**UNITEDSTATESSECURITIES 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, 2003**                                                                            |                                     |
|                                                                                                                                   |                                     |
| **o**                                                                                                                                  |                                     | **TRANSITION  REPORT PURSUANT OR TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |   |
|                                                                                                                                   |                                     |
| **For the  transition period  from        to        ** |                                     |
|                                                                                                                                   |                                     |
| **Commission  file number 333-40478**                                                                                                  |                                     |
|                                                                                                                                   |                                     |
| **AES RED  OAK, L.L.C.**                                                                                                               |                                     |
| (Exact name of registrant  as specified in its charter)                                                                                |                                     |
|                                                                                                                                   |                                     |
| **Delaware**                                                                                                                           | **54-1889658**                           |
| (State or other  jurisdiction of  incorporation or organization)                                                                       | (I.R.S. Employer  Identification Number) |
|                                                                                                                                   |                                     |
| **832 Red  Oak Lane, Sayreville, NJ 08872  (732) 238-1462**                                                                       |
| (Address of principal  executive offices, zip code)  (Telephone number, Including Area Code)                                           |
|                                                                                                                                        |                                          |                                                                                                                  |        |  |  |  |  |

 

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 H.

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (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

 

 

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**AES REDOAK, 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, 2003 and 2002**                                   |   |
|           | **Condensed  Consolidated Balance Sheets, as of September 30, 2003 and  December 31, 2002**                                                 |   |
|           | **Condensed  Consolidated Statement of Changes in Member’s Capital for the Period from  December 31, 2002 through September 30, 2003** |   |
|           | **Condensed  Consolidated Statements of Cash Flows for the Nine Months Ended  September 30, 2003 and 2002**                                      |   |
|           | **Notes  to Condensed Consolidated Financial Statements**                                                                                             |   |
| **Item  2.**   | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                                                       |   |
| **Item  3.**   | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                                                       |   |
|           |                                                                                                                                                  |   |
| **Item 4.**    | **CONTROLS AND PRODECURES**                                                                                                                           |   |
|           |                                                                                                                                                  |   |
| **PART II.**   | **OTHER INFORMATION**                                                                                                                                 |   |
| **Item 1.**    | **LEGAL PROCEEDINGS**                                                                                                                                 |   |
| **Item  2.**   | **CHANGES  IN SECURITIES AND USE OF PROCEEDS**                                                                                                        |   |
| **Item 3.**    | **DEFAULTS UPON  SENIOR SECURITIES**                                                                                                                  |   |
| **Item  4.**   | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                                              |   |
| **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 SUBSIDIARYAN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATIONCondensed Consolidated Statementsof Operations,Three and Nine Months Ended September 30, 2003 and 2002(Unaudited)*(dollars in thousands)***

 
|                              |   | **Three Months  Ended  September 30** |   | **Nine Months  Ended  September 30** |   |
|-----------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                              |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
| OPERATING  REVENUES               |   |                                       |   |                                      |   |   |   |   |   |
| Energy                            |   | $                                          | 25,799 |                                      | $      | 15,060 |   | $ | 52,567 |   | $ | 15,060 |   |
|                              |   |                                       |   |                                      |   |   |   |   |   |
| OPERATING  EXPENSES               |   |                                       |   |                                      |   |   |   |   |   |
| Fuel  costs                       |   | —                                     |   | (6,982                                    | )      | (635 | ) | (6,982 | ) |
| Fuel  conversion volume expense   |   | (1,618                                     | )      | (267                                      | )      | (4,824 | ) | (267 | ) |
| Corporate  management fees        |   | (402                                       | )      | (258                                      | )      | (1,200 | ) | (258 | ) |
| Other  operating expenses         |   | (3,030                                     | )      | (363                                      | )      | (6,639 | ) | (363 | ) |
| Depreciation  expense             |   | (2,830                                     | )      | (1,544                                    | )      | (8,609 | ) | (1,544 | ) |
| Taxes  and insurance         |   | (644                                       | )      | (470                                      | )      | (1,821 | ) | (470 | ) |
| General  and administrative costs |   | (50                                        | )      | (208                                      | )      | (159 | ) | (364 | ) |
| Total  operating expenses         |   | (8,574                                     | )      | (10,092                                   | )      | (23,887 | ) | (10,248 | ) |
|                              |   |                                       |   |                                      |   |   |   |   |   |
| Operating  income                 |   | 17,225                                     |   | 4,968                                     |   | 28,680 |   | 4,812 |   |
|                              |   |                                       |   |                                      |   |   |   |   |   |
| OTHER  INCOME (EXPENSE)           |   |                                       |   |                                      |   |   |   |   |   |
| Interest  income                  |   | 57                                         |   | 34                                        |   | 202 |   | 95 |   |
| Contractor  Rebates               |   | 202                                        |   | 339                                       |   | 1,415 |   | 339 |   |
| Interest  expense                 |   | (8,575                                     | )      | (4,310                                    | )      | (25,681 | ) | (4,574 | ) |
| Letter  of Credit Fees            |   | (255                                       | )      | —                                    |   | (761 | ) | — |   |
| Total  other income (expense)     |   | (8,571                                     | )      | (3,937                                    | )      | (24,825 | ) | (4,140 | ) |
|                              |   |                                       |   |                                      |   |   |   |   |   |
| NET  INCOME                       |   | $                                          | 8,654  |                                      | $      | 1,031 |   | $ | 3,855 |   | $ | 672 |   |

 

See notes tocondensed consolidated financial statements.

 

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**AES RED OAK, L.L.C. AND SUBSIDIARYAN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATIONCondensed Consolidated BalanceSheets,September 30, 2003 and December 31, 2002 *(dollars in thousands, except share amounts)***

 
|                                                                                                       |   | **(Unaudited)**            |    |                      |   |
|------------------------------------------------------------------------------------------------------------|--------|----------------------------|---------|---------------------------|--------|
|                                                                                                       |   | **September 30,**2003 |    | **December 31,**2002 |   |
| **ASSETS:**                                                                                                |   |                       |    |                      |   |
|                                                                                                       |   |                       |    |                      |   |
| Current Assets:                                                                                            |   |                       |    |                      |   |
| Cash                                                                                                       |   | $                          | 20      |                      | $      | 23 |   |
| Restricted cash at cost, which approximates market  value                                                  |   | 35,138                     |    | 7,749                     |   |
| Receivables                                                                                                |   | 12,822                     |    | 8,442                     |   |
| Receivable from affiliate                                                                                  |   | 245                        |    | 309                       |   |
| Inventory                                                                                                  |   | 621                        |    | 550                       |   |
| Prepaid expenses                                                                                           |   | 788                        |    | 230                       |   |
| Total current assets                                                                                       |   | 49,634                     |    | 17,303                    |   |
|                                                                                                       |   |                       |    |                      |   |
| Land                                                                                                       |   | 4,240                      |    | 4,240                     |   |
| Construction in progress                                                                                   |   | **—**                 |    | 344                       |   |
| Property, plant, and equipment – net of accumulated  depreciation of $13,047 and $4,438, respectively |   | 397,615                    |    | 404,752                   |   |
| Deferred financing costs – net of accumulated  amortization of $2,721 and $2,315, respectively        |   | 15,780                     |    | 16,390                    |   |
| Spare parts inventory                                                                                      |   | 12,150                     |    | 12,013                    |   |
| Other assets                                                                                               |   | 146                        |    | 141                       |   |
| Total assets                                                                                               |   | $                          | 479,565 |                      | $      | 455,183 |   |
|                                                                                                       |   |                       |    |                      |   |
| **LIABILITIES AND MEMBER’S CAPITAL:**                                                                 |   |                       |    |                      |   |
| Current Liabilities:                                                                                       |   |                       |    |                      |   |
| Accounts payable                                                                                           |   | $                          | 1,013   |                      | $      | 1,175 |   |
| Accrued liabilities                                                                                        |   | 1,213                      |    | 1,516                     |   |
| Accrued interest                                                                                           |   | 2,778                      |    | 2,804                     |   |
|  

Liabilities under spare parts agreement – current  portion                                    |   | 5,996                      |    | —                    |   |
| Payable to affiliate                                                                                       |   | 380                        |    | 18                        |   |
| Bonds payable-current portion                                                                              |   | 5,652                      |    | 6,219                     |   |
| Notes payable                                                                                              |   | 565                        |    | —                    |   |
| Other current liabilities                                                                                  |   | 35,000                     |    | 10,000                    |   |
| Total current liabilities                                                                                  |   | 52,597                     |    | 21,732                    |   |
| Bonds payable – non current  portion                                                             |   | 372,353                    |    | 375,361                   |   |
| Liabilities under spare parts agreement – non  current portion                                        |   | 1,995                      |    | 9,325                     |   |
|                                                                                                       |   |                       |    |                      |   |
| Total liabilities                                                                                          |   | $                          | 426,945 |                      | $      | 406,418 |   |
|                                                                                                       |   |                       |    |                      |   |
| Member’s capital:                                                                                     |   |                       |    |                      |   |
| Common stock, $1 par value-10 shares authorized,  none issued or outstanding                               |   | $                          | —  |                      | $      | — |   |
| Contributed capital                                                                                        |   | 56,736                     |    | 56,736                    |   |
| Member’s deficit                                                                                      |   | (4,116                     | )       | (7,971                    | )      |
| Total member’s capital                                                                                |   | 52,620                     |    | 48,765                    |   |
|                                                                                                       |   |                       |    |                      |   |
| Total liabilities and member’s capital                                                                |   | $                          | 479,565 |                      | $      | 455,183 |   |

 

See notes tocondensed consolidated financial statements.

