investment grade rating, or postsalternative credit support , the Company either will be required to return the$10 million Prepayment  or WilliamsEnergy will have the right to recoup the Prepayment by set-off of any and allamounts owing to the Company under the Power Purchase Agreement no earlier thanthe June in the calendar year after the occurrence of regaining its investmentgrade 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 gradestatus, the Company will also have access to funds from our $2.5 millionworking capital agreement.  As ofNovember 5, 2004, the Company had cash balances of approximately $48million.  In the event that the Companyis required to return the $10 million prepayment to Williams Energy, theCompany believes that it would use all or a portion of its current cashbalances and cash generated from future operations, with any remaining balancededucted from the monthly amounts due to the Company from Williams Energy.  This belief is subject to certainassumptions, risks and uncertainties, including those set forth above under thecaption “Cautionary Note Regarding Forward-Looking Statements” and there can beno assurances that our operating revenues will generate sufficient cash.

As of September 30,2004, $372 million aggregate principal amount of senior secured bonds, issuedin 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 2029Bonds does not commenceuntil February 28, 2019.  The Company hasprovided the collateral agent with a debt service reserve letter of credit inan initial stated amount of $22.0 million which the collateral agent may drawupon if the Company fails to meet our obligations under the senior securedbonds.

The Company entered intoan agreement with the Borough of Sayreville by which the Company will developand implement a plan to replace trees which were removed during clearing of theFacility site.  The Land Development Planis required for final site approval.  The estimated cost of the plan is approximately $425,000.  The Company is in the process of selecting acontractor to perform the service and no payments have been made as ofSeptember 30, 2004.  On July 23, 2003,the project was secured by a letter of credit issued by Union Bank ofCalifornia for $425,000 with the Borough of Sayreville as the beneficiary andrepresents the amount potentially due if there is a failure of the Company totake action regarding the plan.   Thisirrevocable standby letter of credit had an expiration date of June 30, 2004,but was automatically extended for another one-year period.

For the nine monthsended September 30, 2004, the Company incurred costs related to capitaladditions of approximately $1.4 million, including general improvements of theFacility, EPC related costs and planned maintenance outages. The Companyexpects to incur approximately $0.2 million of such costs for the remainder of2004.

OnAugust 26, 2004, the Company drew down approximately $30.3 million under aletter 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 withcertain performance tests, and Raytheon’s failure to complete other servicesunder the EPC Agreement and certain amendments thereto, including aSettlement Agreement dated August 6, 2002, that purported to resolve disputesover whether Raytheon had achieved Mechanical Completion and ProvisionalAcceptance. As a result, the Company claims that Raytheon’s breaches havecaused damages in excess of the amount of the letter of credit.

 

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

 

On August 27, 2004, Raytheon filed a constructionlien claim for $30,963,662 in Middlesex County against the real property andimprovements owned by the Company under the New Jersey Construction LienLaw.  Among other things, Raytheon claims therein that the draw of the Letterof Credit represents a debt to Raytheon owed by the Company

 

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

 

Since we depend onWilliams Energy for both revenues and fuel supply under the Power PurchaseAgreement, if Williams Energy were to terminate or default under the PowerPurchase Agreement, there would be a severe negative impact to our cash flowand financial condition which could result in a default on our senior securedbonds.  Due to the current PJM power poolprices, we would expect that if the Company was required to seek alternatepurchasers of our power in the event of a default of Williams Energy, even ifthe Company was successful in finding alternate revenue sources, any suchalternate revenue sources would be substantially below the amounts that wouldhave been otherwise payable pursuant to the Power Purchase Agreement. There canbe no assurance as to our ability to generate sufficient cash flow to coveroperating expenses or our debt service obligations in the absence of along-term power purchase agreement with Williams Energy.

In addition to thefactors discussed above, and/or the other factors listed under the “CautionaryNote Regarding Forward-Looking Statements,” if the Company does not receivefinal rebates from Raytheon and/or the working capital agreement continues tobe unavailable as a result of the ratings on our senior secured bonds, we couldexperience a negative impact on our cash flow and financial condition.

The following discussion presents certainfinancial information for the three and nine months ended September 30, 2004 and 2003.

**Energy Revenues**

 

The Company generates energy revenues under thePower Purchase Agreement with Williams Energy. During the 20-year term of theagreement, the Company expects to sell electric energy and capacity produced bythe Facility, as well as ancillary and fuel conversion services. Under thePower Purchase Agreement, the Company also generates revenues from meeting(1) base electrical output guarantees and (2) heat rate rebatesthrough efficient electrical output.

