**UNITED STATESSECURITIES 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 30,2005**

 

**or**

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

 

**For the transition periodfrom                       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 areacode:  **(732)238-1462**

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen 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(1)(a) and (b) of Form 10-Q and is filingthe Quarterly Report on form 10-Q with the reduced disclosure format authorizedby General Instruction H(2).

 

 

----

 

**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 Months and Six Months Ended June 30, 2005 and 2004**                                 | ** ** |
| ** **        | **Condensed Consolidated Balance Sheets, as  of June 30, 2005 and December 31, 2004**                                                     | ** ** |
| ** **        | **Condensed Consolidated Statement of Changes  in Member’s Capital (Deficit), Period from December 31, 2004 through  June 30, 2005** | ** ** |
| ** **        | **Condensed Consolidated Statements of Cash  Flows for the Six Months Ended June 30, 2005 and 2004**                                           | ** ** |
| ** **        | **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**                                                                                                                                        | ** ** |
| ** **        | **SIGNATURES**                                                                                                                                      | ** ** |

 

----

 

**PART I.FINANCIAL INFORMATION**

 

**Item 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AESCORPORATION**

**Condensed Consolidated Statements of Operations,**

**Three and Six Months Ended June 30, 2005 and 2004**

**(Unaudited)**

***(dollars in thousands)***

 
| ** **                               | ** ** | **Three Months**  | ** ** | **Six Months**    | ** ** |
|------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                               | ** ** | **Ended**         | ** ** | **Ended**         | ** ** |
| ** **                               | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                               | ** ** | **2005**          | ** ** | **2004**          | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | ** **        | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
| OPERATING REVENUES                       |       |              |       |              |       |   |   |   |   |
| Energy                                   |       | $                 | 17,074     |              | $          | 17,915 |   | $ | 28,918 |   | $ | 29,543 |   |
|                                     |       |              |       |              |       |   |   |   |   |
| OPERATING EXPENSES                       |       |              |       |              |       |   |   |   |   |
| Fuel conversion volume rebate            |       | 1,631             |       | 1,566             |       | 3,263 |   | 2,595 |   |
| Corporate management fees                |       | 415               |       | 408               |       | 831 |   | 816 |   |
| Other operating expenses                 |       | 1,878             |       | 3,519             |       | 5,003 |   | 6,110 |   |
| Depreciation expense                     |       | 3,018             |       | 2,974             |       | 6,003 |   | 5,825 |   |
| Taxes and insurance                      |       | 600               |       | 748               |       | 1,331 |   | 1,496 |   |
| General and administrative costs         |       | 243               |       | 311               |       | 556 |   | 488 |   |
| Total operating expenses                 |       | 7,785             |       | 9,526             |       | 16,987 |   | 17,330 |   |
|                                     |       |              |       |              |       |   |   |   |   |
| Operating income                         |       | 9,289             |       | 8,389             |       | 11,931 |   | 12,213 |   |
|                                     |       |              |       |              |       |   |   |   |   |
| OTHER INCOME (EXPENSE)                   |       |              |       |              |       |   |   |   |   |
| Interest income                          |       | 267               |       | 58                |       | 558 |   | 119 |   |
| Interest expense                         |       | (8,155            | )          | (8,268            | )          | (16,319 | ) | (16,543 | ) |
| Amortization of deferred financing costs |       | (204              | )          | (203              | )          | (407 | ) | (406 | ) |
| Letter of credit fees and other          |       | (259              | )          | (257              | )          | (558 | ) | (518 | ) |
| Total other (expense)                    |       | (8,351            | )          | (8,670            | )          | (16,726 | ) | (17,348 | ) |
|                                     |       |              |       |              |       |   |   |   |   |
| NET INCOME (LOSS)                        |       | $                 | 938        |              | $          | (281 | ) | $ | (4,795 | ) | $ | (5,135 | ) |

 

See notes to condensedconsolidated financial statements.

 

1

----

 

**AES RED OAK, L.L.C. AND SUBSIDIARYAN INDIRECT, WHOLLY-OWNED SUBSIDIARY OF THE AES CORPORATIONCondensed ConsolidatedBalance Sheets,June 30, 2005 and December 31, 2004***(dollarsin thousands, except share amounts)*

 

***(Unaudited)***

 
| ** **                                                                                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                  | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| **ASSETS:**                                                                                                 |       |              |       |                  |       |
|                                                                                                        |       |              |       |                  |       |
| Current Assets:                                                                                             |       |              |       |                  |       |
| Cash                                                                                                        |       | $                 | 6          |                  | $          | 5 |   |
| Restricted cash at cost, which approximates  market value                                                   |       | 35,681            |       | 41,584                |       |
| Trade receivable                                                                                            |       | 8,947             |       | 4,374                 |       |
| Receivable from affiliate                                                                                   |       | 28                |       | 30                    |       |
| Prepaid and other current assets                                                                            |       | 138               |       | 599                   |       |
| Total current assets                                                                                        |       | 44,800            |       | 46,592                |       |
|                                                                                                        |       |              |       |                  |       |
| Land                                                                                                        |       | 4,240             |       | 4,240                 |       |
| Property, plant, and equipment – net of  accumulated depreciation of $33,605 and $27,614, respectively |       | 396,258           |       | 399,338               |       |
| Deferred financing costs – net of  accumulated amortization of $4,348 and $3,941, respectively         |       | 14,357            |       | 14,764                |       |
| Other assets                                                                                                |       | 606               |       | 606                   |       |
|                                                                                                        |       |              |       |                  |       |
| Total assets                                                                                                |       | $                 | 460,261    |                  | $          | 465,540 |   |
|                                                                                                        |       |              |       |                  |       |
| **LIABILITIES AND MEMBER’S CAPITAL:**                                                                  |       |              |       |                  |       |
|                                                                                                        |       |              |       |                  |       |
| Current Liabilities:                                                                                        |       |              |       |                  |       |
| Accounts payable                                                                                            |       | $                 | 1,148      |                  | $          | 784 |   |
| Accrued liabilities                                                                                         |       | 2,432             |       | 1,945                 |       |
| Accrued interest                                                                                            |       | 2,717             |       | 2,722                 |       |
| Liabilities under spare parts agreement–current  portion                                               |       | 129               |       | 827                   |       |
| Payable to affiliate                                                                                        |       | 374               |       | 282                   |       |
| Bonds payable-current portion                                                                               |       | 5,376             |       | 5,072                 |       |
| Payable to Raytheon                                                                                         |       | 30,302            |       | 30,302                |       |
| Payable to Williams                                                                                         |       | 10,000            |       | 10,000                |       |
| Total current liabilities                                                                                   |       | 52,478            |       | 51,934                |       |
| Bonds payable                                                                                               |       | 363,996           |       | 365,060               |       |
| Other                                                                                                       |       | 109               |       | 141                   |       |
|                                                                                                        |       |              |       |                  |       |
| Total liabilities                                                                                           |       | $                 | 416,583    |                  | $          | 417,135 |   |
|                                                                                                        |       |              |       |                  |       |
| Member’s capital:                                                                                      |       |              |       |                  |       |
| Common stock, $1 par value-10 shares  authorized, none issued or outstanding                                |       | $                 | —     |                  | $          | — |   |
| Contributed capital                                                                                         |       | 53,891            |       | 53,823                |       |
| Member’s deficit                                                                                       |       | (10,213           | )          | (5,418                | )          |
| Total member’s capital                                                                                 |       | 43,678            |       | 48,405                |       |
|                                                                                                        |       |              |       |                  |       |
| Total liabilities and member’s equity                                                                  |       | $                 | 460,261    |                  | $          | 465,540 |   |

 

See notes to condensedconsolidated financial statements.

The Condensed Consolidated Balance Sheet at December 31,2004 has been derived from the audited consolidated financial statements atthat date.

 

2

----

 

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AESCORPORATION**

**Condensed Consolidated Statement of Changesin Member’s Capital (Deficit)**

**Period from December 31, 2004 through June 30,2005**

***(dollars inthousands)***

***(Unaudited)***

 
| ** **                     | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated** | ** ** | ** **  | ** ** |
|--------------------------------|------------|------------------|------------|-------------------------|------------|-----------------|------------|-------------|------------|
| ** **                     | ** ** | **Shares**       | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit** | ** ** | **Total** | ** ** |
|                           |       |             |       |                    |       |            |       |        |       |   |   |
| BALANCE DECEMBER 31, 2004 |       | —           |       | $                       | —     |            | $          | 53,823      |       | $ | (5,418 | ) | $ | 48,405 |   |
| Contributed Capital            |       | —           |       | —                  |       | 68              |       | —      |       | 68 |   |
| Net Loss                       |       | —           |       | —                  |       | —          |       | (4,795      | )          | (4,795 | ) |
| BALANCE JUNE 30, 2005     |       | —           |       | $                       | —     |            | $          | 53,891      |       | $ | (10,213 | ) | $ | 43,678 |   |

 

See notes to condensed consolidated financialstatements.

