10-Q 1 aee200210q063002.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from. . . . . . . .to. . . . . . . . . . . . . . . . . Commission file number 333-89725 AES Eastern Energy, L.P. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (Exact name of registrant as specified in its charter) Delaware 54-1920088 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1001 N. 19th Street, Arlington, Va. 22209 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (703) 522-1315 N/A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Registrant is a wholly owned subsidiary of The AES Corporation. Registrant meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is filing this Quarterly Report on Form 10-Q with the reduced disclosure format authorized by General Instruction H. TABLE OF CONTENTS PART I Page Item 1. Condensed Consolidated Financial Statements (Unaudited) AES EASTERN ENERGY, L.P. Condensed Consolidated Financial Statements: Consolidated Statements of Income for the three months ended June 30, 2002 and June 30, 2001 ........................................3 Consolidated Statements of Income for the six months ended June 30, 2002 and June 30, 2001 ........................................4 Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001 ....5 Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and June 30, 2001 ........................................6 Statement of Changes in Partners' Capital for the six months ended June 30, 2002 ...........................................................7 Notes to Condensed Consolidated Financial Statements.......................8 AES NY, L.L.C. (General Partner of AES Eastern Energy, L.P.)* Condensed Consolidated Balance Sheets: Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001 Notes to Condensed Consolidated Balance Sheets.............................13 * The condensed consolidated balance sheets of AES NY, L.L.C. contained in this Quarterly Report on Form 10-Q should be considered only in connection with its status as the general partner of AES Eastern Energy, L.P. Item 2. Discussion and Analysis of Results of Operations and Financial Condition (a) Results of Operations...........................................21 (b) Liquidity and Capital Resources.................................23 PART II Item 1. Legal Proceedings....................................................26 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits........................................................26 (b) Reports on Form 8-K.............................................26 Signature.....................................................................27 2 PART 1 - FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements (Unaudited)

The notes are an integral part of the condensed consolidated financial statements. 3 Item 1. Condensed Consolidated Financial Statements (Unaudited) (Cont'd) AES Eastern Energy, L.P. Condensed Consolidated Statements of Income For the six months ending June 30, 2002 and June 30, 2001 (Amounts in Thousands) -------------------------------------------------------------------------------- Six months ended June 30, 2002 2001 ---- ---- (Thousands) Operating Revenues Energy $135,115 $175,271 Capacity 15,125 14,536 Transmission congestion contract 18,969 (12,444) Other 4,693 3,723 --------- -------- Total operating revenues 173,902 181,086 Operating Expenses Fuel 64,000 65,064 Operations and maintenance 8,338 11,248 General and administrative 26,775 26,783 Depreciation and amortization 17,371 16,306 --------- -------- Total Operating Expenses 116,484 119,401 --------- -------- Operating Income 57,418 61,685 Other Income/(Expense) Interest expense (28,802) (29,623) Interest income 1,070 2,220 Gain(loss) on derivative valuation 85 (233) -------- -------- Net Income $29,771 $34,049 ========= ======== The notes are an integral part of the condensed consolidated financial statements. 4 Item 1. Condensed Consolidated Financial Statements (Unaudited) (Cont'd) AES Eastern Energy, L.P. Condensed Consolidated Balance Sheets June 30, 2002 and December 31, 2001 (Amounts in Thousands) -------------------------------------------------------------------------------- June 30, Dec. 31, 2002 2001 -------- ------- ASSETS Current Assets Restricted cash: Operating- cash and cash equivalents $ 3,690 $ 4,193 Revenue Account 63,610 71,606 Accounts receivable - trade 30,376 27,590 Accounts receivable - affiliates - 319 Accounts receivable - other 964 2,123 Inventory 26,476 29,615 Prepaid expenses 4,864 6,464 ---------- ---------- Total Current Assets 129,980 141,910 ---------- ---------- Property, Plant, Equipment and Related Assets Land 6,900 6,884 Electric generation assets (net of accumulated depreciation of $75,950 and $62,623) 724,028 732,278 Other intangible assets (net of accumulated amortization of $23,969 and $19,941) 221,836 225,864 ---------- ---------- Total property, plant, equipment and related assets 952,764 965,026 ---------- --------- Other Assets Derivative valuation 34,125 55,182 Transmission congestion contract 12,107 - Rent reserve account 31,721 31,719 ---------- ---------- Total Assets $1,160,697 $1,193,837 ========== ========== LIABILITIES Current Liabilities Accounts payable $ 1,082 $ 1,663 Lease financing - current 4,420 6,223 Environmental remediation 15 155 Accrued interest expense 28,237 28,353 Due to The AES Corporation and affiliates 7,239 6,414 Other accrued expenses 13,269 14,397 Other liabilities and accrued expenses 2,316 4,629 ---------- ---------- Total Current Liabilities 56,578 61,834 ---------- ---------- Long-term liabilities Lease financing - long term 638,511 639,326 Environmental remediation 9,814 11,442 Defined benefit plan obligation 17,317 16,968 Derivative valuation liability 13,036 26,665 Transmission congestion contract - 3,506 Other liabilities 1,190 1,057 --------- ---------- Total Long-term Liabilities 679,868 698,964 --------- ---------- Total Liabilities 736,446 760,798 Commitments and Contingencies (Note 2) PARTNERS' CAPITAL 424,251 433,039 ---------- ---------- Total Liabilities and Partners' Capital $1,160,697 $1,193,837 ========== ========== The notes are an integral part of the condensed consolidated financial statements. 5 Item 1. Condensed Consolidated Financial Statements (Unaudited) (Cont'd)

The notes are an integral part of the condensed consolidated financial statements. 6 Item 1. Condensed Consolidated Financial Statements (Unaudited) (Cont'd)

The notes are an integral part of the condensed consolidated financial statements. 7 Item 1. Condensed Consolidated Financial Statements (Unaudited) (Cont'd) Notes to the Condensed Consolidated Financial Statements Note 1. Unaudited Condensed Consolidated Financial Statements The accompanying unaudited condensed consolidated financial statements of AES Eastern Energy, L.P. (the Partnership) reflect all adjustments which are necessary, in the opinion of management, for a fair presentation of the Partnership's consolidated results for the interim periods. All such adjustments are of a normal recurring nature. The unaudited condensed consolidated financial statements should be read in conjunction with the Partnership's consolidated financial statements as of December 31, 2001 and for the year then ended and notes contained therein, which are set forth in the Partnership's Annual Report on Form 10-K for the year ended December 31, 2001. Note 2. Commitments and Contingencies Coal Purchases - In connection with the acquisition of the Partnership's four coal-fired electric generating stations (the Plants), the Partnership assumed from New York State Electric & Gas Corporation (NYSEG) an agreement to purchase the coal required by the Somerset and Cayuga Plants. Each year, either party can request renegotiation of the price of one-third of the coal supplied pursuant to this agreement. During 2001 the coal suppliers were committed to sell and the Partnership was committed to purchase all three lots of coal for the Somerset Plant as well as 70% of the anticipated coal purchases for the Cayuga Plant. The supplier requested renegotiation during 2001 for the 2002 lot but the parties failed to reach agreement. Therefore, the parties have current commitments with respect to only two lots in 2002 and 50% of the anticipated coal purchases at the Cayuga Plant. Either party may request renegotiation during 2002 on the third lot, and a request could be made to renegotiate the lot for which an agreement was not reached in the prior year. Therefore, the commitment of the Partnership that is not subject to renegotiation and possible cancellation for 2003 is one lot plus 50% of the estimated coal usage for the Cayuga Plant. The termination date for the contract is December 31, 2003. No later than June 30, 2003, the parties shall meet to determine if the agreement is to be extended under mutually agreeable terms and conditions. If the agreement were not extended, the Partnership would seek a new coal supplier. As of the acquisition date of the Plants, the contract prices for the coal purchased through 2002 were above the market price, and the Partnership recorded a purchase accounting liability for approximately $15.7 million related to the fulfillment of its obligation to purchase coal under this agreement. The purchase accounting liability is amortized as a reduction to coal expense over the life of the contract. As of June 30, 2002, the remaining liability was approximately $1.9 million. The Partnership has contracts with other various coal suppliers. These contracts have minimum purchase requirements. These contracts include adequate assurance provisions that under some circumstances would require the Partnership to produce a mutually agreed upon form of credit enhancement. As of June 30, 2002, the remaining anticipated coal purchases for the year ending December 31, 2002 were between $23.6 million and $47.6 million. Based on the coal purchase commitments for 2003, the Partnership has expected coal purchases ranging between $22.8 million and $26.8 million. Transmission Agreements - On August 3, 1998, AES NY, L.L.C., the general partner of the Partnership (the General Partner), entered into an agreement for the purpose of transferring certain rights and obligations from NYSEG to the General Partner under an existing transmission agreement among Niagara Mohawk Power Corporation (NIMO), the New York Power Authority, NYSEG and Rochester Gas & Electric Corporation, and an existing transmission agreement between NYSEG and NIMO. This agreement provides for the assignment of rights to transmit energy from the Somerset Plant and other sources to remote load areas and other delivery points, and was assumed by the Partnership on the date of acquisition of the Plants. In accordance with its plan, as of the acquisition date, the Partnership discontinued using this service. The Partnership did not transmit over these lines but was required to pay the current fees until the effective cancellation date, November 19, 1999. These fees aggregated approximately $3.4 million over the six months ended December 31, 1999, and were recorded as a purchase accounting liability. Because the Partnership did not use the lines during this period, the Partnership received no economic benefit subsequent to the acquisition. The Partnership was informed by NIMO that the Partnership would be responsible for the monthly fees of $500,640 under the existing transmission agreement to the originally scheduled termination date of October 1, 2004. On October 5, 1999, the Partnership filed a complaint against NIMO alleging that the Partnership has a right to non-firm transmission service upon six months prior notice without payment of $500,640 in monthly fees subsequent to the cancellation date of November 19, 1999. 