**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

| **ý**                                                                                                                                           | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**     |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                           |
| **For the quarterly period ended  June 30, 2004**                                                                                               |
| ** **                                                                                                                                           |
| **o**                                                                                                                                                | ** ** | **TRANSITION  REPORT PURSUANT OR TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                           |
| **For the transition period  from          to           ** |

 

**Commission file number 333-40478**

 

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

(Exact name of registrant as specified in itscharter)

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

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (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 an accelerated filer (asdefined in Rule 12b-2 of the Exchange Act).

Yes o   No ý

 

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

 

 

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

**TABLE OF CONTENTS**

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

 

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**PART I****. FINANCIAL INFORMATION**

 

**Item1.****  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

 

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION**

**Condensed Consolidated Statements of Operations,**

**Three and Six Months Ended June 30, 2004 and 2003**

**(Unaudited)**

***(dollars in thousands)***

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

 

See notes to condensedconsolidated financial statements.

 

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

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

 

See notes to condensedconsolidated financial statements.

 

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION**

**CondensedConsolidated Statement of Changes inMember’s Capital (Deficit)**

**Period from December 31, 2003 throughJune 30, 2004**

***(dollars inthousands)***

***(Unaudited)***

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

 

See notes to condensed consolidated financial statements.

 

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AES CORPORATION**

**Condensed Consolidated Statements of Cash Flowsfor the Six Months Ended**

**June 30, 2004 and 2003**

***(dollars inthousands)***

***(Unaudited)***

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

 

See notes to condensed consolidated financialstatements.

 

4

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THEAES CORPORATION**

**Notes to Condensed Consolidated FinancialStatements**

 

**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 an832-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 certain relatedagreements. On March 15, 2000, the Company issued $384 million in seniorsecured bonds for the purpose of providing financing for the construction ofthe Facility and to fund, through the construction period, interest payments tothe bondholders (see Note 6). In late September 2000, the Company consummatedan exchange offer whereby the holders of the senior secured bonds exchangedtheir privately placed senior secured bonds for registered senior securedbonds.

 

The Facility consists of three Westinghouse 501 FD combustion turbines,three unfired heat recovery steam generators, and one multicylinder steamturbine. The Facility produces and sells electricity, as well as provides fuelconversion and ancillary services, solely to Williams Power Company, Inc.,(“Williams Energy”), formerly Williams Energy Marketing & Trading Company,under a 20-year Fuel Conversion Services, Capacity and Ancillary ServicesPurchase Agreement (the “Power Purchase Agreement”).  The term of the Power Purchase Agreement istwenty years from the last day of the month in which commercial operationcommenced, which was September 2002.  TheCompany reached provisional acceptance on August 11, 2002, risk transfer onAugust 13, 2002, and took the position that the Facility was commerciallyavailable on September 1, 2002.  WilliamsEnergy disputed the September 1, 2002, commercial operation date and informedthe Company that it recognized commercial availability of the facility as ofSeptember 28, 2002.  On November 4, 2003,a settlement was reached and a commercial operation date of September 28, 2002was agreed upon.

 

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

 

The equity that Red Oak provided to the Company was provided to Red Oakby AES, which owns all of the equity interests in Red Oak. AES files unauditedquarterly and annual audited reports with the Securities and ExchangeCommission under the Securities Exchange Act of 1934, which are publiclyavailable, but which do not constitute a part of, and are not incorporatedinto, this Form 10-Q.

 

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

 

**2.             BASISOF PRESENTATION**

 

In the Company’s opinion, all adjustmentsnecessary for a fair presentation of the unaudited results of operations forthe interim periods presented herein are included. All such adjustments includeaccruals of a normal and recurring nature. Certain reclassifications have beenmade to prior-period amounts to conform to the 2004 presentation. The resultsof operations for the three and six-month periods presented herein are notnecessarily indicative of the results of operations to be expected for the fullyear or future periods.

 

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

 

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

 

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

 

**3.             BONDSPAYABLE**

** **

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 twoseries: 8.54% senior secured bonds due 2019 (the “2019 Bonds”) in an aggregateprincipal amount of $224 million and 9.20% senior secured bonds due 2029(the “2029 Bonds”) in an aggregate principal amount of $160 million.Principal repayment of the 2019 Bonds commenced with the quarterly payment onAugust 31, 2002. Annual principal repayments on the Bonds are scheduled asfollows:

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

 

Principal repayment dates on the 2019 Bondsare February 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 of the2029 Bonds does not commence until February 28, 2019. The company made thescheduled principal payment of approximately $392,000 in May 2004 on the 2019bonds.

