e10vq
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-Q
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended
September 30, 2006
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OR
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to
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Commission file number 1-6732
Covanta Holding
Corporation
(Exact name of registrant as
specified in its charter)
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Delaware
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95-6021257
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(State or other jurisdiction
of
incorporation or organization)
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(I.R.S. Employer
Identification Number)
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40 Lane Road, Fairfield,
NJ
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07004
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(Address of Principal Executive
Office)
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(Zip code)
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(973) 882-9000
(Registrants telephone
number including area code)
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 þ No o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2
of the Exchange Act.
Large accelerated
filer þ Accelerated
filer o
Non-accelerated
filer o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
The number of shares of the registrants Common Stock
outstanding as of the last practicable date.
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Class
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Outstanding at October 25, 2006
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Common Stock, $
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0.10 par value
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147,656,721 shares
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COVANTA
HOLDING CORPORATION AND SUBSIDIARIES
FORM 10-Q
QUARTERLY REPORT
For the Quarter Ended September 30, 2006
1
Cautionary
Note Regarding Forward-Looking Statements
Certain statements in this Quarterly Report on
Form 10-Q
may constitute forward-looking statements as defined
in Section 27A of the Securities Act of 1933 (the
Securities Act), Section 21E of the Securities
Exchange Act of 1934 (the Exchange Act), the Private
Securities Litigation Reform Act of 1995 (the PSLRA)
or in releases made by the Securities and Exchange Commission
(SEC), all as may be amended from time to time. Such
forward-looking statements involve known and unknown risks,
uncertainties and other important factors that could cause the
actual results, performance or achievements of Covanta Holding
Corporation and its subsidiaries (Covanta) or
industry results, to differ materially from any future results,
performance or achievements expressed or implied by such
forward-looking statements. Statements that are not historical
fact are forward-looking statements. Forward-looking statements
can be identified by, among other things, the use of
forward-looking language, such as the words plan,
believe, expect, anticipate,
intend, estimate, project,
may, will, would,
could, should, seeks, or
scheduled to, or other similar words, or the
negative of these terms or other variations of these terms or
comparable language, or by discussion of strategy or intentions.
These cautionary statements are being made pursuant to the
Securities Act, the Exchange Act and the PSLRA with the
intention of obtaining the benefits of the safe
harbor provisions of such laws. Covanta cautions investors
that any forward-looking statements made by Covanta are not
guarantees nor are indicative of future performance. Important
assumptions and other important factors that could cause actual
results to differ materially from those forward-looking
statements with respect to Covanta, include, but are not limited
to, the risks and uncertainties affecting their businesses
described in Item 1A of Covantas Annual Report on
Form 10-K
for the year ended December 31, 2005 and Item 1A of
Part II of this Quarterly Report on
Form 10-Q
and in other securities filings by Covanta.
Although Covanta believes that its plans, intentions and
expectations reflected in or suggested by such forward-looking
statements are reasonable, actual results could differ
materially from a projection or assumption in any of its
forward-looking statements. Covantas future financial
condition and results of operations, as well as any
forward-looking statements, are subject to change and inherent
risks and uncertainties. The forward-looking statements
contained in this Quarterly Report on
Form 10-Q
are made only as of the date hereof and Covanta does not have or
undertake any obligation to update or revise any forward-looking
statements whether as a result of new information, subsequent
events or otherwise, unless otherwise required by law.
2
PART I.
FINANCIAL INFORMATION
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ITEM 1.
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FINANCIAL
STATEMENTS
|
COVANTA
HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
|
|
|
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|
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|
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Three Months Ended
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Nine Months Ended
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September 30,
|
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|
September 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
(Unaudited)
|
|
|
|
(In thousands, except per share amounts)
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|
OPERATING REVENUES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waste and service revenues
|
|
$
|
203,103
|
|
|
$
|
194,176
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|
|
$
|
607,973
|
|
|
$
|
436,624
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|
Electricity and steam sales
|
|
|
104,019
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|
|
|
103,316
|
|
|
|
329,610
|
|
|
|
225,541
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Other operating revenues
|
|
|
3,993
|
|
|
|
3,998
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|
|
|
13,024
|
|
|
|
13,236
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Total operating revenues
|
|
|
311,115
|
|
|
|
301,490
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|
|
|
950,607
|
|
|
|
675,401
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING EXPENSES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Plant operating expenses
|
|
|
161,611
|
|
|
|
152,984
|
|
|
|
522,330
|
|
|
|
394,183
|
|
Depreciation and amortization
expense
|
|
|
47,752
|
|
|
|
44,580
|
|
|
|
142,987
|
|
|
|
78,111
|
|
Net interest expense on project
debt
|
|
|
14,722
|
|
|
|
16,988
|
|
|
|
46,013
|
|
|
|
36,700
|
|
Other operating (income) expenses
|
|
|
(2,959
|
)
|
|
|
2,378
|
|
|
|
1,251
|
|
|
|
7,736
|
|
General and administrative expenses
|
|
|
18,346
|
|
|
|
18,586
|
|
|
|
54,177
|
|
|
|
45,389
|
|
Restructuring charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,655
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|
Acquisition-related charges
|
|
|
|
|
|
|
983
|
|
|
|
|
|
|
|
2,963
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Total operating expenses
|
|
|
239,472
|
|
|
|
236,499
|
|
|
|
766,758
|
|
|
|
567,737
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
71,643
|
|
|
|
64,991
|
|
|
|
183,849
|
|
|
|
107,664
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income
(expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment income
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|
|
2,483
|
|
|
|
1,657
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|
|
|
7,801
|
|
|
|
3,530
|
|
Interest expense
|
|
|
(26,968
|
)
|
|
|
(30,701
|
)
|
|
|
(87,265
|
)
|
|
|
(59,053
|
)
|
Loss on extinguishment of debt
|
|
|
|
|
|
|
|
|
|
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(2,342
|
)
|
|
|
|
|
Unrealized gain on derivative
instruments, unexercised ACL warrants
|
|
|
|
|
|
|
10,578
|
|
|
|
|
|
|
|
14,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Total other expenses
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|
|
(24,485
|
)
|
|
|
(18,466
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)
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|
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(81,806
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)
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|
|
(40,727
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)
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Income before income tax expense,
minority interests and equity in net income from unconsolidated
investments
|
|
|
47,158
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|
|
|
46,525
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|
|
|
102,043
|
|
|
|
66,937
|
|
Income tax expense
|
|
|
(18,870
|
)
|
|
|
(16,391
|
)
|
|
|
(29,795
|
)
|
|
|
(24,008
|
)
|
Minority interests
|
|
|
(1,982
|
)
|
|
|
(2,172
|
)
|
|
|
(4,861
|
)
|
|
|
(9,311
|
)
|
Equity in net income from
unconsolidated investments
|
|
|
4,945
|
|
|
|
9,439
|
|
|
|
26,460
|
|
|
|
20,003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME
|
|
$
|
31,251
|
|
|
$
|
37,401
|
|
|
$
|
93,847
|
|
|
$
|
53,621
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings Per Share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.21
|
|
|
$
|
0.27
|
|
|
$
|
0.65
|
|
|
$
|
0.46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
0.21
|
|
|
$
|
0.26
|
|
|
$
|
0.64
|
|
|
$
|
0.44
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of the condensed
consolidated financial statements.
3
COVANTA
HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
(In thousands, except per
|
|
|
|
share amounts)
|
|
|
ASSETS
|
Current:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
227,562
|
|
|
$
|
128,556
|
|
Marketable securities available for
sale
|
|
|
7,185
|
|
|
|
7,400
|
|
Restricted funds held in trust
|
|
|
212,152
|
|
|
|
197,527
|
|
Receivables (less allowances of
$3,744 and $4,959)
|
|
|
195,410
|
|
|
|
202,893
|
|
Unbilled service receivables
|
|
|
56,101
|
|
|
|
57,588
|
|
Deferred income taxes
|
|
|
45,325
|
|
|
|
21,058
|
|
Prepaid expenses and other assets
|
|
|
76,121
|
|
|
|
79,378
|
|
|
|
|
|
|
|
|
|
|
Total Current Assets
|
|
|
819,856
|
|
|
|
694,400
|
|
Property, plant and equipment, net
|
|
|
2,640,461
|
|
|
|
2,724,843
|
|
Investments in fixed maturities at
market (cost: $39,023 and $44,824)
|
|
|
37,982
|
|
|
|
43,667
|
|
Restricted funds held in trust
|
|
|
252,630
|
|
|
|
249,905
|
|
Unbilled service receivables
|
|
|
75,695
|
|
|
|
86,830
|
|
Intangible assets, net
|
|
|
395,900
|
|
|
|
434,543
|
|
Goodwill
|
|
|
217,548
|
|
|
|
255,927
|
|
Investments in and advances to
unconsolidated investees and joint ventures
|
|
|
84,731
|
|
|
|
66,301
|
|
Deferred income taxes
|
|
|
56,959
|
|
|
|
26,236
|
|
Other assets
|
|
|
116,774
|
|
|
|
119,513
|
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
4,698,536
|
|
|
$
|
4,702,165
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND
STOCKHOLDERS EQUITY
|
Current:
|
|
|
|
|
|
|
|
|
Current portion of long-term debt
|
|
$
|
36,478
|
|
|
$
|
47,549
|
|
Current portion of project debt
|
|
|
163,055
|
|
|
|
174,114
|
|
Accounts payable
|
|
|
24,505
|
|
|
|
19,447
|
|
Deferred revenue
|
|
|
14,525
|
|
|
|
14,524
|
|
Accrued expenses and other
liabilities
|
|
|
189,350
|
|
|
|
205,351
|
|
|
|
|
|
|
|
|
|
|
Total Current
Liabilities
|
|
|
427,913
|
|
|
|
460,985
|
|
Long-term debt
|
|
|
1,245,765
|
|
|
|
1,260,570
|
|
Project debt
|
|
|
1,338,223
|
|
|
|
1,424,170
|
|
Deferred income taxes
|
|
|
576,911
|
|
|
|
533,169
|
|
Other liabilities
|
|
|
320,424
|
|
|
|
343,402
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
3,909,236
|
|
|
|
4,022,296
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies
(Note 16)
|
|
|
|
|
|
|
|
|
Minority Interests
|
|
|
69,304
|
|
|
|
80,628
|
|
|
|
|
|
|
|
|
|
|
Stockholders
Equity:
|
|
|
|
|
|
|
|
|
Preferred stock ($0.10 par
value; authorized 10,000 shares; none issued and
outstanding)
|
|
|
|
|
|
|
|
|
Common stock ($0.10 par value;
authorized 250,000 shares; issued 147,657 and
141,246 shares; outstanding 147,500 and 141,166 shares)
|
|
|
14,766
|
|
|
|
14,125
|
|
Additional paid-in capital
|
|
|
615,422
|
|
|
|
594,186
|
|
Unearned compensation
|
|
|
|
|
|
|
(4,583
|
)
|
Accumulated other comprehensive
income
|
|
|
991
|
|
|
|
535
|
|
Accumulated earnings (deficit)
|
|
|
88,833
|
|
|
|
(5,014
|
)
|
Treasury stock, at par
|
|
|
(16
|
)
|
|
|
(8
|
)
|
|
|
|
|
|
|
|
|
|
Total Stockholders
Equity
|
|
|
719,996
|
|
|
|
599,241
|
|
|
|
|
|
|
|
|
|
|
Total Liabilities and
Stockholders Equity
|
|
$
|
4,698,536
|
|
|
$
|
4,702,165
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of the condensed
consolidated financial statements.
4
COVANTA
HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
For the
|
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
(Unaudited)
|
|
|
|
(In thousands)
|
|
|
OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
93,847
|
|
|
$
|
53,621
|
|
Adjustments to reconcile net income
to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and amortization
expense
|
|
|
142,987
|
|
|
|
78,111
|
|
Revenue contract levelization
|
|
|
3,312
|
|
|
|
1,007
|
|
Amortization of long-term debt
deferred financing costs
|
|
|
7,247
|
|
|
|
5,584
|
|
Amortization of debt premium and
discount
|
|
|
(16,856
|
)
|
|
|
(11,359
|
)
|
Provision for doubtful accounts
|
|
|
286
|
|
|
|
1,107
|
|
Stock-based compensation expense
|
|
|
4,866
|
|
|
|
1,642
|
|
Equity in net income from
unconsolidated investments
|
|
|
(26,460
|
)
|
|
|
(20,003
|
)
|
Dividends from unconsolidated
investments
|
|
|
6,509
|
|
|
|
12,124
|
|
Minority interests
|
|
|
4,861
|
|
|
|
9,311
|
|
Unrealized gain on derivative
instruments, unexercised ACL warrants
|
|
|
|
|
|
|
(14,796
|
)
|
Deferred income taxes
|
|
|
10,874
|
|
|
|
7,057
|
|
Other, net
|
|
|
4,541
|
|
|
|
6,417
|
|
Change in operating assets and
liabilities, net of effects of acquisition:
|
|
|
|
|
|
|
|
|
Restricted funds for emergence costs
|
|
|
|
|
|
|
8,655
|
|
Receivables
|
|
|
2,421
|
|
|
|
21,859
|
|
Unbilled service receivables
|
|
|
12,622
|
|
|
|
10,444
|
|
Accounts payable and accrued
expenses
|
|
|
4,796
|
|
|
|
3,099
|
|
Accrued emergence costs
|
|
|
|
|
|
|
(8,653
|
)
|
Unpaid losses and loss adjustment
expenses
|
|
|
(5,720
|
)
|
|
|
(12,713
|
)
|
Other, net
|
|
|
(16,997
|
)
|
|
|
(4,662
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
|
233,136
|
|
|
|
147,852
|
|
|
|
|
|
|
|
|
|
|
INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Purchase of ARC Holdings
|
|
|
|
|
|
|
(747,217
|
)
|
Cash acquired from ARC Holdings
|
|
|
|
|
|
|
62,358
|
|
Proceeds from the sale of
investment securities
|
|
|
6,692
|
|
|
|
11,542
|
|
Purchase of investment securities
|
|
|
(774
|
)
|
|
|
(2,605
|
)
|
Purchase of property, plant and
equipment
|
|
|
(35,693
|
)
|
|
|
(14,127
|
)
|
Other, net
|
|
|
4,468
|
|
|
|
1,839
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing
activities
|
|
|
(25,307
|
)
|
|
|
(688,210
|
)
|
|
|
|
|
|
|
|
|
|
FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Proceeds from the 9.25% rights
offering, net
|
|
|
20,498
|
|
|
|
|
|
Proceeds from the ARC Holdings
rights offering, net
|
|
|
|
|
|
|
395,871
|
|
Proceeds from the exercise of
options for common stock
|
|
|
1,126
|
|
|
|
3,881
|
|
Purchase of treasury stock
|
|
|
|
|
|
|
(897
|
)
|
Proceeds from borrowings on
long-term debt
|
|
|
97,619
|
|
|
|
675,000
|
|
Proceeds from borrowings on project
debt
|
|
|
6,233
|
|
|
|
42,447
|
|
Principal payments on long-term debt
|
|
|
(120,080
|
)
|
|
|
(336,492
|
)
|
Principal payments on project debt
|
|
|
(86,612
|
)
|
|
|
(96,127
|
)
|
Premium received on refinancing of
long-term debt
|
|
|
|
|
|
|
1,862
|
|
Payments of long-term debt deferred
financing costs
|
|
|
(2,129
|
)
|
|
|
(34,574
|
)
|
Increase in holding company
restricted funds
|
|
|
|
|
|
|
(6,471
|
)
|
Increase in restricted funds held
in trust
|
|
|
(17,451
|
)
|
|
|
(24,926
|
)
|
Distributions to minority partners
|
|
|
(7,990
|
)
|
|
|
(9,632
|
)
|
Other, net
|
|
|
(37
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by
financing activities
|
|
|
(108,823
|
)
|
|
|
609,942
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash
equivalents
|
|
|
99,006
|
|
|
|
69,584
|
|
Cash and cash equivalents at
beginning of period
|
|
|
128,556
|
|
|
|
96,148
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
period
|
|
$
|
227,562
|
|
|
$
|
165,732
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of the condensed
consolidated financial statements.
5
COVANTA
HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS
EQUITY
For The Nine Months Ended September 30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
|
|
|
Other
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
Paid-In
|
|
|
Unearned
|
|
|
Comprehensive
|
|
|
Earnings
|
|
|
Treasury Stock
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Compensation
|
|
|
Income
|
|
|
(Deficit)
|
|
|
Shares
|
|
|
Amount
|
|
|
Total
|
|
|
|
(Unaudited)
|
|
|
|
(In thousands)
|
|
|
Balance as of December 31, 2005
|
|
|
141,246
|
|
|
$
|
14,125
|
|
|
$
|
594,186
|
|
|
$
|
(4,583
|
)
|
|
$
|
535
|
|
|
$
|
(5,014
|
)
|
|
|
80
|
|
|
$
|
(8
|
)
|
|
$
|
599,241
|
|
Reclass of unearned compensation
upon adoption of SFAS 123R
|
|
|
|
|
|
|
|
|
|
|
(4,583
|
)
|
|
|
4,583
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares issued in 9.25% rights
offering
|
|
|
5,697
|
|
|
|
570
|
|
|
|
19,928
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,498
|
|
Stock-based compensation expense
|
|
|
|
|
|
|
|
|
|
|
4,866
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,866
|
|
Shares cancelled for terminated
employees
|
|
|
|
|
|
|
|
|
|
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
71
|
|
|
|
(7
|
)
|
|
|
|
|
Shares cancelled for non-vested
stock rights for terminated employee
|
|
|
|
|
|
|
|
|
|
|
(37
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6
|
|
|
|
(1
|
)
|
|
|
(38
|
)
|
Exercise of options to purchase
common stock
|
|
|
178
|
|
|
|
18
|
|
|
|
1,108
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,126
|
|
Shares issued in non-vested stock
award
|
|
|
536
|
|
|
|
53
|
|
|
|
(53
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income, net of income
taxes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
93,847
|
|
|
|
|
|
|
|
|
|
|
|
93,847
|
|
Foreign currency translation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(113
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(113
|
)
|
Net unrealized gain on
available-for-sale
securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
337
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
337
|
|
Net unrealized gain on derivative
instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
232
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
232
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
456
|
|
|
|
93,847
|
|
|
|
|
|
|
|
|
|
|
|
94,303
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of September 30,
2006
|
|
|
147,657
|
|
|
$
|
14,766
|
|
|
$
|
615,422
|
|
|
$
|
|
|
|
$
|
991
|
|
|
$
|
88,833
|
|
|
|
157
|
|
|
$
|
(16
|
)
|
|
$
|
719,996
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of the condensed
consolidated financial statements.
6
COVANTA
HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
|
|
Note 1.
|
Organization
and Basis of Presentation
|
Organization
Covanta Holding Corporation (Covanta) is a holding
company that owns subsidiaries engaged in the businesses of
waste and energy services, and insurance services. The
predominant business is the waste and energy business which is
comprised of Covanta Energy Corporation and its subsidiaries
(Covanta Energy), which subsidiaries include Covanta
ARC Holdings, Inc. and its subsidiaries (ARC
Holdings), which Covanta Energy acquired on June 24,
2005 (the Acquisition Date). See Note 3.
Acquisition. Covantas business segments are comprised of
Waste and Energy Services, which is comprised of Covanta
Energys domestic and international operations, and Other
Services, which is comprised of the holding company and
insurance subsidiaries operations.
Covanta Energy and its domestic subsidiaries develop, construct,
own and operate for themselves and others infrastructure for the
conversion of
waste-to-energy,
waste disposal and independent power production businesses in
the United States. Covanta Energys subsidiary, Covanta
Power International Holdings, Inc. and its subsidiaries
(CPIH), engage primarily in the independent power
production business outside the United States.