 

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**AES REDOAK, L.L.C. AND SUBSIDIARYAN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION****CondensedConsolidated Statement of Changes****inMember’s CapitalPeriod from December 31, 2002 through September  30, 2003*(dollars in thousands)(Unaudited)***

 
|                             |   |              |   |       |                       | **Additional    Paid-in   Capital** |   |      |   |   |   |
|----------------------------------|--------|-------------------|--------|------------|----------------------------|-------------------------------------|--------|-----------|--------|--------|--------|
|                             |   | **Common  Stock** |   |       | **Accumulated    Deficit** |                                |   |      |
|                             |   | **Shares**        |   | **Amount** |                       |                                |   | **Total** |   |
|                             |   |              |   |       |                       |                                |   |      |   |   |   |
| BALANCE DECEMBER 31,  2002  |   | —            |   | $          | —                     |                                | $      | 56,736    |   | $      | (7,971 | ) | $ | 48,765 |   |
| Net income                       |   | —            |   | —     |                       | —                              |   | $         | 3,855  |   | $      | 3,855 |   |
| BALANCE September 30,  2003 |   | —            |   | $          | —                     |                                | $      | 56,736    |   | $      | (4,116 | ) | $ | 52,620 |   |

 

See notes to condensedconsolidated financial statements.

 

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**AES REDOAK, L.L.C. AND SUBSIDIARYAN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION****CondensedConsolidated Statements of Cash Flows****for theNine Months EndedSeptember 30, 2003 and 2002*(dollars in thousands)(Unaudited)***

 
|                                                  |   | **Nine months  Ended  September 30** |       |
|-------------------------------------------------------|--------|-------------------------------------------|------------|
|                                                  |   | **2003**                                  |       | **2002** |   |
|                                                  |   |                                      | ** ** |   | ** ** |
| **OPERATING  ACTIVITIES:**                            |   |                                      |       |   |   |
| Net income                                            |   | $                                         | 3,855      |   | $ | 672 |   |
| Amortization of deferred  financing costs             |   | 610                                       |       | 609 |   |
| Depreciation                                          |   | 8,609                                     |       | 1,475 |   |
|                                                  |   |                                      |       |   |   |
| Change in:                                            |   |                                      |       |   |   |
| Accrued liabilities                                   |   | (329                                      | )          | 277 |   |
| Accounts receivable — trade                      |   | (4,380                                    | )          | (6,606 | ) |
| Accounts receivable —  from affiliates      |   | 64                                        |       | 1,664 |   |
| Other assets                                          |   | (76                                       | )          | (265 | ) |
| Payable to affiliates                                 |   | 362                                       |       | (1,823 | ) |
| Prepaid expenses                                      |   | 7                                         |       | (513 | ) |
| Accounts payable                                      |   | (162                                      | )          | 1,950 |   |
|                                                  |   |                                      |       |   |   |
| Net cash (used in) provided  by operating activities  |   | $                                         | 8,560      |   | $ | (2,560 | ) |
|                                                  |   |                                      |       |   |   |
| **INVESTING  ACTIVITIES:**                            |   |                                      |       |   |   |
| Payments for construction  in progress                |   | —                                    |       | (51,965 | ) |
| Purchases of property,  plant, and equipment          |   | (1,265                                    | )          | — |   |
| Restricted cash                                       |   | (27,389                                   | )          | (2,165 | ) |
| Other                                                 |   |                                      |       | 2,137 |   |
|                                                  |   |                                      |       |   |   |
| Net cash used in investing  activities                |   | $                                         | (28,654    | ) | $ | (51,993 | ) |
|                                                  |   |                                      |       |   |   |
| **FINANCING  ACTIVITIES:**                            |   |                                      |       |   |   |
| Payment of principal on  bonds payable                |   | (3,575                                    | )          | (1,210 | ) |
| Other liabilities                                     |   | 25,000                                    |       | — |   |
| Payments for Long Term  Parts                         |   | (1,334                                    | )          | — |   |
| Contribution from parent                              |   | —                                    |       | 55,750 |   |
|                                                  |   |                                      |       |   |   |
| Net cash provided in  financing activities            |   | $                                         | 20,091     |   | $ | 54,540 |   |
|                                                  |   |                                      |       |   |   |
| **NET  (DECREASE) IN CASH AND CASH EQUIVALENTS** |   | $                                         | (3         | ) | $ | (13 | ) |
|                                                  |   |                                      |       |   |   |
| **CASH AND  CASH EQUIVALENTS, BEGINNING OF PERIOD**   |   | 23                                        |       | 48 |   |
| **CASH AND  CASH EQUIVALENTS, END OF PERIOD**         |   | $                                         | 20         |   | $ | 35 |   |
|                                                  |   |                                      |       |   |   |
| **SUPPLEMENTAL  DISCLOSURE:**                         |   |                                      |       |   |   |
| Interest paid (net of  amounts capitalized)           |   | $                                         | 25,202     |   | $ | 1,689 |   |

 

See notes to condensed consolidatedfinancial statements.

 

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**AES REDOAK, L.L.C. AND SUBSIDIARYAN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATIONNotes to Condensed ConsolidatedFinancial Statements**

 

**1.****            ****ORGANIZATION**

 

AES Red Oak, L.L.C. (the “Company”) was formed on September 13,1998, in the State of Delaware, to develop, construct, own and operate an830-megawatt (MW) gas-fired, combined cycle electric generating facility (the“Facility”) in the Borough of Sayreville, Middlesex County, New Jersey. TheCompany was considered dormant until March 15, 2000 (hereinafter,“inception”), at which time it consummated a project financing and certainrelated agreements. On March 15, 2000, the Company issued $384 million insenior 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 (see Note 3). In late September 2000,the Company consummated an exchange offer whereby the holders of the seniorsecured bonds exchanged their privately placed senior secured bonds forregistered senior secured bonds.

 

The Facility consists of three Westinghouse 501 FDcombustion turbines, three unfired heat recovery steam generators, and onemulticylinder steam turbine. The Facility provides fuel conversion andancillary services and we make the capacity of the Facility available solely toWilliams Power Company, Inc. (formerly Williams Energy Marketing & TradingCompany) (“Williams Energy”) under a 20-year Fuel Conversion Services, Capacityand Ancillary Services Purchase Agreement (the “Power Purchase Agreement” or“PPA”). The term of the PPA is twenty years from the last day of the month inwhich commercial operation commenced, which was September 2002.  The Company reached provisional acceptanceon August 11, 2002, risk transfer on August 13, 2002, and reachedcommercial availability on September 1, 2002. Williams Energy disputed theSeptember 1, 2002 commercial operation date and informed the Company thatit recognized the Commercial Operation Date of the Facility asSeptember 28, 2002. The Company initiated an arbitration to settle thedispute over the Commercial Operation Date. On November 4, 2003, the Company and Williams Energy settled thisdispute.  Under the settlement, Williamswill make a cash payment to us of $4,050,153 on or before November 14,2003, which includes $225,055 of interest from October 2002 to the paymentdate, and the Commercial Operation Date was agreed to be September 28,2002.  This payment settles all paymentobligations between the parties for the month of September 2002 withrespect to the Commercial Operation Date under the PPA.  From the Company’s perspective, the cashpayment has the economic effect of recognizing a Commercial Operation Dateprior to of September 28, 2002. The Company is disputing $397,000 ofmerchant price, testing gas and other charges with Williams Energy, althoughthis was not part of the arbitration.

 

After the Facility reached provisional acceptance,the Company elected to confirm reliability for up to 19 days before bindingwith Williams Energy. Beginning August 13, 2002 (the risk transfer date)through August 31, 2002, the Company operated the Facility as a merchantplant with electric revenues sold to Williams Energy, in its capacity as theCompany’s PJM account representative, at spot market prices and bought gas fromWilliams Energy at spot market prices. Additionally, duringSeptember 2002, the Company made net electric energy available to WilliamsEnergy during times when it had not received a Williams Energy dispatch notice.This net electric energy is referred to as “other sales of energy” in the PowerPurchase Agreement and is sold at the local marginal price commonly referred toas spot market energy. Gas required for this energy generation was purchasedfrom Williams Energy at spot market prices.

 

The Company is a wholly owned subsidiary of AES RedOak, 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 not expected to have any operations.Red Oak’s only income is distributions (if any) it receives from the Companyand AES Sayreville, L.L.C.  Pursuant toan equity subscription agreement, Red Oak agreed to contribute up toapproximately $56.7 million to the Company to fund construction after the bondproceeds were fully utilized. This full amount was contributed bySeptember 30, 2002.        The Companydoes not have access to additional liquidity pursuant to this agreement as RedOak has fulfilled its funding obligations thereunder. The equity that Red Oakprovided to the Company was provided to Red Oak by AES, which owns all of the

 

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equityinterests in Red Oak. AES files quarterly and annual 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 interests in AESRed Oak Urban Renewal Corporation (“AES URC”), which was organized as an urbanrenewal corporation under New Jersey Law. As an urban renewal corporation underNew Jersey law, portions of the Facility can be 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 OFPRESENTATION**

 

In the Company’s opinion, all adjustments necessaryfor a fair presentation of the unaudited results of operations for the interimperiods presented herein are included. All such adjustments include accruals ofa normal and recurring nature. Certain reclassifications have been made to prior-periodamounts to conform to the 2003 presentation. Prior to the August 13, 2002date of risk transfer, the Facility was under construction, and the Company wasa development stage company. Accordingly, the results of operations for thethree and nine months and cash flows for nine months ended September 30,2003 and 2002 are not comparable. Undue reliance should not be placed upon aperiod-by-period comparison. The results of operations for the three andnine-month periods presented herein are not necessarily indicative of theresults of operations to be expected for the full year or future periods.