8 On March 9, 2000, a settlement was reached between the Partnership and NIMO, which was approved by the Federal Energy Regulatory Commission (FERC). According to the settlement, the Partnership will continue to pay NIMO a fixed rate of $500,640 per month during the period of November 20, 1999 to October 1, 2004, and in turn, will receive a form of transmission service commencing on May 1, 2000, which the Partnership believes will provide an economic benefit over the period of May 1, 2000 to October 1, 2004. The Partnership has the right under a Remote Load Wheeling Agreement (RLWA) to transmit 298 MW over firm transmission lines from the Somerset Plant. The Partnership has the right to designate alternate points of delivery on NIMO's transmission system provided that the Partnership is not entitled to receive any transmission service charge credit on the NIMO system. On November 1, 2000, the effective date of the final settlement, the transmission contract was classified as an energy-trading contract as defined in Emerging Issues Task Force (EITF) No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities. From January 1, 2001 the contract was accounted for as a derivative under SFAS No. 133. The transmission contract was entered into because it provided a reasonable settlement for resolving a FERC issue. The agreement is essentially a swap between the congestion component of the locational prices posted daily by the New York ISO in western New York and the more heavily populated areas in eastern New York. The agreement is a financially settled contract since there is no requirement to flow power under this agreement. The agreement generates gains or losses from exposure to shifts or changes in market prices. The Partnership recorded income of approximately $19.0 million in the first six months of 2002 related to this contract. Line of Credit Agreement - On May 14, 1999, the Partnership established a three-year revolving working capital credit facility of up to $50 million for the purpose of making funds available to pay for certain operating and maintenance costs. This facility was terminated as of March 9, 2001. In April 2001, the Partnership entered into a $35 million secured revolving working capital and letter of credit facility with Union Bank of California, N.A. This facility has a term of approximately twenty-one months. The Partnership can borrow up to $35 million for working capital purposes under this facility. In addition, the Partnership can have letters of credit issued under this facility up to $25 million, provided that the total amount of working capital borrowings and letters of credit issuances may not exceed the $35 million limit on the entire facility. Since the new facility was signed, there have been two borrowings. The first borrowing was for $7 million on July 13, 2001 at an interest rate of 8.125%. The borrowing was repaid on July 31, 2001. The second borrowing was for $8.5 million on January 11, 2002 at an interest rate of 6.125%. The borrowing was repaid in full on February 28, 2002. Environmental - The Partnership has recorded a liability for environmental remediation associated with the acquisition of the Plants. On an ongoing basis, the Partnership monitors its compliance with environmental laws. Because of the uncertainties associated with environmental compliance and remediation activities, future costs of compliance or remediation could be higher or lower than the amount currently accrued. The Partnership received an information request letter dated October 12, 1999 from the New York Attorney General, which seeks detailed operating and maintenance history for the Westover and Greenidge Plants. On January 13, 2000, the Partnership received a subpoena from the New York State Department of Environmental Conservation (DEC) seeking similar operating and maintenance history from the Plants. This information is being sought in connection with the Attorney General's and the DEC's investigations of several electricity generating stations in New York that are suspected of undertaking modifications in the past without undergoing an air permitting review. If the Attorney General or the DEC does file an enforcement action against the Somerset, Cayuga, Westover, or Greenidge Plants, then penalties may be imposed and further emission reductions might be necessary at these Plants. The Partnership is unable to estimate the impact, if any, of these investigations on its financial condition or results of future operations. On April 14, 2000, the Partnership received a request for information pursuant to Section 114 of the Clean Air Act from the U.S. Environmental Protection Agency (EPA) seeking detailed operating and maintenance history data for the Cayuga and Somerset Plants. The EPA has commenced an industry-wide investigation of coal-fired electric power generators to determine compliance with environmental requirements under the Clean Air Act associated with repairs, maintenance, modifications and operational changes made to coal-fired facilities over the years. The EPA's focus is on whether the changes were subject to new source review or new source performance standards, and whether best available control technology was or should have been used. The Partnership has provided the requested documentation, and the EPA is currently evaluating the materials. The Partnership is unable to estimate the impact, if any, of this investigation on its financial condition or results of future operations. 9 By letter dated May 25, 2000, the DEC issued a Notice of Violation (NOV) to NYSEG for violations of the Clean Air Act and the Environmental Conservation Law at the Greenidge and Westover Plants related to NYSEG's alleged failure to obtain an air permitting review for repairs and improvements made during the 1980s and 1990s, which was prior to the acquisition of the Plants by the Partnership. Pursuant to the purchase agreement relating to the acquisition of the Plants from NYSEG, the Partnership agreed to assume responsibility for environmental liabilities that arose while NYSEG owned the Plants. On September 12, 2000, the Partnership agreed with NYSEG that the Partnership will assume the defense of and responsibility for the NOV, subject to a reservation of its right to assert applicable exceptions to its contractual undertaking to assume preexisting environmental liabilities. The financial and operational effect of this NOV is still being discussed with the DEC. The Partnership is unable to estimate the effect of this NOV on its financial condition or results of future operations. It is possible that the DEC NOV and other potential enforcement actions arising out of the Attorney General, DEC, and EPA investigations may result in penalties and the potential requirement to install additional air pollution control equipment and could require the Partnership to make substantial expenditures. Nitrogen Oxide and Sulfur Dioxide Emission Allowances - The Plants emit nitrogen oxide (NOX) and sulfur dioxide (SO2) as a result of burning coal to produce electricity. The Plants have been allocated allowances by the DEC to emit NOX during the ozone season, which runs from May 1 to September 30. Each NOX allowance authorizes the emission of one ton of NOX during the ozone season. The Plants are also subject to SO2 emission allowance requirements imposed by the EPA. Each SO2 allowance authorizes the emission of one ton of SO2 during the calendar year. Both NOX and SO2 allowances may be bought, sold, or traded. If NOX and/or SO2 emissions exceed the allowance amounts allocated to the Plants, then the Partnership may need to purchase additional allowances on the open market or otherwise reduce its production of electricity to stay within the allocated amounts. The Plants were net sellers of NOX allowances in 2001, and are also expected to have a surplus of NOX allowances in 2002. The Plants were self-sufficient with respect to SO2 allowances in 2001; however, it is expected that the Plants may have a shortfall of approximately 10,000 to 13,000 SO2 allowances in 2002 assuming the Plants are operated at capacities similar to 2001. At current market prices, the cost could range from $1.5 million to $2.2 million to purchase sufficient SO2 allowances for 2002. On October 16, 2001, AES Greenidge was awarded a Federal Clean Coal Grant that, if accepted, will fund 50% of the capital costs for backend technology and 30% of the operations and maintenance costs for a test and demonstration period. This technology will include a single bed, in-duct Selective Catalytic Reduction (SCR) unit in combination with low-NOX combustion technology, on Greenidge Unit 4 firing on coal and biomass. It will also include a