Covanta also has investments in subsidiaries engaged in
insurance operations in California. Covanta holds all of the
voting stock of Danielson Indemnity Company (DIND).
DIND owns 100% of the common stock of National American
Insurance Company of California, Covantas principal
operating insurance subsidiary. National American Insurance
Company of California and its subsidiaries are collectively
referred to herein as NAICC. The operations of NAICC
are primarily in property and casualty insurance. NAICC writes
non-standard private automobile insurance policies in California.
Basis
of Presentation
The accompanying unaudited condensed consolidated financial
statements of Covanta have been prepared in accordance with the
instructions to
Form 10-Q.
As permitted by the rules and regulations of the Securities and
Exchange Commission (SEC), the financial statements
contain certain condensed financial information and exclude
certain footnote disclosures normally included in audited
consolidated financial statements prepared in accordance with
United States generally accepted accounting principles
(GAAP). In presenting the unaudited condensed
consolidated financial statements, management makes estimates
and assumptions that affect the amounts reported and related
disclosures. Estimates, by their nature, are based on judgments
and available information. Accordingly, actual results could
differ from those estimates. In the opinion of management, the
accompanying financial statements contain all adjustments,
including normal recurring accruals, necessary to fairly present
the accompanying financial statements. Operating results for the
interim period are not necessarily indicative of the results
that may be expected for the fiscal year ending
December 31, 2006. For further information, refer to the
consolidated financial statements and footnotes thereto included
in Covantas Annual Report on
Form 10-K
for the year ended December 31, 2005.
The condensed consolidated financial statements include the
accounts of Covanta and its wholly-owned subsidiaries. Companies
in which Covanta owns between 20-50% are accounted for using the
equity method. Those companies in which Covanta owns less than
20% are accounted for using the cost method. Certain prior
period amounts have been reclassified in the condensed
consolidated financial statements to conform to the current
period presentation. All intercompany transactions and balances
have been eliminated.
7
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
Note 2.
|
New
Accounting Pronouncements
|
In June 2006, the Financial Accounting Standards Board
(FASB) issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109
(FIN 48). This interpretation increases the
relevancy and comparability of financial reporting by clarifying
the way companies account for uncertainty in income taxes.
FIN 48 prescribes a consistent recognition threshold and
measurement attribute, as well as clear criteria for
subsequently recognizing, derecognizing and measuring such tax
positions for financial statement purposes. The interpretation
also requires expanded disclosure with respect to the
uncertainty in income taxes. FIN 48 is effective for fiscal
years beginning after December 15, 2006. Covanta is
evaluating the potential impact of this interpretation on its
consolidated financial statements.
In September 2006, the FASB issued Statement of Financial
Accounting Standards (SFAS) No. 157, Fair
Value Measurements (SFAS 157).
SFAS 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles
and expands disclosures about fair value measurements.
SFAS 157 will be applied under other accounting principles
that require or permit fair value measurements, as this is a
relevant measurement attribute. This statement does not require
any new fair value measurements. SFAS 157 is effective for
fiscal years beginning after November 15, 2007 and interim
periods within those fiscal years. Covanta is currently
evaluating the impact of this statement on its consolidated
financial statements.
In September 2006, the FASB issued SFAS No. 158,
Employers Accounting for Defined Benefit Pension and
Other Postretirement Plans an amendment of FASB
Statements No. 87, 88, 106, and 132(R)
(SFAS 158). SFAS 158 will require
recognition of the overfunded or underfunded positions of
defined benefit pension and other postretirement benefit plans
on the balance sheet. For an underfunded plan, the incremental
liability to be recorded would be equal to the difference
between the projected benefit obligation and the fair value of
plan assets. SFAS No. 87, Employers
Accounting for Pensions (SFAS 87) and
SFAS No. 106, Employers Accounting for
Postretirement Benefits Other Than Pensions
(SFAS 106) allow for deferred recognition of
this liability through amortization of this difference over
time. Under SFAS 158, actuarial gains and losses and prior
service costs and credits that arise during the period but,
pursuant to SFAS 87 and SFAS 106 are not yet
recognized as components of net periodic benefit cost, would be
recognized as a component of accumulated other comprehensive
income, net of tax. SFAS 158 requires an adjustment to the
beginning balance of accumulated earnings, net of tax, for any
transition obligation remaining from the initial application of
SFAS 87 and SFAS 106. Such amounts would not be
subsequently amortized as a component of net periodic benefit
cost. SFAS 158 is effective for fiscal years ending after
December 15, 2006. Covanta is currently evaluating the
impact of this statement on its consolidated financial
statements.
ARC
Holdings
On June 24, 2005, Covanta, through its wholly-owned
subsidiary Covanta Energy, purchased 100% of the issued and
outstanding shares of ARC Holdings capital stock. Under
the terms of the stock purchase agreement, Covanta paid
approximately $747 million in cash and transaction costs
for the capital stock of ARC Holdings and assumed the
consolidated net debt of ARC Holdings of $1.3 billion at
June 24, 2005 ($1.5 billion of consolidated
indebtedness net of $0.2 billion of cash and restricted
cash). The acquisition of ARC Holdings was financed by a
combination of debt and equity described below. Immediately
after the transaction was completed, ARC Holdings became a
wholly-owned subsidiary of Covanta Energy.
As part of the ARC Holdings acquisition, Covanta Energy entered
into credit arrangements which totaled approximately
$1.1 billion and are guaranteed by Covanta and certain
domestic subsidiaries of Covanta Energy. The proceeds from these
credit arrangements were used to fund the acquisition of ARC
Holdings, to refinance approximately $479 million of
Covanta Energys existing recourse debt and letters of
credit, and to pay related fees and expenses. The revolving
credit and letter of credit facilities are further available for
ongoing permitted
8
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
expenditures and for general corporate purposes. These credit
arrangements were amended in May 2006. For details related to
these amended financing arrangements, see Note 12. Changes
in Capitalization.
The equity component of the financing consisted of a
$400 million offering of warrants to purchase
Covantas common stock (the ARC Holdings Rights
Offering). Such warrants entitled Covantas existing
stockholders to purchase Covantas stock on a pro rata
basis, with each holder entitled to purchase 0.9 shares of
Covantas common stock at an exercise price of $6.00 for
each share of Covantas common stock held as of
May 27, 2005, the record date. Covanta received net
proceeds of approximately $395.8 million ($400 million
gross proceeds, net of $4.2 million of expenses) and issued
66,673,004 shares of common stock.
Three of Covantas largest stockholders, SZ Investments
L.L.C. (together with its affiliate EGI-Fund (05-07) Investors,
L.L.C. to which it transferred a portion of its shares, SZ
Investments), Third Avenue Business Trust, on behalf of
Third Avenue Value Fund Series (Third Avenue),
and D. E. Shaw Laminar Portfolios, L.L.C. (Laminar),
representing an aggregate ownership, at the time of the ARC
Holdings Rights Offering, of approximately 40% of Covantas
outstanding common stock, committed to participate in the ARC
Holdings Rights Offering and acquired at least their pro rata
portion of the shares. As consideration for their commitments,
Covanta paid each of these stockholders an amount equal to 1.75%
of their respective equity commitments, which in the aggregate
was $2.8 million and was accounted for as a reduction of
the ARC Holdings Rights Offering proceeds. See Note 17.
Related-Party Transactions.
The purchase price was comprised of the following (in millions
of dollars):
|
|
|
|
|
Cash
|
|
$
|
740.0
|
|
Debt assumed
|
|
|
1,494.0
|
|
Direct transaction costs
|
|
|
7.3
|
|
Restructuring liability
|
|
|
9.1
|
|
|
|
|
|
|
|
|
$
|
2,250.4
|
|
|
|
|
|
|
The purchase price included acquisition-related restructuring
charges of $9.1 million which were recorded as a liability
and assumed in the ARC Holdings acquisition, and consisted
primarily of severance and related benefits, and the costs of
vacating duplicate facilities. As of September 30, 2006,
the remaining acquisition-related restructuring liability was
$4.4 million.
9
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following table summarizes the purchase price allocation of
the assets acquired and liabilities assumed at the Acquisition
Date in conformity with the SFAS No. 141,
Business Combinations (SFAS 141)
and SFAS No. 109, Accounting for Income
Taxes (SFAS 109) (in thousands of
dollars):
|
|
|
|
|
Current assets
|
|
$
|
233,659
|
|
Property, plant and equipment
|
|
|
1,982,847
|
|
Intangible assets (excluding
goodwill)
|
|
|
287,421
|
|
Goodwill
|
|
|
217,548
|
|
Other assets
|
|
|
146,495
|
|
|
|
|
|
|
Total assets acquired
|
|
$
|
2,867,970
|
|
|
|
|
|
|
Current liabilities
|
|
$
|
76,258
|
|
Current portion of long-term debt
|
|
|
29,958
|
|
Current portion of project debt
|
|
|
64,344
|
|
Long-term debt
|
|
|
662,379
|
|
Project debt
|
|
|
737,385
|
|
Deferred income taxes
|
|
|
377,211
|
|
Other liabilities
|
|
|
170,029
|
|
|
|
|
|
|
Total liabilities assumed
|
|
|
2,117,564
|
|
|
|
|
|
|
Minority interest acquired
|
|
|
3,058
|
|
|
|
|
|
|
Net assets acquired
|
|
$
|
747,348
|
|
|
|
|
|
|
The acquired intangible assets of $287.4 million relate to
favorable energy and waste contracts, landfill rights, other
nonamortizing intangibles and a favorable leasehold interest
with an approximate ten-year average useful life. As part of
Covantas purchase price allocation during the quarter
ended June 30, 2006 for the ARC Holdings acquisition,
goodwill was adjusted to reflect a $28.6 million reversal
of a deferred tax asset valuation allowance as discussed in
Note 11. Income Taxes. Goodwill also reflects an increase
to the carrying value of property, plant and equipment of
$9.5 million; an increase to the deferred tax liability of
$6.9 million; a reduction to the liability of
$27.4 million owed to one of the prior owners of ARC
Holdings (see Note 10. Other Noncurrent Liabilities); an
increase in an unfavorable waste contract of $12.1 million;
and various other asset and liability adjustments of
$8.1 million. As of September 30, 2006, goodwill was
$217.5 million.
Pro
Forma Results of Operations
The results of operations from ARC Holdings are included in
Covantas consolidated results of operations from
June 25, 2005. The following table sets forth certain pro
forma unaudited consolidated operating results for
10
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
2005, as if the acquisition of ARC Holdings was consummated on
the same terms at January 1, 2005 (in thousands of dollars,
except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
Pro Forma
|
|
September 30, 2005
|
|
|
September 30, 2005
|
|
|
Total operating revenues
|
|
$
|
301,490
|
|
|
$
|
905,713
|
|
Net income
|
|
$
|
33,138
|
|
|
$
|
56,511
|
|
Basic earnings per share:
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
140,086
|
|
|
|
140,207
|
|
Earnings per share
|
|
$
|
0.24
|
|
|
$
|
0.40
|
|
Diluted earnings per share:
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
145,737
|
|
|
|
145,907
|
|
Earnings per share
|
|
$
|
0.23
|
|
|
$
|
0.39
|
|
Restructuring
and Acquisition-Related Charges
Covanta Energy incurred restructuring costs in 2005 of
$2.7 million. The restructuring costs resulted from
$2.1 million of severance payments to CPIH executives in
connection with overhead reductions made possible by the
elimination of CPIHs separate capital structure during the
second quarter of 2005. An additional $0.6 million was paid
to remaining CPIH executives as incentive payments from existing
contractual obligations relating to CPIH debt repayment in
connection with the ARC Holdings acquisition.
In connection with the acquisition of ARC Holdings, Covanta
Energy incurred integration costs of $1.0 million and
$3.0 million for the three and nine months ended
September 30, 2005, primarily related to professional fees
and employee incentive costs. These charges were included as
part of the operating costs of the Waste and Energy Services
segment.
11
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
Note 4.
|
Stock-Based
Compensation
|
Effective January 1, 2006, Covanta adopted the fair value
recognition provisions of SFAS No. 123 (revised 2004),
Share-Based Payments (SFAS 123R)
using the modified prospective transition method and therefore
has not restated results for prior periods. Under this
transition method, stock-based compensation expense for the
three and nine months ended September 30, 2006 included
compensation expense for stock-based compensation awards granted
prior to, but not yet vested as of, December 31, 2005,
based on the grant date fair value estimated in accordance with
the original provision of SFAS No. 123,
Accounting for Stock-Based Compensation
(SFAS 123). Stock-based compensation expense
for all stock-based compensation awards granted after
December 31, 2005 is based on the grant date fair value
estimated in accordance with the provisions of SFAS 123R.
In March 2005, the SEC issued Staff Accounting
Bulletin No. 107 (SAB 107) regarding
the SECs interpretation of SFAS 123R and the
valuation of share-based payments for public companies. Covanta
has applied the provisions of SAB 107 in its adoption of
SFAS 123R.
Covanta recognized compensation expense based upon the number of
stock options and restricted stock awards expected to vest,
which was determined based on historical turnover experience of
Covanta Energy employees populations from the Covanta
Energy pension plan. During the quarter ended September 30,
2006, Covanta adjusted the number of stock options and
restricted stock awards expected to vest due to additional stock
option and restricted stock grants as described below and
increased forfeitures of stock options and stock awards as
compared to previous estimations. Covanta recognizes
compensation costs using the graded vesting attribution method
over the requisite service period of the award, which is
generally the vesting term of three years.
The impact to the condensed consolidated financial statements,
as a result of Covantas adoption of SFAS 123R
compared to continued recognition of stock-based compensation
under Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to
Employees (APB 25), was not material to
income before income taxes and net income for the nine months
ended September 30, 2006. The impact on both basic and
diluted earnings per share was less than $0.01 per share
for both the three and nine months ended September 30,
2006. The reductions that resulted from the adoption of
SFAS 123R reflected the stock-based compensation expense
associated with the unvested stock option awards. Stock-based
compensation expense previously recognized in accordance with
APB 25 for restricted stock awards remained essentially
unchanged under the provisions of SFAS 123R.
Covanta received $0.5 million and $1.1 million from
the exercise of non-qualified stock options in the three and
nine months ended September 30, 2006, respectively. The tax
benefits related to the exercise of the non-qualified stock
options and the vesting of the restricted stock award were not
recognized during the nine months of 2006 due to Covantas
net operating loss carryforwards (NOLs). When the
NOLs have been fully utilized by Covanta, Covanta will recognize
a tax benefit and an increase in additional paid-in capital for
the excess tax deductions received on the exercised
non-qualified stock options and vested restricted stock. Future
realization of the tax benefit will be presented in cash flows
from financing activities in the condensed consolidated
statements of cash flows in the period the tax benefit is
recognized.
12
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Prior to the adoption of SFAS 123R, Covanta recognized
stock-based compensation expense in accordance with APB 25
and followed the disclosure requirements of SFAS 123. The
following table illustrates the effect on net income and
earnings per share as if Covanta had applied the fair value
recognition provisions of SFAS 123, as amended by
SFAS No. 148, Accounting for Stock-Based
Compensation Transition and Disclosure (in
thousands of dollars, except per share amounts).
|
|
|
|
|
|
|
|
|
|
|
Three
|
|
|
Nine
|
|
|
|
Months Ended
|
|
|
Months Ended
|
|
|
|
September 30, 2005
|
|
|
September 30, 2005
|
|
|
Net income, as reported
|
|
$
|
37,401
|
|
|
$
|
53,621
|
|
Pro forma stock-based compensation
expense
|
|
|
(1,007
|
)
|
|
|
(2,413
|
)
|
|
|
|
|
|
|
|
|
|
Pro forma net income
|
|
$
|
36,394
|
|
|
$
|
51,208
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share:
|
|
|
|
|
|
|
|
|
As reported
|
|
$
|
0.27
|
|
|
$
|
0.46
|
|
Pro forma
|
|
$
|
0.26
|
|
|
$
|
0.44
|
|
Diluted earnings per share:
|
|
|
|
|
|
|
|
|
As reported
|
|
$
|
0.26
|
|
|
$
|
0.44
|
|
Pro forma
|
|
$
|
0.25
|
|
|
$
|
0.42
|
|
Stock-Based
Awards
Covanta adopted the Covanta Holding Corporation Equity Award
Plan for Employees and Officers (the Employees Plan)
and the Covanta Holding Corporation Equity Award Plan for
Directors (the Directors Plan) (collectively, the
Award Plans), effective with stockholder approval on
October 5, 2004. On July 25, 2005, the Covanta Board
of Directors approved and on September 19, 2005,
Covantas stockholders approved the amendment to the
Employees Plan to authorize the issuance of an additional
2,000,000 shares. The 1995 Stock and Incentive Plan (the
1995 Plan) was terminated with respect to any future
awards under such plan on October 5, 2004 upon stockholder
approval of the Award Plans. The 1995 Plan will remain in effect
until all awards have been satisfied or expired.
Restricted
Stock Awards
Restricted stock awards that have been issued to employees and
directors typically vest over a three-year period. Restricted
stock awards are stock-based awards for which the employee or
director does not have a vested right to the stock
(nonvested) until the requisite service period has
been rendered and the required financial performance factor has
been reached for each pre-determined vesting date. A percentage
of each employee restricted stock awards granted have financial
performance factors. Stock-based compensation expense for each
financial performance factor is recognized beginning in the
period when management has determined it is probable the
financial performance factor will be achieved for the respective
vesting period.
Restricted stock awards to employees are subject to forfeiture
if the employee is not employed on the vesting date. Restricted
stock awards issued to directors prior to 2006 were subject to
the same forfeiture restrictions as are applicable to employees.
Restricted stock awards issued to directors in 2006 are not
subject to forfeiture in the event a director ceases to be a
member of the Board of Directors, except in limited
circumstances. Prior to vesting, restricted stock awards have
all of the rights of common stock (other than the right to sell
or otherwise transfer or to receive dividends, when issued). The
fair value of restricted stock awards is based on the average of
the high and low market price of Covantas common stock on
the day immediately preceding the grant date of the award.
On March 17, 2006, the Compensation Committee of the Board
of Directors, under the Employees Plan, awarded certain
employees 480,055 shares of restricted stock. The
restricted stock awards will be expensed over the requisite
service period, and assumes an eight percent forfeiture rate.
The terms of the restricted stock awards include vesting
provisions based on two financial performance factors
(applicable to 66% of the award) and continued service over the
passage of time (applicable to 34% of the award). If all
performance and service criteria
13
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
are satisfied, the awards vest over three years, with
160,002 shares (33.33%) vesting on March 17, 2007,
160,002 shares (33.33%) vesting on March 17, 2008 and
the remaining 160,051 shares (33.34%) vesting on
March 17, 2009.
On May 31, 2006, in accordance with its existing program
for annual director compensation, Covanta granted
36,000 shares of restricted stock under the Directors Plan.
The awards have a requisite service based vesting period as
follows: 12,000 shares (33.33%) vested on May 31,
2006; 12,000 shares (33.33%) vesting on May 31, 2007;
and 12,000 shares (33.34%) vesting on May 31, 2008.
Covanta determined that the service vesting condition of the
restricted stock awards granted to the directors on May 31,
2006 to be non-substantive and, in accordance with
SFAS 123R, recorded the entire fair value of the awards as
compensation expense in the three months ended June 30,
2006.
Covanta entered into an employment agreement with Mark A. Pytosh
to serve as Covantas Senior Vice President and Chief
Financial Officer (the Employment Agreement). The
Employment Agreement was effective as of September 1, 2006
and has a term expiring October 5, 2009. Pursuant to the
Employment Agreement, upon commencement of his employment on
September 1, 2006, Mr. Pytosh received a grant of
20,000 shares of restricted stock. The restricted stock
award will be expensed over the requisite service period. The
terms of the restricted stock award include vesting provisions
based on financial performance factors (applicable to 66% of the
award) and continued service over the passage of time
(applicable to 34% of the award). If all performance and service
criteria are satisfied, the award vests over three years, with
6,666 shares vesting on March 17, 2007,
6,667 shares vesting on March 17, 2008 and the
remaining 6,667 shares vesting on March 17, 2009.