 

3

----

 

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

**AN INDIRECT, WHOLLY OWNED SUBSIDIARY OF THE AESCORPORATION**

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

**June 30, 2005 and 2004**

***(dollars inthousands)***

***(Unaudited)***

 
| ** **                                                | ** ** | **Six months  Ended  June 30,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **                                                | ** ** | ** **                           | ** ** | ** ** | ** ** |
| **OPERATING ACTIVITIES:**                                 |       |                                 |       |   |   |
| Net income                                                |       | $                                    | (4,795     | ) | $ | (5,135 | ) |
| Amortization of deferred financing costs                  |       | 407                                  |       | 406 |   |
| Depreciation                                              |       | 6,003                                |       | 5,825 |   |
| Loss on disposal of asset                                 |       | 60                                   |       | — |   |
|                                                      |       |                                 |       |   |   |
| Change in:                                                |       |                                 |       |   |   |
| Trade receivable                                          |       | (4,573                               | )          | (4,772 | ) |
| Receivable from affiliate                                 |       | 2                                    |       | 35 |   |
| Prepaid insurance and related note payable,  net          |       | 461                                  |       | (93 | ) |
| Other assets                                              |       | —                               |       | (361 | ) |
| Accounts payable                                          |       | 364                                  |       | 2,348 |   |
| Accrued liabilities                                       |       | 367                                  |       | 715 |   |
| Accrued interest                                          |       | (5                                   | )          | (5 | ) |
| Payable to  affiliates                                    |       | 92                                   |       | 166 |   |
| Other                                                     |       | (32                                  | )          | 30 |   |
|                                                      |       |                                 |       |   |   |
| Net cash used in operating activities                     |       | $                                    | (1,649     | ) | $ | (841 | ) |
|                                                      |       |                                 |       |   |   |
| **INVESTING ACTIVITIES:**                                 |       |                                 |       |   |   |
| Payments for capital additions                            |       | (2,863                               | )          | (1,039 | ) |
| Payments under long-term spare parts  agreement and other |       | (698                                 | )          | (3,816 | ) |
| Restricted cash                                           |       | 5,903                                |       | 6,414 |   |
| Net cash provided by investing activities                 |       | $                                    | 2,342      |   | $ | 1,559 |   |
|                                                      |       |                                 |       |   |   |
| **FINANCING ACTIVITIES:**                                 |       |                                 |       |   |   |
| Payment of principal on bonds payable                     |       | (760                                 | )          | (784 | ) |
| Contribution from parent                                  |       | 68                                   |       | 50 |   |
|                                                      |       |                                 |       |   |   |
| Net cash used in financing activities                     |       | $                                    | (692       | ) | $ | (734 | ) |
|                                                      |       |                                 |       |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS** |       | $                                    | 1          |   | $ | (16 | ) |
|                                                      |       |                                 |       |   |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD**       |       | 5                                    |       | 38 |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**              |       | $                                    | 6          |   | $ | 22 |   |
|                                                      |       |                                 |       |   |   |
| **SUPPLEMENTAL DISCLOSURE:**                              |       |                                 |       |   |   |
| Interest paid                                             |       | $                                    | 16,324     |   | $ | 16,548 |   |
| Liabilities accrued for capital additions                 |       | $                                    | 119        |   | $ | 97 |   |

 

See notes to condensed consolidated financialstatements.

 

4

----

 

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

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

**Notes to Condensed Consolidated FinancialStatements**

 

**1.****                                      ORGANIZATION**

 

**General**

** **

AES Red Oak, L.L.C. (the “Company”)is a Delaware limited liability company formed on September 13, 1998, todevelop, construct, own, lease, operate and maintain a gas-fired electricgenerating power plant in the Borough of Sayreville, Middlesex County, NewJersey and manage the production of electric generating capacity, ancillaryservices and energy at the Company’s facility. The Company reached provisionalacceptance on August 11, 2002, risk transfer on August 13, 2002, andtook the position that the Company was commercially available on September 1,2002.  Williams Power Company, Inc.,(“Williams Energy”) disputed the September 1, 2002 commercial operationdate and informed the Company that it recognized commercial availability of thefacility as of September 28, 2002. On November 4, 2003, a settlement was reached and a commercialoperation date of September 28, 2002 was agreed upon. Since the Company’scommercial operation date, its sole business is the ownership, leasing andoperation of the facility.

 

Our facility was initiallydesigned, engineered, procured and constructed for the Company by WashingtonGroup International, Inc. (“WGI”) (as the successor contractor) on afixed-price, turnkey basis. On May 14, 2001, WGI filed a plan of reorganizationalong with voluntary petitions to restructure under Chapter 11 of the U.S.Bankruptcy Code in the U.S. Bankruptcy Court for the District of Nevada in Reno(the “Bankruptcy Court”). As a result of WGI’s bankruptcy filing, on June 20,2001 the Company made a demand on the Raytheon Company (“Raytheon”) to performits obligations under a guarantee which Raytheon had given the Company of WGI’sperformance obligations under the construction agreement and Raytheon becameresponsible for the construction of the Company’s facility.  As discussed above, provisional acceptancehas been 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 aletter from the project’s independent engineer stating that it could notsupport Raytheon’s claim of final acceptance and it did not consider the July 8,2003 performance test valid.  In makingthis assessment, the independent engineer cited, among other reasons, (i) modificationsmade to certain equipment in performance of the July 8 performance testwhich would adversely impact the operations of the plant and other pieces ofequipment and (ii) Raytheon’s failure to demonstrate compliance withguaranteed emissions limits.  On August 1,2003, the Company rejected Raytheon’s claim of final acceptance.  This rejection was based upon Raytheon’sfailure to meet the conditions for final acceptance provided for in theEngineering, Procurement and Construction Services Agreement (“EPC contract”).On August 7, 2003, the Company received a response from Raytheon in whichRaytheon claims that the Company’s rejection of the final acceptance is invalidand improper.  The Company and Raytheonhave filed complaints against each other. See Note 6.

 

Siemens Power Generation, Inc.(“Siemens” - formerly known as Siemens Westinghouse Power Corporation) providescombustion turbine maintenance services and spare parts with respect to theturbines for the Company’s facility under a maintenance services agreement foran initial term of 16 years from the date of execution of the agreement or afterthe twelfth scheduled outage for a turbine, whichever occurs first, unless theCompany exercises its right to cancel the agreement after the first majoroutage of the turbines. The estimated timeframe for the completion of the firstmajor outages is 2011.

 

The Company has entered intoa power purchase agreement for a term of 20 years under which Williams Energyhas committed to purchase all of the net capacity, fuel conversion andancillary services of its facility (the “Power Purchase Agreement”). Net capacityis the maximum amount of electricity generated by the Company’s facility net ofelectricity used at its facility. Fuel conversion services consist of thecombustion of natural gas in order to generate electric energy. Ancillaryservices consist of services necessary to support the transmission of capacityand energy. Williams Energy is obligated to supply the

 

5

----

 

Company with all natural gas necessary to providenet capacity, fuel conversion services and ancillary services under the PowerPurchase Agreement. During the term of the Power Purchase Agreement,substantially all of the Company’s operating revenues will be derived frompayments made under the Power Purchase Agreement. Under certain limited circumstances,Williams Energy has the right to terminate the Power Purchase Agreement.

 

**OrganizationalStructure**

** **

All of the equity interestsin the Company are owned by AES Red Oak, Inc., a wholly owned subsidiaryof The AES Corporation (“AES”). AES is a leading global power company, with2004 sales of $9.5 billion. AES’s generating assets include interests in 120facilities in 27 countries totaling approximately 44 gigawatts of capacity. Its30,000 people are committed to operational excellence and meeting the world’sgrowing power needs. Approximately****23% of AES’s revenues come from businesses in NorthAmerica, 17% from the Caribbean, 41% from South America, 11% from Europe andAfrica, and 8% from Asia.****

 

AES Red Oak, Inc.currently has no operations outside of its activities in connection with itsproject and does not anticipate undertaking any unrelated operations. AES RedOak, Inc. also owns all of the equity interests in AES Sayreville, L.L.C.,(“AES Sayreville”) which provides development, construction management, andoperations and maintenance services to us. AES Sayreville has no operationsoutside of its activities in connection with its operations. AES Red Oak, Inc.has no assets other than its membership interests in the Company and AESSayreville. The AES Corporation supplies AES Sayreville with personnel andservices necessary to carry out its obligations to us.