 

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

 

Williams Energy is currently the Company’ssole customer for purchases of capacity, ancillary services, and energy and itssole source 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 PurchaseAgreement.  It is unlikely that theCompany would be able to find another purchaser or fuel source with similarterms for its Facility if Williams Energy were not performing under the PowerPurchase Agreement.  Any material failureby Williams Energy to make capacity and fuel conversion payments or to supplyfuel under the Power Purchase Agreement would have a severe impact on theCompany’s operations, and may result in a default on the Company’s debt.  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 gauranty were initially capped at an amountequal to approximately $510 million. Beginning on January 1 of the first full year after the commercialoperation date, this guarantee cap is to be reduced semiannually by a fixedamount which is based on the amortization of our senior secured bonds duringthe applicable semiannual period. As of June 30, 2004, the gauranty was cappedat $506.6 million.

 

The minimum capacity payments provided for under the Power PurchaseAgreement have been the Company’s primary source of operating revenues, representing$62.0 million of total revenues of $64.2 million in 2003.  The minimum cash flow from Williams under thepower purchase agreement is approximately $3.8 million per month for Octoberthrough May and $7.9 million per month from June through September.

 

During 2003, the Company’s first full year of operations, net cashprovided by operating activities was $14.8 million.  The Company currently anticipates that theplant will be dispatched in future periods to a similar degree as it was during2003, that operating cash flow will be comparable to 2003 in 2004 and thatoperating cash requirements will be similar in 2004 and 2005 as they wereduring this first year of operation.  TheCompany also believes that cash flows from the sale of electricity and/or minimumcapacity payments under the Power Purchase Agreement, and funds available to bedrawn under the debt service reserve letter of credit or the power purchaseletter of credit, will be sufficient to fund operating expenses and debtservice costs.

 

The Company’s dependence upon The Williams Companies, Inc. and itsaffiliates under the Power Purchase Agreement exposes the Company to possibleloss of revenues and fuel supply, which in turn, could negatively impact itscash flow and financial condition and may result in a default on its seniorsecured bonds.  There can be noassurances as to the Company’s ability to generate sufficient cash flow tocover operating expenses or its debt service obligations in the absence of along-term power purchase agreement with Williams Energy.

 

**5.             POWERPURCHASE AGREEMENT**

 

The Company and Williams Energy have entered into a Power PurchaseAgreement for the sale of all capacity produced by the Facility, as well asancillary services and fuel conversion services. Under the Power PurchaseAgreement, Williams Energy has the obligation to deliver, on an exclusivebasis, all quantities of natural gas 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, orrequired dispatch by Williams Energy for any reason. The term of the PowerPurchase Agreement is 20 years from the first contract anniversary date, whichis the last day of the month in which commercial availability occurred.  As part of the arbitration settlement withWilliams Energy, described below, the Company recognizes September 28, 2002 asthe commercial availability date.

 

The Company entered into arbitration with Williams Energy to resolve certaindisputes regarding the date of commercial operation and the properinterpretation of certain provisions of the Power Purchase Agreement relatingto the amounts claimed by the Company to be payable by Williams Energy.  Williams Energy has withheld or offset fromamounts invoiced by the Company amounts that Williams Energy believes were

 

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improperly invoiced based onWilliams Energy’s interpretation of the Power Purchase Agreement.  The arbitration related to disputed amountsof approximately $7.6 million, which included a $594,000 payment extensionoption dispute and a $7 million commercial operation start date dispute. OnNovember 4, 2003, the Company and Williams Energy settled this dispute.  Under the settlement, Williams made a cashpayment to the Company of $4,050,153 on November 14, 2003, which included$225,055 of interest from October 2002 to the payment date, and the commercialoperation date was agreed to be September 28, 2002. The related revenue hadbeen substantially recorded in September 2002, with the remaining amountrecorded in the fourth quarter of 2003.  This payment settled all payment obligations between the parties for themonth of September 2002 with respect to the commercial operation date under thePower Purchase Agreement.  From theCompany’s perspective, the cash payment had the economic effect of recognizinga commercial operation date prior to September 28, 2002. The Company is alsocurrently disputing approximately $800,000 of merchant price, testing gas andother charges with Williams Energy that the Company contends is owed byWilliams Energy. This was not part of the above arbitration.