Changes in nonvested restricted stock awards during the nine
months ended September 30, 2006 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Average
|
|
|
|
Number of
|
|
|
Grant Date
|
|
|
|
Shares
|
|
|
Fair Value
|
|
|
Nonvested at December 31, 2005
|
|
|
828,154
|
|
|
$
|
9.88
|
|
Granted
|
|
|
536,055
|
|
|
|
17.05
|
|
Vested
|
|
|
(351,105
|
)
|
|
|
9.17
|
|
Forfeited
|
|
|
(71,309
|
)
|
|
|
13.14
|
|
|
|
|
|
|
|
|
|
|
Nonvested at September 30,
2006
|
|
|
941,795
|
|
|
|
13.82
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2006, there was $8.6 million
unrecognized stock-based compensation expense related to
nonvested restricted stock awards. This expense is expected to
be recognized over a period of up to three years. Total
compensation expense for restricted stock awards was
$1.2 million and $4.0 million for the three and nine
months ended September 30, 2006, respectively.
Stock
Options
Covanta has also awarded stock options to certain employees and
directors. Stock options awarded to directors vested
immediately. Stock options awarded to employees typically vested
annually over three years. Covanta had one nonvested stock
option award outstanding as of December 31, 2005, which was
granted in October 2004. The fair value of the options was
calculated using the Black-Scholes option pricing model with the
following assumptions: fair value option price
$5.68; risk-free interest rate 4.25%; dividend
yield 0%; expected volatility (based on historical
volatility) 76%; and expected life
8 years.
Pursuant to the Employment Agreement as discussed above, upon
commencement of his employment on September 1, 2006,
Mr. Pytosh received options to purchase 50,000 shares
of Covantas common stock. The options have an exercise
price of $20.35 per share and expire ten years from the
date of grant. The options vest in two equal installments, with
25,000 shares vesting on February 28, 2007 and
25,000 shares vesting on February 28, 2008. The fair
value of the options was calculated using the Black-Scholes
option pricing model with the following
14
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
assumptions: fair value option price $10.90;
risk-free interest rate 4.65%; dividend
yield 0%; expected volatility (based on historical
volatility) 40%; and expected life
8 years.
Option activity for all outstanding options, vested and
nonvested, from January 1, 2006 through September 30,
2006 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Aggregate
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual Life
|
|
|
Intrinsic Value
|
|
|
|
Shares
|
|
|
Price
|
|
|
(In years)
|
|
|
(In thousands)
|
|
|
Outstanding at December 31,
2005
|
|
|
1,243,208
|
|
|
$
|
7.41
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
50,000
|
|
|
|
20.35
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(178,210
|
)
|
|
|
6.32
|
|
|
|
|
|
|
|
|
|
Forfeited and cancelled
|
|
|
(85,334
|
)
|
|
|
7.43
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30,
2006
|
|
|
1,029,664
|
|
|
|
8.22
|
|
|
|
7.5
|
|
|
$
|
13,702
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest in the
future at September 30, 2006
|
|
|
978,891
|
|
|
|
8.21
|
|
|
|
7.4
|
|
|
$
|
13,039
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30,
2006
|
|
|
394,998
|
|
|
|
7.86
|
|
|
|
6.4
|
|
|
$
|
5,400
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value in the table above represents the
total pre-tax intrinsic value (the difference between the
closing stock price on the last trading day of the third quarter
of 2006 and the exercise price, multiplied by the number of
in-the-money
options) that would have been received by the option holders had
all option holders exercised their options on the last trading
day of the third quarter of 2006 (September 29, 2006). The
intrinsic value changes based on the fair market value of
Covantas common stock. Total intrinsic value of options
exercised for the nine months ended September 30, 2006 was
$2.1 million. The total fair value of options expensed was
$0.3 million and $0.9 million for the three and nine
months ended September 30, 2006, respectively.
As of September 30, 2006, there was $1.5 million of
total unrecognized compensation expense related to stock options
which is expected to be recognized over a weighted-average
period of 1.4 years.
|
|
Note 5.
|
Earnings
Per Share
|
Per share data is based on the weighted average outstanding
number of shares of Covantas common stock, par value
$0.10 per share, during the relevant period. Basic earnings
per share are calculated using only the weighted average number
of outstanding shares of common stock. Diluted earnings per
share computations, as calculated under the treasury stock
method, include the weighted average number of shares of
additional outstanding common stock issuable for stock options,
restricted stock, and rights whether or not currently
exercisable. Diluted earnings per share for all the periods
presented do not include shares related to stock options and
rights if their effect was anti-dilutive (in thousands, except
per share amounts).
15
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
Net income
|
|
$
|
31,251
|
|
|
$
|
37,401
|
|
|
$
|
93,847
|
|
|
$
|
53,621
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average basic common
shares outstanding
|
|
|
146,418
|
|
|
|
140,086
|
|
|
|
145,393
|
|
|
|
116,181
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share
|
|
$
|
0.21
|
|
|
$
|
0.27
|
|
|
$
|
0.65
|
|
|
$
|
0.46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average basic common
shares outstanding
|
|
|
146,418
|
|
|
|
140,086
|
|
|
|
145,393
|
|
|
|
116,181
|
|
Stock options
|
|
|
559
|
|
|
|
545
|
|
|
|
546
|
|
|
|
733
|
|
Restricted stock
|
|
|
289
|
|
|
|
1,049
|
|
|
|
227
|
|
|
|
801
|
|
Rights
|
|
|
|
|
|
|
4,057
|
|
|
|
544
|
|
|
|
4,166
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average diluted common
shares outstanding
|
|
|
147,266
|
|
|
|
145,737
|
|
|
|
146,710
|
|
|
|
121,881
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per share
|
|
$
|
0.21
|
|
|
$
|
0.26
|
|
|
$
|
0.64
|
|
|
$
|
0.44
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
There were 50,000 stock options excluded from the weighted
average diluted common shares calculation for the three and nine
months ended September 30, 2006 because their inclusion
would have been anti-dilutive as their exercise price was higher
than the average market price during the respective periods.
Basic and diluted earnings per share and the weighted average
shares outstanding have been retroactively adjusted in 2005 to
reflect the bonus element contained in the ARC Holdings Rights
Offering that was consummated in June 2005. See Note 3.
Acquisition for information related to the ARC Holdings Rights
Offering.
|
|
Note 6.
|
Pass
Through Costs
|
Pass through costs are costs for which Covanta Energy receives a
direct contractually committed reimbursement from the municipal
client which sponsors a
waste-to-energy
project. These costs generally include utility charges,
insurance premiums, ash residue transportation and disposal and
certain chemical costs. These costs are recorded net of
municipal client reimbursements in Covantas condensed
consolidated financial statements. Total pass through costs were
$12.0 million and $13.4 million for three months ended
September 30, 2006 and 2005, respectively, and
$40.4 million and $43.4 million for the nine months
ended September 30, 2006 and 2005, respectively.
16
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
Note 7.
|
Revenues
and Unbilled Service Receivables
|
The following table summarizes the components of waste and
service revenues for the periods presented below (in thousands
of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months
|
|
|
For the Nine Months
|
|
|
|
Ended September 30,
|
|
|
Ended September 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
Waste and service revenues
unrelated to project debt
|
|
$
|
176,549
|
|
|
$
|
166,382
|
|
|
$
|
528,094
|
|
|
$
|
365,910
|
|
Revenue earned explicitly to
service project debt-principal
|
|
|
17,274
|
|
|
|
16,940
|
|
|
|
51,822
|
|
|
|
44,478
|
|
Revenue earned explicitly to
service project debt-interest
|
|
|
9,280
|
|
|
|
10,854
|
|
|
|
28,057
|
|
|
|
26,236
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total waste and service revenues
|
|
$
|
203,103
|
|
|
$
|
194,176
|
|
|
$
|
607,973
|
|
|
$
|
436,624
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unbilled service receivables include fees related to the
principal portion of debt service earned to service project debt
principal where such fees are expressly included as a component
of the service fee paid by the municipality pursuant to
applicable
waste-to-energy
service agreements. Regardless of the timing of amounts paid by
municipalities relating to project debt principal, Covanta
Energy records service revenue with respect to this principal
component on a levelized basis over the term of the service
agreement. Long-term unbilled service receivables related to
waste-to-energy
operations are recorded at their discounted amounts.
Electricity and steam sales included lease income from the
international business of $18.1 million and
$23.2 million for the three months ended September 30,
2006 and 2005, respectively, and $79.4 million and
$73.9 million for the nine months ended September 30,
2006 and 2005, respectively.
|
|
Note 8.
|
Equity in
Net Income from Unconsolidated Investments
|
Equity in net income from unconsolidated investments was
$4.9 million and $9.4 million for the three months
ended September 30, 2006 and 2005, respectively, and
$26.5 million and $20.0 million for the nine months
ended September 30, 2006 and 2005, respectively. Equity in
net income from unconsolidated investments primarily relates to
Covanta Energys 26% investment in Quezon Power, Inc.
(Quezon). The unaudited results of operations from
Quezon were as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quezon
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended September 30,
|
|
|
Ended September 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
Revenue
|
|
$
|
70,198
|
|
|
$
|
74,307
|
|
|
$
|
202,771
|
|
|
$
|
184,614
|
|
Operating income
|
|
|
32,478
|
|
|
|
35,614
|
|
|
|
82,541
|
|
|
|
79,383
|
|
Net income
|
|
|
9,030
|
|
|
|
26,859
|
|
|
|
72,346
|
|
|
|
52,807
|
|
Equity in net income from unconsolidated investments for the
nine months ended September 30, 2006 includes approximately
$5.6 million of cumulative deferred income tax benefits
related to unrealized foreign exchange losses at its Quezon
facility that are expected to be tax deductible for Philippine
tax purposes in future years. Covanta Energy recorded a
cumulative deferred income tax benefit of $7.0 million in
the quarter ended June 30, 2006 on the basis of rulings
which were issued by the Philippine tax authorities in June 2006
clarifying the tax deductibility of such losses upon
realization. The realization of this deferred tax benefit is
subject to fluctuations in the value of the Philippine peso
versus the US dollar. During the three months ended
September 30, 2006, Covanta reduced this cumulative
deferred income tax benefit by approximately $1.4 million
as a result of the strengthening of the Philippine peso versus
the US dollar.
17
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Over the last six years, Quezon has benefited from Philippine
tax regulations which were designed to promote investments in
certain industries (including power generation). Equity in net
income from unconsolidated investments for the three months
ended September 30, 2006 includes approximately
$1.8 million of increased tax expense for Quezon related to
the conclusion of this six-year income tax holiday in May 2006.
|
|
Note 9.
|
Intangible
Assets and Goodwill
|
Intangible
Assets
Intangible assets consisted of the following (in thousands of
dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
Useful Life
|
|
2006
|
|
|
2005
|
|
|
Waste and energy contracts
|
|
2 - 22 years
|
|
$
|
388,378
|
|
|
$
|
388,378
|
|
Lease interest and other
|
|
12 - 23 years
|
|
|
72,133
|
|
|
|
72,314
|
|
Landfill
|
|
7 years
|
|
|
17,985
|
|
|
|
17,985
|
|
Other intangibles
|
|
Indefinite
|
|
|
4,528
|
|
|
|
4,528
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
483,024
|
|
|
|
483,205
|
|
Accumulated amortization
|
|
|
|
|
(87,124
|
)
|
|
|
(48,662
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets, net
|
|
|
|
$
|
395,900
|
|
|
$
|
434,543
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization expense related to waste and energy contracts and
other intangible assets was $12.1 million and
$11.4 million for the three months ended September 30,
2006 and 2005, respectively, and $36.2 million and
$21.7 million for the nine months ended September 30,
2006 and 2005, respectively. The lease interest asset is
amortized to rent expense in plant operating expenses and was
$0.7 million and $2.2 million for the three and nine
months ended September 30, 2006, respectively.
The following table details the amount of the actual/estimated
amortization expense associated with intangible assets as of
September 30, 2006 included or expected to be included in
Covantas statement of operations for each of the years
indicated (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waste and
|
|
|
Landfill, Lease
|
|
|
|
|
|
|
Energy
|
|
|
Interest and Other
|
|
|
|
|
|
|
Contracts
|
|
|
Contracts
|
|
|
Totals
|
|
|
Nine Months ended
September 30, 2006
|
|
$
|
33,864
|
|
|
$
|
4,598
|
|
|
$
|
38,462
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remainder of 2006
|
|
$
|
11,296
|
|
|
$
|
1,052
|
|
|
$
|
12,348
|
|
2007
|
|
|
44,854
|
|
|
|
5,146
|
|
|
|
50,000
|
|
2008
|
|
|
43,180
|
|
|
|
5,146
|
|
|
|
48,326
|
|
2009
|
|
|
39,635
|
|
|
|
5,146
|
|
|
|
44,781
|
|
2010
|
|
|
27,317
|
|
|
|
5,146
|
|
|
|
32,463
|
|
Thereafter
|
|
|
141,530
|
|
|
|
61,924
|
|
|
|
203,454
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
307,812
|
|
|
$
|
83,560
|
|
|
$
|
391,372
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
In connection with the ARC Holdings acquisition, Covanta Energy
recorded $217.5 million of goodwill in its purchase price
allocation as of September 30, 2006. Goodwill represents
the total consideration paid in excess of the fair value of the
net tangible and identifiable intangible assets acquired and the
liabilities assumed in the ARC Holdings acquisition in
accordance with the provisions of SFAS No. 142,
Goodwill and Other Intangible Assets
18
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
(SFAS 142). Goodwill has an indefinite life and
is not amortized but is reviewed for impairment under the
provisions of SFAS 142. Covanta will perform an annual fair
value test of its recorded goodwill for its reporting units in
the fourth quarter of 2006 using a discounted cash flow approach
as of October 1, 2006. Goodwill is not deductible for
federal income tax purposes.
|
|
Note 10.
|
Other
Noncurrent Liabilities
|
Other noncurrent liabilities consisted of the following (in
thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Waste and service contracts
|
|
$
|
138,595
|
|
|
$
|
135,076
|
|
Interest rate swap
|
|
|
10,320
|
|
|
|
11,852
|
|
Accrued pre-petition tax
liabilities
|
|
|
19,604
|
|
|
|
19,604
|
|
Pension benefit obligation
|
|
|
45,153
|
|
|
|
45,705
|
|
Asset retirement obligation
|
|
|
29,227
|
|
|
|
25,506
|
|
Liability to prior ARC Holdings
owner
|
|
|
|
|
|
|
25,602
|
|
Insurance loss and loss adjustment
reserves
|
|
|
41,148
|
|
|
|
46,868
|
|
Service contract obligations
|
|
|
11,883
|
|
|
|
8,718
|
|
Other
|
|
|
24,494
|
|
|
|
24,471
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
320,424
|
|
|
$
|
343,402
|
|
|
|
|
|
|
|
|
|
|
As of June 25, 2005, ARC Holdings waste and service
contracts were recorded at their fair market values, in
accordance with SFAS 141, based upon discounted cash flows
attributable to the below market portion of the
waste and service contracts using currently available
information.
Agreements between an ARC Holdings subsidiary and one of
the prior owners of ARC Holdings were terminated as of
June 14, 2006. The liability related to these agreements
has been adjusted to recognize the termination of the liability.
See Note 3. Acquisition for ARC Holdings purchase price
allocation adjustment related to the termination of these
agreements.
The following table details the amount of the actual/estimated
amortization contra-expense associated with the below market
waste and service contracts liability as of September 30,
2006 included or expected to be included in Covantas
statements of operations for each of the years indicated (in
thousands of dollars):
|
|
|
|
|
|
|
Waste and
|
|
|
|
Service
|
|
|
|
Contracts
|
|
|
Nine Months ended
September 30, 2006
|
|
$
|
8,622
|
|
|
|
|
|
|
Remainder of 2006
|
|
$
|
2,987
|
|
2007
|
|
|
11,942
|
|
2008
|
|
|
11,955
|
|
2009
|
|
|
12,002
|
|
2010
|
|
|
12,094
|
|
Thereafter
|
|
|
87,615
|
|
|
|
|
|
|
Total
|
|
$
|
138,595
|
|
|
|
|
|
|
19
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Covanta records its interim tax provision based upon its
estimated annual effective tax rate and accounts for the tax
effects of discrete events in the period in which they occur.
Covanta currently estimates its annual effective tax rate for
the year ended December 31, 2006 to be approximately 31.2%.
Covanta reviews the annual effective tax rate on a quarterly
basis as projections are revised.
The effective income tax rate was 29.2% and 35.9% for the nine
months ended September 30, 2006 and 2005, respectively. The
nine months ended September 30, 2006 effective income tax
rate includes the impact of the cumulative adjustment due to the
adoption of the permanent reinvestment exception under APB
Opinion No. 23, Accounting for Income
Taxes Special Areas (APB 23)
as discussed below. Excluding the cumulative adjustment of
$10 million due to APB 23, the effective income tax
rate would have been 39.0% for the nine months ended
September 30, 2006.
Beginning in the second quarter of 2006, Covanta adopted the
permanent reinvestment exception under APB 23 whereby
Covanta will no longer provide for deferred taxes on the
undistributed earnings of its international subsidiaries.
Covanta intends to permanently reinvest its international
earnings outside of the United States in its existing
international operations and in any new international business
it may develop or acquire. As a result of the adoption of
APB 23, Covanta recognized a benefit of $10 million
during the three months ended June 30, 2006 associated with
the reversal of deferred taxes accrued on unremitted earnings of
international affiliates in prior periods.
Covanta files a federal consolidated income tax return with its
eligible subsidiaries in the United States. Covantas
federal consolidated income tax return includes the results of
ARC Holdings after June 24, 2005. Covantas federal
consolidated income tax return also includes the taxable results
of certain grantor trusts which were established by state
insurance regulators in California and Missouri as part of the
1990 reorganization of certain of Covantas predecessor
insurance entities (the Mission Insurance Entities)
and their emergence from federal bankruptcy and various state
insolvency court proceedings. These trusts were created for the
purpose of assuming various liabilities associated with certain
of the Mission Insurance Entities. This allowed the state
regulators to administer the continuing run-off of the insolvent
insurance business, while Covanta (then named Mission Insurance
Group, Inc.) and the remaining Mission Insurance Entities were
released, discharged and dismissed from the proceedings free of
any claims and liabilities of any kind, including any obligation
to provide further funding to the trusts. The Insurance
Commissioner for the State of California (the California
Commissioner) and the Director of the Division of
Insurance of the State of Missouri (the Missouri
Director), as the trustees, have sole management authority
over the trusts. Neither Covanta nor any of its subsidiaries has
any power to control or otherwise influence the management of
the trusts nor do they have any rights with respect to the
selection or replacement of the trustees. At the present time,
it is not likely that Covanta or any of its subsidiaries will
receive any distribution with regard to their residual interests
in the existing trusts. Since Covanta does not have a
controlling financial interest in these trusts and is not the
primary beneficiary, the trusts are not consolidated with
Covanta for financial statement purposes.
During or at the conclusion of the administration of these
grantor trusts, taxable income could result which could utilize
a portion of Covantas NOLs which in turn could accelerate
the date on which Covanta may be otherwise obligated to pay
incremental cash taxes.