Circulating Dry Scrubber (CDS) for SO2, Mercury and acid gas removal. AES Greenidge's share of the project's costs will be approximately $9.8 million. The Partnership is obligated to make payments under the Coal Hauling Agreement with Somerset Railroad Corporation (SRC), an affiliated company, in an amount sufficient, when added with funds available from other sources, to enable SRC to pay, when due, all of its operating expenses and other expenses, including interest on and principal of outstanding indebtedness. As of June 30, 2002 and 2001, The Partnership recorded $2.0 million and $2.5 million, respectively, as operating expenses and other accrued liabilities under this agreement. On August 14, 2000, SRC entered into a $26 million credit facility with Fortis Capital Corp. which replaced in its entirety a credit facility for the same amount previously provided to SRC by an affiliate of CIBC World Markets. The new credit facility provided by Fortis Capital Corp. consists of a 14-year term note (maturing on May 6, 2014), with principal and interest payments due quarterly. The current interest rate on the loans under this credit facility is equal to a Base Rate plus 0.625% for the Base Rate loans and LIBOR plus 1.375% for LIBOR loans. The principal amount of SRC's outstanding indebtedness under this credit facility was approximately $22.3 million as of June 30, 2002. The agreements governing the leases of the Somerset and Cayuga Plants include negative covenants restricting the Partnership's ability to incur indebtedness and to make payments to its partners (which are referred to as restricted payments). The incurrence of indebtedness covenant states that neither the Partnership nor any of its subsidiaries may create, incur, assume, suffer to exist, guarantee or otherwise become directly or indirectly liable with respect to indebtedness except for permitted indebtedness. Neither SRC nor the limited liability company that owns SRC may incur any indebtedness, other than the SRC credit facility or a replacement facility or other than any operating leases in respect of rail assets, without the written consent of the institutional investors that organized the trusts that own the Somerset and Cayuga Plants and lease them to the Partnership. These agreements do permit 10 the Partnership to incur indebtedness for certain purposes and subject to applicable limits, including indebtedness to finance modifications to the Somerset and Cayuga Plants required by law and up to $100,000,000 of additional indebtedness, provided that no more than $75,000,000 of such additional indebtedness may be incurred to provide working capital and no more than $50,000,000 of such additional indebtedness may be secured by liens upon the Partnership's assets and no more than $25,000,000 of such additional indebtedness may be incurred for purposes other than to provide working capital. The covenant restricting incurrence of indebtedness will restrict the Partnership's future ability to obtain additional debt financing for working capital, capital expenditures or other purposes. Note 3. Comprehensive Income Comprehensive Income - In 1999, the Partnership adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income", which establishes rules for the reporting of comprehensive income and its components. As of June 30, 2002, the Partnership has recorded $21.0 million of other comprehensive income due to the adoption of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". In the years prior to the adoption of SFAS No. 133, the Partnership did not have any items of other comprehensive income. On January 1, 2001, the Partnership adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", which, as amended and interpreted, established new accounting and reporting standards for derivative instruments and hedging activities. The Statement requires that the Partnership recognize all derivatives, as defined in the Statement, on the balance sheet at fair value. Derivatives, or any portion thereof, that are not effective hedges are adjusted to fair value through income. Derivatives that are effective hedges are adjusted to fair value through other comprehensive income (loss) until the hedged items are recognized in earnings. The adoption of SFAS No. 133 on January 1, 2001, resulted in a cumulative reduction of Other Comprehensive Income (OCI) in Partner's Capital of $66.3 million. The Partnership utilizes derivative financial instruments to hedge commodity price risk. The Partnership utilizes electric derivative instruments, including swaps and forwards, to hedge the risk related to forecasted electricity sales over the next four years. The majority of the Partnership's electric derivatives are designated and qualify as cash flow hedges. No hedges were derecognized or discontinued during the six months ended June 30, 2002. No significant amounts of hedge ineffectiveness were recognized in earnings during the six months ended June 30, 2002. Gains and losses on derivatives reported in accumulated other comprehensive income are reclassified into earnings when the hedged forecasted sale occurs. Approximately $9.4 million of other comprehensive income is expected to be recognized as an addition to earnings over the next twelve months. Amounts recorded in other comprehensive income during the six months ended June 30, 2002, were as follows (in millions): Balance as of December 31, 2001 $28.5 Reclassified to earnings 21.7 Change in fair value (29.2) ------ Balance, June 30, 2002 $21.0 ====== In addition to the electric derivatives classified as cash flow hedge contracts, the Partnership has a Transmission Congestion Contract that is a derivative under the definition of SFAS No.133, but does not qualify for hedge accounting. This contract is recorded at fair value on the balance sheet with changes in the fair value recognized through earnings. In 2000, this contract was also recorded at fair value with changes in fair value recorded through income under the requirements of EITF No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities. Note 4. New Accounting Pronouncements In June 2001, the FASB issued SFAS No. 142, entitled, "Goodwill and Other Intangible Assets". This standard eliminates the amortization of goodwill, and requires goodwill to be reviewed periodically for impairment. This standard also requires the useful lives of previously recognized assets to be adjusted accordingly. This standard is effective for fiscal years beginning after December 15, 2001, for all goodwill and other intangible assets recognized on the Partnership's balance sheet at that date, regardless of when the assets were initially recognized. The Partnership will continue to amortize the other intangible assets currently recorded on the balance sheet. The adoption of SFAS 142 does not have a significant impact on The Partnership's financial reporting. Any impairment will be determined in accordance with the provisions of SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets." 11 In July 2001, the FASB issued SFAS No. 143, entitled "Accounting for Asset Retirement Obligations". This standard is effective for fiscal years beginning after June 15, 2002, and provides accounting requirements for asset retirement obligations associated with tangible long-lived assets. The Partnership has not determined the effects of this standard on its financial reporting. In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets." The provisions of this statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and address reporting for the impairment or disposal of long-lived assets. SFAS No. 144 provides guidance for developing estimates of future cash flows used to test assets for recoverability and requires that assets to be disposed of be classified as held for sale when certain criteria are met. The statement also extends the reporting of discontinued operations to all components of an entity and provides guidance for recognition of a liability for obligations associated with disposal activity. The Partnership believes that the initial adoption of the provisions of SFAS No. 144 will not have any material impact on its financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current GAAP criteria for extraordinary classification. In addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. The statement also contains other nonsubstantive corrections to authoritative accounting literature. The changes related to debt extinguishment will be effective for fiscal years beginning after May 15, 2002, and the changes related to lease accounting will be effective for transactions occurring after May 15, 2002. Adoption of this standard will not have any immediate effect on the Partnership's consolidated financial statements. The Partnership has not determined the effects of this standard on its financial reporting. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The Partnership will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company's commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized. This standard will be accounted for prospectively. Note 5. Reclassifications Certain 2001 amounts have been reclassified in the condensed consolidated financial statements to conform with the 2002 presentation. Note 6. Subsequent Events Cash flow from the Partnership's operations during the first half of 2002 was sufficient to cover the aggregate rental payments under the leases on the Somerset Generating Station and the Cayuga Generation Station due July 2, 2002. On this date, rental payments were made in the amount of $40.0 million. Cash flow from operations in excess of the aggregate rental payments under the Partnership's leases may be distributed to AES NY, LLC if certain criteria are met. On July 5, 2002, the Partnership made a distribution payment of $31.4 million. The Partnership borrowed $14.0 million on July 9, 2002, for working capital purposes under the $35 million secured revolving working capital and letter of credit facility with Union Bank of California, N.A. The borrowing was at an interest rate of 6.125%. The Partnership repaid $7.2 million on July 31, 2002. In July 2002, the Partnership offered a Voluntary Early Retirement Program to union employees at the Cayuga, Greenidge and Westover Plants who were age 53 on or before December 31, 2002, have completed a period in service of at least five years under The Retirement Benefit Plan for Employees of AES NY, L.L.C., as of May 29, 1999 and retire on September 1, 2002. Forty-nine employees at the three Plants are eligible to retire under this program. The deadline for employees to accept the Voluntary Early Retirement Program is August 20, 2002. 12 Item 1. Condensed Consolidated Financial Statements (Unaudited) (Cont'd)