 

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

 

The payment obligations of Williams Energy under the Power PurchaseAgreement are guaranteed by The Williams Companies, Inc.  The payment obligations of The WilliamsCompanies, Inc. under the guarantee were initially capped at an amount equal toapproximately $510 million.  Beginning onJanuary 1 of the first full year after the commercial operation date, thisguarantee cap is to be reduced semiannually by a fixed amount which is based onthe amortization of our senior secured bonds during the applicable semiannualperiod. As of June 30, 2004 the guaranty was capped at $506.6 million.

 

Pursuant to Section 18.3 of the Power Purchase Agreement, in the eventthat Standard & Poors or Moody’s rates the long-term senior unsecured debtof The Williams Companies, Inc. lower than investment grade, The WilliamsCompanies, Inc. is required to supplement The Williams Companies, Inc.guarantee with additional alternative security that is acceptable to theCompany within 90 days after the loss of such investment grade rating.  According to published sources, The WilliamsCompanies, Inc.’s long term senior unsecured debt has been rated belowinvestment grade since 2002 by both S&P and Moody’s.

 

Due to the downgrade of The Williams Companies, Inc. to belowinvestment grade, the Company and Williams Energy entered into a letteragreement dated November 7, 2002 (the “Letter Agreement”), under which WilliamsEnergy agreed to provide the Company (a) a prepayment of $10 million withinfive business days after execution of the Letter Agreement (the “Prepayment”);(b) alternative credit support equal to $35 million on or before January 6,2003 in any of the following forms: (i) cash, (ii) letter(s) of credit with theCompany as the sole beneficiary substantially in the form of the Power PurchaseAgreement Letter of Credit, unless mutually agreed to otherwise, or (iii) adirect obligation of the United States Government delivered to a custodialsecurities account as designated by the Company with a maturity of not morethan three years; and (c) replenish any portion of the alternative creditsupport that is drawn, reduced, cashed, or redeemed, at any time, with an equalamount of alternative credit support.  Inthe Letter Agreement, the Company and Williams Energy acknowledged that theposting of such alternative credit support and Williams Energy’s agreement andperformance of the requirements of (a), (b), and (c), as set forth in theimmediately preceding sentence, would be in full satisfaction of WilliamsEnergy’s obligations contained in Section 18.3 of the Power PurchaseAgreement.  In the Letter Agreement, theCompany and Williams Energy expressly agreed that the posting of the Prepaymentor any alternative credit support either now or in the future or any otherterms set forth in the Letter Agreement is not intended to and did not modify,alter, or amend in any way, the terms and conditions or relieve The WilliamsCompany, Inc. from any obligations it has under its guarantee of the paymentobligations of Williams Energy under the Power Purchase Agreement.  The guarantee remains in full force andeffect and the Company retains all of its rights and remedies provided by thatguarantee.

 

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Under the terms ofthe Letter Agreement, the Company is obligated to return the Prepayment toWilliams Energy upon the earlier of (i) The Williams Companies, Inc. regainingits investmentgrade rating or Williams Energy providing a substitute guarantee of investmentgrade rating; (ii) the beginning of Contract Year 20; or (iii) the posting ofalternative credit support by Williams Energy as set forth below.  In the case of items (i) and (iii) above,except to the extent, in the case of item (iii), Williams Energy elects to haveall or a portion of the Prepayment make up a combination of the alternativecredit support required to be posted pursuant to Section 18.3(b) of the PowerPurchase Agreement, Williams Energy shall have the right to recoup the Prepaymentby set-off of any and all amounts owing to the Company under the Power PurchaseAgreement beginning no earlier than the June in the calendar year after theoccurrence of item (i) or (iii) and continuing thereafter until the Prepaymenthas been fully recovered.  In the caseof item (ii) above, Williams Energy shall have the right to immediately set-offall amounts 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 to Williams Energy as setforth in the preceding paragraph, then the Company shall be considered indefault under the Letter Agreement and Williams Energy shall be entitled toenforce any and or all of its contractual rights and remedies as set forth inthe Power Purchase Agreement, including, but not limited to, drawing on theLetter of Credit previously posted by the Company in favor of Williams Energy.

 

Williams Energy made the Prepayment on November 14, 2002 and providedan additional $25 million of cash to the Company on January 6, 2003 as thealternative credit support.  As allowedby the Letter Agreement, Williams has elected to have the $10 millionPrepayment included as part of the alternative credit support.  In the event that Williams regains andmaintains its investment grade status, provides a substitute guarantee ofinvestment grade rating, or posts a letter of credit, the Company will berequired to return the $35 million alternative credit support to Williams Energyin accordance with the terms of the Letter Agreement as described above.