Covanta is in discussions with the Missouri Director regarding
arrangements similar to those entered into with the California
Commissioner for distribution of Covanta common stock held by
the Missouri Director to claimants of the Missouri grantor
trusts. Because Covantas discussions with the Missouri
Director are currently at a preliminary stage, Covanta is unable
to determine at this time whether all claimants contemplated by
the 1989 and 1990 agreement as eligible to receive such stock
will receive a distribution from the Missouri Director. As a
result of this uncertainty, in the second quarter of 2006,
Covanta reduced the aggregate amount of its available NOLs by
$46 million and reduced the valuation allowance
accordingly. Covanta cannot provide any assurance that it will
20
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
enter into such similar arrangements with the Missouri Director
or that the NOL reduction will ultimately be reversed. However,
in connection with the administration or conclusion of the
grantor trusts, Covanta does not expect either further
reductions to its available NOLs or additional material amounts
of taxable income to be recognized as a result of the
administration or conclusion of the grantor trusts.
SFAS 109 requires the establishment of a valuation
allowance when Covanta concludes that it is more likely
than not that it will not realize its deferred tax assets.
Pursuant to SFAS 109, Covanta makes periodic determinations
in this regard with respect to all or a portion of its deferred
tax assets. In making these determinations, Covanta considers
all of the relevant factors, both positive and negative, which
may impact its future taxable income including the size and
operating results of its subsidiaries, the competitive
environment in which these subsidiaries operate and the impact
of grantor trust activity. The remainder of the valuation
allowance associated with the NOLs was released during the
quarter ended June 30, 2006, primarily due to
Covantas determination that it was more likely than
not that all remaining deferred tax assets associated with
the NOLs will be realized.
If Covantas existing insurance business were to require
capital infusions in order to meet certain regulatory capital
requirements, and were Covanta to fail to provide such capital,
some or all of its subsidiaries comprising the insurance
business could enter insurance insolvency or bankruptcy
proceedings. In such event, such subsidiaries may no longer be
included in Covantas consolidated income tax return and
potentially, a significant portion of Covantas remaining
NOLs would no longer be available to it. Such an event may also
result in a significant inclusion of taxable income in
Covantas federal consolidated tax return.
Covanta had NOLs estimated to be approximately $489 million
for federal income tax purposes as of the end of 2005. The NOLs
will expire in various amounts from December 31, 2006
through December 31, 2023, if not used.
If Covanta were to undergo an ownership change, as
such term is used in Section 382 of the Internal Revenue
Code, the use of its NOLs in any given year could be limited.
The impacts, if any, to Covanta of any such limitation would
depend upon factors such as the amount of Covantas taxable
income in a given tax year, the date on which an ownership
change were to occur, and Covantas market
capitalization at the time of an ownership change.
Generally, Covanta will be treated as having had an
ownership change if there is a more than 50%
increase in stock ownership during a three-year testing
period by a 5% stockholder. Since 1990,
Covantas certificate of incorporation has contained stock
transfer restrictions that were designed to help preserve
Covantas NOLs by avoiding an ownership change. Primarily
due to the substantial increase in Covantas market
capitalization in recent years and changes to applicable tax
laws, Covanta has concluded that, such an ownership
change is no longer an event that can reasonably be
expected to jeopardize Covantas use of its NOLs. As a
result, Covantas Board of Directors has proposed, subject
to stockholder approval, that Covantas certificate of
incorporation be amended to remove the transfer restrictions.
Covanta is currently soliciting proxies for a special meeting of
stockholders to be held on November 16, 2006 to approve
such changes to Covantas certificate of incorporation.
Covantas provision for income taxes in the condensed
consolidated statements of operations also includes certain
state and other taxes. Tax filings for these jurisdictions do
not consolidate the activity of the grantor trusts referred to
above and in certain states reflect preparation on a
separate-company basis. For further information, refer to
Note 22. Income Taxes of the Notes to the Consolidated
Financial Statements included in Covantas Annual Report on
Form 10-K
for the year ended December 31, 2005.
21
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
Note 12.
|
Changes
in Capitalization
|
Financing
Arrangements
As part of the ARC Holdings acquisition on June 24, 2005,
Covanta Energy entered into credit arrangements which totaled
approximately $1.1 billion and are guaranteed by Covanta
and certain domestic subsidiaries of Covanta Energy. These
credit arrangements consisted of a first priority senior secured
credit facility and a second priority senior secured credit
facility. The first priority senior secured credit facility was
initially comprised of a $275 million first lien term loan,
a $100 million revolving credit facility, and a
$340 million letter of credit facility. The second priority
senior secured credit facility was initially a $400 million
second lien term loan facility.
On May 26, 2006, Covanta Energy entered into agreements
which amended its credit arrangements. All material terms of
Covanta Energys first priority senior secured credit
facility and second priority senior secured credit facility
remained unchanged after the amendments except for the following:
|
|
|
|
|
Interest rates applicable to the existing first lien term loan
and to credit linked deposits applicable to its first lien
funded letter of credit facility were reduced from LIBOR plus
3.00% to LIBOR plus 2.25%.
|
|
|
|
The amount available for the issuance of letters of credit under
the existing $100 million first lien revolving credit
facility was increased from $75 million to $90 million.
|
|
|
|
New term loan commitments were provided which allowed Covanta
Energy to increase the principal amount outstanding under its
first lien term loan facility by up to $140 million, the
proceeds of which were to be used to prepay up to
$140 million under the existing second lien term loan
facility.
|
|
|
|
Certain covenants restricting Covanta Energys ability to
invest available cash and enter into limited recourse borrowings
were modified to provide additional flexibility in the context
of permitted acquisitions.
|
On June 30, 2006, Covanta Energy utilized the new term loan
commitment of $140 million on its first lien term loan
facility to prepay $140 million under the second lien term
loan facility. Covanta Energy recognized a loss on
extinguishment of debt of $2.3 million which was classified
as other expense on the condensed consolidated statement of
operations and a write-off of $4.5 million of second lien
term loan facility deferred financing costs in the three months
ended June 30, 2006 related to the $140 million
prepayment under the second lien term loan facility.
22
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Covanta
Energy Long-Term Debt
Long-term debt is comprised of credit facilities and
intermediate debt as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
As of
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
Covanta Energy Senior Secured
Credit Facilities
|
|
|
|
|
|
|
|
|
First Lien Term Loan Facility
|
|
$
|
369,312
|
|
|
$
|
229,312
|
|
Second Lien Term Loan Facility
|
|
|
260,000
|
|
|
|
400,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
629,312
|
|
|
|
629,312
|
|
|
|
|
|
|
|
|
|
|
Intermediate Subsidiary
Debt
|
|
|
|
|
|
|
|
|
6.26% Senior Notes due 2015
|
|
|
211,600
|
|
|
|
234,000
|
|
8.50% Senior Secured Notes
due 2010
|
|
|
195,785
|
|
|
|
195,785
|
|
7.375% Senior Secured Notes
due 2010
|
|
|
224,100
|
|
|
|
224,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
631,485
|
|
|
|
653,885
|
|
Unamortized debt premium
|
|
|
21,311
|
|
|
|
24,726
|
|
|
|
|
|
|
|
|
|
|
Total intermediate subsidiary debt
|
|
|
652,796
|
|
|
|
678,611
|
|
|
|
|
|
|
|
|
|
|
Other long-term debt
|
|
|
135
|
|
|
|
196
|
|
|
|
|
|
|
|
|
|
|
Total long-term debt
|
|
|
1,282,243
|
|
|
|
1,308,119
|
|
Less: current portion (includes
$4,971 and $4,807 of unamortized premium)
|
|
|
(36,478
|
)
|
|
|
(47,549
|
)
|
|
|
|
|
|
|
|
|
|
Total long-term debt
|
|
$
|
1,245,765
|
|
|
$
|
1,260,570
|
|
|
|
|
|
|
|
|
|
|
Amortization
Terms
The amended first lien term loan facility includes mandatory
annual amortization to be paid in quarterly installments
beginning September 30, 2006, through the date of maturity
as follows (in thousands of dollars):
|
|
|
|
|
|
|
Annual Remaining
|
|
|
|
Amortization
|
|
|
2006
|
|
$
|
1,847
|
|
2007
|
|
|
3,693
|
|
2008
|
|
|
3,693
|
|
2009
|
|
|
3,693
|
|
2010
|
|
|
3,693
|
|
2011
|
|
|
177,270
|
|
2012
|
|
|
175,423
|
|
|
|
|
|
|
Total
|
|
$
|
369,312
|
|
|
|
|
|
|
The September 30, 2006 scheduled principal payment on the
amended first lien term loan facility was made on
October 2, 2006 (the next business day). The second lien
term loan facility has no mandatory amortization requirements
and is required to be repaid in full on its maturity date in
2013.
23
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Covanta
Energy Short-Term Liquidity
Covanta Energy had available credit for liquidity as follows (in
thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
Available
|
|
|
|
Available
|
|
|
|
|
|
As of
|
|
|
|
Under Facility
|
|
|
Maturing
|
|
|
September 30, 2006
|
|
|
Revolving credit facility(1)
|
|
$
|
100,000
|
|
|
|
2011
|
|
|
$
|
100,000
|
|
Funded letter of credit facility
|
|
$
|
320,000
|
|
|
|
2012
|
|
|
$
|
31,045
|
|
|
|
|
(1) |
|
Up to $90 million of which may be utilized for letters of
credit. |
As of September 30, 2006, Covanta Energy had neither drawn
on the revolving credit facility nor caused any letters of
credit to be issued under the revolving credit facility. On
March 21, 2006, Covantas availability under the
funded letter of credit facility was voluntarily reduced to
$320 million from $340 million. As of
September 30, 2006, Covanta Energy had approximately
$289 million of outstanding letters of credit under the
funded letter of credit facility.
Debt
Covenants and Defaults
The loan documentation under the credit facilities, as amended,
contains customary affirmative and negative covenants and
financial covenants. During the term of the credit facilities,
Covanta expects that the negative covenants will restrict the
ability of Covanta Energy and its subsidiaries to take specified
actions, subject to exceptions. As of September 30, 2006,
Covanta Energy was in compliance with covenants under the credit
facilities.
Interest
and Fee Terms
Under the amended credit facilities, the borrowing margins for
first lien term loan facility and the funded letter of credit
facility are 2.25% for Eurodollar rate loans and 1.25% for base
rate loans. The borrowing margins under the second lien term
loan facility are 5.50% for Eurodollar rate loans and 4.50% for
base rate loans. The borrowing margins for the revolving credit
facility remain unchanged from the existing agreements.
Stockholders
Equity
Covanta agreed as part of the Covanta Energy acquisition in
March 2004 to conduct a rights offering for up to
3.0 million shares of its common stock to certain holders
of 9.25% debentures issued by Covanta Energy prior to its
bankruptcy at a purchase price of $1.53 per share (the
9.25% Offering). Because of the possibility that the
9.25% Offering could not be completed prior to the completion of
the ARC Holdings acquisition, and the related ARC Holdings
Rights Offering, Covanta restructured the 9.25% Offering so that
the holders that participated in the 9.25% Offering were offered
the right to purchase an additional 2.7 million shares of
Covantas common stock at the same purchase price
($6.00 per share) as in the ARC Holdings Rights Offering.
This represented an equivalent number of shares of common stock
that such holders would have been entitled to purchase in the
ARC Holdings Rights Offering if the 9.25% Offering was
consummated on or prior to the record date for the ARC Holdings
Rights Offering. On February 24, 2006, Covanta completed
the 9.25% Offering in which 5,696,911 shares were issued in
consideration for $20.8 million in gross proceeds.
Effective as of March 17, 2006, the Compensation Committee
of the Board of Directors authorized the award of
480,055 shares of restricted stock to certain employees
under the Employee Plan. On May 31, 2006, Covanta granted
36,000 shares of restricted stock under the Directors Plan.
On September 1, 2006, Covanta granted 20,000 shares of
restricted stock and options to purchase 50,000 shares of
Covantas common stock to Mark A. Pytosh pursuant to an
employment agreement. See Note 4. Stock-Based Compensation.
24
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
Note 13.
|
Business
Segments
|
Covanta has two reportable business segments Waste
and Energy Services and Other Services. Within the Waste and
Energy Services segment, Covanta develops, constructs, owns and
operates for others key infrastructure for the disposal of waste
(primarily
waste-to-energy)
and independent power production facilities in the
United States and abroad. Covanta also has one water
treatment facility in this segment. The Other Services segment
is comprised of Covantas insurance business, which writes
primarily property and casualty insurance in California, and the
holding company of Covantas
waste-to-energy
and insurance subsidiaries, which primarily receives income from
its investments.
Segment results are shown below (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
Operating Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waste and Energy Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic
|
|
$
|
279,672
|
|
|
$
|
265,558
|
|
|
$
|
828,264
|
|
|
$
|
559,339
|
|
International
|
|
|
28,255
|
|
|
|
32,312
|
|
|
|
111,700
|
|
|
|
104,605
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal Waste and Energy Services
|
|
|
307,927
|
|
|
|
297,870
|
|
|
|
939,964
|
|
|
|
663,944
|
|
Other Services
|
|
|
3,188
|
|
|
|
3,620
|
|
|
|
10,643
|
|
|
|
11,457
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
$
|
311,115
|
|
|
$
|
301,490
|
|
|
$
|
950,607
|
|
|
$
|
675,401
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waste and Energy Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic
|
|
$
|
67,134
|
|
|
$
|
61,325
|
|
|
$
|
165,614
|
|
|
$
|
95,487
|
|
International
|
|
|
4,610
|
|
|
|
3,558
|
|
|
|
18,053
|
|
|
|
11,704
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal Waste and Energy Services
|
|
|
71,744
|
|
|
|
64,883
|
|
|
|
183,667
|
|
|
|
107,191
|
|
Other Services
|
|
|
(101
|
)
|
|
|
108
|
|
|
|
182
|
|
|
|
473
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating income
|
|
|
71,643
|
|
|
|
64,991
|
|
|
|
183,849
|
|
|
|
107,664
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment income
|
|
|
2,483
|
|
|
|
1,657
|
|
|
|
7,801
|
|
|
|
3,530
|
|
Interest expense
|
|
|
(26,968
|
)
|
|
|
(30,701
|
)
|
|
|
(87,265
|
)
|
|
|
(59,053
|
)
|
Loss on extinguishment of debt
|
|
|
|
|
|
|
|
|
|
|
(2,342
|
)
|
|
|
|
|
Unrealized gain on derivative
instruments, unexercised ACL warrants
|
|
|
|
|
|
|
10,578
|
|
|
|
|
|
|
|
14,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense,
minority interests and equity in net income from unconsolidated
investments
|
|
$
|
47,158
|
|
|
$
|
46,525
|
|
|
$
|
102,043
|
|
|
$
|
66,937
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
25
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
Note 14.
|
Pension
and Other Post-retirement Benefits
|
Net periodic defined pension and other post-retirement benefit
expense for Covanta Energy were as follows (in thousands of
dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension
|
|
|
Other Post-Retirement
|
|
|
|
Benefits(1)
|
|
|
Benefits
|
|
|
|
For the Three
|
|
|
For the Nine
|
|
|
For the Three
|
|
|
For the Nine
|
|
|
|
Months Ended
|
|
|
Months Ended
|
|
|
Months Ended
|
|
|
Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
Service cost
|
|
$
|
|
|
|
$
|
1,805
|
|
|
$
|
|
|
|
$
|
5,417
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Interest cost
|
|
|
1,075
|
|
|
|
997
|
|
|
|
3,225
|
|
|
|
2,992
|
|
|
|
154
|
|
|
|
165
|
|
|
|
463
|
|
|
|
493
|
|
Expected return on plan assets
|
|
|
(922
|
)
|
|
|
(753
|
)
|
|
|
(2,766
|
)
|
|
|
(2,261
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of net gain
|
|
|
(16
|
)
|
|
|
|
|
|
|
(48
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost
|
|
$
|
137
|
|
|
$
|
2,049
|
|
|
$
|
411
|
|
|
$
|
6,148
|
|
|
$
|
154
|
|
|
$
|
165
|
|
|
$
|
463
|
|
|
$
|
493
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Effective December 31, 2005, Covanta Energy froze the
defined benefit pension plan. |
Effective December 31, 2005, Covanta Energy froze the
Covanta Energy Pension Plan (the defined benefit pension plans
for domestic employees). All active employees who were eligible
participants in the defined benefit pension plan as of
December 31, 2005, were 100% vested and had a
non-forfeitable right to these benefits as of such date.
Effective January 1, 2006, in connection with freezing its
defined benefit pension plans for domestic employees, Covanta
Energy enhanced the Covanta Energy Savings Plan (the defined
contribution plan for domestic employees) by increasing its
contribution toward the savings plan. Covanta Energys
costs related to these savings plans were $2.6 million and
$0.8 million for the three months ended September 30,
2006 and 2005, respectively, and $8.4 million and
$2.7 million for the nine months ended September 30,
2006 and 2005, respectively.
|
|
Note 15.
|
Financial
Instruments
|
ACL
Warrants
On January 12, 2005, two subsidiaries of Covanta received
warrants to purchase 168,230 shares of common stock of
American Commercial Lines LLC (ACL) at
$12.00 per share. The number of shares and exercise price
subject to the warrants were subsequently adjusted to
672,920 shares at an exercise price of $3.00 per
share, as a result of a
four-for-one
stock split effective as of August 2005. The warrants were given
by certain of the former creditors of ACL under the ACL plan of
reorganization. Covantas investment in ACL was written
down to zero in 2003.
Covanta recorded the warrants as a derivative security in
accordance with SFAS No. 133 Accounting for
Derivative Instruments and Hedging Activities
(SFAS 133). Covanta recorded the warrants at
their aggregate fair value of $0.8 million on the grant
date and marked the warrants to their fair value of
$5.0 million as of June 30, 2005. On October 7,
2005, ACL issued 7.5 million shares in an initial public
offering. Based on market quotes as of September 30, 2005,
Covanta recorded a
mark-to-market
adjustment for the quarter ended September 30, 2005 which
increased the value of its investment in ACL warrants to
$15.6 million in the condensed consolidated balance sheet
and recorded a corresponding pre-tax gain on derivative
instruments of $10.6 million for the three months ended
September 30, 2005. In October 2005, Covanta converted the
ACL warrants into shares of ACLs common stock and sold the
shares.
Interest
Rate Swaps
Under its credit arrangements, Covanta Energy is required to
enter into hedging arrangements for a portion of its exposure to
interest rate changes with respect to its borrowings under the
credit facilities. On July 8, 2005,
26
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Covanta Energy entered into two separate pay fixed, receive
floating interest rate swap agreements with a total notional
amount of $300 million. On March 21, 2006, Covanta
entered into one additional pay fixed, receive floating interest
rate swap agreement with a notional amount of
$37.5 million. These swaps were designated as cash flow
hedges in accordance with SFAS 133. Accordingly, unrealized
gains or losses will be deferred in other comprehensive income
until the hedged cash flows affect earnings. The impact of the
swaps increased interest expense for the three months ended
September 30, 2005 by $0.5 million. The impact of the
swaps decreased interest expense for the three months and nine
months ended September 30, 2006 by $0.9 million and
$1.6 million, respectively. As of September 30, 2006,
the net after-tax deferred gain in other comprehensive income
was $2.1 million ($3.5 million before income taxes)
which was recorded in other assets.
|
|
Note 16.
|
Commitments
and Contingencies
|
Covanta
and/or its
subsidiaries are party to a number of claims, lawsuits and
pending actions, most of which are routine and all of which are
incidental to its business. Covanta assesses the likelihood of
potential losses on an ongoing basis and when losses are
considered probable and reasonably estimable, records as a loss
an estimate of the ultimate outcome. If Covanta can only
estimate the range of a possible loss, an amount representing
the low end of the range of possible outcomes is recorded. The
final consequences of these proceedings are not presently
determinable with certainty.
|
|
|
Covanta
Energy Corporation
|
Generally, claims and lawsuits arising from events occurring
prior to their respective petition dates against Covanta Energy
and its subsidiaries, that had filed bankruptcy petitions and
subsequently emerged from bankruptcy, have been resolved
pursuant to the Covanta Energy reorganization plan, and have
been discharged pursuant to orders of the Bankruptcy Court which
confirmed the Covanta Energy reorganization plan or similar
plans of subsidiaries emerging separately from Chapter 11.