The notes are an integral part of the condensed consolidated financial statements. 13 Item 1. Condensed Consolidated Financial Statements (Unaudited) (Cont'd) Note 1. Condensed Consolidated Balance Sheets The accompanying unaudited condensed consolidated balance sheets of AES NY, L.L.C. (the Company) reflect all adjustments which are necessary, in the opinion of management, for a fair presentation of the Company's consolidated financial position for the interim periods. All such adjustments are of a normal recurring nature. The unaudited condensed consolidated balance sheets should be read in conjunction with the Company's consolidated balance sheet as of December 31, 2001 and notes contained therein, which are set forth in the Annual Report on Form 10-K of AES Eastern Energy, L.P. (AEE) for the year ended December 31, 2001. Note 2. Plants Placed on Long-Term Cold Standby During the fourth quarter of 2000, AES Creative Resources, L.P. (ACR) placed its AES Hickling and AES Jennison plants (ACR Plants) on long-term cold standby. The long-term cold standby designation means that these plants require more than 14 days to be brought on-line. The Company is currently evaluating the future of these plants. AES Hickling will be fully depreciated at the end of the current year. AES Jennison is currently fully depreciated. Note 3. Commitments and Contingencies Coal Purchases - In connection with the acquisition by AEE of its four coal-fired electric generating stations (the AEE Plants), AEE assumed from New York State Electric & Gas Corporation (NYSEG) an agreement to purchase the coal required by the AEE Somerset and Cayuga plants. Each year either party can request renegotiation of the price of one-third of the coal supplied pursuant to this agreement. During 2001, the coal suppliers were committed to sell and AEE was committed to purchase all three lots of coal for the Somerset Plant as well as 70% of the anticipated coal purchases for the Cayuga Plant. The supplier requested renegotiation during 2001 for the 2002 lot, but the parties failed to reach agreement. Therefore, the parties have current commitments with respect to only two lots in 2002 and 50% of the anticipated coal purchases at the Cayuga Plant. Either party may request renegotiation during 2002 on the third lot, and a request could be made to renegotiate the lot for which an agreement was not reached in the prior year. Therefore, the commitment of AEE that is not subject to renegotiation and possible cancellation for 2003 is one lot plus 50% of the estimated coal usage for Cayuga. The termination date for the contract is December 31, 2003. No later than June 30, 2003, the parties shall meet to determine if the agreement is to be extended under mutually agreeable terms and conditions. If the agreement were not extended, AEE would seek a new coal supplier. As of the acquisition date of the Plants, the contract prices for the coal purchased through 2002 were above the market price, and AEE recorded a purchase accounting liability for approximately $15.7 million related to the fulfillment of its obligation to purchase coal under this agreement. The purchase accounting liability is amortized as a reduction to coal expense over the life of the contract. As of June 30, 2001, the remaining liability was approximately $1.9 million. AEE has contracts with other various coal suppliers. These contracts have minimum purchase requirements. These contracts include adequate assurance provisions that under some circumstances would require AEE to produce a mutually agreed upon form of credit enhancement. As of June 30, 2002, the remaining anticipated coal purchases for the year ending December 31, 2002 were between $23.6 million and $47.6 million. Based on the coal purchase commitments for 2003, AEE has expected coal purchases ranging between $22.8 million and $26.8 million. Transmission Agreements - On August 3, 1998, the Company entered into an agreement for the purpose of transferring certain rights and obligations from NYSEG to the Company under an existing transmission agreement among Niagara Mohawk Power Corporation (NIMO), the New York Power Authority, NYSEG and Rochester Gas & Electric Corporation, and an existing transmission agreement between NYSEG and NIMO. This agreement provides for the assignment of rights to transmit energy from the Somerset Plant and other sources to remote load areas and other delivery points, and was assumed by AEE on the date of acquisition of the Plants. In accordance with its plan, as of the acquisition date, AEE discontinued using this service. AEE did not transmit over these lines but was required to pay the current fees until the effective cancellation date, November 19, 1999. These fees aggregated approximately $3.4 million over the six months ended December 31, 1999, and were recorded as a purchase accounting liability. Because AEE did not use the lines during this period, AEE received no economic benefit subsequent to the acquisition. AEE was informed by NIMO that AEE would be responsible for the monthly fees of $500,640 under the existing transmission agreement to the originally scheduled termination date of October 1, 2004. On October 5, 1999, AEE filed a complaint against NIMO alleging that AEE has a right to non-firm transmission service upon six months prior notice without payment of $500,640 in monthly fees subsequent to the cancellation date of November 19, 1999. 14 On March 9, 2000, a settlement was reached between AEE and NIMO, which was approved by the Federal Energy Regulatory Commission (FERC). According to the settlement, AEE will continue to pay NIMO a fixed rate of $500,640 per month during the period of November 20, 1999 to October 1, 2004 and, in turn, will receive a form of transmission service commencing on May 1, 2000, which AEE believes will provide an economic benefit over the period of May 1, 2000 to October 1, 2004. AEE has the right under a Remote Load Wheeling Agreement (RLWA) to transmit 298 MW over firm transmission lines from the Somerset Plant. AEE has the right to designate alternate points of delivery on NIMO's transmission system provided that AEE is not entitled to receive any transmission service charge credit on the NIMO system. On November 1, 2000, the effective date of the final settlement, the transmission contract was classified as an energy-trading contract as defined in Emerging Issues Task Force (EITF) No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities. From January 1, 2001 the contract was accounted for as a derivative under SFAS No. 133. The transmission contract was entered into because it provided a reasonable settlement for resolving a FERC issue. The agreement is essentially a swap between the congestion component of the locational prices posted daily by the New York ISO in western New York and the more heavily populated areas in eastern New York. The agreement is a financially settled contract since there is no requirement to flow power under this agreement. The agreement generates gains or losses from exposure to shifts or changes in market prices. AEE recorded income of approximately $19.0 million in the first six months of 2002 related to this contract. Line of Credit Agreement - On May 14, 1999, AEE established a three-year revolving working capital credit facility of up to $50 million for the purpose of making funds available to pay for certain operating and maintenance costs. This facility was terminated as of March 9, 2001. In April 2001, AEE entered into a $35 million secured revolving working capital and letter of credit facility with Union Bank of California, N.A. This facility has a term of approximately twenty-one months. AEE can borrow up to $35 million for working capital purposes under this facility. In addition, AEE can have letters of credit issued under this facility up to $25 million, provided that the total amount of working capital borrowings and letters of credit issuances may not exceed the $35 million limit on the entire facility. Since the new facility was signed, there have been two borrowings. The first borrowing was for $7 million on July 13, 2001 at an interest rate of 8.125%. The borrowing was repaid on July 31, 2001. The second borrowing was for $8.5 million on January 11, 2002 at an interest rate of 6.125%. The borrowing was repaid in full on February 28, 2002. Environmental - The Company has recorded a liability for environmental remediation associated with the acquisition of the AEE Plants and the ACR Plants. On an ongoing basis, the Company monitors its compliance with environmental laws. Because of the uncertainties associated with environmental compliance and remediation activities, future costs of compliance or remediation could be higher or lower than the amount currently accrued. AEE received an information request letter dated October 12, 1999 from the New York Attorney General, which seeks detailed operating and maintenance history for the Westover and Greenidge Plants. On January 13, 2000, the Company received a subpoena from the New York State Department of Environmental Conservation (DEC) seeking similar operating and maintenance history from the AEE and ACR Plants. This information is being sought in connection with the Attorney General's and the DEC's investigations of several electricity generating stations in New York that are suspected of undertaking modifications in the past without undergoing an air permitting review. If the Attorney General or the DEC does file an enforcement action against the Somerset, Cayuga, Westover, or Greenidge Plants, then penalties may be imposed and further emission reductions might be necessary at these Plants. The Company is unable to estimate the impact, if any, of these investigations on its financial condition or results of operations. On April 14, 2000, AEE received a request for information pursuant to Section 114 of the Clean Air Act from the U.S. Environmental Protection Agency (EPA) seeking detailed operating and maintenance history data for the Cayuga and Somerset Plants. The EPA has commenced an industry-wide investigation of coal-fired electric power generators to determine compliance with environmental requirements under the Clean Air Act associated with repairs, maintenance, modifications and operational changes made to coal-fired facilities over the years. The EPA's focus is on whether the changes were subject to new source review or new source performance standards, and whether best available control technology was or should have been used. AEE has provided the requested documentation and the EPA is currently evaluating the materials. AEE is unable to estimate the impact, if any, of this investigation on its financial condition or results of future operations. 