 

The Company also owns all ofthe equity interests in AES Red Oak Urban Renewal Corporation (“AES URC”),which was organized as an urban renewal corporation under New Jersey law sothat portions of its project can be designated as redevelopment areas orprojects in order to provide certain real estate tax and development benefitsfor its project. AES URC has no operations outside of its activities inconnection with the Company’s operations.

 

**2.****                                      BASISOF PRESENTATION**

 

In the Company’s opinion, all adjustments necessary for a fairpresentation of the unaudited results of operations for the interim periodspresented herein are included. All such adjustments include accruals of anormal recurring nature. The results of operations for the three and six-monthperiods presented herein are not necessarily indicative of the results ofoperations to be expected for the full year or future periods.

 

Certain reclassificationshave been made to conform to the current presentation.  Suchreclassifications also include the correction for $3.05 million of dividendsthat were erroneously recorded against member’s deficit.  In the absenceof retained earnings, the Company should have recorded the dividends as areduction to contributed capital, a component of total member’s capital. This correction had no impact on total member’s capital.

 

These financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America forinterim financial information and with the instructions to Form 10-Q andRegulation S-X. Accordingly, they do not include all of the informationand footnotes required by generally accepted accounting principles (“GAAP”) forcomplete financial statements. The accompanying condensed consolidatedfinancial statements are unaudited and they should be read in conjunction withthe audited financial statements and notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004.

 

6

----

 

**3.**                                      **CONCENTRATION OF 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 20 year-term of the Power Purchase Agreement.  It is unlikely that the Company would be ableto find another purchaser or fuel source on similar terms for its facility ifWilliams Energy were not performing under the Power Purchase Agreement.  Any material failure by Williams Energy tomake capacity and fuel conversion payments or to supply fuel under the PowerPurchase Agreement would have a severe impact on the Company’s operations, andmay result in a default on the Company’s debt. The payment obligations of Williams Energy under the Power PurchaseAgreement are guaranteed by The Williams Companies, Inc.  The payment obligations of The WilliamsCompanies, Inc. under the guaranty are capped at an amount equal toapproximately $510 million.  Beginning onJanuary 1 of the first full year after the commercial operation date, thisguaranty cap is to be reduced semiannually by a fixed amount which is based onthe amortization of the Company’s senior secured bonds during the applicablesemiannual period. As of June 30, 2005, the guaranty was capped at $500.6million.

 

The minimum capacitypayments provided for under the Power Purchase Agreement have been the Company’sprimary source of operating revenues, representing $27.1 million of totalrevenues of $28.9 million for the six months ending June 30, 2005 and $27.0million of total revenues of $29.5 million for the six months ended June 30,2004.  The minimum cash flow fromWilliams Energy under the Power Purchase Agreement is approximately $3.8million per month for October through May and $7.9 million per monthfrom June through September.

 

The Company currentlyanticipates that the plant will be dispatched in future periods to a similarrange as it was during the first two years of full operation in 2003 and 2004, andthat operating cash flow and operating cash requirements in 2005 will also bein a comparable range of the first two years of operation.  The Company also believes that cash flowsfrom the sale of electricity and/or minimum capacity payments under the PowerPurchase Agreement, and funds available to be drawn under the debt servicereserve letter of credit or the power purchase letter of credit, will besufficient to fund operating expenses and debt service costs.

 

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

 

**4.**                                      BONDS PAYABLE

** **

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. In September 2000, the Company consummated an exchangeoffer whereby the holders of the senior secured bonds exchanged their privatelyplaced senior secured bonds for registered senior secured bonds.

 

The senior secured bonds were issued in two series: 8.54% seniorsecured bonds due 2019 (the “2019 Bonds”) in an aggregate principal amount of$224 million and 9.20% senior secured bonds due 2029 (the “2029 Bonds”) inan aggregate principal amount of $160 million. Principal repayment of the2019 Bonds commenced with the quarterly payment on August 31, 2002. Annualprincipal repayments on the Bonds are scheduled as follows:

 

7

----

 
| ** **                                         | ** ** | **(in thousands)** | ** ** | ** **    | ** ** |
|----------------------------------------------------|------------|--------------------|------------|---------------|------------|
| **Year**                                           | ** ** | **Interest**       | ** ** | **Principal** | ** ** |
| 2005 (remaining subsequent to June 30,  2005) |       | $                  | 16,252     |          | $          | 4,312 |   |
| 2006                                               |       | 32,111             |       | 7,100         |       |
| 2007                                               |       | 31,502             |       | 6,106         |       |
| 2008                                               |       | 30,940             |       | 8,122         |       |
| 2009                                               |       | 30,117             |       | 12,520        |       |
| Thereafter                                         |       | 287,290            |       | 331,212       |       |
| Total                                              |       | $                  | 428,212    |          | $          | 369,372 |   |

 

Principal repayment dates on the 2019 Bonds are February 28, May 31,August 31, and November 30 of each year, with the final payment due November 30,2019. Quarterly principal repayment of the 2029 Bonds does not commence until February 28,2019.  The Company made a principalpayment of $380,000 in May 2005.

 

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

 

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

 

The Company entered intoarbitration with Williams Energy to resolve certain disputes regarding the dateof commercial operation and the proper interpretation of certain provisions ofthe Power Purchase Agreement relating to the amounts claimed by the Company to bepayable by Williams Energy. On November 4, 2003, the Company and WilliamsEnergy settled this dispute.  From theCompany’s perspective, the settlement had the economic effect of recognizing acommercial operation date prior to September 28, 2002. The Company is alsodisputing approximately $1.7 million of merchant price, testing gas and othercharges with Williams Energy that the Company contends is owed by WilliamsEnergy. This was not part of the above arbitration.

 

The Company providedWilliams Energy a letter of credit (“Power Purchase Agreement Letter of Credit”)in the amount of $30 million to support specific payment obligations should thefacility not achieve commercial operation by the date required under the PowerPurchase Agreement. Upon the commencement of commercial operations in September 2002,the stated amount of that letter of credit was reduced to $10 million. Therepayment obligations with respect to any drawings under the Power PurchaseAgreement Letter of Credit are a senior debt obligation of the Company.

 

The payment obligations ofWilliams Energy under the Power Purchase Agreement are guaranteed by TheWilliams Companies, Inc.  Thepayment obligations of The Williams Companies, Inc. under the guaranty arecapped at an amount equal to approximately $510 million.  Beginning on January 1 of the first fullyear after the commercial operation date, this guaranty cap is to be reducedsemiannually by a fixed amount which is based on the amortization of theCompany’s senior secured bondsduring the applicable semiannual period. As of June 30, 2005 the guaranty wascapped at $500.6 million.

 

Pursuant to Section 18.3of the Power Purchase Agreement, in the event that Standard & Poors orMoody’s rates the long-term senior unsecured debt of The Williams Companies, Inc.lower than investment grade, The Williams Companies, Inc. is required tosupplement The Williams Companies, Inc. guaranty with additionalalternative security that is acceptable to the Company within 90 days after theloss of such

 

8

----

 

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 TheWilliams Companies, Inc. to below investment grade, the Company andWilliams Energy entered into a letter agreement dated November 7, 2002(the “Letter Agreement”), under which Williams Energy agreed to provide theCompany (a) a prepayment of $10 million within five business days afterexecution of the Letter Agreement (the “Prepayment”); (b) alternativecredit support equal to $35 million on or before January 6, 2003 in any ofthe 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 guaranty of thepayment obligations of Williams Energy under the Power Purchase Agreement.  The guaranty remains in full force and effectand the Company retains all of its rights and remedies provided by thatguaranty.