However, to the extent that claims are not dischargeable in
bankruptcy, such claims may not be discharged. For example, the
claims of certain persons who were personally injured prior to
the petition date but whose injury only became manifest
thereafter may not be discharged pursuant to the Covanta Energy
reorganization plan.
Covanta Energys operations are subject to environmental
regulatory laws and environmental remediation laws. Although
Covanta Energys operations are occasionally subject to
proceedings and orders pertaining to emissions into the
environment and other environmental violations, which may result
in fines, penalties, damages or other sanctions, Covanta
believes that Covanta Energy is in substantial compliance with
existing environmental laws and regulations.
Covanta Energy may be identified, along with other entities, as
being among parties potentially responsible for contribution to
costs associated with the correction and remediation of
environmental conditions at disposal sites subject to federal
and/or
analogous state laws. In certain instances, Covanta Energy may
be exposed to joint and several liabilities for remedial action
or damages. Covanta Energys ultimate liability in
connection with such environmental claims will depend on many
factors, including its volumetric share of waste, the total cost
of remediation, and the financial viability of other companies
that also sent waste to a given site and, in the case of
divested operations, its contractual arrangement with the
purchaser of such operations. Generally, such claims arising
prior to the first petition date were resolved in and discharged
by Covanta Energys Chapter 11 cases.
The potential costs related to the matters described below and
the possible impact on future operations are uncertain due in
part to the complexity of governmental laws and regulations and
their interpretations, the varying costs and effectiveness of
cleanup technologies, the uncertain level of insurance or other
types of recovery and the questionable level of Covanta
Energys responsibility. Although the ultimate outcome and
expense of any litigation,
27
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
including environmental remediation, is uncertain, Covanta
Energy believes that the following proceedings will not have a
material adverse effect on Covanta Energys consolidated
financial position or results of operations.
In June 2001, the Environmental Protection Agency
(EPA) named Covanta Energys wholly-owned
subsidiary, Covanta Haverhill, Inc. (Haverhill), as
one of 2,000 potentially responsible parties (PRPs)
at the Beede Waste Oil Superfund Site, Plaistow, New Hampshire
(Beede site), a former waste oil recycling facility.
The total quantity of waste oil alleged by EPA to have been
disposed at the Beede site is approximately 14.3 million
gallons. Haverhill is alleged to have disposed of approximately
45,000 gallons of waste oil at the Beede site. On
January 9, 2004, EPA signed its Record of Decision
(ROD) with respect to cleanup of the Beede site. The
estimated cost to implement the remedial alternative selected in
the ROD is $48 million, exclusive of reimbursement of past
costs and future oversight costs of EPA and the State of New
Hampshire. On June 20, 2006, EPA issued a Unilateral
Administrative Order (UAO) to a group of PRPs,
including Haverhill, with respect to implementation of the Beede
site cleanup. Haverhills ultimate liability in this matter
cannot be determined at this time as a result of uncertainties
regarding the source and scope of contamination, the large
number of PRPs, the varying degrees of responsibility among
various classes of PRPs and uncertainty as to the actions or
positions that may be taken by other PRPs with respect to the
UAO in the event that a settlement with EPA cannot be reached
and the UAO becomes effective. Covanta currently believes that
based on the amount of waste oil Haverhill is alleged to have
sent to the Beede site in comparison to other respondent PRPs,
its ultimate liability will not be material to its financial
position and results of operations.
By letters dated August 13, 2004 and May 3, 2005, EPA
notified Covanta Essex Company (Essex and formerly
named American Ref-Fuel Company of Essex County) that it was
potentially liable under CERCLA Section 107(a) for response
actions in the Lower Passaic River Study Area, referred to as
LPRSA, a 17 mile stretch of river in northern
New Jersey. Essex is one of at least 60 PRPs named thus far that
have joined the cooperating PRP group. EPA alleges that
hazardous substances found in the LPRSA were being released from
the Essex site, which abuts the river. EPAs notice letters
stated that Essex may be liable for costs related to a proposed
remedial investigation and feasibility study (RI/FS)
of the Lower Passaic River, for certain past costs incurred by
EPA and for unspecified natural resource damages. Essex entered
into an arrangement with EPA and the cooperating PRP group of
which Essex is a member to settle the potential liability Essex
might have for the $2.8 million in past costs incurred by
EPA, and for the $10 million then estimated by EPA as the
cost of the RI/FS by contributing $0.25 million to the cost
of the RI/FS and by agreeing to share in certain past and
ongoing legal fees and other costs of the cooperating PRP group.
It is anticipated that additional contributions to the cost of
the RI/FS will be required of PRPs, including Essex, as
the RI/FS proceeds through its predicted completion in 2010.
Considering the history of industrial and other discharges into
the LPRSA from other sources, including named PRPs, Essex
believes any releases from its site to be de minimis in
comparison; however, it is not possible at this time to predict
that outcome with certainty or to estimate Essexs ultimate
liability in the matter, including for natural resource damages.
Other
Commitments
Covanta Energys other commitments as of September 30,
2006 were as follows (in thousands of dollars):
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Commitments Expiring by Period
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Less Than
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More Than
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Total
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One Year
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One Year
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Letters of credit
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$
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292,374
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$
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19,827
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$
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272,547
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Surety bonds
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51,651
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51,651
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Total other
commitments net
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$
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344,025
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$
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71,478
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$
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272,547
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The letters of credit were issued pursuant to the facilities to
secure Covanta Energys performance under various
contractual undertakings related to its domestic and
international projects, or to secure obligations under its
28
insurance program. Each letter of credit relating to a project
is required to be maintained in effect for the period specified
in related project contracts, and generally may be drawn if it
is not renewed prior to expiration of that period.
As of September 30, 2006, Covanta Energy had approximately
$31 million in available capacity for additional letters of
credit under its funded letter of credit facility and
$90 million available capacity for letters of credit under
its revolving credit facility. Covanta Energy believes that it
will be able to fully perform its contracts to which these
existing letters of credit relate, and that it is unlikely that
letters of credit would be drawn because of a default of its
performance obligations. If any of Covanta Energys letters
of credit were to be drawn under its current debt facilities,
the amount drawn would be immediately repayable to the issuing
bank. If Covanta Energy were unable to immediately repay such
amounts drawn under letters of credit, unreimbursed amounts
would be treated under the credit facilities as additional term
loans.
The surety bonds listed on the table above relate primarily to
performance obligations under contracts ($42.1 million) and
possible closure costs for various energy projects when such
projects cease operating ($9.6 million). Were these bonds
to be drawn upon, Covanta Energy would have a contractual
obligation to indemnify the surety company.
Covanta Energy and certain of its subsidiaries have issued or
are party to performance guarantees and related contractual
support obligations undertaken mainly pursuant to agreements to
construct and operate certain
waste-to-energy
facilities and a water facility. With respect to its domestic
businesses, Covanta Energy and certain of its subsidiaries have
issued guarantees to municipal clients and other parties that
Covanta Energys subsidiaries will perform in accordance
with contractual terms, including, where required, the payment
of damages or other obligations. Such contractual damages or
other obligations could be material, and in circumstances where
one or more subsidiarys contract has been terminated for
its default, such damages could include amounts sufficient to
repay project debt. For facilities owned by municipal clients
and operated by Covanta Energy, Covanta Energys potential
maximum liability as of September 30, 2006 associated with
the repayment of the municipalities project debt on such
facilities was in excess of $1 billion. This amount was not
recorded as a liability in Covanta Energys consolidated
balance sheet as of September 30, 2006 as Covanta Energy
believes that it had not incurred such liability at the date of
the financial statements. Additionally, damages payable under
such guarantees on Covanta Energy-owned
waste-to-energy
facilities could expose Covanta Energy to recourse liability on
project debt. Covanta Energy also believes that it has not
incurred such liabilities at the date of the financial
statements. If Covanta Energy is asked to perform under one or
more of such guarantees, its liability for damages upon contract
termination would be reduced by funds held in trust and proceeds
from sales of the facilities securing the project debt, which is
presently not estimable.
With respect to its international businesses, Covanta Energy has
issued guarantees on behalf of certain of CPIHs operating
subsidiaries with respect to contractual obligations to operate
independent power projects. The potential damages owed under
such arrangements for international projects may be material.
Depending upon the circumstances giving rise to such domestic
and international damages, the contractual terms of the
applicable contracts, and the contract counterpartys
choice of remedy at the time a claim against a guarantee is
made, the amounts owed pursuant to one or more of such
guarantees could be greater than Covanta Energys
then-available sources of funds. To date, Covanta Energy has not
incurred material liabilities under its guarantees, either on
domestic or international projects.
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Note 17.
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Related-Party
Transactions
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As described in Note 8. Equity in Net Income from
Unconsolidated Investments, Covanta Energy holds a 26%
investment in Quezon. Covanta Energy and Quezon are both party
to an agreement in which Covanta Energy assumed responsibility
for the operation and maintenance of Quezons coal-fired
electricity generation facility. For the three months ended
September 30, 2006 and 2005, Covanta Energy collected
$9.0 million and $10.6 million,
29
COVANTA
HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Concluded)
respectively, and for the nine months ended September 30,
2006 and 2005, Covanta Energy collected $25.9 million and
$25.2 million, respectively, for the operation and
maintenance of the facility. As of September 30, 2006, the
net amount due to Quezon was $2.5 million and as of
December 31, 2005, the net amount due from Quezon was
$0.1 million.
ACL was an indirect, wholly-owned subsidiary of Covanta prior to
ACLs bankruptcy proceedings. At that same time, SZ
Investments equity ownership in Covanta was approximately
18%. SZ Investments is affiliated with Samuel Zell,
Covantas current Chairman of the Board of Directors and
William Pate, the former Chairman of Covantas Board and a
current Director. Another affiliate of SZ Investments, HY I
Investments, LLC, was a holder of approximately 42% of
ACLs Senior Notes and PIK Notes. The holders of ACLs
Senior Notes were among the class of grantors of the warrants to
subsidiaries of Covanta.
SZ Investments, Third Avenue and Laminar, then representing
aggregate ownership of approximately 40% of Covantas
outstanding common stock, each agreed to and participated in the
ARC Holdings Rights Offering and acquired at least their
respective pro rata portion of the shares. As consideration for
their commitments, Covanta paid each of these stockholders an
amount equal to 1.75% of their respective equity commitments,
which in the aggregate was $2.8 million. Covanta also
agreed to amend an existing registration rights agreement to
provide these stockholders with the right to demand that Covanta
undertake an underwritten offering within twelve months of the
closing of the acquisition of ARC Holdings in order to provide
such stockholders with liquidity or to register for resale
common stock acquired in such offering. None of such
stockholders exercised such right to request an underwritten
offering prior to the expiration of such period.
Covanta agreed as part of the Covanta Energy acquisition to
conduct the 9.25% Offering and because of the possibility that
the 9.25% Offering could not be completed prior to the
completion of the ARC Holdings Rights Offering, Covanta
restructured the 9.25% Offering to include an additional
2.7 million shares of Covantas common stock at the
same purchase price as in the ARC Holdings Rights Offering. On
February 24, 2006, Covanta completed the 9.25% Offering in
which 5,696,911 shares were issued in consideration for
$20.8 million in gross proceeds, including
633,380 shares purchased by Laminar pursuant to the
exercise of rights held by Laminar as a holder of 9.25%
debentures. See Note 3. Acquisition and Note 12.
Changes in Capitalization.
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Note 18.
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Other
Operating (Income) Expenses
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During the third quarter ended September 30, 2006, Covanta
recognized other operating income of $4.9 million resulting
from $2.6 million in proceeds received for final
distributions and settlements of disputed matters relating to
Covanta Energys reorganization, and $2.3 million
received for insurance recoveries.
30
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ITEM 2.
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MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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The following discussion addresses the financial condition of
Covanta Holding Corporation (Covanta) as of
September 30, 2006 and its results of operations for the
three and nine months ended September 30, 2006, compared
with the same periods last year. It should be read in
conjunction with Covantas Audited Consolidated Financial
Statements and Notes thereto for the year ended
December 31, 2005 and Managements Discussion and
Analysis of Financial Condition and Results of Operations
included in Covantas Annual Report on
Form 10-K
for the year ended December 31, 2005 and in the interim
unaudited financial statements and notes included in the
Quarterly Reports on
Form 10-Q
for the periods ended March 31, 2006 and June 30,
2006, to which the reader is directed for additional information.
The preparation of interim financial statements necessarily
relies heavily on estimates. Due to the use of estimates and
certain other factors, such as the seasonal nature of
Covantas waste and energy business, as well as competitive
and other market conditions, Covanta does not believe that
interim results of operations are indicative of full year
results of operations. The preparation of financial statements
requires management to make estimates and assumptions that
affect the reported amounts and classification of assets and
liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual
results could differ materially from those estimates.
OVERVIEW
Covanta is organized as a holding company with substantially all
of its current consolidated operations conducted in the waste
and energy services business through its wholly-owned subsidiary
Covanta Energy Corporation and its subsidiaries (Covanta
Energy), including Covanta ARC Holdings, Inc. (ARC
Holdings).
On June 24, 2005, Covanta acquired, through Covanta Energy,
100% of the issued and outstanding shares of ARC Holdings. ARC
Holdings and its subsidiaries operate six
waste-to-energy
facilities located in the northeastern United States and
TransRiver Marketing Company, L.P., a waste procurement company.
Immediately upon closing of the acquisition, ARC Holdings became
a wholly-owned subsidiary of Covanta Energy, and Covanta Energy
assumed control of the management and operations of the ARC
Holdings facilities. ARC Holdings results of operations
were consolidated into Covanta beginning on June 25, 2005.
See Note 3. Acquisition of the Notes to Condensed
Consolidated Financial Statements (Notes). The
acquisition of ARC Holdings provided Covanta Energy with the
opportunity to achieve efficiencies and economies of scale by
combining its businesses with those of ARC Holdings and the
opportunity to refinance its recourse debt and thereby lower its
cost of capital and obtain less restrictive covenants in the
credit agreements.
The consolidated performance of Covanta in 2006 and 2005 has
predominantly reflected, and the continued future performance of
Covanta will predominantly reflect, the performance of its waste
and energy services operations which are significantly larger
than its insurance operations. Accordingly, Covantas
financial performance prior to June 25, 2005 is not
comparable with its financial performance subsequent to that
date, as Covanta Energys performance has been materially
affected by the ARC Holdings acquisition. Readers are directed
to Managements Discussion and Analysis of Covantas
waste and energy services business below for a discussion of
managements perspective on important factors of operating
and financial performance.
Covantas management is focused on:
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providing its customers with superior service by operating its
existing businesses to historic high standards;
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generating sufficient cash to meet its liquidity needs;
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paying down Covanta Energys debt, as well as project and
intermediate holding company debt; and
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investing in and growing its business in order to create
additional value for stockholders.
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31
Maintaining historic facility production levels while
effectively managing operating and maintenance expense is
important to optimize Covanta Energys long-term cash
generation. Covanta Energy does not expect to receive any cash
contributions from Covanta except in conjunction with certain
acquisitions permitted under its principal financing
arrangements, and is prohibited under such financing
arrangements from using its cash to issue dividends to Covanta
except in limited circumstances. For expanded discussions of
liquidity, see Liquidity and Capital Resources
below.
Covantas liquidity is enhanced by the existence of net
operating loss carryforwards (NOLs), which
predominantly arose from predecessor insurance entities
(Mission Insurance Entities) of Covanta (formerly
named Mission Insurance Group, Inc.), which have been in state
insolvency proceedings in California and Missouri since the late
1980s. As described below, certain grantor trusts
associated with these predecessor insurance entities (and the
taxable income and loss they generate) continue to be included
in Covantas consolidated tax group. The Internal Revenue
Service (IRS) has not audited any of Covantas
tax returns relating to the years during which the NOLs were
generated. It is possible that the IRS could undertake an audit
of Covantas tax returns for such years, as well as
subsequent years during which taxable income or loss of such
grantor trusts (and the taxable income and loss they generate)
will continue to be included in Covantas consolidated tax
group.
The ability of Covanta to utilize its NOLs to offset taxable
income generated by operations in its Waste and Energy Services
segment could have a material effect on Covantas
consolidated financial condition and results of operations.
Covanta had NOLs estimated to be $489 million for federal
income tax purposes as of December 31, 2005. The NOLs will
expire in various amounts from December 31, 2006 through
December 31, 2023, if not used. The amount of NOLs
available to Covanta Energy will be reduced by any taxable
income generated by current members of Covantas
consolidated tax group, which include the grantor trusts
described above. During or at the conclusion of the
administration of these grantor trusts by state insurance
regulatory agencies, taxable income could result, which could
utilize a portion of Covantas NOLs and in turn could
accelerate the date on which Covanta may be otherwise obligated
to pay incremental cash taxes. While Covanta cannot predict with
certainty what amounts, if any, may be includable in
Covantas taxable income as a result of the final
administration of the trusts, Covanta believes that any such
taxable income will not result in a material reduction in
available NOLs.
Since 1990, Covantas certificate of incorporation has
contained stock transfer restrictions that were designed to help
preserve Covantas NOLs by avoiding an ownership
change, as such term is used in Section 382 of the
Internal Revenue Code. Primarily due to the substantial increase
in Covantas market capitalization in recent years and
changes to applicable tax laws, Covanta has concluded that such
an ownership change is no longer an event that can reasonably be
expected to jeopardize Covantas use of the NOLs. As a
result, Covantas Board of Directors has proposed, subject
to stockholder approval, that Covantas certificate of
incorporation be amended to remove the transfer restrictions.
Covanta is currently soliciting proxies for a special meeting of
stockholders to be held on November 16, 2006 to approve
such changes to Covantas certificate of incorporation.
For additional detail relating to Covantas NOLs and risks
attendant thereto, see Note 11. Income Taxes of the Notes
and Item 1A. Risk Factors in this Quarterly Report on
Form 10-Q
and Item 1A. Risk Factors in Covantas Annual Report
on
Form 10-K
for the year ended December 31, 2005.
On May 26, 2006, Covanta Energy completed the repricing of
its first lien term loan and first lien funded letter of credit
facilities, reducing interest rates on these facilities by
0.75%. Covanta Energy also received commitments to increase its
first lien term loan by $140 million, the proceeds of which
were used to pay down a portion of its higher-priced second lien
term loan facility. On June 30, 2006, Covanta Energy
reduced the second lien term loan facility from
$400 million to $260 million, and paid a required call
premium of 2%, or $2.8 million. At the same time, the
amount outstanding under the first lien term loan facility was
increased from $229 million to $369 million. Covanta
Energys first lien funded letter of credit and revolving
credit facilities remained unchanged at $320 million and
$100 million respectively. The amount available for
issuance of letters of credit under the revolving credit
facility was increased to $90 million from
$75 million. Management estimates that the repricing will
generate pre-tax cash savings through reduced interest expense
of approximately $8 million per year beginning in 2007.
Covanta expects that the cash savings in 2006 will be
substantially less due to the related transaction costs and call
premium that were paid in connection with these changes in
capitalization.
32
Covantas
Business Segments
Covanta has two reportable business segments Waste
and Energy Services and Other Services.
Waste and
Energy Services
The Waste and Energy Services segment includes Covanta
Energys domestic and international businesses. Covanta
Energys subsidiary Covanta Power International Holdings,
Inc. and its subsidiaries (CPIH) engage primarily in
the independent power production business outside the United
States.
For all
waste-to-energy
projects, Covanta Energy receives revenue from two primary
sources: fees it charges for operating projects or processing
waste received and payments for electricity and steam sales.
Covanta Energy also operates, and in some cases has ownership
interests in, transfer stations and landfills which generate
revenue from waste disposal fees or operating fees. In addition,
Covanta Energy owns and in some cases operates other renewable
energy projects in the United States which generate electricity
from wood waste, landfill gas, and hydroelectric resources. The
electricity from these projects is sold to utilities. For these
projects, Covanta Energy receives revenue from electricity
sales, and in some cases cash from equity distributions.