15 By letter dated May 25, 2000, the DEC issued a Notice of Violation (NOV) to NYSEG for violations of the Clean Air Act and the Environmental Conservation Law at the Greenidge and Westover Plants related to NYSEG's alleged failure to obtain an air permitting review for repairs and improvements made during the 1980s and 1990s, which was prior to the acquisition of the Plants by AEE. Pursuant to the purchase agreement relating to the acquisition of the Plants from NYSEG, AEE agreed to assume responsibility for environmental liabilities that arose while NYSEG owned the Plants. On September 12, 2000, AEE agreed with NYSEG that AEE will assume the defense of and responsibility for the NOV, subject to a reservation of its right to assert applicable exceptions to its contractual undertaking to assume preexisting environmental liabilities. The financial and operational effect of this NOV is still being discussed with the DEC. The Company is unable to estimate the effect of this NOV on its financial condition or results of future operations. It is possible that the DEC NOV and other potential enforcement actions arising out of the Attorney General, DEC, and EPA investigations may result in penalties and the potential requirement to install additional air pollution control equipment and could require AEE to make substantial expenditures. Nitrogen Oxide and Sulfur Dioxide Emission Allowances - The AEE Plants emit nitrogen oxide (NOX) and sulfur dioxide (SO2) as a result of burning coal to produce electricity. The six Plants have been allocated allowances by the DEC to emit NOX during the ozone season, which runs from May 1 to September 30. Each NOX allowance authorizes the emission of one ton of NOX during the ozone season. The six Plants are also subject to SO2 emission allowance requirements imposed by the EPA. Each SO2 allowance authorizes the emission of one ton of SO2 during the calendar year. Both NOX and SO2 allowances may be bought, sold, or traded. If NOX and/or SO2 emissions exceed the allowance amounts allocated to the six Plants, then the Company may need to purchase additional allowances on the open market or otherwise reduce its production of electricity to stay within the allocated amounts. The Plants were net sellers of NOX allowances in 2001. The Plants were self-sufficient with respect to SO2 allowances in 2001; however, it is expected that the Plants may have a shortfall of approximately 10,000 to 13,000 SO2 allowances in 2002 assuming the Plants are operated at capacities similar to 2001. At current market prices, the cost could range from $1.5 million to $2.2 million to purchase sufficient SO2 allowances for 2002. On October 16, 2001, AES Greenidge was awarded a Federal Clean Coal Grant that, if accepted, will fund 50% of the capital costs for backend technology and 30% of the operations and maintenance costs for a test and demonstration period. This technology will include a single bed, in-duct Selective Catalytic Reduction (SCR) unit in combination with low-NOX combustion technology, on Greenidge Unit 4 firing on coal and biomass. It will also include a Circulating Dry Scrubber (CDS) for SO2, Mercury and acid gas removal. AES Greenidge's share of the costs for the project will be approximately $9.8 million. In October 1999, ACR entered into a consent order with the DEC to resolve alleged violations of the water quality standards in the groundwater downgradient of an ash disposal site. The consent order included a suspended $5,000 civil penalty and a requirement to submit a work plan to initiate closure of the landfill by October 8, 2000. The consent order also called for a site investigation, which was conducted and indicated that there is a possibility that some groundwater remediation at the site may be required. Further compliance with this order included a Closure Investigation Report which was submitted to the NYSDEC in the spring of 2000, and a Closure Plan which was submitted to the NYSDEC in January 2001. The Closure Plan was implemented in December 2001 when capping of the site was completed. AEE2, L.L.C. contributed one-half of the costs to close the landfill, which were approximately $2 million, and it will contribute additional costs for long-term groundwater monitoring. Nevertheless, if a groundwater remediation is required, these costs have not been budgeted, and AEE2, L.L.C. may be responsible for a portion of such costs. ACR has recently reported that concentrations of a number of chemicals in a few groundwater wells increased in the year ending December 31, 2001, since the Jennison and Hickling Plants were placed on long-term cold standby. The early 2002 testing data indicates that the increase in concentrations has ended and are starting to decrease. AES Creative Resources, L.P. and the DEC have agreed that remediation is not needed at this time. ACR will continue to monitor the groundwater conditions and include an assessment of the groundwater concentration trends in its 2002 annual report to the DEC. 16 AEE is obligated to make payments under the Coal Hauling Agreement with Somerset Railroad Corporation (SRC), an affiliated company, in an amount sufficient, when added with funds available from other sources, to enable SRC to pay, when due, all of its operating expenses and other expenses, including interest on and principal of outstanding indebtedness. As of June 30, 2002 and 2001, AEE had recorded $2.0 million and $2.5 million, respectively, as operating expenses and other accrued liabilities under this agreement. On August 14, 2000, SRC entered into a $26 million credit facility with Fortis Capital Corp. which replaced in its entirety a credit facility for the same amount previously provided to SRC by an affiliate of CIBC World Markets. The new credit facility provided by Fortis Capital Corp. consists of a 14-year term note (maturing on May 6, 2014), with principal and interest payments due quarterly. The current interest rate on the loans under this credit facility is equal to a Base Rate plus 0.625% for the Base Rate loans and LIBOR plus 1.375% for LIBOR loans. The principal amount of SRC's outstanding indebtedness under this credit facility was approximately $22.3 million as of June 30, 2002. The agreements governing the leases of the Somerset and Cayuga Plants include negative covenants restricting AEE's ability to incur indebtedness and to make payments to its partners (which are referred to as restricted payments). The incurrence of indebtedness covenant states that neither AEE nor any of its subsidiaries may create, incur, assume, suffer to exist, guarantee or otherwise become directly or indirectly liable with respect to indebtedness except for permitted indebtedness. Neither SRC nor the limited liability company that owns SRC may incur any indebtedness, other than the SRC credit facility or a replacement facility or other than any operating leases in respect of rail assets, without the written consent of the institutional investors that organized the trusts that own the Somerset and Cayuga Plants and lease them to AEE. These agreements do permit AEE to incur indebtedness for certain purposes and subject to applicable limits, including indebtedness to finance modifications to the Somerset and Cayuga Plants required by law and up to $100,000,000 of additional indebtedness, provided that no more than $75,000,000 of such additional indebtedness may be incurred to provide working capital and no more than $50,000,000 of such additional indebtedness may be secured by liens upon AEE's assets and no more than $25,000,000 of such additional indebtedness may be incurred for purposes other than to provide working capital. The covenant restricting incurrence of indebtedness will restrict the Company's future ability to obtain additional debt financing for working capital, capital expenditures or other purposes. Note 4. Comprehensive Income In 1999, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income"; which establishes rules for the reporting of comprehensive income and its components. As of June 30, 2002, the Company has recorded $21.0 million of other comprehensive income due to the adoption of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". In the years prior to the adoption of SFAS No. 133, the Company did not have any items of other comprehensive income. On January 1, 2001, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which, as amended and interpreted, established new accounting and reporting standards for derivative instruments and hedging activities. The Statement requires that the Company recognize all derivatives, as defined in the Statement, on the balance sheet at fair value. Derivatives, or any portion thereof, that are not effective hedges are adjusted to fair value through income. Derivatives that are effective hedges are adjusted to fair value through other comprehensive income (loss) until the hedged items are recognized in earnings. The adoption of SFAS No. 133 on January 1, 2001 resulted in a cumulative reduction of Other Comprehensive Income (OCI) in member's equity of $66.3 million. AEE utilizes derivative financial instruments to hedge commodity price risk. AEE utilizes electric derivative instruments, including swaps and