 

Under the terms of theLetter Agreement, the Company is obligated to return the Prepayment to WilliamsEnergy upon the earlier of (i) The Williams Companies, Inc. regainingits investment grade rating or Williams Energy providing a substitute guarantyof investment grade rating; (ii) the beginning of Contract Year 20; or (iii) theposting of alternative credit support by Williams Energy as set forthbelow.  In the case of items (i) and(iii) above, except to the extent, in the case of item (iii), WilliamsEnergy elects to have all or a portion of the Prepayment make up a combinationof the alternative credit support required to be posted pursuant to Section 18.3(b) ofthe Power Purchase Agreement, Williams Energy shall have the right to recoupthe Prepayment by set-off of any and all amounts owing to the Company under thePower Purchase Agreement beginning no earlier than the June in thecalendar year after the occurrence of item (i) or (iii) andcontinuing thereafter until the Prepayment has been fully recovered.  In the case of item (ii) above, WilliamsEnergy shall have the right to immediately set-off all amounts owing to theCompany under the Power Purchase Agreement after the occurrence of item (ii) andcontinuing thereafter until the Prepayment has been fully recovered.  Except to the extent Williams Energy electsto include the Prepayment as part of the alternative credit support, the amountof alternative credit support posted by Williams Energy pursuant to the LetterAgreement shall be initially reduced by the amount of the Prepayment, andWilliams Energy shall thereafter increase the alternative credit supportproportionately as Williams Energy recoups the Prepayment set-off on thepayment due date of amounts owing to the Company.

 

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

 

Williams Energy made thePrepayment on November 14, 2002 and provided an additional $25 million ofcash to the Company on January 6, 2003 as the alternative creditsupport.  As allowed by the LetterAgreement, Williams Energy elected to have the $10 million Prepayment includedas part of the alternative credit support. On September 24, 2004, WilliamsEnergy posted a letter of credit and the Company returned the $25 million ofalternative credit support. In the event that The Williams Companies, Inc.regains and maintains its investment grade status, provides a substituteguaranty of investment grade rating, or posts a letter of credit, the Companywill be required to return the remaining $10 million alternative credit support

 

9

----

 

to Williams Energy in accordance with the terms ofthe Letter Agreement as described above. Williams Energy has notified the Company that it is posting a letter ofcredit for the remaining $10 million and has begun withholding $2 million amonth, starting with its July payment for the June billing month. Asof August 15, 2005, the Company had cash balances of approximately $46million.  See “Item 2-Managements Discussion and Analysis ofFinancial Condition and Results of Operations -Liquidity and Capital Resources”.

 

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

 

*Construction Agreement*- The Company entered into an Agreement for Engineering, Procurement andConstruction (EPC) services, dated as of October 15, 1999 (the “EPCAgreement”), between the Company and WGI (as the successor contractor), asamended for the design, engineering, procurement, site preparation andclearing, civil works, construction, start-up, training and testing and toprovide all materials and equipment (excluding operational spare parts),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 EPC Agreement are irrevocably and unconditionally guaranteed by Raytheon.In 2001, as a result of WGI’s bankruptcy filing, the Company made a demand onRaytheon to perform its obligations under the Raytheon guaranty and WGI,Raytheon and the Company entered into agreements pursuant to which Raytheonbecame responsible for the construction of the facility*.*

 

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

 

OnAugust 27, 2004, Raytheon filed a construction lien claim for approximately$30.3 million in Middlesex County against the real property and improvementsowned by the Company under the New Jersey Construction Lien Law.  Amongother things, Raytheon claims therein that the draw of the Letter of Creditrepresents a debt to Raytheon owed by the Company.

 

OnOctober 28, 2004, the Company received a complaint filed by Raytheon inthe State of New York. In the complaint, Raytheon is seeking to recover approximately$30.3 million, which represents the amount Red Oak drew down on the letter ofcredit on August 26, 2004, attorneys’ fees and costs, and also to recoverup to $110 million of net expense Raytheon claims to have incurred in goodfaith under the governing guaranty and construction agreements.  The Company filed an answer and counterclaimon December 13, 2004, in which it denied liability to Raytheon, assertedvarious defenses and countersued Raytheon for breach of the EPC Agreement andSettlement Agreement, breach of express warranties under the EPC Agreement, andfraudulent misrepresentation and concealment. The Company claimed damages of not less than $140 million and attorneys’fees and costs to the extent allowable. Raytheon moved to dismiss the Company’s fraudulent misrepresentation andconcealment claim and to limit the Company’s damages on January 14,2005.  The Company filed its oppositionto the motion to dismiss and also filed an amended counterclaim on February 18,2005. Thereafter, Raytheon agreed to withdraw its motion to dismiss.  On March 4,2005, Raytheon filed a motion for summary judgment that seeks the return of approximately$16.3 million of the Letter of Credit draw.  The Company filed itsopposition on April 12, 2005, and Raytheon filed a reply on April 25,2005.  In addition, on April 8,2005, Raytheon renewed its motion to dismiss the fraudulent misrepresentationand concealment claims in the Company’s amended counterclaim and to limit theCompany’s damages.  The Company filed its opposition to therenewed motion to dismiss on April 29, 2005.  The Court heard arguments on both motions on May 26,

 

10

----

 

2005,but has not yet ruled on the pending motions.  Raytheon has not yet filed an answer to theamended counterclaim. Raytheon also filed a related action against Red Oak inthe Superior Court of Middlesex County, New Jersey, on May 27, 2005,seeking to foreclose on a construction lien filed against property allegedlyowned by Red Oak, in the amount of $30,963,662. Red Oak has not been servedwith the Complaint.  We have reviewed theComplaint, however, and the damages that support the lien claimed in New Jerseyare completely duplicative of the damages claimed in the New York action.Raytheon has stated that it wishes to stay the New Jersey action pending theoutcome of the New York action.  Webelieve that Red Oak has meritorious defenses to the lien claim byRaytheon.  Red Oak has not decidedwhether it wishes to oppose the lien, or consent to a stay.  The Company has recorded the $30.3 million asa current liability, but has not accrued any additional amounts with respect toRaytheon’s claims.  The Company believes it has meritorious defenses tothe claims asserted by Raytheonagainst it and intends to defend the lawsuit and pursue its counterclaimsvigorously.

 

*Maintenance Services Agreement- *The Company has enteredinto the Maintenance Program Parts, Shop Repairs and Scheduled Outage TFAServices Contract (the “Maintenance Services Agreement”), dated as of December 8,1999, with Siemens by which Siemens will provide the Company with, among otherthings, combustion turbine parts, shop repairs and scheduled outage technicalfield assistance services. The Maintenance Services Agreement became effectiveon the date of execution and unless terminated early, will terminate uponcompletion of shop repairs performed by Siemens following the twelfth scheduledoutage of the applicable combustion turbine or 16 years from the effective dateof the contract, whichever occurs first, unless the Company exercises its rightto terminate the agreement after the first major outage of the turbines.

 

TheMaintenance Services Agreement indicates that the Company will pay fees eachmonth based on a stated amount for each equivalent base load hour (“EBH”) ofthe combustion turbines, adjusted for inflation, over the term of theagreement.  However, if a scheduledmaintenance outage occurs prior to 8,000 EBH’s being accumulated since the lastscheduled maintenance outage for that turbine, the Company will be invoiced theremaining amount to equate to 8,000 hours (“true-up”). In the event the Companyis not required to dispatch the facility, there is no charge for that month.

 

*LandDevelopment Plan* – TheCompany entered into an agreement with the Borough of Sayreville by which theCompany will develop and implement a plan to replace trees which were removedduring 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 hasselected contractors to perform these services, but only minimal payments forpreparation work have been made as of June 30, 2005.  On July 23, 2003, the project wassecured by a letter of credit issued by Union Bank of California for $425,000with the Borough of Sayreville as the beneficiary.  This irrevocable standby letter of credit hadan expiration date of June 30, 2004, but was automatically extended foranother one-year period. On August 19, 2004, The AES Corporation (“AES”),  secured a performance bond for $539,493relating to the tree replacement and other site improvements. This bondreplaces the previous letter of credit and represents the amount potentiallydue if there is a failure of AES Red Oak, LLC to take action regarding theplan.

 

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

 

*Implicit Variable InterestEntities*.  In March 2005, the FASB issued Staff Position(FSP) No. FIN 46(R)-5, “Implicit Variable Interests under FASBInterpretation No. 46 (revised December 2003), Consolidation ofVariable Interest Entities”. This FSP clarifies that when applying the variableinterest consolidation model, a reporting enterprise should consider whether itholds an implicit variable interest in a variable interest entity (VIE) orpotential VIE. FSP No. FIN 46(R)-5 is effective as of April 1, 2005. Theadoption of FIN 46(R)-5 did not have a material effect on the Company’sfinancial position, results of operations, or cash flows.