 

The Company generates energy revenues under thePower Purchase Agreement with Williams Energy. During the 20-year term of theagreement, the Company expects to sell capacity and electric energy produced bythe Facility, as well as ancillary services and fuel conversion services. Underthe Power Purchase Agreement, the Company also generates revenues from meeting(1) base electrical output guarantees and (2) heat rate rebatesthrough efficient electrical output. Revenues from the sales of electric energyand capacity are recorded based on output delivered and capacity provided atrates as specified under contract terms. Revenues for ancillary and otherservices are recorded when the services are rendered.

 

Upon its expiration, or in the event that the PowerPurchase Agreement is terminated prior to its 20-year term or Williams Energyotherwise fails to perform, the Company would seek to generate energy revenues fromthe sale of electric energy and capacity into the merchant market or under newshort or long-term power purchase or similar agreements. Due to recent declinesin pool prices, however, the Company would expect that even if it weresuccessful 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.

 

These financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and with the instructions toForm 10-Q and Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples (“GAAP”) for complete financial statements. The accompanyingcondensed consolidated financial statements are unaudited and they should beread in conjunction with the audited financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2002.

 

**3.**             BONDS PAYABLE

** **

On March 15, 2000, the Company issued$384 million in senior secured bonds for the purpose of providingfinancing for the construction of the Facility and to fund, through theconstruction period, interest payments to the bondholders. InSeptember 2000, the Company consummated an exchange offer whereby theholders of the senior secured bonds exchanged their privately placed seniorsecured bonds for registered senior secured bonds.

 

The senior secured bonds were issued in two series:8.54% senior secured bonds due 2019 (the

 

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“2019Bonds”) in an aggregate principal amount of $224 million and 9.20% seniorsecured bonds due 2029 (the “2029 Bonds”) in an aggregate principal amount of$160 million. Annual principal repayments on the Bonds are scheduled asfollows:

 
| **Year**                                                |   | **Annual  Payment** |          |
|---------------------------------------------------------|--------|---------------------|---------------|
|                                                    |   |                |          |
| 2003 (remaining subsequent  to September 30, 2003) |   | $                   | 2.6 million   |   |
| 2004                                                    |   | $                   | 5.2 million   |   |
| 2005                                                    |   | $                   | 5.1 million   |   |
| 2006                                                    |   | $                   | 7.1 million   |   |
| 2007                                                    |   | $                   | 6.1 million   |   |
| Thereafter                                              |   | $                   | 351.9 million |   |
| Total                                                   |   | $                   | 378.0 million |   |

 

Principal repayment dates on the 2019 Bonds areFebruary 28, May 31, August 31, and November 30 of eachyear, with the final payment due November 30, 2019. Quarterly principalrepayments commenced on August 31, 2002. Quarterly principal repayment ofthe 2029 Bonds does not commence until February 28, 2019. The company madethe scheduled principal payment of approximately $2.64 million inAugust 2003 on the 2019 bonds.

 

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

 

Williams Energy is currently the Company’s solecustomer for purchases of capacity, ancillary services, and energy and its solesource for fuel.  Williams Energy’spayments under the Power Purchase Agreement are expected to provide all of theCompany’s operating revenues during the term of the Power Purchase Agreement(see Note 5). It is unlikely that the Company would be able to find anotherpurchaser or fuel source on similar terms for its Facility if Williams Energywere 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.  The payment obligations of Williams Energyunder the Power Purchase Agreement are guaranteed by The Williams Companies,Inc.  The payment obligations of TheWilliams Companies, Inc. under the guaranty were originally capped at an amountequal to approximately $510 million. Beginning on January 1 of the first full year after the commercialoperation date, this guaranty cap is to be reduced semiannually by a fixedamount which is based on the amortization of the company’s senior secured bondsduring the applicable semiannual period. As of September 30, 2003 the guarantee was capped at $507.6million.

 

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.  Therecan be no assurances as to the Company’s ability to generate sufficient cashflow to cover operating expenses or its debt service obligations in the absenceof a long-term power purchase agreement with Williams Energy.

 

**5.****            ****POWERPURCHASE AGREEMENT**

 

The Company and Williams Energy have entered into aPower Purchase Agreement for the sale of all capacity produced by the Facility,as well as ancillary services and fuel conversion services. Under the PPA,Williams Energy has the obligation to deliver, on an exclusive basis, allquantities of natural gas and fuel oil required by the Facility to generateelectricity or ancillary services, to start-up or shut-down the plant, and tooperate the Facility during any period other than a start-up, shut-down, or requireddispatch by Williams Energy for any reason.

 

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The term of the PPA is 20 years from the firstcontract anniversary date, which is the last day of the month in whichcommercial availability occurs.  TheCompany entered into arbitration with Williams Energy to resolve a disputeregarding the commercial operation date and disputes over the properinterpretation of certain provisions of the Power Purchase Agreement withrespect to amounts claimed by the Company to be payable by Williams Energyunder the Power Purchase Agreement (see Note 6).  On November 4, 2003, the Company and Williams Energy settledthese disputes and the Commercial Operation Date was agreed to beSeptember 28, 2002.  The relatedrevenue had been substantially recorded in September 2002, with the remainingamount to be recorded in the fourth quarter of 2003.  The agreed upon payment settles all payment obligations betweenthe parties for the month of September 2002 with respect to the CommercialOperation Date under the PPA.  The Companyis disputing $397,000 of merchant price, testing gas and other charges withWilliams Energy, although this was not part of the arbitration.

 

Public Service Electric and Gas constructed, onbehalf of Williams Energy, all natural gas interconnection facilities necessaryfor the delivery of natural gas to the Company’s natural gas delivery point.This includes metering equipment, valves and piping.  Upon the expiration or termination of the PPA , the Company hasthe right to purchase the natural gas interconnection facilities from Williams.

 

The Company has provided Williams Energy a letter ofcredit (the “PPA Letter of Credit”) in an amount of $10 million to support theCompany’s obligations under the Power Purchase Agreement.  The repayment obligations with respect toany drawings under the PPA Letter of Credit are a senior debt obligation of theCompany.

 

The payment obligations of Williams Energy under thePPA are guaranteed by The Williams Companies, Inc.  The payment obligations of The Williams Companies, Inc. under theguaranty were originally capped at an amount equal to approximately $510million.  Beginning on January 1 ofthe first full year after the commercial operation date, this guaranty cap isto be reduced semiannually by a fixed amount which is based on the amortizationof our senior secured bonds during the applicable semiannual period.  As of September 30, 2003 the guaranteewas capped at $507.6 million.

 

Pursuant to Section 18.3 of the Power PurchaseAgreement, in the event that Standard & Poor’s “S&P” or Moody’s ratesthe long-term senior unsecured debt of The Williams Companies, Inc. lower thaninvestment grade, The Williams Companies, Inc. is required to supplement itsguarantee with additional alternative security that is acceptable to theCompany within 90 days after the loss of such investment grade rating.  According to published sources, on July 23,2002, S&P lowered the long-term senior unsecured debt rating of TheWilliams Companies, Inc. to “BB-” from “BBB-” and further lowered such ratingto “B” on July 25, 2002.  According topublished sources, on July 24, 2002, Moody’s lowered the long-term seniorunsecured debt rating of The Williams Companies, Inc. to “B1” from “Baa3” andfurther lowered such rating on November 22, 2002 to “Caa1.”  Accordingly, The Williams Companies, Inc.’slong term senior unsecured debt is currently rated below investment grade byboth S&P and Moody’s.

 

Due to the downgrade of The Williams Companies, Inc.to below investment grade, the Company and Williams Energy entered into aletter agreement dated November 7, 2002 (the “Letter Agreement”), underwhich Williams Energy agreed to (a) provide the Company a prepayment of $10million within five business days after the execution of the Letter Agreement (the“Prepayment”); (b) provide the Company alternative credit support equal to $35million 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 PPA Letter of Credit, unless mutually agreedto otherwise, or (iii) a direct obligation of the United States Governmentdelivered to a custodial securities account as designated by the Company with amaturity of not more than three years; and (c) replenish any portion of thealternative credit support that is drawn, reduced, cashed, or redeemed, at anytime, 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 inSection 18.3 of the Power Purchase Agreement.  In the Letter Agreement, the Company and Williams Energyexpressly agreed that the posting of the Prepayment or any alternative creditsupport at any time or any other terms set forth in the Letter Agreement, werenot intended, and did not modify, alter, or

 

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amend in any way, the terms and conditions orrelieve The Williams Company, Inc. from any obligations it has under itsguaranty of the payment obligations of Williams Energy under the Power PurchaseAgreement.  The guaranty remains in fullforce and effect, and the Company retains all of its rights and remediesprovided by that guaranty.