forwards, to hedge the risk related to forecasted electricity sales over the next four years. The majority of AEE's electric derivatives are designated and qualify as cash flow hedges. No hedges were derecognized or discontinued during the six months ended June 30, 2002. No significant amounts of hedge ineffectiveness were recognized in earnings during the six months ended June 30, 2002. Gains and losses on derivatives reported in accumulated other comprehensive income are reclassified into earnings when the hedged forecasted sale occurs. Approximately, $9.4 million of other comprehensive income is expected to be recognized as an addition to earnings over the next twelve months. Amounts recorded in other comprehensive income during the six months ended June 30, 2002, were as follows (in millions): 17 Balance, December 31, 2001 $28.5 Reclassified to earnings 21.7 Change in fair value (29.2) ------ Balance, June 30, 2002 $21.0 ====== In addition to the electric derivatives classified as cash flow hedge contracts, AEE has a Transmission Congestion Contract that is a derivative under the definition of SFAS No. 133, but does not qualify for hedge accounting. This contract is recorded at fair value on the balance sheet with changes in the fair value recognized through earnings. In 2000, this contract was also recorded at fair value with changes in fair value recorded through income under the requirements of EITF No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities. Note 5. New Accounting Pronouncements In June 2001, the FASB issued SFAS No. 142, entitled, "Goodwill and Other Intangible Assets". This standard eliminates the amortization of goodwill, and requires goodwill to be reviewed periodically for impairment. This standard also requires the useful lives of previously recognized assets to be adjusted accordingly. This standard is effective for fiscal years beginning after December 15, 2001, for all goodwill and other intangible assets recognized on the Company's balance sheet at that date, regardless of when the assets were initially recognized. The Company will continue to amortize the other intangible assets currently recorded on the balance sheet. The adoption of SFAS 142 does not have a significant impact on the Company's financial reporting. Any impairment will be determined in accordance with the provisions of SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets." In July 2001, the FASB issued SFAS No. 143, entitled "Accounting for Asset Retirement Obligations". This standard is effective for fiscal years beginning after June 15, 2002, and provides accounting requirements for asset retirement obligations associated with tangible long-lived assets. The Company has not determined the effects of this standard on its financial reporting. In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets." The provisions of this statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and address reporting for the impairment or disposal of long-lived assets. SFAS No. 144 provides guidance for developing estimates of future cash flows used to test assets for recoverability and requires that assets to be disposed of be classified as held for sale when certain criteria are met. The statement also extends the reporting of discontinued operations to all components of an entity and provides guidance for recognition of a liability for obligations associated with disposal activity. The Company believes that the initial adoption of the provisions of SFAS No. 144 will not have any material impact on its financial position or results of operations. In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This statement eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current GAAP criteria for extraordinary classification. In addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. The statement also contains other nonsubstantive corrections to authoritative accounting literature. The changes related to debt extinguishment will be effective for fiscal years beginning after May 15, 2002, and the changes related to lease accounting will be effective for transactions occurring after May 15, 2002. Adoption of this standard will not have any immediate effect on the Company's consolidated financial statements. The Company has not determined the effects of this standard on its financial reporting. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company's commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized. This standard will be accounted for prospectively. 18 Note 6. Subsequent Events Cash flow from AEE's operations during the first half of 2002 was sufficient to cover the aggregate rental payments under the leases on the Somerset Generating Station and the Cayuga Generation Station due July 2, 2002. On this date, rental payments were made in the amount of $40.0 million. Cash flow from operations in excess of the aggregate rental payments under AEE's leases may be distributed to AES NY, LLC if certain criteria are met. On July 5, 2002, AEE made a distribution of $31.4 million. AEE borrowed $14.0 million on July 9, 2002, for working capital purposes under the $35 million secured revolving working capital and letter of credit facility with Union Bank of California, N.A. The borrowing was at an interest rate of 6.125%. AEE repaid $7.2 million on July 31, 2002 In July 2002, AEE offered a Voluntary Early Retirement Program to union employees at the Cayuga, Greenidge and Westover Plants who were age 53 on or before December 31, 2002, have completed a period in service of at least five years under The Retirement Benefit Plan for Employees of AES NY, L.L.C., as of May 29, 1999 and retire on September 1, 2002. Forty-nine employees at the three Plants are eligible to retire under this program. The deadline for employees to accept the Voluntary Early Retirement Program is August 20, 2002. 19 Item 2. Discussion and analysis of results of operations and financial condition The information in this Management's Discussion and Analysis should be read in conjunction with the accompanying consolidated financial statements and the related Notes to the Financial Statements. Forward looking statements in this Management's Discussion and Analysis are qualified by the cautionary statement in the Forward Looking Statements section of the Management's Discussion and Analysis of Financial Condition and Results of Operations. Critical Accounting Policies General We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which we believe are most critical to understanding and evaluating our reported financial results include the following: Revenue Recognition, Property, Plant and Equipment, Contingencies and Derivatives. Revenue Recognition Revenues from the sale of electricity are recorded based upon output delivered and rates specified under contract terms. Revenues generated from commodity forwards, swaps and options, which are entered into for the hedging of forecasted sales, are recorded based on settlement accounting with the net amount received recognized as revenue. Revenues for ancillary and other services are recorded when the services are rendered. Property, Plant and Equipment Electric generation assets and inseparable intangible assets that existed at the date of acquisition are recorded at fair market value. Somerset and Cayuga, which represent $650 million of the electric generation assets, are subject to a leasing arrangement accounted for as a financing. Additions or improvements thereafter are recorded at cost. Depreciation is computed using the straight-line method over the 34-year and 28-year lease terms for Somerset and Cayuga, respectively, and over the estimated useful lives for the other fixed assets, which range from 7 to 35 years. The lease expiration date for the Cayuga lease is November 13, 2027 and the lease expiration date for the Somerset lease is February 13, 2033. A significant decrease in the estimated useful life of a material amount of our property, plant or equipment could have a material adverse impact on our operating results in the period in which the estimate is revised and subsequent periods. Maintenance and repairs are charged to expense as incurred. Contingencies We accrue for loss contingencies when the amount of the loss is probable and estimable. We are subject to various environmental regulations, and we are involved in certain legal proceedings. If our actual environmental and/or legal obligations are materially different from our estimates, the recognition of the actual amounts may have a material impact on our operating results and financial condition. Derivatives On January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which, as amended and interpreted, established new accounting and reporting standards for derivative instruments and hedging activities. SFAS 133 requires that all derivatives (including derivatives embedded in other contracts) be recorded as either assets or liabilities at fair value on the balance sheet. Changes in the derivative's fair value are to be recognized in earnings in the period of change, unless hedge accounting criteria are met. Hedge accounting allows the derivative's gains or losses in fair value to offset the related results of the hedged item. We utilize derivative financial instruments to manage commodity price risk. Although the majority of our derivative instruments qualify for hedge accounting, SFAS No. 133 resulted in more variation to our results of operations from changes in commodity prices. For the six months ended June 30, 2002, we recognized $19.0 million of income pursuant to SFAS No. 133 related to derivatives, which did not qualify for hedge accounting. We performed a value-at-risk (VaR) calculation on the transmission congestion contract with Niagara Mohawk Power Corporation using a model based on the variance/covariance methodology with a delta gamma model for optionality. We express VaR as a dollar amount of the potential loss in the fair value of our portfolio based on a 95% confidence level and a one-day holding period. Our daily VaR for the transmission congestion contract as of December 31, 2002 was $8.2 million. 