 

***Asset Retirement Obligations***.  In March 2005, the FASB issued FASBInterpretation No. (FIN) 47 “Accounting for Conditional Asset RetirementObligations, an interpretation of FASB Statement No. 143”, which clarifiesthe term “conditional asset retirement obligation” as used in SFAS No. 143

 

11

----

 

***“Accounting for Asset RetirementObligations”. Specifically, FIN 47 provides that an asset retirement obligationis conditional when either the timing and (or) method of settling theobligation is conditioned on a future event. Accordingly, an entity is requiredto recognize a liability for the fair value of a conditional asset retirementobligation if the fair value of the liability can be reasonably estimated.Uncertainty about the timing and (or) method of settlement of a conditionalasset retirement obligation should be factored into the measurement of theliability when sufficient information exists. This interpretation alsoclarifies when an entity would have sufficient information to reasonablyestimate the fair value of an asset retirement obligation. FIN 47 is effectivefor fiscal years ending after December 15, 2005. Management is currentlyevaluating the effect that adoption of this interpretation will have on theCompany’s financial position and results of operations.***

*** ***

**8.**                                      RELATED PARTY TRANSACTIONS

** **

Effective March 2000, the Company entered into a32-year development and construction management agreement with AES Sayreville,L.L.C. (“AES Sayreville”), another wholly owned subsidiary of Red Oak, toprovide certain support services required by the Company for the developmentand construction of the facility. Under this agreement AES Sayreville has alsoprovided operations management services for the Company since the commencementof commercial operation. Minimum amounts payable under the contract during 2005were approximately $138,000 per month. Corporate management fees were $800,000for each of the six-month periods ended June 30, 2005 and 2004. Corporatemanagement fees are charged on a monthly basis based on a fixed amount which isadjusted annually for inflation.

 

AES Sayreville is compensated for its maintenance andoperation services on a cost basis, and it also receives certain managementfees which it passes on to The AES Corporation. For the six-month periods ended June 30, 2005 and 2004 the Companypaid AES Sayreville a total of $2.1 million and $2.0 million, respectively, fortheir services. AES will continue to supply AES Sayreville with the personnel,operational and maintenance services necessary to carry out its obligations tothe Company.

 

The Company had accounts receivable from affiliates of$28,000 and $30,000 as of June 30, 2005 and December 31, 2004,respectively.  The Company had accountspayable to its parent and affiliates of $374,000 and $282,000 as of June 30,2005 and December 31, 2004, respectively. Accounts receivable from affiliates generally represents charges forcertain projects that the Company has paid for and invoiced to itsaffiliates.  Accounts payable to parentand affiliates represent general amounts owed to the Company’s parent andaffiliates for shared services.

 

12

----

 

**Item2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

**Cautionary Note Regarding Forward-LookingStatements**

 

Some of the statements in this Form 10-Q, as wellas statements made by AES Red Oak, L.L.C. (“the Company”) in periodic pressreleases and other public communications, constitute “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995.  Certain, but not necessarilyall, of such forward-looking statements can be identified by the use offorward-looking terminology, such as “believes,” “estimates,” “plans,” “projects,”“expects,” “may,” “will,” “should,” “approximately,” or “anticipates” or thenegative thereof or other variations thereof or comparable terminology, or bydiscussion of strategies, each of which involves risks and uncertainties. TheCompany has based these forward-looking statements on its current expectationsand projections about future events based upon its knowledge of facts as of thedate of this Form 10-Q and its assumptions about future events.

 

All statements other than of historical facts includedherein, including those regarding market trends, the Company’s financialposition, business strategy, projected plans and objectives of management forfuture operations of the facility, are forward-looking statements. Suchforward-looking statements involve known and unknown risks, uncertainties andother factors outside of the Company’s control that may cause its actual resultsor performance to be materially different from any future results, performanceor achievements expressed or implied by the forward-looking statements. Theserisks, uncertainties and other factors include, among others, the following:

 

•                  unexpected problems relating to theperformance of the facility,

 

•                  the financial condition of third parties onwhich the Company depends, including in particular, Williams Power Company, Inc.,(“Williams Energy”), formerly Williams Energy Marketing & TradingCompany, as fuel supplier under the power purchase agreement 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 guarantorof Williams Energy’s performance under the Power Purchase Agreement,

 

•                  delays in, or disputes over, the finalcompletion of the Company’s facility,

 

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

 

•                  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 their guarantyof Williams Energy’s performance under the Power Purchase Agreement,

 

•                  the Company’s ability to find a replacementpower purchaser 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 possibility that Williams Energy will notrequest that the Company run or “dispatch” the facility as provided under thePower Purchase Agreement,

 

•                  inadequate insurance coverage,

 

13

----

 

•                  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 theCompany or beyond the Company’s control.

 

The Company has no obligation to publicly update orrevise any forward-looking statement, whether as a result of new information,future events or otherwise.

 

**General**

 

The Company is a Delaware limited liability companyformed on September 13, 1998 to develop, construct, own, lease, operateand maintain the Company’s facility. The Company was dormant until March 15,2000, the date of the sale of the Company’s senior secured bonds. The Companyobtained $384 million of project financing from the sale of the senior securedbonds.

 

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

 

**Liquidity and Capital Resources**

 

Under the Power Purchase Agreement with WilliamsEnergy, the Company is eligible to receive variable operations and maintenancepayments, total fixed minimum capacity payments, energy exercise fee payments(each as defined in the Power Purchase Agreement) and other payments for the deliveryof fuel conversion, capacity and ancillary services. During 2003 the Pennsylvania-NewJersey-Maryland market, into which the Company’s generation is distributed,experienced a general decline in the amount paid for electricity. There wasalso a marked increase in the cost of natural gas. As a result, Williams Energydispatched the Company’s facility on a very limited basis. The Company’sfacility was called on to generate only 21% of the year in 2004 and only 14% ofthe year in 2003.  Accordingly, theminimum capacity payments provided for under the Power Purchase Agreement havebeen the Company’s primary source of operating revenues, representing $27.1million of total revenues of $28.9 million for the six months ending June 30,2005 and $27.0 million of total revenues of $29.5 million for the six monthsended June 30, 2004.  The minimumcash flow from Williams Energy under the power purchase agreement isapproximately $3.8 million per month for October through May and $7.9million per month from June through September. The Company’s restrictedcash balance fluctuates seasonally due to these payment terms. The Company isentitled to use the proceeds from the Prepayment from Williams Energy foroperations as needed, but will be required to return these funds to WilliamsEnergy as discussed below.

 

The Company currently anticipates that the facilitywill be dispatched in future periods to a similar range as it was during thefirst two years of full operation in 2003 and 2004, and that operating cashflow and operating cash requirements in 2005 will also be in a comparable rangeof the first two years of operation.  TheCompany also believes that cash flows from the sale of electricity and/orminimum capacity payments under the Power Purchase Agreement, and fundsavailable to be drawn under the debt service reserve letter of credit or thepower purchase letter of credit, will be sufficient to fund operating expensesand debt service costs.

 

The Company has provided Williams Energy a $10 millionletter of credit under the Power Purchase Agreement, which The Company refersto as the power purchase letter of credit, to support specific paymentobligations under the Power Purchase Agreement. The repayment obligations withrespect to any drawings under the power purchase letter of credit are theCompany’s senior debt obligation.

 

14

----

 

Due to the downgrade of The Williams Companies, Inc.’sdebt to below investment grade, The Williams Companies, Inc. is requiredto supplement The Williams Companies, Inc. guaranty with additionalalternative security that is acceptable to us. Since The Williams Companies, Inc. debt rating fell belowinvestment grade in 2002, Williams Energy has provided the Company with $35million of cash as alternate credit support. Williams Energy made the Prepayment on November 14, 2002 andprovided an additional $25 million of cash to the Company on January 6,2003 as the alternative credit support. As allowed by the Letter Agreement, Williams Energy elected to have the$10 million Prepayment included as part of the alternative credit support. On September 24,2004, Williams Energy posted a letter of credit and the Company returned the$25 million of alternative credit support. In the event that The WilliamsCompanies, Inc. regains and maintains its investment grade status,provides a substitute guaranty of investment grade rating, or posts a letter ofcredit, the Company will be required to return the remaining $10 millionalternative credit support to Williams Energy in accordance with the terms ofthe Letter Agreement as described above Williams Energy has notified theCompany that it is posting a letter of credit for the remaining $10 million andhas begun withholding $2 million a month, starting with its July paymentfor the June billing month.