 

Under the terms of the Letter Agreement, the Companyis obligated to return the Prepayment to Williams Energy upon the earlier of(i) The Williams Companies, Inc. regaining its investment grade rating orWilliams Energy providing a substitute guaranty of investment grade rating;(ii) the beginning of Contract Year 20; or (iii) the posting of alternativecredit support by Williams Energy as set forth below.  In the case of items (i) and (iii) above, except to the extent,in the case of item (iii), Williams Energy elects to have all or a portion ofthe Prepayment make up a combination of the alternative credit support requiredto be posted pursuant to Section 18.3(b) of the Power Purchase Agreement,Williams Energy shall have the right to recoup the Prepayment by set-off of anyand all amounts owing to the Company under the Power Purchase Agreementbeginning no earlier than June in the calendar year after the occurrenceof item (i) or (iii) and continuing thereafter until the Prepayment has beenfully recovered.  In the case of item(ii) above, Williams Energy shall have the right to immediately set-off allamounts owing to the Company under the Power Purchase Agreement after theoccurrence of item (ii) and continuing thereafter until the Prepayment has beenfully recovered.  Except to the extentWilliams Energy elects to include the Prepayment as part of the alternativecredit support, the amount of alternative credit support posted by WilliamsEnergy pursuant to the Letter Agreement shall be initially reduced by theamount of the Prepayment, and Williams Energy shall thereafter increase thealternative credit support proportionately as Williams Energy recoups thePrepayment set-off on the payment due date of amounts owing to the Company.

 

If the Company does not return the Prepayment toWilliams Energy as set forth in the preceding paragraph, then the Company shallbe considered in default under the Letter Agreement and Williams Energy shallbe entitled to enforce any or all of its contractual rights and remedies as setforth in the Power Purchase Agreement, including, but not limited to its rightto draw on the Letter of Credit previously posted by the Company in favor ofWilliams Energy.

 

Williams Energy made the $10 million Prepayment onNovember 14, 2002 and provided an additional $25 million of cash to theCompany on January 6, 2003 as the alternative credit support.  As allowed by the Letter Agreement, Williamshas elected to have the $10 million Prepayment included as part of thealternative credit support.  In theevent that Williams regains and maintains its investment grade status, providesa substitute guaranty of investment grade rating, or posts a letter of credit,the Company will be required to return the $35 million alternative creditsupport to Williams Energy in accordance with the terms of the Letter Agreementas described above. Accordingly, the $35 million received is included as arestricted cash asset and as a current liability.

 

**6.****            ****COMMITMENTSAND CONTINGENCIES**

 

*WilliamsEnergy Arbitration* – As discussed in Note 5, 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 withheld or offset from amounts invoiced by the Company amounts thatWilliams Energy believes were improperly invoiced based on Williams Energy’sinterpretation of the Power Purchase Agreement.  The arbitration related to disputed amounts of approximately $7.6million, which included a $594,000 payment extension option dispute and a $7.0million commercial operation start date dispute. On November 4, 2003, theCompany and Williams Energy settled this dispute.  Under the settlement, Williams will make a cash payment to us of$4,050,153 on or before November 14, 2003, which includes $225,055 ofinterest from October 2002 to the payment date, and the CommercialOperation Date was agreed to be September 28, 2002.  The related revenue had been substantiallyrecorded in September 2002, with the remaining amount to be recorded in thefourth quarter of 2003.  This paymentsettles all payment obligations between the parties for the month ofSeptember 2002 with respect to the Commercial Operation Date under thePPA.  From the Company’s perspective,the cash payment has the economic effect of recognizing a Commercial OperationDate prior to September 28, 2002. The Company is disputing $397,000 ofmerchant price, testing gas and other charges with Williams Energy, althoughthis was not part of the

 

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arbitration.

 

*ConstructionAgreement -*The Company entered into an Agreement forEngineering, Procurement and Construction (EPC) services, dated as ofOctober 15, 1999, between the Company and WGI (as the successorcontractor), as amended for the design, engineering, procurement, sitepreparation and clearing, civil works, construction, start-up, training andtesting and to provide all materials and equipment (excluding operational spareparts), machinery, tools, construction fuels, chemicals and utilities, labor,transportation, administration and other services and items (collectively andseparately, the “services”) of the Facility. Under a guaranty in the Company’sfavor, effective as of October 15, 1999, all of WGI’s obligations underthe construction agreement are irrevocably and unconditionally guaranteed byRaytheon. In 2001, as a result of WGI’s bankruptcy filing, the Company made ademand on Raytheon to perform its obligations under the Raytheon guarantee andWGI, Raytheon and the Company entered into agreements pursuant to whichRaytheon became responsible for the construction of the Facility*.*

 

Under the construction agreement, in lieu of theCompany’s retainage, Raytheon is entitled to post a letter of credit in theamount of the then current retainage. As of September 30, 2003, Raytheon had provided a letter of creditof approximately $30.8 million.  We maydraw on this letter of credit in the event that Raytheon fails to pay us anyamount owed to us under the construction agreement.  As of October 31, 2003 we have drawn $447,000 on this letterof credit.

 

As discussed in Note 1, provisional acceptance hasbeen granted and the Facility has commenced commercial operations, however,Raytheon must perform certain agreed upon completion items in order to obtainfinal acceptance. Raytheon gave notice of Final Acceptance on July 22,2003 based on its July 8, 2003 performance test.  On July 31, 2003, the Company received a letter from theproject’s independent engineer stating that it could not support Raytheon’sclaim of final acceptance and it did not consider the July 8, 2003performance test valid.  In making thisassessment, 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 finalacceptance.  This rejection was basedupon Raytheon’s failure to meet the conditions for final acceptance providedfor in the EPC contract. On August 7, 2003, the Company received aresponse from Raytheon in which Raytheon claims that the Company’s rejection ofthe final acceptance is invalid and improper. The Company is currently considering its options for resolving thisdispute.

 

*MaintenanceServices –* Pursuant to a maintenance services agreement datedDecember 5, 1999, Siemens Westinghouse is to provide the Company with specificcombustion turbine maintenance services and spare parts for twelve maintenanceperiods or until December 8, 2015. As of September 30, 2003, the Company has received approximately$10.5 million in rotable spare parts under this agreement.  This amount is recorded as spare partsinventory and current and long-term liabilities in the accompanying balancesheets.  The fees assessed by SiemensWestinghouse will be based on the number of Equivalent Base Load Hoursaccumulated by the applicable Combustion Turbine as adjusted forinflation.  These fees are capitalizedto the Facility when paid and expensed as maintenance occurs.  For financial reporting purposes thepayments made to Siemens Westinghouse are treated as a reduction of theliabilities under the spare-parts agreement in the accompanying balance sheet.

 

*WaterSupply and Water Supply Pipeline* – The Company has enteredinto a contract with the Borough of Sayreville (the “Borough”) by which theBorough will provide untreated water to the Company. The contract has a term of30 years with an option to extend for up to four additional five-year terms.The Company is contractually committed to a minimum annual payment of $300,000.

 

*InterconnectionAgreement (GPU) –* The Company has entered into an interconnectionagreement with Jersey Central Power & Light Company d/b/a GPU Energy(“GPU”) to transmit the electricity generated by the Facility to thetransmission grid so that it may be sold as prescribed under the PPA. Theagreement is in effect for the life of the Facility, yet may be terminated bymutual consent of both GPU and the Company under certain circumstances asdetailed in the agreement. Costs associated with the agreement

 

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are based on electricity transmitted via GPUat a variable price and the PJM (Pennsylvania/New Jersey/Maryland) Tariff ascharged by GPU, which is comprised of both service cost and asset recoverycost, as determined by GPU and approved by the Federal Energy RegulatoryCommittee. The Company has been importing electricity from the transmissionsystem to support commissioning of the Facility since July 2001 and theinterconnection facilities have exported power to the transmission system sincethat time.

 

*InterconnectionInstallation Agreement (GPU)* – The Company entered intoan interconnection agreement with GPU on April 27, 1999 to design,furnish, install and own certain facilities required to interconnect theCompany with the transmission system. Under the terms of this agreement, GPU will provide all labor,supervision, materials and equipment necessary to perform the interconnectioninstallation. The cost of these interconnection facilities is approximately$5.3 million. The Company had paid $5.1 million to GPU for these facilities asof September 30, 2003.

 

*InterconnectionServices Agreement (PJM)* – The Company entered into aninterconnection agreement with the Independent System Operator (“ISO”) of thePJM Control Area on December 24, 2001, as required under the PJM OpenAccess Transmission Tariff. This agreement includes specifications for eachgenerating unit that will be interconnected to the Transmission System,confirms Capacity Interconnection Rights and includes the Company’s agreementto abide by all rules and procedures pertaining to generation in the PJM ControlArea.

 

*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 isapproximately $425,000.  The Company isin the process of selecting a contractor to perform the service and no paymentshave been made as of September 30, 2003. On July 23, 2003, the project was secured by a letter of creditissued by Union Bank of California for $425,000 with the Borough of Sayrevilleas the beneficiary.  This irrevocablestandby letter of credit currently has an expiration date of June 30, 2004and represents the amount potentially due if there is a failure of AES Red Oak,LLC to take action regarding the plan.

 

**7.****            ****NEWACCOUNTING PRONOUNCEMENTS**

 

In July 2001, the FASB issued SFAS No. 143,entitled “Accounting for Asset Retirement Obligations.”  This standard is effective for fiscal yearsbeginning after June 15, 2002 and provides accounting requirements forasset retirement obligations associated with long-lived assets.  Under the Statement, the asset retirementobligation is recorded at fair value in the period in which it is incurred byincreasing the carrying amount of the related long-lived asset.  The liability is accreted to its presentvalue in each subsequent period and the capitalized cost is depreciated overthe useful life of the related asset. The adoption of this standard did nothave a material effect on the Company’s financial statements.