 

**6.             COMMITMENTSAND CONTINGENCIES**

 

*Construction Agreement* - The Company enteredinto an Agreement for Engineering, Procurement and Construction (EPC) services,dated as of October 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 guarantee in the Company’sfavor, effective as of October 15, 1999, all of WGI’s obligations under theconstruction 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 the Company’s retainage,Raytheon is entitled to post a letter of credit in the amount of the thencurrent retainage.  As of June 30, 2004,Raytheon had provided a letter of credit of approximately $30.8 million.  The Company may draw on this letter ofcredit in the event that Raytheon fails to pay us any amount owed to us underthe construction agreement.  As of June30, 2004, the Company had drawn $544,000 on this letter of credit for interimrebates which Raytheon then resumed paying until their notice of FinalAcceptance.

 

Provisionalacceptance has been granted and the Facility has commenced commercialoperations, however, Raytheon must perform certain agreed upon completion itemsin order to obtain final acceptance.

 

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Raytheon gave notice of Final Acceptance on July 22, 2003 based on itsJuly 8, 2003 performance test.  On July31, 2003, the Company received a letter from the project’s independent engineerstating that it could not support Raytheon’s claim of final acceptance and itdid not consider the July 8, 2003 performance test valid.  In making this assessment, the independentengineer cited, among other reasons, (i) modifications made to certainequipment in performance of the July 8 performance test which would adverselyimpact the operations of the plant and other pieces of equipment and (ii)Raytheon’s failure to demonstrate compliance with guaranteed emissionslimits.  On August 1, 2003, the Companyrejected Raytheon’s claim of final acceptance. This rejection was based upon Raytheon’s failure to meet the conditionsfor final acceptance provided for in the EPC contract. On August 7, 2003, theCompany received a response from Raytheon in which Raytheon claims that theCompany’s rejection of the final acceptance is invalid and improper.  The Company is currently considering itsoptions for resolving this dispute.

 

*Land Development Plan*– The Company entered into an agreement with the Borough of Sayreville by whichthe Company will develop and implement a plan to replace trees which wereremoved during clearing of the Facility site. The Land Development Plan is required for final site approval.   The estimated cost of the plan is approximately$425,000.  The Company is in the processof selecting a contractor to perform the service and no payments have been madeas of June 30, 2004.  On July 23, 2003,the project was secured by a letter of credit issued by Union Bank ofCalifornia for $425,000 with the Borough of Sayreville as the beneficiary.  This irrevocable standby letter of credithad an expiration date of June 30, 2004, but was automatically extended foranother one-year period, and represents the amount potentially due if there isa failure of AES Red Oak, LLC to take action regarding the plan.

 

**7.             NEWACCOUNTING PRONOUNCEMENTS**

 

In January 2003, the Financial Accounting Standards Board (“FASB”)issued FIN No. 46, Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51 (“FIN No. 46”).  In October 2003, FASB StaffPosition No. 46-6, “Effective Date of FIN No. 46, Consolidation of VariableInterest Entities” deferred the effective date of FIN No. 46 for variableinterests held by a public entity in a variable interest entity (“VIE”) thatwas created or acquired before February 1, 2003 to the end of the first interimor annual period ending after December 15, 2003.  In December 2003, FASBissued FIN 46 (revised December 2003), Consolidation of Variable InterestEntities, an Interpretation of ARB No. 51 (“FIN 46(R)”), which clarified somerequirements and incorporated several staff positions that the Company wasalready required to apply.  In addition, FIN 46(R) deferred the effectivedate for VIEs that were created or acquired before February 1, 2003 and werenot considered special purpose entities (“SPEs”) prior to the issuance of theinterpretation until the end of the first reporting period ending after March15, 2004.  FIN 46(R) defines a VIE as (i) any entity in which the equityinvestors at risk in such entity do not have the characteristics of acontrolling financial interest, or (ii) any entity that does not havesufficient equity at risk to finance its activities without additionalsubordinated financial support from other parties.  It requires theconsolidation of the VIE by the primary beneficiary.  The adoption of FIN46(R) requires the Company to include disclosures for non SPE VIEs created oracquired on or after February 1, 2003 in its consolidated financial statementsrelated to the total assets and the maximum exposure to loss resulting from theCompany’s interests in VIEs.  The adoption of FIN 46(R) did not have amaterial effect on our financial position, results of operations, or cashflows.