 

As of June 30, 2005, approximately $370 millionaggregate principal amount of senior secured bonds, issued in two tranches,were outstanding.  Quarterly principalrepayments on the 2019 Bonds 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.  The Company has provided the collateral agentwith a debt service reserve letter of credit in an initial stated amount of$22.0 million which the collateral agent may draw upon if the Company fails tomeet the Company obligations under the senior secured bonds.

 

The Company entered into an agreement with the Boroughof Sayreville by which the Company will develop and implement a plan to replacetrees which were removed during clearing of the facility site.  The Land Development Plan is required forfinal site approval.   The estimated costof the plan is approximately $425,000.  TheCompany has selected contractors to perform these services, but only minimalpayments for preparation work have been made as of June 30, 2005. On July 23,2003, the project was secured by a letter of credit issued by Union Bank ofCalifornia for $425,000 with the Borough of Sayreville as the beneficiary.  This irrevocable standby letter of credit hadan expiration date of June 30, 2004, but was automatically extended foranother one-year period. On August 19, 2004, The AES Corporation (“AES”),  secured a performance bond for $539,493relating to the tree replacement and other site improvements. This bondreplaces the previous letter of credit and represents the amount potentiallydue if there is a failure of AES Red Oak, LLC to take action regarding theplan.

 

For the six months ended June 30, 2005, theCompany incurred costs related to capital additions of approximately $2.9million, including general improvements of the facility, EPC related costs andplanned maintenance outages. The Company expects to incur approximately $0.4million of such costs for the remainder of 2005.

 

Under the construction agreement, the Company wasentitled to retain certain amounts from each scheduled payment until afterfinal acceptance by the Company of the facility unless Raytheon posted a letterof credit in the amount of payments that would otherwise be retained.  On August 26, 2004, the Company drewdown approximately $30.3 million under a letter of credit posted by Raytheonpursuant to the terms of the EPC Agreement. Prior to this date, the Company haddrawn $544,000 on this letter of credit. The Company believes that Raytheonsubstantially breached the EPC Agreement, due, among other things, to thefacility’s failure to achieve compliance with certain performance tests, andRaytheon’s failure to complete other services under the EPC Agreement andcertain amendments thereto, including a Settlement Agreement dated August 6,2002, that purported to resolve disputes over whether Raytheon had achievedMechanical Completion and Provisional Acceptance. As a result, the Companyclaims that Raytheon’s breaches have caused damages in excess of the amount ofthe letter of credit. Raytheon disputes these claims and has failed and refusedto pay costs and damages to the Company despite the Company’s demands for suchpayment.

 

On October 28, 2004, the Company received acomplaint filed by Raytheon in the State of New York.

 

15

----

 

In thecomplaint, Raytheon is seeking to recover approximately $30.3 million, whichrepresents the amount Red Oak drew down on the letter of credit on August 26,2004, attorneys’ fees and costs, and also to recover up to $110 million of netexpense Raytheon claims to have incurred in good faith under the governing guarantyand construction agreements.  The Companyfiled an answer and counterclaim on December 13, 2004, in which it deniedliability to Raytheon, asserted various defenses and countersued Raytheon forbreach of the EPC Agreement and Settlement Agreement, breach of expresswarranties under the EPC Agreement, and fraudulent misrepresentation andconcealment.  The Company claimed damagesof not less than $140 million and attorneys’ fees and costs to the extentallowable.  Raytheon moved to dismiss theCompany’s fraudulent misrepresentation and concealment claim and to limit theCompany’s damages on January 14, 2005. The Company filed its opposition to the motion to dismiss and also filedan amended counterclaim on February 18, 2005. Thereafter, Raytheon agreedto withdraw its motion to dismiss.  On March 4, 2005, Raytheon fileda motion for summary judgment that seeks the return of approximately $16.3million of the Letter of Credit draw.  The Company filed its opposition onApril 12, 2005, and Raytheon filed a reply on April 25, 2005.  In addition, on April 8, 2005, Raytheonrenewed its motion to dismiss the fraudulent misrepresentation and concealmentclaims in the Company’s amended counterclaim and to limit the Company’sdamages.  The Company filed its oppositionto the renewed motion to dismiss on April 29, 2005.  The Court heard arguments on both motions on May 26,2005, but has not yet ruled on the pending motions.  Raytheon has not yet filed an answer to theamended counterclaim.  The Company hasrecorded the $30.3 million as a current liability, but has not accrued anyadditional amounts with respect to Raytheon’s claims.  The Companybelieves it has meritorious defenses to the claims asserted by Raytheon againstit and intends to defend the lawsuit and pursue its counterclaims vigorously.

 

Since the Company depends on Williams Energy for bothrevenues and fuel supply under the Power Purchase Agreement, if Williams Energywere to terminate or default under the Power Purchase Agreement, there would bea severe negative impact to the Company’s cash flow and financial conditionwhich could result in a default on the Company’s senior secured bonds.  Due to the current power pool prices, theCompany would expect that if the Company were required to seek alternatepurchasers of its power in the event of a default of Williams Energy, even if theCompany was successful in finding alternate revenue sources, any such alternaterevenue sources would be substantially below the amounts that would have beenotherwise payable pursuant to the Power Purchase Agreement. There can be noassurance as to the Company’s ability to generate sufficient cash flow to coveroperating expenses or the Company’s debt service obligations in the absence ofa long-term power purchase agreement with Williams Energy.

 

The Company is currently reviewing financingfacilities, comparable to the working capital agreement which expired March 15,2005, that would allow for funds to be available for future working capitalrequirements. Since the Company’s senior secured bonds are currently ratedbelow investment grade, the Company’s working capital facility had beenunavailable.

 

In addition to the factors discussed above, and/or theother factors listed under the “Cautionary Note Regarding Forward-LookingStatements,” if a working capital facility continues to be unavailable, theCompany could experience a negative impact on its cash flow and financialcondition, which may make it necessary to draw upon its letters of credit. Thefollowing discussion presents certain financial information for the three andsix-month periods ended June 30, 2005 and 2004.

 

**Energy Revenues**

 

The Company generates energy revenues under the Power PurchaseAgreement with Williams Energy. During the 20-year term of the agreement, theCompany expects to sell electric energy and capacity produced by the facility,as well as ancillary and fuel conversion services. Under the Power PurchaseAgreement, the Company also generates revenues from meeting (1) baseelectrical output guarantees and (2) heat rate rebates through efficientelectrical output.

 

Upon its expiration, or in the event that the Power Purchase Agreementis terminated prior to its 20-

 

16

----

 

year term, the Company 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 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.

 

**Operating Expenses**

 

Under an agreement with AES Sayreville, L.L.C., a wholly-ownedsubsidiary of AES Red Oak, Inc. (“Red Oak”), which is a wholly-ownedsubsidiary of AES, the Company is required to reimburse all operator costs on amonthly basis. Operator costs generally consist of all direct costs andoverhead associated with running the facility. Additionally, an operator fee ofapproximately $400,000, subject to annual adjustment, is payable on each bondpayment date.

 

**Performance Guarantees**

 

*Electrical Output*

 

Under the EPC Agreement, ifthe average net electrical output of the Company’s facility at provisionalacceptance or interim acceptance, whichever is the earlier to occur, is lessthan the electrical output guarantee, then Raytheon must pay us, as a rebateand not as liquidated damages, for each day during the interim period, anamount equal to $0.22 per day for each kilowatt by which the average netelectrical output is less than the electrical output guarantee.  During performance testing, the Company’s outputwas calculated to be 13,370 kilowatts less than the electrical outputguarantee.  Accordingly, the Company’s dailycharge for this amount has been calculated at $2,941.40 per day. Raytheon paid theCompany this amount until their notice of final acceptance date of July 22,2003, but the Company is disputing this claim of final acceptance and contendthat these amounts should continue to be paid until the final acceptance date.

 

Upon final acceptance, ifthe average net electrical output of the Company’s facility during thecompleted performance test is less than the electrical output guarantee, thenRaytheon must pay us, as a bonus, an amount equal to $520 for each kilowatt bywhich the average net electrical output is less than the guaranty minus anyinterim rebates paid or to be paid by Raytheon.