 

In April 2002, the FASB issued SFAS No. 145,entitled “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASBStatement No. 13, and Technical Corrections.” This statement eliminates the current requirement that gains and losseson debt extinguishment must be classified as extraordinary items in the incomestatement.  Instead, such gains andlosses will be classified as extraordinary items only if they are deemed to beunusual and infrequent, in accordance with the current GAAP criteria forextraordinary classification.  Inaddition, SFAS No. 145 eliminates an inconsistency in lease accounting byrequiring that modifications of capital leases that result in reclassificationas operating leases be accounted for consistent with sale-leaseback accountingrules.  The statement also containsother nonsubstantive corrections to authoritative accounting literature.  The changes related to debt extinguishmentare effective for fiscal years beginning after May 15, 2002, and thechanges related to lease accounting are effective for transactions occurringafter May 15, 2002. The adoption of this standard did not have a materialeffect on the Company’s financial statements.

 

In June 2002, the FASB issued SFAS No. 146,entitled “Accounting for Costs Associated with Exit or Disposal Activities,”which addresses accounting for restructuring and similar costs.  SFAS No. 146

 

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supersedes previous accounting guidance, principallyEmerging Issues Task Force (“EITF”) Issue No. 94-3.  The Company will adopt the provisions of SFAS No. 146 forrestructuring activities initiated after December 31, 2002. SFAS No. 146requires that the liability for costs associated with an exit or disposalactivity be recognized when the liability is incurred.  Under EITF Issue No. 94-3, a liability foran exit cost was recognized at the date of a company’s commitment to an exitplan.  SFAS No. 146 also establishesthat the liability should initially be measured and recorded at fairvalue.  Accordingly, SFAS No. 146 mayaffect the timing of recognizing future restructuring costs as well as theamount recognized. The adoption of this standard did not have a material effecton the Company’s financial statements.

 

In April 2003, the FASB issued Statement No.149, Amendment of Statement 133 on Derivative Instruments and HedgingActivities (“SFAS No. 149”).  SFAS No. 149 amends and clarifies theaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts, and for hedging activitiesunder SFAS No. 133.  The amendments set forth in SFAS No. 149 require thatcontracts with comparable characteristics be accounted for similarly.  Inparticular, this statement clarifies under what circumstances a contract withan initial net investment meets the characteristics of a derivative accordingto SFAS No. 133 and when a derivative contains a financing component thatwarrants special reporting in the statement of cash flows.  In addition,the statement amends the definition of an underlying to conform it to languageused in FASB Interpretation No. 45, Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers, and amends certain other existing pronouncements.

 

The requirements of SFAS No. 149 are effective forcontracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003.  The provisions of thestatement that relate to SFAS No. 133 implementation issues that have beeneffective for fiscal quarters that began prior to June 15, 2003, shouldcontinue to be applied in accordance with their respective effective dates. Theadoption of this standard did not have a material effect on the Company’sfinancial statements.

 

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

 

In November 2002, the FASB issued InterpretationNo. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others”.  This interpretation establishes newdisclosure requirements for all guarantees, but the measurement criteria areapplicable to guarantees issued and modified after December 31, 2002. Theadoption of this interpretation did not have any immediate material effect onthe Company’s financial statements.

 

In January 2003, the FASB issued InterpretationNo. 46, “Consolidation of Variable Interest Entities”.  This interpretation is effective immediatelyfor all enterprises with variable interests in variable interest entitiescreated after January 31, 2003.  FIN 46 provisions must be applied tovariable interests in variable interest entities created beforeFebruary 1, 2003 from the beginning of the fourth quarter of 2003 or firstquarter of 2004.  If an entity is determined to be a variable interestentity, it must be consolidated by the enterprise that absorbs the majority ofthe entity’s expected losses if they occur and/or receives a majority of theentity’s expected residual returns if they occur.  If significant variableinterests are held in a variable interest entity, the company must disclose thenature, purpose, size and activity of the variable interest entity and thecompany’s maximum exposure to loss as a result of its involvement with thevariable interest entity in all financial statements issued afterJanuary 31, 2003.  The adoption of this interpretation did not have amaterial effect on the Company’s financial statements.

 

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

 

**Cautionary Note Regarding Forward-Looking Statements**

 

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 notnecessarily all, of such forward- looking statements can be identified by theuse of forward-looking terminology, such as “believes,” “estimates,” “plans,”“projects,” “expects,” “may,” “will,” “should,” “approximately,” or“anticipates” or the negative thereof or other variations thereof or comparableterminology or by discussion of strategies, each of which involves risks anduncertainties. We have based these forward-looking statements on our currentexpectations and projections about future events based upon our knowledge offacts as of the date of this Form 10-Q and our assumptions about futureevents.

 

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, are forward-looking statements. Such forward-lookingstatements involve known and unknown risks, uncertainties, and other factorsoutside of our control that may cause our actual results or performance to bematerially different from any future results, performance or achievementsexpressed or implied by the forward-looking statements. These risks,uncertainties, and other factors include, among others, the following:

 

•               unexpected problems relating to the performanceof the Facility;

 

•               the financial condition ofthird parties on which we depend, including in particular Williams Energy, asthe fuel supplier under the Power Purchase Agreement (PPA) we entered into withWilliams Energy for the sale of all electric energy and capacity produced bythe Facility, as well as ancillary and fuel conversion services, and TheWilliams Companies Inc, as the guarantor of Williams Energy’s performance underthe Power Purchase Agreement;

 

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

 

•               the continued performance ofWilliams Energy (as guaranteed by The Williams Companies, Inc.) under the PowerPurchase Agreement;

 

•               the ability of The WilliamsCompanies, Inc. or its affiliates to avoid a default under the PowerPurchase Agreement by continuing to maintain or provide adequate security tosupplement their guarantee of Williams Energy’s performance under the PowerPurchase Agreement;

 

•               our ability to find areplacement power purchaser on favorable or reasonable terms, if necessary;

 

•               an adequate merchant marketafter the expiration, or in the event of termination, of the Power PurchaseAgreement;

 

•               capital shortfalls andaccess to additional capital on reasonable terms, or in the event that thePower Purchase Agreement is terminated;

 

•               the possibility thatWilliams Energy will not request that we run or “dispatch” the Facility asprovided under the Power Purchase Agreement;

 

•               inadequate insurancecoverage;

 

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•               unexpected expenses or lowerthan expected revenues;

 

•               environmental and regulatorycompliance;

 

•               terrorist acts and adversereactions to United States anti-terrorism activities; and

 

•               the additional factors thatare unknown to us or beyond our control.

 

We have no obligation topublicly update or revise any forward-looking statement, whether as a result ofnew information, future events, or otherwise.

 

**General**

 

We are a Delaware limited liability company formedon September 13, 1998 to develop, construct, own, operate and maintain ourFacility. We were dormant until March 15, 2000, the date of the sale ofour senior secured bonds. We obtained $384 million of project financing fromthe sale of the senior secured bonds. In late September 2000, weconsummated an exchange offer whereby the holders of our senior secured bondsexchanged their privately placed senior secured bonds for registered seniorsecured bonds.  The total cost of theconstruction of our Facility is estimated to be approximately $454 million, whichwas historically financed by the proceeds from our sale of the senior securedbonds, equity contributions, operating revenues and the amount of liquidateddamages received from Raytheon through August 10, 2002, under theConstruction Agreement, as described below. We plan to finance any remaining costs related to the facility withoperation revenues and any additional interim rebates that may be received fromRaytheon.

 

The facility reached provisional acceptance onAugust 11, 2002, risk transfer on August 13, 2002, and becamecommercially available under the Power Purchase Agreement on September 1,2002.  Williams Energy has disputed theSeptember 1, 2002 commercial operation date and informed the Company thatit recognizes commercial availability of the Facility as of September 28,2002. On November 4, 2003, the Company and Williams Energy settled thisdispute.  Under the settlement, Williamswill make a cash payment to us of $4,050,153 on or before November 14,2003, which includes $225,055 of interest from October 2002 to the paymentdate, and the Commercial Operation Date was agreed to be September 28,2002.  The related revenue had beensubstantially recorded in September 2002, with the remaining amount to berecorded in the fourth quarter of 2003. This payment settles all payment obligations between the parties for themonth of September 2002 with respect to the Commercial Operation Dateunder the PPA.  From the Company’sperspective, the cash payment has the economic effect of recognizing aCommercial Operation Date prior to of September 28, 2002. The Company isdisputing $397,000 of merchant price, testing gas and other charges withWilliams Energy, although this was not part of the arbitration.

 

Since achieving commercial operations, under thePower Purchase Agreement with Williams Energy, we are eligible to receivevariable operations and maintenance payments, total fixed payments, energyexercise fee payments (each as defined in the Power Purchase Agreement) andother payments for the delivery of fuel conversion, capacity and ancillaryservices.  From May 5, 2003 throughSeptember 22, 2003, Williams Energy requested that we run the Facility or“dispatch” the Facility. From September 28,2002 to May 2003 and fromSeptember 23, 2003 through the date of this filing.  Williams Energy did not request that we runthe Facility or “dispatch” the facility to a significant degree and the minimumcapacity payments provided for under the Power Purchase Agreement were ourprimary source of operating revenues. We have used these operating revenues, together with interim rebatesreceived from Raytheon under the construction agreement, interest income fromthe investment of a portion of the proceeds from the sale of the senior securedbonds and the $10 million Prepayment from Williams Energy to fund ourgeneration expenses and other operations and maintenance expenses.

 

The following discussion presents certain financialinformation for the three and nine months ended September 30, 2003 and2002.