20 Results of Operations for the three months ended June 30, 2002 ------------------------------------------------------------------------------- (Amounts in Millions) % For the three months ended June 30, 2002 2001 Change ------ ------ ------- Energy revenue $66.1 $81.2 (18.6) Capacity revenue 9.7 6.8 42.6 Transmission Congestion Contract 12.6 (19.3) - Other 1.0 1.0 - Energy revenues for the three months ended June 30, 2002 were $66.1 million, compared to $81.2 million for the comparable period of the prior calendar year, a decrease of 18.6%. The decrease in Energy Revenues is primarily due to lower market prices and lower demand. Market prices for peak and offpeak electricity were 33.3% and 23.4% lower than the comparable period of the prior calendar year. Demand for peak and offpeak electricity was 6.8% and 5.8% lower than the comparable period of the prior calendar year. The year-to-year price and demand comparisons are based on data reported by the New York ISO. Capacity revenues for the three months ended June 30, 2002 were $9.7 million, compared to $6.8 million for the comparable period of the prior calendar year, an increase of 42.6%. The increase in capacity revenue is primarily due to the higher bilateral prices received for the current summer capacity period (May - October) over the prior year's summer capacity period. Transmission Congestion Contract income for the three months ended June 30, 2002 was $12.6 million, compared to a loss of $19.3 million for the comparable period of the prior calendar year. This agreement is essentially a swap between the congestion component of the locational prices posted by the New York ISO in western New York and eastern New York. This contract is a derivative under the definition of SFAS No. 133, but does not qualify for hedge accounting. This contract is recorded at fair value on the balance sheet with changes in the fair value recognized through earnings. The transmission contract was entered into because it provided a reasonable settlement for resolving a FERC dispute between the Partnership and Niagara Mohawk Power Corporation. Operating Expenses -------------------- % For the three months ended June 30, 2002 2001 Change ------ ------ ------- Fuel expense $29.5 $29.0 1.7 Operations and maintenance 5.2 7.8 (33.3) General and administrative 14.3 12.4 15.3 Depreciation and amortization 8.7 8.2 6.1 Fuel expenses for the three months ended June 30, 2002 were $29.5 million, compared to $29.0 million for the comparable period of the prior calendar year, a decrease of 1.7%. Operations and maintenance expense for the three months ended June 30, 2002 was $5.2 million, compared to $7.8 million for the comparable period of the prior calendar year, a decrease of 33.3%. This decrease is primarily due to maintenance expenses incurred during a scheduled outage at Cayuga in the second quarter of 2001, which are not annually recurring. In addition, we have initiated a cost reduction program and a voluntary early retirement program. General and administrative expense for the three months ended June 30, 2002 was $14.3 million, compared to $12.4 million for the comparable period of the prior calendar year, an increase of 15.3%. This increase is primarily due to significant increases in property taxes and property and medical insurance. Depreciation and amortization expense for the three months ended June 30, 2002 was $8.7 million, compared to $8.2 million for the comparable period of the prior calendar year, an increase of 6.1%. This increase is primarily due to deprecation of the SCR system to reduce NOx emissions at Cayuga, which was operational June 7, 2001. 21 Other Expenses -------------------- % For the three months ended June 30, 2002 2001 Change ------ ------ ------- Interest expense $14.4 $14.7 (2.0) Interest income 0.6 1.3 (53.8) Other income/expenses for the three months ended June 30, 2002 were net expenses of $13.8 million, compared to net expenses of $13.4 million for the comparable period of the prior calendar year, a decrease of 3.0%. Results of Operations for the six months ended June 30, 2002 ------------------------------------------------------------ (Amounts in Millions) % For the six months ended June 30, 2002 2001 Change ------ ------ ------- Energy revenue $135.1 $175.3 (22.9) Capacity revenue 15.1 14.5 4.1 Transmission Congestion Contract 19.0 (12.4) - Other 4.7 3.7 27.0 Energy revenues for the six months ended June 30, 2002 were $135.1 million, compared to $175.3 million for the comparable period of the prior calendar year, a decrease of 22.9%. The decrease in Energy Revenues is primarily due to lower market prices and lower demand. Market prices for peak and off-peak electricity were 48.7% and 31.2% lower than the comparable period of the prior calendar year. Demand for peak and off-peak electricity was 5.6% and 5.8% lower than the comparable period of the prior calendar year. The year-to-year price and demand comparisons are based on data reported by the New York ISO. Capacity revenues for the six months ended June 30, 2002 were $15.1 million, compared to $14.5 million for the comparable period of the prior calendar year, an increase of 4.1%. The increase in capacity revenue is primarily due to the higher bilateral prices received for the current summer capacity period (May - October) over the prior year's summer capacity period, although the effects of lower market rates in 2001 were partially offset by a long term capacity contract which expired in April 2001. Transmission Congestion Contract income for the six months ended June 30, 2002 was $19.0 million, compared to a loss of $12.4 million for the comparable period of the prior calendar year. This agreement is essentially a swap between the congestion component of the locational prices posted by the New York ISO in western New York and eastern New York. This contract is a derivative under the definition of SFAS No. 133, but does not qualify for hedge accounting. This contract is recorded at fair value on the balance sheet with changes in the fair value recognized through earnings. The transmission contract was entered into because it provided a reasonable settlement for resolving a FERC dispute between the Partnership and Niagara Mohawk Power Corporation. Operating Expenses -------------------- % For the six months ended June 30, 2002 2001 Change ------ ------ ------- Fuel expense $64.0 $65.1 (1.7) Operations and maintenance 8.3 11.2 (25.9) General and administrative 26.8 26.8 - Depreciation and amortization 17.4 16.3 6.7 Fuel expenses for the six months ended June 30, 2002 were $64.0 million, compared to $65.1 million for the comparable period of the prior calendar year, a decrease of 1.7%. The decrease in Fuel Expenses is primarily due to lower operating levels due to lower demand. Operations and maintenance expense for the six months ended June 30, 2002 was $8.3 million, compared to $11.2 million for the comparable period of the prior calendar year, a decrease of 25.9%. This decrease is primarily due to maintenance expenses incurred during a scheduled outage at Cayuga in the second quarter of 2001, which are not annually recurring expenses. In addition, we have initiated a cost reduction program and a voluntary early retirement program. 22 General and administrative expense for the six months ended June 30, 2002 was $26.8 million, compared to $26.8 million for the comparable period of the prior calendar year. The significant increases in property taxes and property and medical insurance were offset by reversal of accruals for potential environmental liabilities which were resolved at a lower cost than projected. Depreciation and amortization expense for the six months ended June 30, 2002 was $17.4 million, compared to $16.3 million for the comparable period of the prior calendar year, an increase of 6.7%. This increase is primarily due to deprecation of the SCR system to reduce NOx emissions at Cayuga, which was operational June 7, 2001. Other Expenses -------------------- % For the six months ended June 30, 2002 2001 Change ------ ------ ------- Interest expense $28.8 $29.6 (2.7) Interest income 1.1 2.2 (50.0) Other income/expenses for the six months ended June 30, 2002 were net expenses of $27.7 million, compared to net expenses of $27.4 million for the comparable period of the prior calendar year, a decrease of 1.1%. Liquidity and Capital Resources ---------------------------------- Net working capital at June 30, 2002 and December 31, 2001 was $73.4 million and $80.1 million, respectively. Cash flow from our operations during the first half of 2002 was sufficient to cover the aggregate rental payments under the leases of Somerset and Cayuga paid July 2, 2002. We believe that cash flow from our full years' operations will be sufficient to cover aggregate rental payments due on January 2, 2003. We also believe that future cash flows will be sufficient to cover future rent payments. The lease expiration date for the Cayuga lease is November 13, 2027 and the lease expiration date for the Somerset lease is February 13, 2033. We are obligated to make payments under the Coal Hauling Agreement with Somerset Railroad Corporation (SRC), an affiliated company, in an amount sufficient, when added with funds available from other sources, to enable SRC to pay, when due, all of its operating expenses and other expenses, including interest on and principal of outstanding indebtedness. As of June 30, 2002 and 2001, we had recorded $2.0 million and $2.5 million, respectively, as operating expenses and other accrued liabilities under this agreement. On August 14, 2000, SRC entered into a $26 million credit facility with Fortis Capital Corp. which replaced in its entirety a credit facility for the same amount previously provided to SRC by an affiliate of CIBC World Markets. The new credit facility provided by Fortis Capital Corp. consists of a 14-year term note (maturing on May 6, 2014), with principal and interest payments due quarterly. The current interest rate on the loans under this credit facility is equal to a Base Rate plus 0.625% for the Base Rate loans and LIBOR plus 1.375% for LIBOR loans. The principal amount of SRC's outstanding indebtedness under this credit facility was approximately $22.3 million as of June 30, 2002. At March 9, 2001, our $20 million Credit Suisse First Boston working capital credit facility was terminated. In April 2001, we entered into a $35 million secured revolving working capital and letter of credit facility with Union Bank of California, N.A. This facility has a term of approximately twenty-one months. We can borrow up to $35 million for working capital purposes under this facility. In addition, we can have letters of credit issued under this facility up to $25 million, provided that the total amount of working capital borrowings and letters of credit issuances may not exceed the $35 million limit on the entire facility. There have been three borrowings under this facility from signing through August 14, 2002. The first borrowing was for $7 million on July 13, 2001 at an interest rate of 8.125%. The borrowing was repaid on July 31, 2001. The second borrowing was for $8.5 million on January 11, 2002 at an interest rate of 6.125%. The borrowing was repaid in full on February 28, 2002. The third borrowing was for $14.0 million on July 9, 2002 at an interest rate of 6.125%. We repaid $7.2 million on July 31, 2002. 