 

**Item 2.**** MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Cautionary Note Regarding Forward-LookingStatements**

 

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

 

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

 

All statements other than of historical facts included herein,including those regarding market trends, our financial position, businessstrategy, projected plans and objectives of management for future operations ofthe Facility, are forward-looking statements. Such forward-looking statementsinvolve known and unknown risks, uncertainties and other factors outside of ourcontrol that may cause our actual results or performance to be materiallydifferent from any future results, performance or achievements expressed orimplied by the forward-looking statements. These risks, uncertainties and otherfactors include, among others, the following:

 

•                  unexpected problems relating to theperformance of the Facility,

 

•                  the financial condition of third parties onwhich we depend, including in particular, Williams Power Company, Inc.,(“Williams Energy”), formerly Williams Energy Marketing & Trading Company,as fuel supplier under the power purchase agreement 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 (the “PowerPurchase Agreement”), and The Williams Companies, Inc., as the guarantor ofWilliams Energy’s performance under the Power Purchase Agreement,

 

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

 

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

 

•                  the ability of The Williams Companies, Inc.or its affiliates to avoid a default under the Power Purchase Agreement bycontinuing to maintain or provide adequate security to supplement theirguarantee of Williams Energy’s performance under the Power Purchase Agreement,

 

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

 

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

 

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

 

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

 

•                  inadequate insurance coverage,

 

•                  unexpected expenses or lower than expectedrevenues,

 

•                  environmental and regulatory compliance,

 

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

 

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

 

We undertake no obligation to publicly update or revise anyforward-looking statement, whether as a result of new information, futureevents or otherwise.

 

**General**

 

We are a Delaware limited liability companyformed on September 13, 1998 to develop, construct, own, operate and maintainour Facility. We were dormant until March 15, 2000, the date of the sale of oursenior

 

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

 

We reached provisional acceptance on August11, 2002, risk transfer on August 13, 2002, and in a settlement with WilliamsEnergy reached on November 4, 2003, a commercial operation date of September28, 2002 was agreed upon.

 

**Liquidity and Capital Resources**

 

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

 

The minimum capacity payments provided for under the Power PurchaseAgreement have been our primary source of operating revenues, representing$62.0 million of our total revenues of $64.2 million in calendar year 2003, and$27.0 million of our total revenues of $29.5 million for the first six monthsof 2004. The minimum cash flow from Williams under the power purchase agreementis approximately $3.8 million per month for October through May and $7.9million per month from June through September.

 

During 2003, the Company’s first full year of operations, net cashprovided by operating activities was $14.8 million.  We currently anticipate that the plant will be dispatched infuture periods to a similar degree as it was during 2003, that operating cashflow will be comparable to 2003 in 2004 and that operating cash requirementswill be similar in 2004 and 2005 as they were during this first year ofoperation.  We also believe that cashflows from the sale of electricity and/or minimum capacity payments under thePower Purchase Agreement, and funds available to be drawn under the debtservice reserve letter of credit or the power purchase letter of credit, willbe sufficient to fund our operating expenses and debt service costs.

 

We have provided Williams Energy a $10 million letter of credit underthe Power Purchase Agreement, which we refer to as the power purchase letter ofcredit, to support specific payment obligations under the Power PurchaseAgreement. The repayment obligations with respect to any drawings under thepower purchase letter of credit are our senior debt obligation.

 

Due to the downgrade of The Williams Companies, Inc.’s debt to belowinvestment grade, the Williams Companies, Inc. is required to supplement TheWilliams Companies, Inc. guarantee with additional alternative security that isacceptable to us.  Since The WilliamsCompanies, Inc. debt rating fell below investment grade in 2002, WilliamsEnergy has provided us with $35 million of cash as alternate credit support.  In the event that the Williams Companies,Inc. regains and maintains its investment grade status, provides a substituteguarantee of investment grade rating, or posts a letter of credit, we will berequired to return the $35 million alternative credit support to WilliamsEnergy. Under the terms of the Letter Agreement, Williams Energy shall have theright to recoup the Prepayment by set-off of any and all amounts owing to theCompany under the Power Purchase Agreement no earlier than the June in thecalendar year after the occurrence of regaining its investment grade rating orthe beginning of calendar year 20, whichever comes first. In the event weregain investment grade status, we will also have access to funds from our $2.5million working capital agreement.  Asof August 5, 2004, we had cash balances of approximately $33.0 million.  In the event that we are required to returnthe $35 million alternative credit support to Williams, we believe that wewould use all or a portion of our current cash balances and cash generated fromfuture operations, with any remaining balance deducted from the monthly amountsdue to us from Williams Energy.  Thisbelief is subject to certain assumptions, risks and uncertainties, includingthose set forth above under the caption “Cautionary Note RegardingForward-Looking Statements” and there can be no assurances that our operatingrevenues will generate sufficient cash.