 

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**Energy Revenues**

 

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

 

Upon its expiration, or in the event that the PowerPurchase Agreement is terminated prior to its 20-year term, we would seek togenerate energy revenues from the sale of electric energy and capacity into themerchant market or under new short- or long-term power purchase or similaragreements. Due to recent declines in pool prices, however, we would expectthat even if we were successful in finding alternate revenue sources, any suchalternate revenues would be substantially below the amounts that would havebeen otherwise payable pursuant to the Power Purchase Agreement. There can beno assurances as to whether such efforts would be successful.

 

**Operating Expenses**

 

Under an agreement with AES Sayreville, L.L.C., weare required to reimburse all operator costs on a monthly basis. Operator costsgenerally consist of all direct costs and overhead associated with running theFacility. Additionally, an operator fee of approximately $400,000, subject toannual adjustment, is payable on each bond payment date.

 

**Performance Guarantees**

 

*ElectricalOutput*

 

Since the average net electrical output of thefacility at provisional acceptance was less than the electrical outputguarantee, Raytheon Company (“Raytheon”) is required to pay us, as a rebate andnot as liquidated damages, for each day during the period from August 11,2002 until the date of the next performance test, which we refer to as theinterim period, an amount equal to $0.22 per day for each kilowatt by which theaverage net electrical output was less than the electrical output guarantee.During initial performance testing, our output was calculated to be 13,370kilowatts less than the electrical output guarantee. Accordingly, our dailyrebate charge to Raytheon for this amount has been calculated at approximately$2,941 per day since August 14, 2002.

 

Upon final acceptance, if the average net electricaloutput of our facility during the completed performance test is less than theguarantee, then Raytheon must pay us, as a bonus, an amount equal to $520 foreach kilowatt by which the average net electrical output is less than theguarantee.

 

*Heat Rate Guarantees*

 

Since the average net heat rate of our facility atprovisional acceptance exceeded the guaranteed amount, Raytheon is required topay us, as a rebate and not as liquidated damages, for each day during theinterim period, an amount equal to $46 per day for each BTU/KwH by which themeasured net heat rate was greater than the guaranteed amount.

 

Upon final acceptance, if the net heat rate of ourfacility during the completed performance test exceeds the guaranteed amount,then Raytheon must pay us, as a rebate, an amount equal to $110,000 for eachBTU/KwH by which the measured heat rate is greater than the natural gas-basedheat rate guarantee.

 

During the three-month period endedSeptember 30, 2003, the company invoiced Raytheon approximately $208,000in electrical output and heat rate rebates for July, 2003. As ofSeptember 30, 2003, Raytheon has paid approximately $148,000 of therebates invoiced.

 

Raytheon gave notice of Final Acceptance onJuly 22, 2003 based on its July 8, 2003 performance test.  On July 31, 2003, the Company receiveda letter from the project’s independent engineer stating that it

 

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could not support Raytheon’s claim of finalacceptance and it did not consider the July 8, 2003 performance testvalid.  In making this assessment, theindependent engineer cited, among other reasons, (i) modifications made tocertain equipment in performance of the July 8 performance test whichwould adversely impact the operations of the plant and other pieces ofequipment and (ii) Raytheon’s failure to comply with guaranteed emissionslimits.  On August 1, 2003, theCompany 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 Raytheonin which Raytheon claims that the Company’s rejection of the final acceptanceis invalid and improper.  The Company iscurrently considering its options for resolving this dispute.

 

**Recent and New Accounting Pronouncements**

 

In July 2001, the FASB issued SFAS No. 143,entitled “Accounting for Asset Retirement Obligations.”  This standard is effective for fiscal yearsbeginning after June 15, 2002 and provides accounting requirements forasset retirement obligations associated with long-lived assets.  Under the Statement, the asset retirementobligation is recorded at fair value in the period in which it is incurred byincreasing the carrying amount of the related long-lived asset.  The liability is accreted to its presentvalue in each subsequent period and the capitalized cost is depreciated overthe useful life of the related asset. The adoption of this standard did nothave a material effect on the Company’s financial statements.

 

In April 2002, the FASB issued SFAS No. 145,entitled “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASBStatement No. 13, and Technical Corrections.” This statement eliminates the current requirement that gains and losseson debt extinguishment must be classified as extraordinary items in the incomestatement.  Instead, such gains andlosses will be classified as extraordinary items only if they are deemed to beunusual and infrequent, in accordance with the current GAAP criteria forextraordinary classification.  Inaddition, SFAS No. 145 eliminates an inconsistency in lease accounting byrequiring that modifications of capital leases that result in reclassificationas operating leases be accounted for consistent with sale-leaseback accountingrules.  The statement also containsother nonsubstantive corrections to authoritative accounting literature.  The changes related to debt extinguishmentwill be effective for fiscal years beginning after May 15, 2002, and thechanges related to lease accounting will be effective for transactionsoccurring after May 15, 2002. The adoption of this standard did not have amaterial effect on the Company’s financial statements.

 

In June 2002, the FASB issued SFAS No. 146,entitled “Accounting for Costs Associated with Exit or Disposal Activities,”which addresses accounting for restructuring and similar costs.  SFAS No. 146 supersedes previous accountingguidance, principally Emerging Issues Task Force (“EITF”) Issue No. 94-3.  The Company will adopt the provisions ofSFAS No. 146 for restructuring activities initiated after December 31,2002. SFAS No. 146 requires that the liability for costs associated with anexit or disposal activity be recognized when the liability is incurred.  Under EITF Issue No. 94-3, a liability foran exit cost was recognized at the date of a company’s commitment to an exitplan.  SFAS No. 146 also establishesthat the liability should initially be measured and recorded at fairvalue.  Accordingly, SFAS No. 146 mayaffect the timing of recognizing future restructuring costs as well as theamount recognized. The adoption of this standard did not have a material effecton the Company’s financial statements.

 

In April 2003, the FASB issued Statement No.149, Amendment of Statement 133 on Derivative Instruments and HedgingActivities (“SFAS No. 149”).  SFAS No. 149 amends and clarifies theaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts, and for hedging activitiesunder SFAS No. 133.  The amendments set forth in SFAS No. 149 require thatcontracts with comparable characteristics be accounted for similarly.  Inparticular, this statement clarifies under what circumstances a contract withan initial net investment meets the characteristics of a derivative accordingto SFAS No. 133 and when a derivative contains a financing component thatwarrants special reporting in the statement of cash flows.  In addition,the statement amends the definition of an underlying to conform it to languageused in FASB Interpretation No. 45, Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers, and amends certain other existing pronouncements.

 

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The requirements of SFAS No. 149 are effective forcontracts entered into or modified after June 30, 2003 and for hedgingrelationships designated after June 30, 2003.  The provisions of thestatement that relate to SFAS No. 133 implementation issues that have beeneffective for fiscal quarters that began prior to June 15, 2003, shouldcontinue to be applied in accordance with their respective effective dates. Theadoption of this standard did not have a material effect on the Company’sfinancial statements.

 

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

 

In November 2002, the FASB issuedInterpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others”.  This interpretation establishes newdisclosure requirements for all guarantees, but the measurement criteria areapplicable to guarantees issued and modified after December 31, 2002. Theadoption of this interpretation did not have any immediate material effect onthe Company’s financial statements.

 

In January 2003, the FASB issued InterpretationNo. 46, “Consolidation of Variable Interest Entities”.  This interpretation is effective immediatelyfor all enterprises with variable interests in variable interest entitiescreated after January 31, 2003.  FIN 46 provisions must be applied tovariable interests in variable interest entities created beforeFebruary 1, 2003 from the beginning of the fourth quarter of 2003 or firstquarter of 2004.  If an entity is determined to be a variable interestentity, it must be consolidated by the enterprise that absorbs the majority ofthe entity’s expected losses if they occur and/or receives a majority of theentity’s expected residual returns if they occur.  If significant variableinterests are held in a variable interest entity, the company must disclose thenature, purpose, size and activity of the variable interest entity and thecompany’s maximum exposure to loss as a result of its involvement with thevariable interest entity in all financial statements issued afterJanuary 31, 2003.  The adoption of this interpretation did not have amaterial effect on the Company’s financial statements.

 

**Results of Operations**

 

Our Facility reached provisional acceptance onAugust 11, 2002, risk transfer on August 13, 2002 and reachedcommercial availability under the Power Purchase Agreement inSeptember 2002. Prior to August 13, 2002, the Facility was underconstruction, and we were a development stage company. Accordingly, the resultsof operations, the financial condition, and cash flows for the three and ninemonths ended September 30, 2003 and 2002 are not comparable.

 

***For the Three Months Ended September 30, 2003 and 2002***

 

Operating revenues for thethree months ended September 30, 2003 were approximately $25.8 millioncompared to $15.1 million for the three months ended September 30, 2002.Revenue in the three months ended September 30, 2003 consists of capacitysales as well as ancillary services and fuel conversion services under thePower Purchase Agreement. The revenues for the three months endedSeptember 30, 2002 consists of merchant revenue for August and partof September and capacity sales under the Power Purchase Agreement inSeptember.

 

Operating expenses for the three months endedSeptember 30, 2003 were approximately $8.6 million compared to $10.1million from the three months ended September 30, 2002. Operating expensesconsist of depreciation, fuel conversion volume rebate (see below), managementfees and reimbursable operating and maintenance expenses paid to AESSayreville, L.L.C.  The decrease in operating expenses is due to

 

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increased Facility dispatch in 2003.

 

General and administrative costs for the threemonths ended September 30, 2003 were $50,000 compared to $208,000 for thethree months ended September 30, 2002. These costs did not directly relateto construction and are included as expenses in the statement of operations.The decrease is due to the absence in 2003 of initial plant startup costsincurred in 2002.