Upon its expiration, or in the event that thePower Purchase Agreement is terminated prior to its 20-year term, the Companywould seek to generate energy revenues from the sale of electric energy andcapacity into the merchant market or under new short or long-term powerpurchase or similar agreements. Due to recent declines in PJM power poolprices, however, the Company would expect that even if the Company wassuccessful in finding alternate revenue sources, any such alternate revenueswould be substantially below the amounts that would have been otherwise payablepursuant to the Power Purchase Agreement. There can be no assurances as towhether 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 awholly-owned subsidiary of The AES Corporation (“AES”), the Company is required to reimburse all operator costs on a monthlybasis. Operator costs generally consist of all direct costs

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and overhead associated withrunning 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 acceptanceor interim acceptance, whichever is the earlier to occur, is less than theelectrical output guarantee, then Raytheon must pay us, as a rebate and not asliquidated 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 isless than the electrical output guarantee. During performance testing, our output was calculated to be 13,370kilowatts less than the electrical output guarantee.  Accordingly, our daily charge for this amounthas been calculated at $2,941.40 per day. Raytheon paid us this amount untiltheir notice of Final Acceptance date of July 22, 2003, but we are disputingthis claim of final acceptance and contend that these amounts should continueto be paid until the final acceptance date.

Upon final acceptance,if the average net electrical output of our Facility during the completedperformance test is less than the electrical output guarantee, then Raytheonmust pay us, as a bonus, an amount equal to $520 for each kilowatt by which theaverage net electrical output is less than the guarantee minus any interimrebates paid or to be paid by Raytheon.

*Heat Rate Guarantees*

 

If the average net heatrate of our Facility at provisional acceptance or interim acceptance, if havingoccurred before final acceptance, exceeds the heat rate guarantee, thenRaytheon must pay us, as a rebate and not as liquidated damages, for each dayduring the interim period, an amount equal to $46 per day for each BTU/KwH bywhich 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 testexceeds the heat rate guarantee, then Raytheon will pay us, as a rebate, a lumpsum amount equal to $110,000 for each BTU/KwH by which the measured heat rateis greater than the heat rate guarantee minus any interim rebates paid or to bepaid by Raytheon.

The Company has notinvoiced Raytheon for the nine-month period ended September 30, 2004, forelectrical output and heat rate rebates. As of September 30, 2004, Raytheonowed approximately $65,000 in rebates for amounts invoiced in 2003.

 

**Recent and New Accounting Pronouncements**

 

In January 2003, the Financial AccountingStandards Board  (“FASB”) issued FIN No. 46, Consolidation of VariableInterest Entities, an Interpretation of ARB No. 51 (“FIN No. 46”).  InOctober 2003, FASB Staff Position No. 46-6, “Effective Date of FIN No. 46,Consolidation of Variable Interest Entities” deferred the effective date of FINNo. 46 for variable interests held by a public entity in a variable interestentity (“VIE”) that was created or acquired before February 1, 2003 to the endof the first interim or annual period ending after December 15, 2003.  InDecember 2003, FASB issued FIN 46 (revised December 2003), Consolidation ofVariable Interest Entities, an Interpretation of ARB No. 51 (“FIN 46(R)”),which clarified some requirements and incorporated several staff positions thatthe Company was already required to apply.  In addition, FIN 46(R)deferred the effective date for VIEs that were created or acquired beforeFebruary 1, 2003 and were not considered special purpose entities (“SPEs”)prior to the issuance of the interpretation until the end of the firstreporting 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 havethe characteristics of a controlling financial interest, or (ii) any entitythat does not have sufficient equity at risk to finance its activities withoutadditional subordinated financial support from other parties.  It requiresthe consolidation

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of the VIE by the primarybeneficiary.  The adoption of FIN 46(R) requires the Company to includedisclosures for non SPE VIEs created or acquired on or after February 1, 2003in its  consolidated financial statementsrelated to the total assets and the maximum exposure to loss resulting from theCompany’s interests in VIEs.  The adoption of FIN 46(R) did not have amaterial effect on our financial position, results of operations, or cashflows.