 

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

 

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

 

The Company entered into an agreement with the Borough of Sayreville bywhich the Company will develop and implement a plan to replace trees which wereremoved during clearing of the Facility site. The Land Development Plan is 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 March 31, 2004.  OnJuly 23, 2003, the project was secured by a letter of credit issued by UnionBank of California for $425,000 with the Borough of Sayreville as thebeneficiary.  This irrevocable standbyletter of credit had an expiration date of June 30, 2004, but was automaticallyextended for another one-year period, and represents the amount potentially dueif there is a failure of the Company to take action regarding the plan.

 

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

 

Under the construction agreement, we were entitled to retain certainamounts from each scheduled payment until after final acceptance by us of theFacility unless Raytheon posted a letter of credit in the amount of paymentsthat would otherwise be retained.  As ofJune 30, 2004, Raytheon had provided a letter of credit of approximately $30.8million and we had paid Raytheon for any amounts previously retained.  We may draw on this letter of credit in theevent that Raytheon fails to pay us any amount owed to us under theconstruction agreement.  As of June 30,2004 we have drawn $544,000 on this letter of credit.

 

Since we depend on Williams Energy for both revenues and fuel supplyunder the Power Purchase Agreement, if Williams Energy were to terminate ordefault under the Power Purchase Agreement, there would be a severe negativeimpact to our cash flow and financial condition which could result in a defaulton our senior secured bonds.  Due to thecurrent PJM power pool prices, we would expect that if we were required to seekalternate purchasers of our power in the event of a default of Williams Energy,even if we were successful in finding alternate revenue sources, any suchalternate revenue sources would be substantially below the amounts that wouldhave been otherwise payable pursuant to the Power Purchase Agreement. There canbe no assurance as to our ability to generate sufficient cash flow to coveroperating expenses or our debt service obligations in the absence of along-term power purchase agreement with Williams Energy.

 

In addition to the factors discussed above, and/or the other factorslisted under the “Cautionary Note Regarding Forward-Looking Statements,” if wedo not receive final rebates from Raytheon and/or the working capital agreementcontinues to be unavailable as a result of the ratings on our senior securedbonds, we could experience a negative impact on our cash flow and financialcondition.

 

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

 

**Energy Revenues**

 

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

 

Upon its expiration, or in the event that the Power Purchase Agreementis terminated prior to its 20-year term, we would seek to generate energyrevenues from the sale of electric energy and capacity into the merchant marketor under new short or long-term power purchase or similar agreements. Due torecent declines in PJM power pool prices, however, we would expect that even ifwe were successful in finding alternate revenue sources, any such alternaterevenues would be substantially below the amounts that would have beenotherwise payable pursuant to the Power Purchase Agreement. There can be noassurances as to whether such efforts would be successful.

 

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**Operating Expenses**

 

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

 

**Performance Guarantees**

 

*Electrical Output*

 

Under the construction contract, if the average net electrical outputof our Facility at provisional acceptance or interim acceptance, whichever isthe earlier to occur, is less than the electrical output guarantee, thenRaytheon must pay us, as a rebate and not as liquidated damages, for each dayduring the interim period, an amount equal to $0.22 per day for each kilowattby which the average net electrical output is less than the electrical outputguarantee.  During performance testing,our output was calculated to be 13,370 kilowatts less than the electricaloutput guarantee.  Accordingly, ourdaily charge for this amount has been calculated at $2,941.40 per day. Raytheonpaid us this amount until their notice of Final Acceptance date of July 22,2003, but we are disputing this claim of final acceptance and contend thatthese amounts should continue to be paid until the final acceptance date.

 

Upon final acceptance, if the average net electrical output of ourFacility during the completed performance test is less than the electricaloutput guarantee, then Raytheon must pay us, as a bonus, an amount equal to$520 for each kilowatt by which the average net electrical output is less thanthe guarantee minus any interim rebates paid or to be paid by Raytheon.

 

*Heat Rate Guarantees*

 

If the average net heat rate of our Facility at provisional acceptanceor interim acceptance, if having occurred before final acceptance, exceeds theheat rate guarantee, then Raytheon must pay us, as a rebate and not asliquidated damages, for each day during the interim period, an amount equal to$46 per day for each BTU/KwH by which the measured net heat rate is greaterthan the heat rate guarantee.