 

Fuel Conversion Volume expense for the three monthsended September 30, 2003 were $1.6 million compared to $267,000 for thethree months ended September 30, 2002. Fuel Conversion Volume expenserepresents a charge paid to Williams Energy under the Power Purchase Agreementbased upon utilization of the Facility. The increase in the expense during thethree months ended September 30, 2003 compared to the three months endedSeptember 30, 2002 is due to the Facility not operating under the PPAuntil September 2002.

 

Total other income (expense) for the three monthsended September 30, 2003 and 2002 was $(8.6) million and ($3.9) million,respectively, and is primarily comprised of contractor rebates, Letter of Creditfees, interest expense and interest income. Contractor rebates are received bythe Company from the EPC contractor for underperformance of the Facility.  Letter of Credit fees relate to our debtservice letter of credit and reimbursement agreement and power purchaseagreement letter of credit and reimbursement agreement.  The increase in other expense for the threemonths ended September 30, 2003 compared to the three months endedSeptember 30, 2002 is primarily due to higher interest expense. The Facilitywas under construction until August 2002, at which time the relatedinterest was first charged to expense. .

 

We had net income of $8.7 million for the threemonths ended September 30, 2003 compared to a net income of $1.0 millionfor the three months ended September 30, 2002.

 

***For the Nine Months Ended September 30, 2003 and 2002***

 

Operating revenues for the nine months endedSeptember 30, 2003 were approximately $52.6 million compared to $15.1million for the comparable period of the prior calendar year. Revenues for thenine months ended September 30, 2003 consist of capacity sales as well asancillary services and fuel conversion services under the Power PurchaseAgreement. Revenues for the nine months ended September 30, 2002 consistof merchant revenue for August and part of September and capacitysales under the Power Purchase Agreement in September.

 

Operating expenses for the nine months endedSeptember 30, 2003 were approximately $23.9 million compared to $10.2million for the nine months ended September 30, 2002. Operating expensesconsist of depreciation, fuel conversion volume rebate (see below), managementfees and reimbursable operating and maintenance expenses paid to AESSayreville, L.L.C., and gas purchased from Williams Energy for the PJM capacitytest in the amount of $635,000 in February 2003. The increase in operatingexpenses is due to increased Facility dispatch in 2003.

 

General and administrative costs for the nine monthsended September 30, 2003 were $159,000 compared to $364,000 for the ninemonths ended September 30, 2002. These costs did not directly relate toconstruction and are included as expenses in the statement of operations. Thedecrease is due to initial startup costs in 2002. The decrease is due to theabsence in 2003 of initial plant startup costs incurred in 2002.

 

Fuel Conversion Volume costs for the nine monthsended September 30, 2003 were $4.8 million compared to $267,000 for thecomparable period for the prior calendar year. Fuel Conversion Volume expenserepresent a charge paid to Williams Energy under the Power Purchase Agreementbased upon utilization of the Facility. The increase is due to the Facility notoperating under the PPA until September 2002.

 

Total other income (expense) for the nine monthsended September 30, 2003 and 2002 was $(24.8)

 

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million and $(4.1) million respectively, andis comprised of contractor rebates, Letter of Credit fees, interest expense andinterest income. Contractor rebates are received by the Company from the EPCcontractor for underperformance of the Facility.  Letter of Credit fees relate to our debt service letter of creditand reimbursement agreement and power purchase agreement letter of credit andreimbursement agreement. The increase in other expense for the nine monthsended September 30, 2003 compared to the nine months endedSeptember 30, 2002 is primarily due to higher interest expense. TheFacility was under construction until August 2002, at which time therelated interest was first charged to expense. .

 

We had a net income of $3.9 million for thenine months ended September 30, 2003 compared to a net income of $672,000for the comparable period of the prior year.

 

**Liquidity and Capital Resources**

 

Under the Power Purchase Agreement with WilliamsEnergy, we are eligible to receive variable operations and maintenancepayments, total fixed payments, energy exercise payments (each as defined inthe Power Purchase Agreement) and other payments for the delivery of fuelconversion, capacity and ancillary services. During the period September 2002 to May 4, 2003 and sinceSeptember 23, 2003 Williams Energy did not and has not dispatched theFacility to a significant degree. During these periods the minimum capacity payments provided for underthe Power Purchase Agreement have been our primary source of operatingrevenues.  Williams Energy did requestthat we run the Facility or “dispatch” the Facility from May 5, 2003through September 22, 2003.  Wehave used these revenues for the sale of energy under the Power PurchaseAgreement (including minimum capacity payments), together with interim rebatesreceived from Raytheon under the construction agreement, interest income fromthe investment of a portion of the proceeds from the sale of the senior securedbonds and the $10 million Prepayment from Williams Energy to fund ourgeneration expenses and other operations and maintenance expenses.

 

 We haveprovided Williams Energy a $10 million letter of credit under the PowerPurchase Agreement, which we refer to as the PPA Letter of Credit to supportour payment obligations under the Power Purchase Agreement.  The repayment obligations with respect toany drawings under the PPA Letter of Credit are a senior debt obligation of theCompany.

 

Due to the downgrade of The Williams Companies,Inc.’s debt to below investment grade, the Company and Williams Energy enteredinto a Letter Agreement dated November 7, 2002, under which WilliamsEnergy agreed to provide the Company with a $10 million Prepayment within fivebusiness days after execution of the Letter Agreement and at least $25 millionadditional collateral on January 6, 2003. Williams Energy made the $10million Prepayment on November 14, 2002 and provided an additional $25million of cash to us as alternative credit support.  As allowed by the Letter Agreement, Williams Energy has electedto have the $10 million Prepayment included as part of the alternative creditsupport.  In the event that the WilliamsCompanies, Inc. regains and maintains its investment grade status, provides asubstitute guaranty of Investment Grade rating, or posts a letter of credit, wewill be required to return the $35 million alternative credit support toWilliams Energy in accordance with the terms of the Letter Agreement, asdescribed in Note 5 to our Condensed Financial Statements.  As of October 31, 2003, we had cashbalances of approximately $41.1 million. In the event we are required to return the $35 million we believe thatwe would use all or a portion of our current cash balances plus cash generatedfrom future operations in order to return the $35 million to WilliamsEnergy.  This belief is subject tocertain assumptions, risks and uncertainties, including those set forth aboveunder the caption “Cautionary Note Regarding Forward-Looking Statements” andthere can be no assurances that our operating revenues will generate sufficientcash.

 

As of September 30, 2003, $378 millionaggregate principal amount of senior secured bonds were outstanding.  Quarterly principal repayments on the 2019Bonds commenced on August 31, 2002 and are due on February 28,May 31, August 31, and November 30 of each year.  Quarterly principal repayment of the 2029Bonds does not commence until February 28, 2019.  We have provided the collateral agent with a debt service reserveletter of credit in an initial stated amount of $22 million which thecollateral agent may draw upon if we fail to meet our obligations under thesenior secured bonds.

 

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As of September 30, 2003, we had capitalcommitments of $539,000 related to major projects.  This amount includes $114,000 related to a road modificationproject and $425,000 related to the Land Development Plan.

 

Under the construction agreement, we are entitled towithhold from each scheduled payment, other than the last milestone payment,10% of the requested payment until after final acceptance by us of the Facilityunless, as discussed below, Raytheon posts a letter of credit equal or greaterthan the amounts which would otherwise be retained. Within 10 days after thefinal acceptance, we are required to pay all retainage except for (a) 150% ofthe cost of completing all punch list items and (b) the lesser of (i) 150% ofthe cost of repairing or replacing any items that have already been repaired orreplaced by Raytheon and (ii) $1 million. Within 30 days after projectcompletion, we are required to pay the sum of the unpaid balance of thecontract price, including all retainage, less the amount indicated in (b) ofthe immediately proceeding sentence. Within 30 days of the first anniversary ofthe earlier of provisional acceptance or final acceptance, we are required, solong as project completion has occurred, to pay all remaining retainage, ifany.

 

Under the construction agreement, in lieu of ourretaining these amounts, Raytheon is entitled to post a letter of credit in theamount of the then current retainage. As of September 30, 2003, Raytheon had provided a letter of creditof approximately $30.8 million.  We maydraw on this letter of credit in the event that Raytheon fails to pay us anyamount owed to us under the construction agreement.  While there were no drawdowns in the current quarter, we havedrawn $447,000 on this letter of credit through October 31, 2003.

 

We believe that (i) interim rebates paid and to bepaid by Raytheon through final acceptance, (ii) cash flows from the sale ofelectricity and/or minimum capacity payments under the Power Purchase Agreementand (iii) funds available to be drawn under the debt service reserve letter ofcredit or the power purchase letter of credit (each as described above) will besufficient to (1) fund remaining construction costs at our facility and ourcommercial operations, (2) pay fees and expenses in connection with the powerpurchase agreement letter of credit (as described above) and (3) pay projectcosts, including ongoing expenses and principal and interest on our seniorsecured bonds as described above.  Asdiscussed above, in the event we are required to return the alternate creditsupport we may also use a portion of operating revenues for this purpose.  After the Power Purchase Agreement expires,we plan to depend on revenues generated from market sales of electricity.  These beliefs are subject to certainassumptions, risks and uncertainties, including those set forth above under thecaption “Cautionary Note Regarding Forward-Looking Statements” and there can beno assurances.

 

**Concentration of Credit Risk**

 

Williams Energy is currently the Company’s solecustomer for purchases of capacity, ancillary services, and energy and theCompany’s 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 beable to find another purchaser or fuel source on similar terms for the Facilityif Williams 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.