 

*Heat Rate Guarantees*

 

If the average net heat rateof the Company’s facility at provisional acceptance or interim acceptance, ifhaving occurred before final acceptance, exceeds the heat rate guarantee, thenRaytheon must pay us, as a rebate and not as liquidated damages, for each dayduring the interim period, an amount equal to $46 per day for each BTU/KwH bywhich the measured net heat rate is greater than the heat rate guarantee.

 

Upon final acceptance, ifthe net heat rate of the Company’s facility during the completed performancetest exceeds the heat rate guarantee, then Raytheon will pay us, as a rebate, alump sum amount equal to $110,000 for each BTU/KwH by which the measured heatrate is greater than the heat rate  minusany interim rebates paid or to be paid by Raytheon.

 

The Company has not invoicedRaytheon in 2004 or 2005 for electrical output and heat rate rebates. As of June 30,2005, Raytheon owed approximately $65,000 in rebates for amounts invoiced in2003.

 

17

----

 

**Recent and New Accounting Pronouncements**

 

Implicit Variable InterestEntities.  In March 2005, the FASB issued Staff Position (FSP) No. FIN46(R)-5, “Implicit Variable Interests under FASB Interpretation No. 46(revised December 2003), Consolidation of Variable Interest Entities”.This FSP clarifies that when applying the variable interest consolidationmodel, a reporting enterprise should consider whether it holds an implicitvariable interest in a variable interest entity (VIE) or potential VIE. FSP No. FIN46(R)-5 is effective as of April 1, 2005. The adoption of FIN 46(R)-5 didnot have a material effect on the Company’s financial position, results ofoperations, or cash flows.

 

Asset RetirementObligations.  In March 2005, the FASB issued FASB Interpretation No. (FIN)47 “Accounting for Conditional Asset Retirement Obligations, an interpretationof FASB Statement No. 143”, which clarifies the term “conditional assetretirement obligation” as used in SFAS No. 143 “Accounting for AssetRetirement Obligations”. Specifically, FIN 47 provides that an asset retirementobligation is conditional when either the timing and (or) method of settlingthe obligation is conditioned on a future event. Accordingly, an entity isrequired to recognize a liability for the fair value of a conditional assetretirement obligation if the fair value of the liability can be reasonablyestimated. Uncertainty about the timing and (or) method of settlement of aconditional asset retirement obligation should be factored into the measurementof the liability when sufficient information exists. This interpretation alsoclarifies when an entity would have sufficient information to reasonablyestimate the fair value of an asset retirement obligation. FIN 47 is effectivefor fiscal years ending after December 15, 2005. Management is currentlyevaluating the effect that adoption of this interpretation will have on theCompany’s financial position and results of operations.

 

**Results of Operations**

 

Under the Power PurchaseAgreement with Williams Energy, the Company is eligible to receive variableoperations and maintenance payments, total fixed payments, energy exercise fees(each as defined in the Power Purchase Agreement) and other payments for thedelivery of fuel conversion, capacity and ancillary services. The Company’sfacility was dispatched 29% and 50% for the three months ended June 30,2005 and June 30, 2004, respectively and 20% and 27% for the six monthsended June 30, 2005 and June 30, 2004, respectively. Accordingly, theminimum capacity payments have been the Company’s primary source of operatingrevenues.

 

***For the Three Months Ended June 30, 2005 and 2004***

 

Operating revenues were $17.1million and $17.9 million for the three months ended June 30, 2005 and June 30,2004, respectively.  These amountsinclude fixed payments of $15.7 million and $15.6 million for the quartersending June 30, 2005 and 2004, respectively. The remaining amount ofrevenue relates to variable revenue that the Company receives when its facilityis dispatched and ancillary services. The Company has no control over when itsfacility is dispatched, as that decision is made by Williams Energy based onseveral factors including market conditions.

 

Other operating expenses were$1.9 million and $3.5 million for the three months ended June 30, 2005 andJune 30, 2004, respectively. The higher level of costs in the prior-yearperiod related to a combustion inspection outage and a higher level of facilitydispatch.

 

Total other income (expense)was $(8.4) million and $(8.7) million for the three months ended June 30,2005 and 2004, respectively, and was primarily comprised of interest expense,interest income, and letter of credit fees. Interest income was $0.2 millionhigher during the current three-month period, as compared to the same periodlast year, due to higher interest rates and higher average cash balances.

 

18

----

 

***For the Six Months Ended June 30, 2005 and 2004***

 

Operating revenues were $28.9million and $29.5 million for the six months ended June 30, 2005 and June 30,2004, respectively.  These amountsinclude fixed payments of $27.1 million and $27.0 million for the six-monthperiods ending June 30, 2005 and June 30, 2004, respectively. Theremaining amount of revenue relates to variable revenue that the Companyreceives when its facility is dispatched and ancillary services. The Companyhas no control over when its facility is dispatched, as that decision is madeby Williams Energy based on several factors including market conditions.

 

The fuel conversion volumerebate was $3.3 million and $2.6 million for the six months ended June 30,2005 and June 30, 2004, respectively. This cost represents a charge paidto Williams Energy under the Power Purchase Agreement based upon utilization ofthe facility. The increase in the expense during the current six month period,compared to same period last year, is due to the utilization factor for theprior twelve-month period exceeding 20%.

 

Corporate management feeswere $.8 million for each of the six-month periods ended June 30, 2005 andJune 30, 2004. Corporate management fees are charged on a monthly basisbased on a fixed amount that is adjusted annually for inflation.

 

Other operating expenses were$5.0 million and $6.1 million for the six months ended June 30, 2005 and June 30,2004, respectively. The higher level of costs in the prior-year period relatedto two combustion inspection outages and a higher level of facility dispatch

 

Total other income (expense)was $(16.7) million and $(17.3) million for the six months ended June 30,2004 and June 30, 2004, respectively, and was primarily comprised ofinterest expense, interest income, and letter of credit fees. Interest incomewas $.4 million higher during the current six-month period, as compared to thesame period last year, due to higher interest rates and higher average cashbalances.

 

**Concentration of Credit Risk**

 

Williams Energy is currentlythe Company’s sole customer for purchases of capacity, ancillary services, andenergy and its sole source for fuel. Williams Energy’s payments under the Power Purchase Agreement areexpected to provide all of Company’s operating revenues during the term of thePower Purchase Agreement.  It is unlikelythat the Company would be able to find another purchaser or fuel source onsimilar terms for its facility if Williams Energy were not performing under thePower Purchase Agreement.  Any materialfailure by Williams Energy to make capacity and fuel conversion payments or tosupply fuel under the Power Purchase Agreement would have a severe impact on Company’soperations, and may result in a default on its debt.  The payment obligations of Williams Energyunder the Power Purchase Agreement are guaranteed by The Williams Companies, Inc.  The payment obligations of The WilliamsCompanies, Inc. under the guaranty are capped at an amount equal toapproximately $510 million.  Beginning onJanuary 1 of the first full year after the commercial operation date, thisguaranty cap is to be reduced semiannually by a fixed amount which is based onthe amortization of Company’s senior secured bonds during the applicablesemiannual period. As of June 30, 2005, the guaranty was capped at $500.6 million.

 

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

 

**Critical Accounting Policies**

 

*General* — The Company prepares its financialstatements in accordance with accounting principles generally accepted in theUnited States of America. As such, the Company is required to make certain

 

19

----

 

estimates, judgments and assumptions that theCompany believes are reasonable based upon the information available. Theseestimates and assumptions affect the reported amounts of assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the periods presented. The significant accounting policieswhich the Company believes are most critical to understanding and evaluating Company’sreported financial results include the following:  Restricted Cash, Revenue Recognition,Property, Plant and Equipment and Contingencies.

 

*Restricted Cash —* The Company has recorded the drawdown on theRaytheon letter of credit and the Prepayment from Williams Energy as restrictedcash. The proceeds from the Raytheon letter of credit are deposited in theconstruction account. The Prepayment from Williams Energy, which the Company isentitled to use for operations as needed, is deposited in the revenue account.

 

*Revenue Recognition* — The Company generates energy revenuesunder the Power Purchase Agreement with Williams Energy.  During the 20-year term of the agreement, theCompany expects to sell capacity and electric energy produced by the facility,as well as ancillary services and fuel conversion services.  Under the Power Purchase Agreement, revenuesare generated from meeting (1) base electrical output guarantees and (2) heat-raterebates through efficient electrical output. Revenues from the sales of electric energy and capacity are recordedbased on output delivered and capacity provided at rates as specified undercontract terms.  Revenues for ancillaryand other services are recorded when the services are rendered. Amounts thatare in dispute are reserved accordingly, based on the probability that theywill be realized.