Through CPIH, Covanta Energy also has ownership interests in,
and/or
operates, independent power production facilities in the
Philippines, China, Bangladesh, India, and Costa Rica, and one
waste-to-energy
facility in Italy. The Costa Rica facilities generate
electricity from hydroelectric resources while the other
independent power production facilities generate electricity and
steam by combusting coal, natural gas, or heavy fuel oil. For
these projects, CPIH receives revenue from operating fees,
electricity and steam sales, and in some cases cash from equity
distributions.
Contract
Structures
Covanta Energy has 23
waste-to-energy
projects at which it charges a fixed fee (which escalates over
time pursuant to contractual indices Covanta Energy believes are
appropriate to reflect price inflation) for its operation and
maintenance services. These projects are referred to as having a
Service Fee structure. Covanta Energys
contracts at its Service Fee projects provide revenue that does
not materially vary based on the amount of waste processed or
energy generated and as such is relatively stable for the
contract term. In addition, at most of Covanta Energys
Service Fee projects, the operating subsidiary retains only a
fraction of the energy revenues generated, with the balance used
to provide a credit to the municipal client against its disposal
costs. Therefore, in these projects, the municipal client
derives most of the benefit and risk of energy production and
changing energy prices.
Covanta Energy also has eight
waste-to-energy
projects at which it receives a per-ton fee under contracts for
processing waste. These projects are referred to as having a
Tip Fee structure. At its Tip Fee projects, Covanta
Energy generally enters into long-term waste disposal contracts
for a substantial portion of project disposal capacity and
retains all of the energy revenue generated. Covanta
Energys waste disposal and energy revenue from these
projects is more dependent upon operating performance, and as
such is subject to greater revenue fluctuation to the extent
performance levels fluctuate.
Under both structures, Covantas returns are expected to be
stable if it does not incur material unexpected operation and
maintenance costs or other expenses. In addition, most of
Covanta Energys
waste-to-energy
project contracts are structured so that contract counterparties
generally bear, or share in, the costs associated with events or
circumstances not within Covanta Energys control, such as
uninsured force majeure events and changes in legal
requirements. The stability of Covanta Energys domestic
revenues and returns could be affected by its ability to
continue to enforce these obligations. Also, at some of Covanta
Energys
waste-to-energy
facilities, commodity price risk is mitigated by passing through
commodity costs to contract counterparties. With respect to its
domestic and international independent power projects, such
structural features generally do not exist because either
Covanta Energy operates and maintains such facilities for its
own account or does so on a cost-plus basis rather than a
fixed-fee basis.
33
Seasonal
Effects
Covanta Energys quarterly operating income from domestic
and international operations within the same fiscal year
typically differs substantially due to seasonal factors,
primarily as a result of the timing of scheduled plant
maintenance. Covanta Energy has typically experienced lower
operating income from its projects during the first six months
of each year, and higher operating income during the second six
months of each year.
Contract
Duration
Covanta Energy operates its domestic
waste-to-energy
projects under long-term agreements. Energy sales contracts at
Covanta Energy-owned
waste-to-energy
projects generally expire at or after the date on which a
projects agreement expires. Expiration of these contracts
will subject Covanta Energy to greater market risk in
maintaining and enhancing its revenues. As its agreements at
municipally-owned projects expire, Covanta Energy will seek to
enter into renewal or replacement contracts to continue
operating such projects. As its agreements at facilities it owns
begin to expire, Covanta Energy intends to seek replacement or
additional contracts for waste supplies. Because project debt on
these facilities will be paid off at such time, Covanta Energy
believes it will be able to offer disposal services at rates
that will attract sufficient quantities of waste and provide
acceptable revenues. Covanta Energy will seek to bid
competitively in the market for additional contracts to operate
other facilities as similar contracts of other vendors expire.
At Covanta Energys domestic facilities, the expiration of
existing energy sales contracts will require Covanta Energy to
sell project energy output either into the electricity grid or
pursuant to new contracts. There can be no assurance that
Covanta will be able to enter into such renewals, replacement or
additional contracts, or that the terms available in the market
at the time will be favorable to Covanta Energy.
Business
Development
Covantas opportunities for growth by investing in new
development opportunities will be limited by Covanta
Energys debt covenants, as well as by competition from
other companies in the waste disposal and energy businesses.
Covanta Energys business is capital intensive since it is
based upon building and operating municipal solid waste
processing and energy generating projects. In order to provide
meaningful growth, Covanta must be able to invest its own funds,
obtain equity or debt financing, and provide support to its
operating subsidiaries. Covantas domestic project
development has recently concentrated on working with its client
communities to expand existing
waste-to-energy
project capacities, and it has one project in advanced stages of
development and another under construction. Covanta is pursuing
additional project expansion opportunities, as well as
opportunities in businesses ancillary to its existing business,
such as additional waste transfer, transportation, processing
and landfill businesses. Covanta is also pursuing international
waste and/or
energy business opportunities, particularly in markets where the
market demand, regulatory environment or other factors encourage
technologies such as
waste-to-energy
in order to reduce dependence on landfilling, such as Italy, the
United Kingdom, China or island nations where landfilling is a
less desirable disposal option.
Other
Services
Covantas Other Services segment is comprised of the
holding company and insurance subsidiaries operations. The
operations of Covantas insurance subsidiary, National
American Insurance Company of California (NAICC),
and its subsidiary Valor Insurance Company, Incorporated, are
primarily property and casualty insurance. Holding company
operations prior to the acquisition of Covanta Energy on
March 10, 2004, primarily included general and
administrative expense related to officer salaries, legal and
other professional fees and insurance. Subsequent to the
acquisition of Covanta Energy, these expenses have been
reimbursed by Covanta Energy under a corporate services
agreement. The holding company operations also include income
earned on its investments.
RESULTS
OF OPERATIONS
The results of operations for the nine months ended
September 30, 2005 are not representative of Covantas
ongoing results since ARC Holdings results of operations
were included in Covanta Energys consolidated results of
operations from June 25, 2005 forward. Therefore, given the
significance of the ARC Holdings acquisition to
34
Covantas current and future results of operations and
financial condition, Covanta believes that an understanding of
its reported results, trends and ongoing performance is enhanced
by presenting results on a pro forma basis at both the
consolidated level and the Waste and Energy Services segment
level for the nine months ended September 30, 2006 and
2005. The pro forma basis presentation assumes that the
acquisition of ARC Holdings occurred on January 1, 2005.
However, the pro forma results are equivalent to reported
results for the nine months ended September 30, 2006 as
there are no pro forma adjustments for this period. The pro
forma financial information is presented for informational
purposes only and is not indicative of the results of operations
that would have been achieved if the acquisition had taken place
on January 1, 2005 or that may result in the future. In
addition, the pro forma information provided below has not been
adjusted to reflect any operating efficiencies that may be
realized as a result of the ARC Holdings acquisition.
Covantas consolidated and segment results of operations,
as reported and where applicable, on a pro forma basis, are
summarized in the tables and discussions below. The pro forma
adjustments are described starting on page 45.
Consolidated
Results
Covantas consolidated results of operations are presented
on a reported basis for the three months ended
September 30, 2006 and 2005 and on both a reported and pro
forma basis for the nine months ended September 30, 2006
and 2005 in the table below (in thousands of dollars, except per
share amounts):
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Three Months Ended September 30,
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Nine Months Ended September 30,
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Reported
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Reported
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Pro Forma
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2006
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2005
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2006
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|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
(Unaudited)
|
|
|
CONSOLIDATED RESULTS OF
OPERATIONS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
$
|
311,115
|
|
|
$
|
301,490
|
|
|
$
|
950,607
|
|
|
$
|
675,401
|
|
|
$
|
950,607
|
|
|
$
|
905,713
|
|
Total operating expenses
|
|
|
239,472
|
|
|
|
236,499
|
|
|
|
766,758
|
|
|
|
567,737
|
|
|
|
766,758
|
|
|
|
753,046
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
71,643
|
|
|
|
64,991
|
|
|
|
183,849
|
|
|
|
107,664
|
|
|
|
183,849
|
|
|
|
152,667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER INCOME
(EXPENSE):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment income
|
|
|
2,483
|
|
|
|
1,657
|
|
|
|
7,801
|
|
|
|
3,530
|
|
|
|
7,801
|
|
|
|
4,755
|
|
Interest expense
|
|
|
(26,968
|
)
|
|
|
(30,701
|
)
|
|
|
(87,265
|
)
|
|
|
(59,053
|
)
|
|
|
(87,265
|
)
|
|
|
(88,810
|
)
|
Loss on extinguishment of debt
|
|
|
|
|
|
|
|
|
|
|
(2,342
|
)
|
|
|
|
|
|
|
(2,342
|
)
|
|
|
|
|
Unrealized gain on derivative
instruments, unexercised ACL warrants
|
|
|
|
|
|
|
10,578
|
|
|
|
|
|
|
|
14,796
|
|
|
|
|
|
|
|
14,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expense
|
|
|
(24,485
|
)
|
|
|
(18,466
|
)
|
|
|
(81,806
|
)
|
|
|
(40,727
|
)
|
|
|
(81,806
|
)
|
|
|
(69,259
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes,
minority interests and equity in net income from unconsolidated
investments
|
|
|
47,158
|
|
|
|
46,525
|
|
|
|
102,043
|
|
|
|
66,937
|
|
|
|
102,043
|
|
|
|
83,408
|
|
Income tax expense
|
|
|
(18,870
|
)
|
|
|
(16,391
|
)
|
|
|
(29,795
|
)
|
|
|
(24,008
|
)
|
|
|
(29,795
|
)
|
|
|
(37,533
|
)
|
Minority interests
|
|
|
(1,982
|
)
|
|
|
(2,172
|
)
|
|
|
(4,861
|
)
|
|
|
(9,311
|
)
|
|
|
(4,861
|
)
|
|
|
(9,367
|
)
|
Equity in net income from
unconsolidated investments
|
|
|
4,945
|
|
|
|
9,439
|
|
|
|
26,460
|
|
|
|
20,003
|
|
|
|
26,460
|
|
|
|
20,003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME
|
|
$
|
31,251
|
|
|
$
|
37,401
|
|
|
$
|
93,847
|
|
|
$
|
53,621
|
|
|
$
|
93,847
|
|
|
$
|
56,511
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EARNINGS PER SHARE:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.21
|
|
|
$
|
0.27
|
|
|
$
|
0.65
|
|
|
$
|
0.46
|
|
|
$
|
0.65
|
|
|
$
|
0.40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
0.21
|
|
|
$
|
0.26
|
|
|
$
|
0.64
|
|
|
$
|
0.44
|
|
|
$
|
0.64
|
|
|
$
|
0.39
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
35
Basic and diluted earnings per share and the average shares used
in the calculation of basic and diluted earnings per share have
been adjusted retroactively to reflect the bonus element
contained in the rights offering conducted in June 2005.
The following general discussions should be read in conjunction
with the above table, the condensed consolidated financial
statements and the Notes thereto and other financial information
appearing and referred to elsewhere in this report. Additional
detail on comparable revenues, costs and expenses, and operating
income is provided in the reported and pro forma Waste and
Energy Services segment discussion and reported Other Services
segment discussion below.
Consolidated
Results of Operations Comparison of Reported Results
for the Three Months Ended September 30, 2006 vs. Reported
Results for the Three Months Ended September 30,
2005
Covantas operating revenues increased by $9.6 million
primarily from increased waste and service revenues due to
contract fee escalations and higher energy prices in 2006 in the
domestic Waste and Energy Services segment. Operating income
increased by $6.7 million resulting primarily from a
decrease in other operating expenses of $5.3 million
primarily due to $2.6 million in final distributions and
settlements of disputed matters relating to Covanta
Energys reorganization, and $2.3 million in insurance
recoveries. Operating income also increased due to increased
operating revenues and cost reduction initiatives in the Waste
and Energy Services segment.
Total investment income increased by $0.8 million primarily
due to higher invested cash balances. Interest expense decreased
by $3.7 million primarily due to lower interest rates in
the new financing arrangements put into place in May 2006. For
the three months ended September 30, 2005, Covanta recorded
a pre-tax unrealized gain on derivative instruments of
$10.6 million related to its investment in American
Commercial Lines LLC (ACL) warrants which was
liquidated in October 2005 as discussed in Note 15.
Financial Instruments of the Notes.
Equity in net income from unconsolidated investments decreased
by $4.5 million primarily due to the effects of the
following factors relating to Covantas interest in the
Quezon facility in the Philippines:
|
|
|
|
|
a $1.4 million adjustment to the existing deferred tax
asset as a result of strengthening of the Philippine peso versus
the US dollar in the third quarter of 2006 related to a
cumulative deferred income tax benefit of $7.0 million
which Covanta recorded in the quarter ended June 30,
2006 and
|
|
|
|
increased income tax expense of approximately $1.8 million
resulting from the conclusion of a six-year income tax holiday
in May 2006.
|
Income tax expense increased by $2.5 million primarily due
to higher taxable income.
Net income and diluted earnings per share decreased by
$6.2 million and $0.05, respectively, as a result of the
combined effects of the factors in this section as discussed
above.
Consolidated
Results of Operations Comparison of Reported Results
for the Nine Months Ended September 30, 2006 vs. Reported
Results for the Nine Months Ended September 30,
2005
Covantas operating revenues increased by
$275.2 million primarily from increases in waste and
service revenues of $171.3 million and increases in
electricity and steam sales of $104.1 million. Operating
income increased by $76.2 million resulting primarily from
impacts of the businesses acquired as part of the ARC Holdings
acquisition in the second quarter of 2005 combined with
increased operating revenues, cost reduction initiatives and
reduced scope of scheduled maintenance activity in 2006 in the
Waste and Energy Services segment. Other operating expenses
decreased by $6.5 million primarily due to
$2.6 million in final distributions and settlements of
disputed matters relating to Covanta Energys
reorganization, and $2.3 million in insurance recoveries.
Total investment income increased by $4.3 million primarily
due to higher invested cash balances. Interest expense increased
by $28.2 million primarily due to the new financing
arrangements put into place as part of the ARC Holdings
acquisition in June 2005 and the write-off of $4.5 million
of deferred financing costs related to the amendments to the
financing arrangements in May 2006. As a result of the 2006
amendments to the financing arrangements, a loss on
extinguishment of debt of $2.3 million was recognized for
the nine months ended
36
September 30, 2006. For the nine months ended
September 30, 2005, Covanta recorded a pre-tax unrealized
gain on derivative instruments of $14.8 million related to
its investment in ACL warrants which was liquidated in October
2005 as discussed in Note 15. Financial Instruments of the
Notes.
Equity in net income from unconsolidated investments increased
by $6.5 million due to the effects of the following factors
relating to the Quezon facility:
|
|
|
|
|
the absence during 2006 of a major scheduled turbine-generator
maintenance project that occurred during 2005 that is generally
scheduled twice in a seven year cycle, and
|
|
|
|
a $5.6 million cumulative deferred income tax benefit
recorded related to unrealized foreign exchange losses as
discussed above; offset by
|
|
|
|
an increase in tax expense of approximately $1.8 million
related to the conclusion of a six-year income tax holiday in
May 2006.
|
Income tax expense increased by $5.8 million due to higher
taxable income primarily from impacts of the businesses acquired
as part of the ARC Holdings acquisition offset by a one-time tax
benefit of $10 million recorded during the three months
ended June 30, 2006 associated with the adoption of the
permanent reinvestment exception under APB 23. For
additional detail, see Note 11. Income Taxes of the Notes.
Net income and diluted earnings per share increased by
$40.2 million and $0.20, respectively, as a result of the
combined effects of the factors in this section as discussed
above.
Consolidated
Results of Operations Comparison of Reported Results
for the Nine Months Ended September 30, 2006 vs. Pro Forma
Results for the Nine Months Ended September 30,
2005
Covantas operating revenues increased by
$44.9 million primarily from increases in waste and service
revenues of $20.7 million and increases in electricity and
steam sales of $24.4 due to contract fee escalations and higher
energy and scrap metal prices. Operating income increased by
$31.2 million primarily due to higher operating revenues,
cost reduction initiatives and reduced scope of scheduled
maintenance activity in the Waste and Energy Services segment
during the nine months ended September 30, 2006. Other
operating expenses decreased by $7.0 million primarily due
to $2.6 million in final distributions and settlements of
disputed matters relating to Covanta Energys
reorganization, and $2.3 million in insurance recoveries.
Total investment income increased by $3.0 million primarily
due to higher invested cash balances. Interest expense increased
by $1.5 million primarily due to the write-off of
$4.5 million of deferred financing costs related to the
amendments to the financing arrangements in May 2006, offset by
lower outstanding debt balances. As a result of the 2006
amendments to the financing arrangements, a loss on
extinguishment of debt of $2.3 million was recognized for
the nine months ended September 30, 2006. For the nine
months ended September 30, 2005, Covanta recorded a pre-tax
unrealized gain on derivative instruments of $14.8 million
related to its investment in ACL warrants which was liquidated
in October 2005 as discussed in Note 15. Financial
Instruments of the Notes.
Equity in net income from unconsolidated investments increased
by $6.5 million due to the effects of the following factors
relating to the Quezon facility:
|
|
|
|
|
the absence during 2006 of a major scheduled turbine-generator
maintenance project that occurred during 2005 that is generally
scheduled twice in a seven year cycle, and
|
|
|
|
a $5.6 million cumulative deferred income tax benefit
recorded related to unrealized foreign exchange losses as
discussed above; offset by
|
|
|
|
an increase in tax expense of approximately $1.8 million of
related to the conclusion of a six-year income tax holiday in
May 2006.
|
Income tax expense decreased by $7.7 million primarily due
to a one-time tax benefit of $10 million recorded during
the three months ended June 30, 2006 associated with the
adoption of the permanent reinvestment exception under
APB 23. For additional detail, see Note 11. Income
Taxes of the Notes.
37
Net income and diluted earnings per share increased by
$37.3 million and $0.25, respectively, as a result of the
combined effects of the factors in this section as discussed
above.