**Results of Operations**

 

Under the Power PurchaseAgreement with Williams Energy, we are eligible to receive variable operationsand maintenance payments, total fixed payments, energy exercise fees (each asdefined in the Power Purchase Agreement) and other payments for the delivery offuel conversion, capacity and ancillary services.  The Facility’s utilization factor for the nine months ended September30, 2004, was approximately 28% as compared to approximately 16% for the sameperiod in 2003. Accordingly, the minimumcapacity 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, wereapproximately $27.9 million compared to $25.8 million for the three monthsended September 30, 2003.   Revenue inthe current three-month period was higher primarily due to increased dispatchperiods by Williams, a higher unforced capacity rating than in the prior yearperiod and an availability bonus earned from Williams in the currentthree-month period.

 

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

 

 Other operating expenses for thethree months ended September 30, 2004, were approximately $3.2 millioncompared to $2.9 million for the three months ended September 30, 2003. Theincrease in other operating expenses was primarily due to maintenance costsincurred 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 thecomparable period of the prior year. A higher level of local property tax wasinitiated 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 wasprimarily comprised of interest expense, interest income, interim rebates andletter of credit fees.  Interest incomewas $0.1 million higher during the current three-month period, as compared tothe same period in 2003. This increase was related to higher interest rates andhigher average cash balances. Interim rebates were received by the Company fromthe EPC contractor for underperformance of the Facility in the prior yearperiod.  Letter of credit fees relate toour debt service letter of credit and reimbursement agreement and powerpurchase 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, wereapproximately $57.4 million compared to $52.6 million for the comparable periodof the prior year. Revenue in the current nine-month period was higherprimarily due to increased dispatch periods by Williams, a higher unforcedcapacity rating than in the prior year period and an availability bonus earnedfrom Williams in the current year.

 

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

 

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comparedto $4.8 million for the comparable period of the prior year. Fuel ConversionVolume expense represents a charge paid to Williams Energy under the PowerPurchase Agreement based upon utilization of the Facility. The decrease was dueto the Facility not operating over a certain dispatch level for the last twelvemonths, which is a factor in the determination of this cost under the PowerPurchase Agreement. The factor applied in the prior-year period was fixed forthe first twelve-month period commencing with the commercial operation date ofSeptember 28, 2002. To the extent that our utilization exceeds 20% for theprior twelve month period, this expense may rise back up to the 2003 level infuture periods.

 

Other operating expenses for the nine months ended September 30, 2004,were approximately $9.4 million compared to $6.7 million for the ninemonths ended September 30, 2003. The increase in other operating expenses wasprimarily due to costs related to two planned combustion inspection maintenanceoutages 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 thecomparable period of the prior year. A higher level of local property tax wasinitiated 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 wasprimarily comprised of interest expense, interest income, interim rebates fromthe 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 tointerim rebates that were received in the prior year period. Interest incomewas $0.1 million higher during the current year-to-date period, as compared tothe same period last year. This increase was related to higher interest ratesand higher average cash balances.

 

**Concentration of Credit Risk**

 

Williams Energy iscurrently the Company’s sole customer for purchases of capacity, ancillaryservices, and energy and its sole source for fuel.  Williams Energy’s payments under the PowerPurchase Agreement are expected to provide all of the Company’s operatingrevenues during the term of the Power Purchase Agreement.  It is unlikely that the Company would be ableto find another purchaser or fuel source on similar terms for its Facility ifWilliams Energy were not performing under the Power Purchase Agreement.  Any material failure by Williams Energy tomake capacity and fuel conversion payments or to supply fuel under the PowerPurchase Agreement would have a severe impact on the Company’s operations, andmay result in a default on the Company’s debt. The payment obligations of Williams Energy under the Power PurchaseAgreement are guaranteed by The Williams Companies, Inc.  The payment obligations of The WilliamsCompanies, Inc. under the guarantee were initially capped at an amount equal toapproximately $510 million.  Beginning onJanuary 1 of the first full year after the commercial operation date, this guaranteecap is to be reduced semiannually by a fixed amount which is based on theamortization of our senior secured bonds during the applicable semiannualperiod. As of September 30, 2004, the guarantee was capped at $506.6 million.

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

 

**Critical Accounting Policies**

 

*General* — The Company prepares its financial statements inaccordance with accounting principles generally accepted in the United Statesof America. As such, the Company is required to make certain estimates,judgments and assumptions that it believes are reasonable based upon theinformation available. These estimates and assumptions affect the reportedamounts of assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the periods presented. The

 

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significantaccounting policies which the Company believes are most critical tounderstanding and evaluating its reported financial results include thefollowing:  Revenue Recognition,Property, Plant and Equipment and Contingencies.