 

The payment obligations of the Williams Companies,Inc. under its guaranty of Williams Energy’s obligations under the PowerPurchase Agreement were originally capped at an amount equal to approximately$510 million. Beginning on January 1 of the first full year after thecommercial operation date, this guaranty cap is to be reduced semiannually by afixed amount which is based on the amortization of our senior secured bondsduring the applicable semiannual period. As of September 30, 2003 the guarantee was capped at $507.6million.

 

Due to the downgrade of The Williams Companies, Inc.to below investment grade, the Company and Williams Energy entered into a LetterAgreement dated November 7, 2002 under which Williams Energy agreed toprovide the Company with a $10 million Prepayment and $25 million in additional

 

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collateral. A description of the collateral that supports Williams Energy’sobligations under the Power Purchase Agreement is set forth above under“Liquidity and Capital Resources”.

 

Since we depend on Williams Energy for both revenuesand fuel supply under the Power Purchase Agreement, if Williams Energy were toterminate or default under the Power Purchase Agreement, there would be asevere negative impact on our cash flow and financial condition which couldresult in a default on our senior secured bonds.  Due to the decline in pool prices, we would expect that if wewere required to seek alternate purchasers of our power in the event of adefault of Williams Energy, even if we were successful in finding alternaterevenue sources, any such alternate revenue sources would be substantiallybelow the amounts that would have been otherwise payable pursuant to the PowerPurchase Agreement. There can be no assurance as to our ability to generatesufficient cash flow to cover operating expenses or our debt serviceobligations in the absence of a long-term power purchase agreement withWilliams Energy.

 

**Business Strategy and Outlook**

 

Our overall business strategy is to market and sellall of our net capacity, fuel conversion and ancillary services to WilliamsEnergy during the 20-year term of the Power Purchase Agreement. Afterexpiration of the Power Purchase Agreement, or in the event the Power PurchaseAgreement is terminated prior to its 20-year term or Williams Energy otherwisefails to perform, we would seek to sell our Facility’s capacity, ancillaryservices and energy in the spot market or under a short or long-term powerpurchase agreement or into the PJM power pool market.  Due to recent declines in pool prices, however, we would expectthat even if we were successful in finding alternate revenue sources, any suchalternate revenues would be substantially below the amounts that would havebeen otherwise payable pursuant to the Power Purchase Agreement.  There can be no assurances as to whethersuch efforts would be successful.

 

We intend to cause our Facility to be managed,operated and maintained in compliance with the project contracts and allapplicable legal requirements.

 

**Critical Accounting Policies**

 

*General* — We prepareour financial statements in accordance with accounting principles generallyaccepted in the United States of America. As such, we are required to makecertain estimates, judgments and assumptions that we believe are reasonablebased upon the information available. These estimates and assumptions affectthe reported amounts of assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during the periodspresented. The significant accounting policies which we believe are mostcritical to understanding and evaluating our reported financial results includethe following:  Revenue Recognition,Property, Plant and Equipment and Contingencies.

 

*RevenueRecognition* — We generate energy revenues under the PowerPurchase Agreement with Williams Energy. During the 20-year term of the agreement, we expect to sell capacity andelectric energy produced by the facility, as well as ancillary services andfuel conversion services.  Under thePower Purchase Agreement, we also generate revenues from meeting (1) baseelectrical output guarantees and (2) heat rate rebates through efficient electricaloutput.  Revenues from the sales ofelectric energy and capacity are recorded based on output delivered andcapacity provided at rates as specified under contract terms.  Revenues for ancillary and other servicesare recorded when the services are rendered.

 

Upon its expiration, or in the event that the PowerPurchase Agreement is terminated prior to its 20-year term or Williams Energyotherwise fails to perform, we would seek to generate energy revenues from thesale of electric energy and capacity into the merchant market or under newshort- or long-term power purchase or similar agreements.  Due to declines in pool prices, however, wewould expect that even if we were successful in finding alternate revenuesources, any such alternate revenues would be substantially below the amountsthat would have been otherwise payable pursuant to the Power PurchaseAgreement.  There can be no assurancesas to whether such efforts would be successful.

 

*Property,Plant and Equipment* — Property, plant and equipment is recorded at costand is depreciated over its useful life. The estimated lives of our generation facilities range from five tothirty-six

 

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years. A significant decrease in the estimated useful life of a material amountof our property, plant or equipment could have a material adverse impact on ouroperating results in the period in which the estimate is revised and insubsequent periods.  The depreciablelives of our property plant and equipment by category are as follows*:*

* *
| **Description of Asset** |   | **Depreciable Life** |   | **September 30, 2003   (000’s)** |    |
|--------------------------|--------|----------------------|--------|--------------------------------------------|---------|
| Buildings                |   | 35                   |   | $                                          | 1,710   |   |
| Vehicles                 |   | 5                    |   | 90                                         |    |
| Computers                |   | 6                    |   | 648                                        |    |
| Furniture and Fixtures   |   | 10                   |   | 472                                        |    |
| Gas Turbine Parts        |   | 9-36                 |   | 43,637                                     |    |
| Gas Heaters              |   | 35                   |   | 1,086                                      |    |
| Plant                    |   | 35                   |   | 349,972                                    |    |
|                     |   |                 |   | $                                          | 397,615 |   |

 

**Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

 

Not applicable pursuant to General Instruction H ofForm 10-Q.

 

# **Item 4. CONTROLS ANDPROCEDURES**

# ** **

*Evaluation of Disclosure Controlsand Procedures*.  OurPresident and our Chief Financial Officer, based on the evaluation of our“disclosure controls and procedures” (as defined in the Securities Exchange Actof 1934 (the “Exchange Act”) Rules 13a-15e and 15d – 15(e)) required byparagraph (b) of Exchange Act Rules 13a – 15 or 15d – 15 as of the end of theperiod ended September 30, 2003, have concluded that our disclosurecontrols and procedures are effective and designed to ensure that informationrequired to be disclosed by us in the reports that we file under the ExchangeAct is recorded, processed, summarized and reported within these periodsspecified in the Securities and Exchange Commissions rules and forms.

 

*Changes in Internal Controls*.  There were no changes in ourinternal controls over financial reporting identified in connection with theevaluation required by paragraph (d) of the Exchange Rules 13a – 15 or 15d -15that occurred during the fiscal quarter ended September 30, 2003 that havematerially affected or are reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

**PART II.OTHER INFORMATION**

 

**Item 1.LEGAL PROCEEDINGS**

 

We 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 amounts we claim are payable byWilliams Energy.  We recognized acommercial operation date of September 1, 2002 (the date on which wenotified Williams of commercial availability) while Williams Energy recognizeda commercial operation date of September 28, 2002; Williams Energy hadwithheld or offset, from amounts invoiced by us, amounts that Williams Energybelieved were improperly invoiced by us based on Williams Energy’sinterpretation of the Power Purchase Agreement.  We entered into arbitration to settle the dispute over thecommercial operation date and the proper interpretation of certain provisionsof

 

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the Power PurchaseAgreement. The arbitration related to disputed amounts of approximately $7.6 million,which includes a $594,000 payment extension option dispute and a $7.0 millioncommercial operation start date dispute On November 4, 2003, the Companyand Williams Energy settled this dispute. Under the settlement, Williams will make a cash payment to us of$4,050,153 on or before November 14, 2003, which includes $225,055 ofinterest from October 2002 to the payment date, and the CommercialOperation Date shall remain as September 28, 2002.  This payment settles all payment obligationsbetween the parties for the month of September 2002 with respect to theCommercial Operation Date under the PPA. From the Company’s perspective, the cash payment has the economic effectof recognizing a Commercial Operation Date prior to of September 28, 2002.The Company is disputing $397,000 of merchant price, testing gas and othercharges with Williams Energy, although this was not part of the arbitration.

 

**Item 2.**  **CHANGES IN SECURITIES AND USEOF PROCEEDS****.**

 

Notapplicable pursuant to General Instruction H of Form 10-Q.

 

**Item 3.****DEFAULTS UPON SENIOR SECURITIES**.

 

Notapplicable pursuant to General Instruction H of Form 10-Q.

 

**Item 4.****SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**.

 

Notapplicable pursuant to General Instruction H of Form 10-Q.

 

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**Item 5.OTHER INFORMATION**

 

None.

 

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**Item 6.  EXHIBITS ANDREPORTS ON FORM 8-K**

 

**(a)****         ****Exhibits**

 

31.1  Certification of principal executive officerrequired by Rule 13a –14(a) or 15d-14(a) of the Exchange Act.

31.2  Certification of principal financial officerrequired by Rule 13a – 14(a) or 15d-14(a) of the Exchange Act.

32.1  Certification of principal executive officerand principal financial officer required by Rule 13a – 14(b) or 15d – 14(b) ofthe Exchange Act.

 

**(b)****         ****Reports onForm 8-K**

 

The Company did not file any reports on Form 8-Kduring the quarter ended September 30, 2003.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                         | **AES RED OAK, L.L.C.** |
|------------------------------|-------------------------|
|                         |                    |
| Date: November 14, 2003 | By:                     | /s/ A.W. BERGERON |   |
|                         |                    | **A.W. Bergeron**President |
|                         |                    |   |
| Date: November 14, 2003 | By:                     | /s/ PAM STRUNK |   |
|                         |                    | **Pam Strunk**Chief Financial Officer |
|                         |                    |   |
| Date: November 14, 2003 | By:                     | /s/ THOMAS P. KEATING |   |
|                         |                    | **Thomas P. Keating**Principal Accounting Officer |
|                              |                         |  |  |  |  |

 

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