Waste and
Energy Services Results
Waste and Energy Services results of operations are presented on
a reported basis for the three months ended September 30,
2006 and 2005 and on both a reported and pro forma basis for the
nine months ended September 30, 2006 and 2005 in the table
below (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
Reported
|
|
|
Reported
|
|
|
Pro Forma
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
(Unaudited)
|
|
|
Waste and service revenues
|
|
$
|
203,103
|
|
|
$
|
194,176
|
|
|
$
|
607,973
|
|
|
$
|
436,624
|
|
|
$
|
607,973
|
|
|
$
|
587,276
|
|
Electricity and steam sales
|
|
|
104,019
|
|
|
|
103,316
|
|
|
|
329,610
|
|
|
|
225,541
|
|
|
|
329,610
|
|
|
|
305,201
|
|
Other operating revenues
|
|
|
805
|
|
|
|
378
|
|
|
|
2,381
|
|
|
|
1,779
|
|
|
|
2,381
|
|
|
|
1,779
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
307,927
|
|
|
|
297,870
|
|
|
|
939,964
|
|
|
|
663,944
|
|
|
|
939,964
|
|
|
|
894,256
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Plant operating expenses
|
|
|
161,611
|
|
|
|
152,984
|
|
|
|
522,330
|
|
|
|
394,183
|
|
|
|
522,330
|
|
|
|
500,936
|
|
Depreciation and amortization
|
|
|
47,726
|
|
|
|
44,551
|
|
|
|
142,926
|
|
|
|
78,027
|
|
|
|
142,926
|
|
|
|
136,882
|
|
Net interest expense on project
debt
|
|
|
14,722
|
|
|
|
16,988
|
|
|
|
46,013
|
|
|
|
36,700
|
|
|
|
46,013
|
|
|
|
51,766
|
|
Other operating income
|
|
|
(5,459
|
)
|
|
|
(345
|
)
|
|
|
(6,845
|
)
|
|
|
(705
|
)
|
|
|
(6,845
|
)
|
|
|
(186
|
)
|
General and administrative expenses
|
|
|
17,583
|
|
|
|
17,826
|
|
|
|
51,873
|
|
|
|
42,930
|
|
|
|
51,873
|
|
|
|
52,664
|
|
Restructuring charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,655
|
|
|
|
|
|
|
|
|
|
Acquisition-related charges
|
|
|
|
|
|
|
983
|
|
|
|
|
|
|
|
2,963
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
236,183
|
|
|
|
232,987
|
|
|
|
756,297
|
|
|
|
556,753
|
|
|
|
756,297
|
|
|
|
742,062
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
71,744
|
|
|
$
|
64,883
|
|
|
$
|
183,667
|
|
|
$
|
107,191
|
|
|
$
|
183,667
|
|
|
$
|
152,194
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following business segment discussion is presented on a
reported basis for the three months ended September 30,
2006 and 2005 and on a pro forma basis for the nine months ended
September 30, 2006 and 2005. The results of operations for
the nine months ended September 30, 2005 are not
representative of Covantas ongoing results since ARC
Holdings results of operations were included in Covanta
Energys consolidated results of operations from
June 25, 2005 forward. Therefore, given the significance of
the ARC Holdings acquisition to Covantas current and
future results of operations and financial condition, Covanta
believes that an understanding of its reported results, trends
and ongoing performance is enhanced by discussing results on a
pro forma basis at the Waste and Energy Services segment levels
for the nine months ended September 30, 2005. The following
general discussion should be read in conjunction with the above
table, the condensed consolidated financial statements and the
Notes. Additional detail on comparable revenues, costs and
expenses, and operating income, within the Waste and Energy
Services segment is provided in the reported and pro forma
domestic and international business discussion below.
Waste and
Energy Services Results of Operations Comparison of
Reported Results for the Three Months Ended September 30,
2006 vs. Reported Results for the Three Months Ended
September 30, 2005
Operating income increased by $6.9 million primarily due to
the effects of:
|
|
|
|
|
increases in operating revenues of $10.1 million primarily
due to contract fee escalations and higher energy prices in 2006
in the domestic business, and
|
|
|
|
increases in operating expenses of $3.2 million primarily
due to higher plant operating expenses.
|
Additional information regarding changes in revenues and
expenses is provided below in the discussion of domestic and
international businesses comprising the Waste and Energy
Services segment.
38
Waste and
Energy Services Results of Operations Comparison of
Reported Results for the Nine Months Ended September 30,
2006 vs. Pro Forma Results for the Nine Months Ended
September 30, 2005
Operating income increased by $31.5 million primarily due
to the effects of:
|
|
|
|
|
increases in operating revenues of $45.7 million primarily
due to contract fee escalations and higher energy prices in 2006
in the domestic business, and
|
|
|
|
increases in operating expenses of $14.2 million primarily
due to higher plant operating expenses.
|
Additional information regarding changes in revenues and
expenses is provided below in the discussion of domestic and
international businesses comprising the Waste and Energy
Services segment.
Waste and
Energy Services Domestic Business
The domestic business results of operations are presented on a
reported basis for the three months ended September 30,
2006 and 2005 and on both a reported and pro forma basis for the
nine months ended September 30, 2006 and 2005 in the table
below (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
Reported
|
|
|
Reported
|
|
|
Pro Forma
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
(Unaudited)
|
|
|
Waste and service revenues
|
|
$
|
202,154
|
|
|
$
|
194,176
|
|
|
$
|
604,734
|
|
|
$
|
433,319
|
|
|
$
|
604,734
|
|
|
$
|
583,971
|
|
Electricity and steam sales
|
|
|
76,713
|
|
|
|
71,004
|
|
|
|
221,149
|
|
|
|
124,241
|
|
|
|
221,149
|
|
|
|
203,901
|
|
Other operating revenues
|
|
|
805
|
|
|
|
378
|
|
|
|
2,381
|
|
|
|
1,779
|
|
|
|
2,381
|
|
|
|
1,779
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
279,672
|
|
|
|
265,558
|
|
|
|
828,264
|
|
|
|
559,339
|
|
|
|
828,264
|
|
|
|
789,651
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Plant operating expenses
|
|
|
142,717
|
|
|
|
131,600
|
|
|
|
441,726
|
|
|
|
322,302
|
|
|
|
441,726
|
|
|
|
429,055
|
|
Depreciation and amortization
|
|
|
45,793
|
|
|
|
42,294
|
|
|
|
136,709
|
|
|
|
71,435
|
|
|
|
136,709
|
|
|
|
130,290
|
|
Net interest expense on project
debt
|
|
|
13,125
|
|
|
|
15,075
|
|
|
|
40,655
|
|
|
|
30,778
|
|
|
|
40,655
|
|
|
|
45,844
|
|
Other operating income expense
|
|
|
(5,411
|
)
|
|
|
(2,270
|
)
|
|
|
(5,060
|
)
|
|
|
(2,821
|
)
|
|
|
(5,060
|
)
|
|
|
(2,302
|
)
|
General and administrative expenses
|
|
|
16,314
|
|
|
|
16,551
|
|
|
|
48,620
|
|
|
|
39,195
|
|
|
|
48,620
|
|
|
|
48,929
|
|
Acquisition-related charges
|
|
|
|
|
|
|
983
|
|
|
|
|
|
|
|
2,963
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
212,538
|
|
|
|
204,233
|
|
|
|
662,650
|
|
|
|
463,852
|
|
|
|
662,650
|
|
|
|
651,816
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
67,134
|
|
|
$
|
61,325
|
|
|
$
|
165,614
|
|
|
$
|
95,487
|
|
|
$
|
165,614
|
|
|
$
|
137,835
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waste and
Energy Domestic Business Results of Operations
Comparison of Reported Results for the Three Months Ended
September 30, 2006 vs. Reported Results for the Three
Months Ended September 30, 2005
Total domestic revenue increased by $14.1 million primarily
due to contract fee escalation and higher energy and scrap metal
prices as described below.
Waste and service revenues increased by $8.0 million or
4.1% as a result of the following factors:
|
|
|
|
|
Revenue from
waste-to-energy
projects structured with Service Fee arrangements increased by
$1.6 million. Such revenues increased $2.7 million
primarily due to contractual escalations offset by a reduction
of $1.1 million related to lower revenues earned explicitly
to service debt;
|
|
|
|
Revenue from
waste-to-energy
projects structured with Tip Fee arrangements increased by
$3.9 million. Such revenues increased by $1.6 million
primarily driven by higher volumes of waste handled and
$2.3 million due to the emergence of a subsidiary from
bankruptcy in December 2005, and its subsequent inclusion in
Covantas consolidated results of operations; and
|
39
|
|
|
|
|
Other waste and service fee revenues increased by
$2.4 million primarily due to higher pricing for scrap
metal.
|
Electricity and steam revenue increased $5.7 million or 8%,
comprised of an increase of $4.1 million due to higher
energy rates and an increase of $1.6 million due to the
emergence of a subsidiary from bankruptcy in December 2005, and
its subsequent inclusion in Covantas consolidated results
of operations.
Plant operating expenses increased by $11.1 million
primarily due to normal cost escalations such as wages, timing
of scheduled plant maintenance, and the emergence of a
subsidiary from bankruptcy in December 2005, and its subsequent
inclusion in Covantas consolidated results of operations,
partially offset by cost reduction initiatives.
Depreciation and amortization increased by $3.5 million
primarily due to additions of property, plant and equipment and
the emergence of a subsidiary from bankruptcy in December 2005,
and its subsequent inclusion in Covantas consolidated
results of operations.
Net interest expense on project debt decreased by
$2.0 million primarily due to lower project debt balances.
Other operating income increased by $3.1 million primarily
due to final distributions and settlements of disputed matters
relating to Covanta Energys reorganization, and insurance
recoveries.
General and administrative expenses for the three months ended
September 30, 2006 were comparable to the same period in
2005 primarily due to wage escalations and increased development
spending offset by additional synergies from the ARC Holdings
acquisition.
Waste and
Energy Domestic Business Results of Operations
Comparison of Reported Results for the Nine Months Ended
September 30, 2006 vs. Pro Forma Results for the Nine
Months Ended September 30, 2005
Total domestic revenue increased by $38.6 million primarily
due to contract fee escalation and higher energy and scrap metal
prices as described below.
Waste and service revenues increased by $20.8 million or
3.6% resulting from the impacts of the following factors:
|
|
|
|
|
Revenue from
waste-to-energy
projects structured with Service Fee arrangements increased by
$4 million. Such revenues increased by $10.6 million
primarily due to contractual escalations and higher additional
waste service fees offset by a reduction of $6.6 million
related to lower revenues earned explicitly to service debt;
|
|
|
|
Revenue from
waste-to-energy
projects structured with Tip Fee arrangements increased by
$11 million. Such revenues increased by $4.5 million
primarily driven by favorable pricing and higher volumes for
waste handled and $6.5 million primarily due to the
emergence of a subsidiary from bankruptcy in December 2005, and
its subsequent inclusion in Covantas consolidated results
of operations; and
|
|
|
|
Other waste and service fee revenues increased by
$5.8 million primarily due to higher pricing for scrap
metal.
|
Electricity and steam revenue increased by $17.3 million or
8.5%, comprised of an increase of $12.9 million due to
higher energy rates and increased production, and an increase of
$4.4 million due to the emergence of a subsidiary from
bankruptcy in December 2005, and its subsequent inclusion in
Covantas consolidated results of operations.
Plant operating expenses increased by $12.7 million
primarily due to normal cost escalations such as wages and the
emergence of a subsidiary from bankruptcy in December 2005, and
its subsequent inclusion in Covantas consolidated results
of operations, partially offset by reduced scope of scheduled
plant maintenance and cost reduction initiatives.
Depreciation and amortization increased by $6.4 million
primarily due to additions to property, plant and equipment and
the emergence of a subsidiary from bankruptcy in December 2005,
and its subsequent inclusion in Covantas consolidated
results of operations.
40
Net interest expense on project debt decreased by
$5.2 million primarily as a result of lower project debt
balances.
Other operating income increased by $2.7 million primarily
due to final distributions and settlements of disputed matters
relating to Covanta Energys reorganization, and insurance
recoveries.
General and administrative expenses for the nine months ended
September 30, 2006 were comparable to the same period in
2005 primarily due to wage escalations and increased development
spending offset by additional synergies from the ARC Holdings
acquisition.
Waste and
Energy Services International Business
The international business results of operations are presented
on a reported basis for the three months ended
September 30, 2006 and 2005 and on both a reported and pro
forma basis for the nine months ended September 30, 2006
and 2005 in the table below (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
Reported
|
|
|
Reported
|
|
|
Pro Forma
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
(Unaudited)
|
|
|
Waste and service revenues
|
|
$
|
949
|
|
|
$
|
|
|
|
$
|
3,239
|
|
|
$
|
3,305
|
|
|
$
|
3,239
|
|
|
$
|
3,305
|
|
Electricity and steam sales
|
|
|
27,306
|
|
|
|
32,312
|
|
|
|
108,461
|
|
|
|
101,300
|
|
|
|
108,461
|
|
|
|
101,300
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
28,255
|
|
|
|
32,312
|
|
|
|
111,700
|
|
|
|
104,605
|
|
|
|
111,700
|
|
|
|
104,605
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Plant operating expenses
|
|
|
18,894
|
|
|
|
21,384
|
|
|
|
80,604
|
|
|
|
71,881
|
|
|
|
80,604
|
|
|
|
71,881
|
|
Depreciation and amortization
|
|
|
1,933
|
|
|
|
2,257
|
|
|
|
6,217
|
|
|
|
6,592
|
|
|
|
6,217
|
|
|
|
6,592
|
|
Net interest expense on project
debt
|
|
|
1,597
|
|
|
|
1,913
|
|
|
|
5,358
|
|
|
|
5,922
|
|
|
|
5,358
|
|
|
|
5,922
|
|
Other operating (income) expense
|
|
|
(48
|
)
|
|
|
1,925
|
|
|
|
(1,785
|
)
|
|
|
2,116
|
|
|
|
(1,785
|
)
|
|
|
2,116
|
|
General and administrative expenses
|
|
|
1,269
|
|
|
|
1,275
|
|
|
|
3,253
|
|
|
|
3,735
|
|
|
|
3,253
|
|
|
|
3,735
|
|
Restructuring charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,655
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
23,645
|
|
|
|
28,754
|
|
|
|
93,647
|
|
|
|
92,901
|
|
|
|
93,647
|
|
|
|
90,246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
4,610
|
|
|
$
|
3,558
|
|
|
$
|
18,053
|
|
|
$
|
11,704
|
|
|
$
|
18,053
|
|
|
$
|
14,359
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waste and
Energy International Business Results of Operations
Comparison of Reported Results for the Three Months Ended
September 30, 2006 vs. Reported Results for the Three
Months Ended September 30, 2005
Total revenues for the international business decreased by
$4.1 million primarily due to a $3.1 million decrease
due to the sale of the Huantai facility in China during the
second quarter of 2006, combined with a $1.6 million
decrease in revenues under energy contracts at both Indian
facilities as a result of lower generation during the three
months ended September 30, 2006.
Plant operating expenses decreased by $2.5 million
primarily as a result of a $2.9 million decrease in plant
operating costs due to the sale of the Huantai facility in China
in the second quarter of 2006.
Depreciation and amortization decreased by $0.3 million
primarily due to the sale of the Huantai facility in China in
the second quarter of 2006.
Net interest expense on project debt decreased by
$0.3 million primarily due to the scheduled quarterly pay
down of project debt at both Indian facilities.
Other operating income increased by $2.0 million primarily
due to the $1.8 million write-off of the remaining assets
of the Bataan facility during the three months ended
September 30, 2005.
General and administrative expenses for the three months ended
September 30, 2006 were comparable to the same period in
2005.
41
Waste and
Energy International Business Results of Operations
Comparison of Reported Results for the Nine Months Ended
September 30, 2006 vs. Pro Forma Results for the Nine
Months Ended September 30, 2005
Total revenues for the international business increased by
$7.1 million primarily due to a $13.7 million increase
in revenues under energy contracts at both Indian facilities
resulting from higher fuel costs passed through to the offtaker,
partially offset by a $7.0 million decrease in revenues
from the Huantai facility in China due to lower electricity and
steam sales in 2006 combined with the sale of the facility
during the second quarter of 2006.
Plant operating expenses increased by $8.7 million
primarily as a result of $14.4 million in higher fuel costs
at both Indian facilities, partially offset by a
$5.6 million decrease at the Huantai facility in China due
to lower generation combined with the sale of the facility
during the second quarter of 2006.
Depreciation and amortization decreased by $0.4 million
primarily due to the sale of the Huantai facility in China
during the second quarter of 2006.
Net interest expense on project debt decreased by
$0.6 million primarily due to the scheduled quarterly pay
down of project debt at both Indian facilities.
Other operating income increased by $3.9 million primarily
due to the effects of the following factors:
|
|
|
|
|
a $1.2 million gain on the sale of the Huantai facility in
China during the second quarter of 2006,
|
|
|
|
a $0.4 million gain on the sale of inventory at a facility
in the Philippines during the second quarter of 2006, and
|
|
|
|
a $1.8 million write-off of the remaining assets of the
Bataan facility during the three months ended September 30,
2005.
|
General and administrative expenses decreased by
$0.5 million for the nine months ended September 30,
2006, as compared to the same period in 2005, primarily due to
lower personnel costs in 2006.
Other
Services Results
Other Services reported results of operations are presented in
the table below (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the
|
|
|
For the
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
(Unaudited)
|
|
|
OPERATING REVENUES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums
|
|
$
|
2,817
|
|
|
$
|
3,074
|
|
|
$
|
9,420
|
|
|
$
|
9,928
|
|
Net investment income
|
|
|
400
|
|
|
|
533
|
|
|
|
1,230
|
|
|
|
1,513
|
|
Net realized investment (losses)
gains
|
|
|
(34
|
)
|
|
|
5
|
|
|
|
(60
|
)
|
|
|
(75
|
)
|
Other income
|
|
|
5
|
|
|
|
8
|
|
|
|
53
|
|
|
|
91
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other operating revenues
|
|
|
3,188
|
|
|
|
3,620
|
|
|
|
10,643
|
|
|
|
11,457
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
26
|
|
|
|
29
|
|
|
|
61
|
|
|
|
84
|
|
Other operating expenses
|
|
|
2,500
|
|
|
|
2,723
|
|
|
|
8,096
|
|
|
|
8,441
|
|
General and administrative expenses
|
|
|
763
|
|
|
|
760
|
|
|
|
2,304
|
|
|
|
2,459
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
3,289
|
|
|
|
3,512
|
|
|
|
10,461
|
|
|
|
10,984
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating (loss) income
|
|
$
|
(101
|
)
|
|
$
|
108
|
|
|
$
|
182
|
|
|
$
|
473
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums decreased by $0.3 million and
$0.5 million for the three and nine months ended
September 30, 2006, respectively, as compared to the same
periods in 2005 primarily due to the change in net written
premiums primarily driven by softer market conditions. Net
investment income decreased by $0.1 million and
$0.3 million for the three and nine months ended
September 30, 2006, respectively, as compared to the same
periods in
42
2005 primarily due to a decrease in the fixed income portfolio
basis. Other operating expenses for the three and nine months
ended September 30, 2006 were comparable to the same period
in 2005. Other operating expenses consist of net loss and loss
adjustment expenses (LAE), and policy acquisition
costs as described below. General and administrative expenses
were comparable for the three months ended September 30,
2006 as compared to the same period in 2005 and decreased by
$0.2 million for the nine months ended September 30,
2006 as compared to the same period in 2005 due primarily to
reductions in administrative personnel in the insurance business.
The loss and LAE ratio for the three and nine months ended
September 30, 2006 improved as compared to the same periods
in 2005 due to improved performance of the private passenger
auto programs. The resulting loss and LAE ratios were 64.9% and
69.7% for the nine months ended September 30, 2006 and
2005, respectively. As a percentage of net earned premiums,
policy acquisition costs were 21.0% and 15.4% for the nine
months ended September 30, 2006 and 2005, respectively.
Policy acquisition costs increased in 2006 compared to the 2005
period due to the elimination of the ceding commissions earned
under the quota share reinsurance agreements that were in effect
during 2005.
PRO FORMA
RECONCILIATIONS
The following tables provide reconciliations from the as
reported results to the pro forma results presented above for
Covanta and its Waste and Energy Services segment where
applicable (in thousands of dollars, except per share amounts).
Notes to the pro forma reconciliations begin directly after the
tables.