 

Upon final acceptance, if the net heat rate of our Facility during thecompleted performance test exceeds the heat rate guarantee, then Raytheon willpay us, as a rebate, a lump sum amount equal to $110,000 for each BTU/KwH bywhich the measured heat rate is greater than the heat rate guarantee minus anyinterim rebates paid or to be paid by Raytheon.

 

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

 

**Recent and New Accounting Pronouncements**

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FIN No. 46, Consolidation of Variable Interest Entities, anInterpretation of ARB No. 51 (“FIN No. 46”).  In October 2003, FASB StaffPosition No. 46-6, “Effective Date of FIN No. 46, Consolidation of VariableInterest Entities” deferred the effective date of FIN No. 46 for variableinterests held by a public entity in a variable interest entity (“VIE”) thatwas created or acquired before February 1, 2003 to the end of the first interimor annual period ending after December 15, 2003.  In December 2003, FASBissued FIN 46 (revised December 2003), Consolidation of Variable InterestEntities, an Interpretation of ARB No. 51 (“FIN 46(R)”), which clarified somerequirements and incorporated several staff positions that the Company wasalready required to apply.  In addition, FIN 46(R) deferred the effectivedate for VIEs that were created or acquired before

 

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February 1, 2003 and were not considered special purpose entities(“SPEs”) prior to the issuance of the interpretation until the end of the firstreporting period ending after March 15, 2004.  FIN 46(R) defines a VIE as(i) any entity in which the equity investors at risk in such entity do not havethe characteristics of a controlling financial interest, or (ii) any entitythat does not have sufficient equity at risk to finance its activities withoutadditional subordinated financial support from other parties.  It requiresthe consolidation of the VIE by the primary beneficiary.  The adoption ofFIN 46(R) requires the Company to include disclosures for non SPE VIEs createdor acquired on or after February 1, 2003 in its consolidated financialstatements related to the total assets and the maximum exposure to lossresulting from the Company’s interests in VIEs.  The adoption of FIN 46(R)did not have a material effect on our financial position, results ofoperations, or cash flows.

 

**Results of Operations**

 

Under the Power Purchase Agreement with Williams Energy, we areeligible to receive variable operations and maintenance payments, total fixedpayments, energy exercise fees (each as defined in the Power PurchaseAgreement) and other payments for the delivery of fuel conversion, capacity andancillary services.  We were dispatchedby Williams Energy for two days in the quarter ended March 31, 2004 and duringmost peak periods in the quarter ended June 30, 2004, as compared to the sameperiod for the prior year, and were called to generate only 14% during the 2003calendar year. Accordingly, the minimum capacity payments have been our primarysource of operating revenues.

 

***For the Three MonthsEnded June 30, 2004 and 2003***

 

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

 

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

 

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

 

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

 

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

 

***Forthe Six Months Ended June 30, 2004 and 2003***

 

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

 

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rating than in the prior year period.

 

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

 

Fuel Conversion Volume expense for the six monthsended June 30, 2004 were $2.6 million compared to $3.2 million for thecomparable period for the prior calendar year. Fuel Conversion Volume expenserepresents a charge paid to Williams Energy under the Power Purchase Agreementbased upon utilization of the Facility. The decrease is due to the Facility notoperating over a certain dispatch level for the last twelve months, which is afactor in the determination of this cost under the Power Purchase Agreement.The factor applied in the prior-year period was fixed for the firsttwelve-month period commencing with the Commercial Operation Date. To theextent that our utilization exceeds 20% for the prior twelve month period, thisexpense may rise back up to the 2003 level in future periods.

 

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

 

**Concentration of Credit Risk**

 

Williams Energy is currently our sole customer for purchases ofcapacity, ancillary services, and energy and its sole source for fuel.  Williams Energy’s payments under the PowerPurchase Agreement are expected to provide all of our operating revenues duringthe term of the Power Purchase Agreement. It is unlikely that the Company would be able to find another purchaseror fuel source on similar terms for its Facility if Williams Energy were notperforming under the Power Purchase Agreement. Any material failure by Williams Energy to make capacity and fuelconversion payments or to supply fuel under the Power Purchase Agreement wouldhave a severe impact on our operations, and may result in a default on the ourdebt.  The payment obligations of WilliamsEnergy under the Power Purchase Agreement are guaranteed by The WilliamsCompanies, Inc.  The payment obligationsof The Williams Companies, Inc. under the guarantee were initially capped at anamount equal to approximately $510 million. Beginning on January 1 of the first full year after the commercialoperation date, this guarantee cap is to be reduced semiannually by a fixedamount which is based on the amortization of our senior secured bonds duringthe applicable semiannual period. As of June 30, 2004, the guarantee was cappedat $506.6 million.