 

Upon its expiration, or inthe event that the Power Purchase Agreement is terminated prior to its 20-yearterm or Williams Energy otherwise fails to perform, the Company 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 powerpool prices, however, the Company would expect that even if it found alternaterevenue sources, any such alternate revenues would be substantially below theamounts that would have been otherwise earned pursuant to the Power PurchaseAgreement.

 

*Property, Plant and Equipment** *— Property, plant and equipment is recorded at cost.  Depreciation, after consideration of salvagevalue, is computed using the straight-line method over the estimated usefullives of the assets, which range from five to thirty-six years.  Maintenance and repairs are charged toexpense as incurred.  The depreciablelives of the Company’s property, plant and equipment by category are asfollows:

 
| **Description  of Asset**          | ** ** | **Depreciable Life** | ** ** | **June 30, 2005** | ** ** |
|------------------------------------|------------|----------------------|------------|------------------------|------------|
| ** **                         | ** ** | ** **           | ** ** | **(000’s)**       | ** ** |
| Buildings                          |       | 35                   |       | $                      | 1,767      |   |
| Vehicles                           |       | 5                    |       | 182                    |       |
| Computers                          |       | 6                    |       | 756                    |       |
| Furniture and Fixtures             |       | 10                   |       | 515                    |       |
| Combustion Turbine Generator Parts |       | 9-36                 |       | 53,345                 |       |
| Gas Heaters                        |       | 35                   |       | 1,119                  |       |
| Spare Parts Inventory              |       | —               |       | 5,620                  |       |
| Plant                              |       | 35                   |       | 366,559                |       |
| Subtotal                           |       |                 |       | 429,863                |       |
| Accumulated Depreciation           |       |                 |       | (33,605                | )          |
| Property, Plant and Equipment, net |       |                 |       | $                      | 396,258    |   |
|                                    |            |                      |            |                        |            |  |  |

 

*Contingencies*

 

On October 28, 2004, the Company received a complaint filed byRaytheon in the State of New York. In the complaint, Raytheon is seeking torecover approximately $30.3 million, which represents the amount Red Oak drewdown on the letter of credit on August 26, 2004, attorneys’ fees andcosts, and also to recover up to $110 million of net expense Raytheon claims tohave incurred in good faith under the governing guaranty and constructionagreements.  The Company filed an answerand counterclaim on December 13, 2004, in which it denied liability toRaytheon, asserted various defenses and countersued

 

20

----

 

Raytheon for breach of the EPC Agreement and Settlement Agreement,breach of express warranties under the EPC Agreement, and fraudulentmisrepresentation and concealment.  TheCompany claimed damages of not less than $140 million and attorneys’ fees andcosts to the extent allowable.  Raytheonmoved to dismiss the Company’s fraudulent misrepresentation and concealmentclaim and to limit the Company’s damages on January 14, 2005.  The Company filed its opposition to themotion to dismiss and also filed an amended counterclaim on February 18, 2005.  Thereafter, Raytheon agreed to withdraw itsmotion to dismiss.  On March 4, 2005, Raytheon filed a motion forsummary judgment that seeks the return of approximately $16.3 million of theLetter of Credit draw.  The Company filed its opposition on April 12,2005, and Raytheon filed a reply on April 25, 2005.  In addition, on April 8, 2005, Raytheonrenewed its motion to dismiss the fraudulent misrepresentation and concealmentclaims in the Company’s amended counterclaim and to limit the Company’s damages.  The Company filed its opposition to therenewed motion to dismiss on April 29, 2005.  The Court heard arguments on both motions on May 26,2005, but has not yet ruled on the pending motions.  Raytheon has not yet filed an answer to theamended counterclaim.  Raytheon alsofiled a related action against Red Oak in the Superior Court of MiddlesexCounty, New Jersey, on May 27, 2005, seeking to foreclose on aconstruction lien filed against property allegedly owned by Red Oak, in theamount of $30,963,662. Red Oak has not been served with the Complaint.  We have reviewed the Complaint, however, andthe damages that support the lien claimed in New Jersey are completelyduplicative of the damages claimed in the New York action. Raytheon has statedthat it wishes to stay the New Jersey action pending the outcome of the NewYork action.  We believe that Red Oak hasmeritorious defenses to the lien claim by Raytheon.  Red Oak has not decided whether it wishes tooppose the lien, or consent to a stay. The Company has recorded the $30.3million as a current liability, but has not accrued any additional amounts withrespect to Raytheon’s claims.  The Company believes it has meritoriousdefenses to the claims asserted by Raytheon against it and intends to defendthe lawsuit and pursue its counterclaims vigorously.

 

The Company is disputingapproximately $1.7 million of merchant price, testing gas and other chargeswith Williams Energy that the Company contends is owed from Williams. This wasnot part of the arbitration relating to the commercial operation date which wassettled in November, 2003.

 

# **Item 4.  CONTROLS AND PROCEDURES**

#  

*Evaluation of Disclosure Controls and Procedures.* We carried out an evaluation, under the supervision and with the participationof our management, including the chief executive officer (“CEO”) and chieffinancial officer (“CFO”), of the effectiveness of our “disclosure controls andprocedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and15-d-15 (e) as required by paragraph (b) of the Exchange Act Rules 13a-15or 15d-15) as of June 30, 2005.  The Company’s management, includingthe CEO and CFO, is engaged in a comprehensive effort to review, evaluate andimprove our controls; however, management does not expect that our disclosurecontrols or our internal controls over financial reporting will prevent allerrors and all fraud.  A control system, no matter how well designed andoperated, can provide only reasonable, not absolute, assurance that the controlsystem’s objectives will be met.

 

Based upon the controlsevaluation performed, the CEO and CFO have concluded that as of June 30,2005, our disclosure controls and procedures were effective to providereasonable assurance that material information relating to us and ourconsolidated subsidiary is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rules andforms, including that such information is accumulated and communicated tomanagement as appropriate to allow timely decisions regarding requireddisclosure.

 

*Changes in Internal Controls*.  In thecourse of our evaluation of disclosure controls and procedures, managementconsidered certain internal control areas in which the Company has made and arecontinuing to make changes to improve and enhance controls.  Based uponthat evaluation, the CEO and CFO concluded that there were no changes in ourinternal controls over financial reporting identified in connection with theevaluation required by paragraph (d) of Exchange Act Rules 13a-15 or15d-15 that

 

21

----

 

occurred during the quarter ended June 30, 2005, 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, 2006, Section 404 of theSarbanes-Oxley Act of 2002 will require us to include an internal controlreport of management with our annual report on Form 10-K.  Theinternal control report must contain (1) a statement of management’sresponsibility for establishing and maintaining adequate internal controls overfinancial reporting for our Company, (2) a statement identifying theframework used by management to conduct the required evaluation of theeffectiveness of our internal controls over financial reporting, (3) management’sassessment of the effectiveness of our internal controls over financialreporting as of the end of our most recent fiscal year, including a statementas to whether or not our internal controls over financial reporting areeffective, and (4) a statement that our independent auditors have issuedan attestation report on management’s assessment of our internal controls overfinancial 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 andprocedures on an on-going basis.  Thecomprehensive compliance plan includes (1) documentation and assessment ofthe adequacy of our internal controls over financial reporting, (2) remediationof control weaknesses, (3) validation through testing that controls are functioningas documented and (4) implementation of a continuous reporting andimprovement process for internal controls over financial reporting.  As aresult of this initiative, the Company has made and will continue to makechanges from time to time in our internal controls over financial reporting.

 

**PART II.OTHER INFORMATION**

 

**Item1.  LEGAL PROCEEDINGS**

 

See Note 6 to the Company’s condensed, consolidated financialstatements.

 

**Item5.  OTHER INFORMATION**

 

None.

 

22

----

 

**Item6.  EXHIBITS**

 

**(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                                                                                                               |

 

23

----

 

**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 15, 2005 | By:                      | /s/ A.W. BERGERON |
|                       |                     | **A.W. Bergeron** |
|                       |                     | President |
|                       |                     |   |
| Date: August 15, 2005 | By:                      | /s/ THOMAS P. KEATING |
|                       |                     | **Thomas P. Keating** |
|                       |                     | Chief Financial Officer |

 

24

----