 

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

 

*Revenue Recognition* — The Company generates energy revenues under the Power Purchase Agreement withWilliams Energy.  During the 20-year termof the agreement, the Companyexpects to sell capacity and electric energy produced by the Facility, as wellas ancillary services and fuel conversion services.  Under the Power Purchase Agreement, theCompany also generates revenues frommeeting (1) base electrical output guarantees and (2) heat rate rebates throughefficient electrical output.  Revenuesfrom the sales of electric energy and capacity are recorded based on output deliveredand capacity provided at rates as specified under contract terms.  Revenues for ancillary and other services arerecorded when the services are rendered. Amounts that are in dispute arereserved accordingly, based on the probability that they will be realized.

Upon its expiration, or in the event that the Power Purchase Agreementis terminated prior to its 20-year term or Williams Energy otherwise fails toperform, the Company would seek to generate energy revenues from the sale ofelectric energy and capacity into the merchant market or under new short- orlong-term power purchase or similar agreements. Due to declines in PJM power pool prices, however, the Company wouldexpect that even if it was successful in finding alternate revenue sources, anysuch alternate revenues would be substantially below the amounts that wouldhave been otherwise payable by Williams Energy pursuant to the Power PurchaseAgreement.  There can be no assurances asto whether such efforts would be successful.

 

*Property, Plant and Equipment* —  Property, plant and equipment is recorded atcost and is depreciated over its useful life. The estimated lives of our generation facilities range from five tothirty-six years.  A significant decreasein the estimated useful life of a material amount of our property, plant orequipment could have a material adverse impact on our operating results in theperiod in which the estimate is revised and in subsequent periods.  The depreciable lives of our property plantand 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    |   |

 

 

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** **

**ITEM 4.  CONTROLS AND PROCEDURES**

 

*Evaluation of Disclosure Controlsand Procedures.*  We carried out an evaluation, under thesupervision and with the participation of our management, including the chiefexecutive officer (“CEO”) and chief financial officer (“CFO”), of theeffectiveness of our “disclosure controls and procedures” (as defined in theSecurities Exchange Act of 1934 Rules 13a-15(e) and 15-d-15 (e) asrequired by paragraph (b) of the Exchange Act Rules 13a-15 or 15d-15) as ofSeptember 30, 2004.  The Company’s management, including the CEO and CFO,is engaged in a comprehensive effort to review, evaluate and improve ourcontrols; however, management does not expect that our disclosure controls orour internal controls over financial reporting will prevent all errors and allfraud.  A control system, no matter how well designed and operated, canprovide only reasonable, not absolute, assurance that the control system’sobjectives will be met.

 

Based upon the controls evaluation performed,the CEO and CFO have concluded that as of September 30, 2004, our disclosurecontrols and procedures were effective to provide reasonable assurance thatmaterial information relating to us and our consolidated subsidiaries isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.

 

*Changes in Internal Controls*.  In thecourse of our evaluation of disclosure controls and procedures, managementconsidered certain internal control areas in which the Company has made and arecontinuing to make changes to improve and enhance controls.  Based uponthat evaluation, the CEO and CFO concluded that there were no changes in ourinternal controls over financial reporting identified in connection with theevaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15that occurred during the third quarter ended September 30, 2004, that havematerially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

 

*Compliance with Section 404 ofthe Sarbanes Oxley Act of 2002*.  Beginning with theyear ending December 31, 2005, Section 404 of the Sarbanes-Oxley Act of 2002will require us to include an internal control report of management with ourannual report on Form 10-K.  The internal control report must contain (1)a statement of management’s responsibility for establishing and maintainingadequate internal controls over financial reporting for our Company, (2) astatement identifying the framework used by management to conduct the requiredevaluation of the effectiveness of our internal controls over financialreporting, (3) management’s assessment of the effectiveness of our internalcontrols 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 financialreporting are effective, and (4) a statement that our independent auditors haveissued an attestation report on management’s assessment of our internalcontrols over financial reporting.

 

Management developed a comprehensive plan inorder to achieve compliance with Section 404 within the prescribed period andto review, evaluate and improve the design and effectiveness of our controlsand procedures on an on-going basis.  Thecomprehensive compliance plan includes (1) documentation and assessment of theadequacy of our internal controls over financial reporting, (2) remediation ofcontrol weaknesses, (3) validation through testing that controls arefunctioning as documented and (4) implementation of a continuous reporting andimprovement process for internal controls over financial reporting.  As aresult of this initiative, the Company has made and will continue to makechanges 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 consolidatedfinancial 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                                                                                                  |

 

 

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**SIGNATURES**

 

                Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| ** **              | **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 |

 

 

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