 

The Company’s dependence upon The Williams Companies, Inc. and itsaffiliates under the Power Purchase Agreement exposes the Company to possibleloss of revenues and fuel supply, which in turn, could negatively impact itscash flow and financial condition and may result in a default on its seniorsecured bonds.  There can be noassurances as to the our ability to generate sufficient cash flow to coveroperating expenses or its debt service obligations in the absence of along-term power purchase agreement with Williams Energy.

 

**Critical Accounting Policies**

 

*General* — We prepare our financial statementsin accordance with accounting principles generally accepted in the UnitedStates of America. As such, we are required to make certain estimates, judgmentsand assumptions that we believe are reasonable based upon the informationavailable. These estimates and assumptions affect the reported amounts ofassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the periods presented. The significantaccounting policies which we believe are most critical to understanding andevaluating our reported financial results include the following:  Revenue Recognition, Property, Plant andEquipment and Contingencies.

 

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*Revenue Recognition* — We generate energy revenues under thePower Purchase 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. Amounts that are in dispute arereserved accordingly, based on the probability that they will be realized.

 

Upon its expiration, or in the event that thePower Purchase Agreement is terminated prior to its 20-year term or WilliamsEnergy otherwise fails to perform, we would seek to generate energy revenuesfrom the sale of electric energy and capacity into the merchant market or undernew short- or long-term power purchase or similar agreements.  Due to declines in PJM power pool prices,however, we would expect that even if we were successful in finding alternaterevenue sources, any such alternate revenues would be substantially below theamounts that would have been otherwise payable by Williams Energy pursuant tothe Power Purchase Agreement.  There canbe no assurances as to whether such efforts would be successful.

 

*Property, Plant and Equipment* —  Property, plant and equipment is recorded atcost and is depreciated over its useful life. The estimated lives of our generation facilities range from five tothirty-six years.  A significantdecrease in the estimated useful life of a material amount of our property,plant or equipment could have a material adverse impact on our operatingresults in the period in which the estimate is revised and in subsequentperiods.  The depreciable lives of ourproperty plant and equipment by category are as follows*:*

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

 

# **ITEM 4**.  CONTROLSAND PROCEDURES

 

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

 

Based upon the controls evaluation performed, the CEO and CFO haveconcluded that as of June 30, 2004, our disclosure controls and procedures wereeffective to provide reasonable assurance that material information relating tous and our consolidated subsidiaries is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

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

 

Compliance with Section 404 of the Sarbanes Oxley Act of 2002.  Beginning with the year ending December 31,2005, Section 404 of the Sarbanes-Oxley Act of 2002 will require us to includean internal control report of management with our annual report on Form10-K.  The internal control report mustcontain (1) a statement of management's responsibility for establishing andmaintaining adequate internal controls over financial reporting for ourCompany, (2) a statement identifying the framework used by management toconduct the required evaluation of the effectiveness of our internal controlsover financial reporting, (3) management's assessment of the effectiveness ofour internal controls over financial reporting as of the end of our most recentfiscal year, including a statement as to whether or not our internal controlsover financial reporting are effective, and (4) a statement that ourindependent auditors have issued an attestation report on management'sassessment of our internal controls over financial reporting.  

 

Management developed a comprehensive plan in order to achievecompliance with Section 404 within the prescribed period and to review,evaluate and improve the design and effectiveness of our controls and procedureson an on-going basis.  The comprehensivecompliance plan includes (1) documentation and assessment of the adequacy ofour internal controls over financial reporting, (2) remediation of controlweaknesses, (3) validation through testing that controls are functioning asdocumented and (4) implementation of a continuous reporting and improvementprocess for internal controls over financial reporting.  As a result of this initiative, we have madeand will continue to make changes from time to time in our internal controlsover financial reporting.  

 

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**PART II****. OTHER INFORMATION**

 

**Item 1. LEGALPROCEEDINGS**

 

See Note 6 to our condensed consolidatedfinancial statements.

 

**Item 5. OTHERINFORMATION**

 

None.

 

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**Item 6. EXHIBITS AND REPORTS ON FORM 8-K**

 

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

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

 

**(b)****          Reports on Form 8-K**

 

The Company did not file any reports on Form8-K during the quarter ended June 30, 2004.

 

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**SIGNATURES**

 

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

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

 

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