23 The agreements governing the leases of Somerset and Cayuga include negative covenants restricting our ability to incur indebtedness and to make payments to our partners (which are referred to as restricted payments). The incurrence of indebtedness covenant states that neither we nor any of our subsidiaries may create, incur, assume, suffer to exist, guarantee or otherwise become directly or indirectly liable with respect to indebtedness except for permitted indebtedness. Neither SRC nor the limited liability company that owns SRC may incur any indebtedness, other than the SRC credit facility or a replacement facility or other than any operating leases in respect of rail assets, without the written consent of the institutional investors that organized the trusts that own Somerset and Cayuga and lease them to us. These agreements do permit us to incur indebtedness for certain purposes and subject to applicable limits, including indebtedness to finance modifications to Somerset and Cayuga required by law and up to $100,000,000 of additional indebtedness, provided that no more than $75,000,000 of such additional indebtedness may be incurred to provide working capital and no more than $50,000,000 of such additional indebtedness may be secured by liens upon our assets and no more than $25,000,000 of such additional indebtedness may be incurred for purposes other than to provide working capital. The covenant restricting incurrence of indebtedness will restrict our future ability to obtain additional debt financing for working capital, capital expenditures or other purposes. The restricted payment covenant states that, neither we nor any of our subsidiaries may make any distribution (other than to us or to any of our subsidiaries) unless it is made on or within 10 business days after a rent payment date, and the following conditions are also satisfied: (1) all rent under the leases for Somerset and Cayuga including deferrable payments, must have been paid to date; (2) amounts on deposit or deemed on deposit in the rent reserve account and the additional liquidity account established in connection with the pass through trust certificates issued to finance the acquisition of Somerset and Cayuga must be equal to or greater than the rent reserve account required balance or the additional liquidity required balance, as applicable; (3) no lease material default, lease event of default or event of default under any permitted indebtedness shall have occurred and be then continuing; (4) no amounts may be outstanding under the working capital credit facility; (5) we have no indemnity currently due and payable under specified provisions of the participation agreements relating to the Somerset and Cayuga leases or any other operative document or any obligation to fund the indemnity accounts (as defined in the leases) under the leases; (6) the coverage ratios for each of the two semiannual rent payment periods immediately preceding the rent payment date (based on actual operating history) must be equal to or greater than the required coverage ratio and the pro forma coverage ratios for each of the four semiannual periods immediately succeeding this rent payment date must be equal to or greater than the required coverage ratio; and (7) with respect to the SRC credit facility or any replacement facility, no event of default shall have occurred and be then continuing under the facilities and the remaining term of the SRC credit facility or any replacement facility shall not be less than 30 days. As of June 30, 2002, we were in compliance with all of the conditions of the restricted payment covenant. Investing Activities We incurred approximately $5.1 million and $9.5 million in capital expenditures with regard to our assets for the six months ended June 30, 2002 and 2001, respectively. We will make capital expenditures thereafter according to the maintenance program for our electricity generating stations. In addition to capital requirements associated with the ownership and operation of our electricity generating stations, we will have significant fixed charge obligations in the future, principally with respect to the leases. 24 Compliance with environmental standards will continue to be reflected in our capital expenditures and operating costs. Based on the current status of regulatory requirements, we do not anticipate that any capital expenditures or operating expenses associated with our compliance with current laws and regulations will have a material effect on our results of operations or our financial condition, other than the expenditures for the SCRs at Somerset and Cayuga, including the construction of new landfill space to manage ash from Somerset's SCR system operations and the construction of a SCR system on Cayuga Unit 1, which became operational on June 7, 2001, and expenditures for possible installation of a SCR system on Cayuga Unit 2, the U.S. Department of Energy Power Plant Improvement project on Greenidge Unit 4 and the Westover Overfire Air Project. The AES Corporation contributed approximately $1.5 million to us in the first six months of 2002. The contribution was accounted for as a partner's contribution and was related to the construction of the SCR on Unit 1 of Cayuga, which became operational on June 7, 2001. Credit Rating Discussion Credit ratings affect our ability to execute our commercial strategies in a cost-effective manner. In determining our credit rating, the rating agencies consider a number of factors. Quantitative factors that appear to have significant weight include, among other things, earnings before interest, taxes and depreciation and amortization ("EBITDA"); operating cash flow; total debt outstanding; fixed charges such as interest expense, lease payments; liquidity needs and availability and various ratios calculated from these factors. Qualitative factors appear to include, among other things, predictability of cash flows, business strategy, industry position and contingencies. As of the filing date, the pass through trust certificates issued to finance the acquisition of Somerset and Cayuga carry an investment grade rating (BBB-) from Standard & Poor's Ratings Services and Fitch IBCA, Inc. rating agencies and a non-investment grade rating (Ba1) from Moody's Investors Service, Inc. rating agency. Trigger Events Our commercial agreements typically include adequate assurance provisions relating to trade credit and some agreements have credit rating triggers. These trigger events typically would give counterparties the right to suspend or terminate credit if our credit ratings were downgraded. Under such circumstances, we would need to post collateral to continue transacting risk-management business with many of our counterparties under either adequate assurance or specific credit rating trigger clauses. The cost of posting collateral would have a negative effect on our profitability. If such collateral was not posted, our ability to continue transacting business as before the downgrade would be impaired. As of June 30, 2002, the outstanding exposure to these counterparties was approximately $2.1 million; if netted with outstanding accounts receivable, the exposure is approximately $500 thousand. We have requested credit assurance with a counterparty. The discussions between the two parties are continuing. Financing Activities Cash flow from operations in excess of the aggregate rental payments under our leases may be distributed to AES NY, LLC if certain criteria are met. On January 11, 2002 and July 5, 2002, we made distribution payments of $32.5 million and $31.4 million, respectively. Forward-looking Statements Certain statements contained in this Form 10-Q are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements speak only as of the date hereof. Forward-looking statements can be identified by the use of forward-looking terminology such as "believe," "expects," "may," "intends," "will," "should" or "anticipates" or the negative forms or other variations of these terms or comparable terminology, or by discussions of strategy. Future results covered by the forward-looking statements may not be achieved. Forward-looking statements are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. The most significant risks, uncertainties and other factors are discussed under the heading "Business (a) General Development of Business" in our Annual Report on Form 10-K, and you are urged to read this section and carefully consider such factors. 25 PART II - OTHER INFORMATION Item 1. Legal Proceedings See Note 2 to our Condensed Consolidated Financial Statements and Note 3 to the Condensed Consolidated Balance Sheets of AES NY, L.L.C. in Part I. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None (b) Reports on Form 8-K None 26 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 the undersigned thereunto duly authorized. AES EASTERN ENERGY, L.P. By: AES NY, L.L.C., as General Partner By:/s/ Daniel J. Rothaupt -------------------------------- Daniel J. Rothaupt President By:/s/ Amy Conley --------------------------------- Amy Conley Vice President (principal financial officer) Date: August 14, 2002 27

AES EASTERN ENERGY LP 10-Q