CONSOLIDATED
PRO FORMA RECONCILIATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2006
|
|
|
Nine Months Ended September 30, 2005
|
|
|
|
|
|
|
|
|
|
Acquisition
|
|
|
Pro Forma
|
|
|
|
|
|
|
|
|
Acquisition
|
|
|
Pro Forma
|
|
|
|
|
|
|
|
|
|
As Reported
|
|
|
Activity
|
|
|
Adjust.
|
|
|
Pro Forma
|
|
|
As Reported
|
|
|
Activity
|
|
|
Adjust.
|
|
|
Pro Forma
|
|
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
Operating revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waste and service revenues
|
|
$
|
607,973
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
607,973
|
|
|
$
|
436,624
|
|
|
$
|
148,792
|
|
|
$
|
1,860
|
|
|
$
|
587,276
|
|
|
|
|
|
Electricity and steam sales
|
|
|
329,610
|
|
|
|
|
|
|
|
|
|
|
|
329,610
|
|
|
|
225,541
|
|
|
|
79,660
|
|
|
|
|
|
|
|
305,201
|
|
|
|
|
|
Other operating revenues
|
|
|
13,024
|
|
|
|
|
|
|
|
|
|
|
|
13,024
|
|
|
|
13,236
|
|
|
|
|
|
|
|
|
|
|
|
13,236
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
950,607
|
|
|
|
|
|
|
|
|
|
|
|
950,607
|
|
|
|
675,401
|
|
|
|
228,452
|
|
|
|
1,860
|
|
|
|
905,713
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Plant operating expenses
|
|
|
522,330
|
|
|
|
|
|
|
|
|
|
|
|
522,330
|
|
|
|
394,183
|
|
|
|
103,617
|
|
|
|
3,136
|
|
|
|
500,936
|
|
|
|
|
|
Depreciation and amortization
expense
|
|
|
142,987
|
|
|
|
|
|
|
|
|
|
|
|
142,987
|
|
|
|
78,111
|
|
|
|
57,032
|
|
|
|
1,823
|
|
|
|
136,966
|
|
|
|
|
|
Net interest expense on project debt
|
|
|
46,013
|
|
|
|
|
|
|
|
|
|
|
|
46,013
|
|
|
|
36,700
|
|
|
|
13,964
|
|
|
|
1,102
|
|
|
|
51,766
|
|
|
|
|
|
Other operating expenses
|
|
|
1,251
|
|
|
|
|
|
|
|
|
|
|
|
1,251
|
|
|
|
7,736
|
|
|
|
519
|
|
|
|
|
|
|
|
8,255
|
|
|
|
|
|
General and administrative expenses
|
|
|
54,177
|
|
|
|
|
|
|
|
|
|
|
|
54,177
|
|
|
|
45,389
|
|
|
|
52,133
|
|
|
|
(42,399
|
)
|
|
|
55,123
|
|
|
|
|
|
Restructuring charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,655
|
|
|
|
|
|
|
|
(2,655
|
)
|
|
|
|
|
|
|
|
|
Acquisition-related charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,963
|
|
|
|
|
|
|
|
(2,963
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
766,758
|
|
|
|
|
|
|
|
|
|
|
|
766,758
|
|
|
|
567,737
|
|
|
|
227,265
|
|
|
|
(41,956
|
)
|
|
|
753,046
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
183,849
|
|
|
|
|
|
|
|
|
|
|
|
183,849
|
|
|
|
107,664
|
|
|
|
1,187
|
|
|
|
43,816
|
|
|
|
152,667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income
(expenses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment income
|
|
|
7,801
|
|
|
|
|
|
|
|
|
|
|
|
7,801
|
|
|
|
3,530
|
|
|
|
1,225
|
|
|
|
|
|
|
|
4,755
|
|
|
|
|
|
Interest expense
|
|
|
(87,265
|
)
|
|
|
|
|
|
|
|
|
|
|
(87,265
|
)
|
|
|
(59,053
|
)
|
|
|
(26,368
|
)
|
|
|
(3,389
|
)
|
|
|
(88,810
|
)
|
|
|
|
|
Loss on extinguishment of debt
|
|
|
(2,342
|
)
|
|
|
|
|
|
|
|
|
|
|
(2,342
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on derivative instruments, ACL
warrants
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14,796
|
|
|
|
|
|
|
|
|
|
|
|
14,796
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expenses
|
|
|
(81,806
|
)
|
|
|
|
|
|
|
|
|
|
|
(81,806
|
)
|
|
|
(40,727
|
)
|
|
|
(25,143
|
)
|
|
|
(3,389
|
)
|
|
|
(69,259
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax
(expense) benefit, minority interests and equity in net income
from unconsolidated investments
|
|
|
102,043
|
|
|
|
|
|
|
|
|
|
|
|
102,043
|
|
|
|
66,937
|
|
|
|
(23,956
|
)
|
|
|
40,427
|
|
|
|
83,408
|
|
|
|
|
|
Income tax (expense) benefit
|
|
|
(29,795
|
)
|
|
|
|
|
|
|
|
|
|
|
(29,795
|
)
|
|
|
(24,008
|
)
|
|
|
6,033
|
|
|
|
(19,558
|
)
|
|
|
(37,533
|
)
|
|
|
|
|
Minority interests
|
|
|
(4,861
|
)
|
|
|
|
|
|
|
|
|
|
|
(4,861
|
)
|
|
|
(9,311
|
)
|
|
|
(56
|
)
|
|
|
|
|
|
|
(9,367
|
)
|
|
|
|
|
Equity in net income of
unconsolidated investments
|
|
|
26,460
|
|
|
|
|
|
|
|
|
|
|
|
26,460
|
|
|
|
20,003
|
|
|
|
|
|
|
|
|
|
|
|
20,003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
93,847
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
93,847
|
|
|
$
|
53,621
|
|
|
$
|
(17,979
|
)
|
|
$
|
20,869
|
|
|
$
|
56,511
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings Per Share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.65
|
|
|
|
|
|
|
|
|
|
|
$
|
0.65
|
|
|
$
|
0.46
|
|
|
|
|
|
|
|
|
|
|
$
|
0.40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
0.64
|
|
|
|
|
|
|
|
|
|
|
$
|
0.64
|
|
|
$
|
0.44
|
|
|
|
|
|
|
|
|
|
|
$
|
0.39
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43
WASTE AND
ENERGY SERVICES PRO FORMA RECONCILIATIONS
Domestic
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2006
|
|
|
Nine Months Ended September 30, 2005
|
|
|
|
|
|
|
Acquisition
|
|
|
Pro Forma
|
|
|
|
|
|
|
|
|
Acquisition
|
|
|
Pro Forma
|
|
|
|
|
|
|
As Reported
|
|
|
Activity
|
|
|
Adjust.
|
|
|
Pro Forma
|
|
|
As Reported
|
|
|
Activity
|
|
|
Adjust.
|
|
|
Pro Forma
|
|
|
|
(Unaudited)
|
|
|
Operating revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waste and service revenues
|
|
$
|
604,734
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
604,734
|
|
|
$
|
433,319
|
|
|
$
|
148,792
|
|
|
$
|
1,860
|
|
|
$
|
583,971
|
|
Electricity and steam sales
|
|
|
221,149
|
|
|
|
|
|
|
|
|
|
|
|
221,149
|
|
|
|
124,241
|
|
|
|
79,660
|
|
|
|
|
|
|
|
203,901
|
|
Other operating revenues
|
|
|
2,381
|
|
|
|
|
|
|
|
|
|
|
|
2,381
|
|
|
|
1,779
|
|
|
|
|
|
|
|
|
|
|
|
1,779
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
828,264
|
|
|
|
|
|
|
|
|
|
|
|
828,264
|
|
|
|
559,339
|
|
|
|
228,452
|
|
|
|
1,860
|
|
|
|
789,651
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Plant operating expenses
|
|
|
441,726
|
|
|
|
|
|
|
|
|
|
|
|
441,726
|
|
|
|
322,302
|
|
|
|
103,617
|
|
|
|
3,136
|
|
|
|
429,055
|
|
Depreciation and amortization
expense
|
|
|
136,709
|
|
|
|
|
|
|
|
|
|
|
|
136,709
|
|
|
|
71,435
|
|
|
|
57,032
|
|
|
|
1,823
|
|
|
|
130,290
|
|
Net interest expense on project debt
|
|
|
40,655
|
|
|
|
|
|
|
|
|
|
|
|
40,655
|
|
|
|
30,778
|
|
|
|
13,964
|
|
|
|
1,102
|
|
|
|
45,844
|
|
Other operating expenses
|
|
|
(5,060
|
)
|
|
|
|
|
|
|
|
|
|
|
(5,060
|
)
|
|
|
(2,821
|
)
|
|
|
519
|
|
|
|
|
|
|
|
(2,302
|
)
|
General and administrative expenses
|
|
|
48,620
|
|
|
|
|
|
|
|
|
|
|
|
48,620
|
|
|
|
39,195
|
|
|
|
52,133
|
|
|
|
(42,399
|
)
|
|
|
48,929
|
|
Acquisition-related charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,963
|
|
|
|
|
|
|
|
(2,963
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
662,650
|
|
|
|
|
|
|
|
|
|
|
|
662,650
|
|
|
|
463,852
|
|
|
|
227,265
|
|
|
|
(39,301
|
)
|
|
|
651,816
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
165,614
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
165,614
|
|
|
$
|
95,487
|
|
|
$
|
1,187
|
|
|
$
|
41,161
|
|
|
$
|
137,835
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
International
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2006
|
|
|
Nine Months Ended September 30, 2005
|
|
|
|
|
|
|
Acquisition
|
|
|
Pro Forma
|
|
|
|
|
|
As
|
|
|
Acquisition
|
|
|
Pro Forma
|
|
|
|
|
|
|
As Reported
|
|
|
Activity
|
|
|
Adjust.
|
|
|
Pro Forma
|
|
|
Reported
|
|
|
Activity
|
|
|
Adjust.
|
|
|
Pro Forma
|
|
|
|
(Unaudited)
|
|
|
Operating revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Waste and service revenues
|
|
$
|
3,239
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
3,239
|
|
|
$
|
3,305
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
3,305
|
|
Electricity and steam sales
|
|
|
108,461
|
|
|
|
|
|
|
|
|
|
|
|
108,461
|
|
|
|
101,300
|
|
|
|
|
|
|
|
|
|
|
|
101,300
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating revenues
|
|
|
111,700
|
|
|
|
|
|
|
|
|
|
|
|
111,700
|
|
|
|
104,605
|
|
|
|
|
|
|
|
|
|
|
|
104,605
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Plant operating expenses
|
|
|
80,604
|
|
|
|
|
|
|
|
|
|
|
|
80,604
|
|
|
|
71,881
|
|
|
|
|
|
|
|
|
|
|
|
71,881
|
|
Depreciation and amortization
expense
|
|
|
6,217
|
|
|
|
|
|
|
|
|
|
|
|
6,217
|
|
|
|
6,592
|
|
|
|
|
|
|
|
|
|
|
|
6,592
|
|
Net interest expense on project debt
|
|
|
5,358
|
|
|
|
|
|
|
|
|
|
|
|
5,358
|
|
|
|
5,922
|
|
|
|
|
|
|
|
|
|
|
|
5,922
|
|
Other operating expenses
|
|
|
(1,785
|
)
|
|
|
|
|
|
|
|
|
|
|
(1,785
|
)
|
|
|
2,116
|
|
|
|
|
|
|
|
|
|
|
|
2,116
|
|
General and administrative expenses
|
|
|
3,253
|
|
|
|
|
|
|
|
|
|
|
|
3,253
|
|
|
|
3,735
|
|
|
|
|
|
|
|
|
|
|
|
3,735
|
|
Restructuring charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,655
|
|
|
|
|
|
|
|
(2,655
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
93,647
|
|
|
|
|
|
|
|
|
|
|
|
93,647
|
|
|
|
92,901
|
|
|
|
|
|
|
|
(2,655
|
)
|
|
|
90,246
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
18,053
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
18,053
|
|
|
$
|
11,704
|
|
|
$
|
|
|
|
$
|
2,655
|
|
|
$
|
14,359
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
44
Notes
to Pro Forma Reconciliations
Pro Forma
Assumptions
The unaudited pro forma condensed consolidated financial
statements reflect the following assumptions:
Covanta Energy Transactions:
|
|
|
|
|
The debt structure of Covanta Energy and CPIH that was in place
upon Covanta Energys emergence from bankruptcy on
March 10, 2004, was assumed to be refinanced, prior to the
amendment to the credit facilities on May 26, 2006, in
connection with the acquisition of ARC Holdings as of
January 1, 2005 as more fully described in Note 3.
Acquisition of the Notes.
|
ARC Holdings Transactions:
|
|
|
|
|
Covanta, through Covanta Energy, purchased 100% of the issued
and outstanding shares of ARC Holdings capital stock on
January 1, 2005 on the same terms described in Note 3.
Acquisition of the Notes.
|
Acquisition Activity:
|
|
|
|
|
Represents ARC Holdings actual results of operations for
the period of January 1, 2005 through June 24, 2005.
|
Pro Forma
Adjustments
The following are a summary of the pro forma adjustments made:
|
|
|
|
|
Waste and service revenues: To record
additional revenues prior to June 25, 2005 as a result of
conforming debt service revenue recognition at ARC Holdings
subsidiaries to Covanta Energys debt service revenue
recognition policy, which policy has been implemented by ARC
Holdings since its acquisition.
|
|
|
|
Plant operating expenses: To record as rent
expense the net impact of the change in the fair value of a
lease owned by an operating subsidiary of ARC Holdings as of
January 1, 2005.
|
|
|
|
Depreciation and amortization expense: To
reverse ARC Holdings historical depreciation and
amortization expense and to record pro forma depreciation and
amortization expense based on fair values assigned to ARC
Holdings property, plant and equipment and amortizable
intangible assets prior to its respective acquisition date.
|
|
|
|
Net interest expense on project debt: To
reverse ARC Holdings project debt prior bond issuance cost
amortization and to record the impact of fair value adjustments
to ARC Holdings project debt prior to its acquisition date.
|
|
|
|
General and administrative expenses: To
reverse ARC Holdings executive compensation and related
expenses in the periods prior to the acquisition date.
|
|
|
|
Acquisition-related charges: To reverse
employee bonuses and integration expenses as a result of the
acquisition of ARC Holdings.
|
|
|
|
Interest expense: To reverse ARC
Holdings pre-acquisition period amortization of deferred
financing costs; to record the impact of the fair value
adjustment to the intermediate debt of ARC Holdings; to record
the effect of the fair value adjustment associated with
terminating an obligation to one of ARC Holdings prior
owners; and to record the net adjustment to interest expense as
a result of the initial capital structure of Covanta Energy,
prior to the amendment to the credit facilities on May 26,
2006, described in Managements Discussion and Analysis of
Liquidity and Capital Resources below.
|
Additionally, in the second quarter ended June 30, 2006,
management revised its LIBOR interest rate assumption which
affected the previously disclosed pro forma results for the
period ended March 31, 2005 in the Quarterly Report on
Form 10-Q
for the period ended March 31, 2006. The impact was to
reduce pro forma net income by $1.0 million and reduce pro
forma basic and diluted earnings per share each by $0.01. Such
revision has been reflected in the nine months ended
September 30, 2005 pro forma net income and basic and
diluted earnings per share disclosed in this Quarterly Report on
Form 10-Q.
|
|
|
|
|
Income tax expense: To record the adjustment
for the estimated income tax effects associated with the pro
forma adjustments to pre-tax income and arrive at a blended
assumed effective tax rate of 45% for the nine months ended
September 30, 2005.
|
45
|
|
|
|
|
Earnings per share and shares
outstanding: Basic and diluted earnings per share
and the weighted average shares outstanding used in the
calculation of basic and diluted earnings per share of common
stock and shares of common stock outstanding for the pro forma
nine months ended September 30, 2005 have been adjusted to
reflect the issuance, as of January 1, 2005, of
66.7 million shares pursuant to a pro rata rights offering
to all of Covantas stockholders on June 24, 2005 in
connection with the ARC Holdings acquisition.
|
LIQUIDITY
AND CAPITAL RESOURCES
The information set forth below regarding liquidity and capital
resources is presented according to Covantas consolidated
operations and its Waste and Energy Services and Other Services
business segments. For information related to the Covanta Energy
May 26, 2006 credit agreement repricing, see
Financing Arrangements below.
Capital
Resources and Commitments
The following chart summarizes the various debt facilities and
cash resources at Covanta and its subsidiaries as of
September 30, 2006 (in millions of dollars):
46
Cash Flow
and Liquidity
Summary
Covantas sources of funds are its investments and
financing activities (including offerings of equity
and/or debt
securities), as well as dividends, if any, and other payments
received from Covanta Energy and NAICC. Under its financing
arrangements, Covanta Energys ability to pay dividends to
Covanta is limited, except in certain circumstances. Various
state insurance requirements restrict the amounts that may be
transferred to Covanta in the form of dividends or loans from
Covantas insurance subsidiaries without prior regulatory
approval. Currently, NAICC cannot pay dividends or make loans to
Covanta.
Summarized cash flow information for Covantas business
segments reconciled to the condensed consolidated statements of
cash flows is as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2006
|
|
|
|
Waste and
|
|
|
|
|
|
|
|
|
|
|
|
|
Energy
|
|
|
Other
|
|
|
Eliminations
|
|
|
Total
|
|
|
Net cash provided by (used in)
operating activities
|
|
$
|
234,826
|
|
|
$
|
(1,690
|
)
|
|
$
|
|
|
|
$
|
233,136
|
|
Net cash (used in) provided by
investing activities(1)
|
|
|
(30,793
|
)
|
|
|
5,486
|
|
|
|
|
|
|
|
(25,307
|
)
|
Net cash (used in) provided by
financing activities
|
|
|
(130,308
|
)
|
|
|
21,485
|
|
|
|
|
|
|
|
(108,823
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash
equivalents
|
|
$
|
73,725
|
|
|
$
|
25,281
|
|
|
$
|
|
|
|
$
|
99,006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2005
|
|
|
|
Waste and
|
|
|
|
|
|
|
|
|
|
|
|
|
Energy
|
|
|
Other
|
|
|
Eliminations
|
|
|
Total
|
|
|
Net cash provided by (used in)
operating activities
|
|
$
|
158,715
|
|
|
$
|
(10,863
|
)
|
|
$
|
|
|
|
$
|
147,852
|
|
Net cash (used in) provided by
investing activities(2)
|
|
|
(700,687
|
)
|
|
|
(372,477
|
)
|
|
|
384,954
|
|
|
|
(688,210
|
)
|
Net cash provided by (used in)
financing activities
|
|
|
602,512
|
|
|
|
392,384
|
|
|
|
(384,954
|
)
|
|
|
609,942
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash
equivalents
|
|
$
|
60,540
|
|
|
$
|
9,044
|
|
|
$
|
|
|
|
$
|
69,584
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Waste and Energy Services is net of proceeds of
$3.6 million from the sale of a facility in China. |
|
(2) |
|
Waste and Energy Services is net of cash acquired from ARC
Holdings of $62.4 million. |
Waste and
Energy Services Segment
Cash provided by operating activities was $234.8 million
and $158.7 million for the nine months ended
September 30, 2006 and 2005, respectively. The increase in
cash flow from operating activities was primarily due to
operations acquired in the ARC Holdings acquisition. Net cash
used in investing activities was $30.8 million in the nine
months ended September 30, 2006 and was primarily due to
the purchase of property, plant and equipment. Net cash used in
financing activities was $130.3 million for the nine months
ended September 30, 2006 and was primarily driven by the
payment of debt partially offset by a decrease in restricted
funds held in trust.
Restricted funds held in trust were $464.8 million as of
September 30, 2006. Restricted funds held in trust are
primarily amounts received and held by third party trustees
relating to projects owned by Covanta Energy, and which may be
used only for specified purposes. These payments are made
directly to the trustee primarily for related project debt and
are held by it until paid to project debt holders. Covanta does
not have access to these funds. In addition, as of
September 30, 2006, Covanta had $19.6 million in cash
held in restricted accounts to pay for certain taxes which may
be due relating to the period prior to Covanta Energys
bankruptcy and that are estimated to be paid in the future. Cash
held in such reserve accounts is not available for general
corporate purposes.
47
Generating sufficient cash to meet Covanta Energys
liquidity needs, pay down its debt and invest in its business
remains an important objective of management. Maintaining
historic facility production levels while effectively managing
operating and maintenance expenses is important to optimize
Covanta Energys long-term cash generation. Covanta Energy
does not expect to receive any cash contributions from Covanta
except in connection with certain acquisitions permitted under
its principal financing arrangements, and is prohibited under
such financing arrangements from using its cash to issue
dividends to Covanta except in limited circumstances.
Covanta Energy derives its cash flow principally from its
domestic and international project operations and businesses.
The frequency and predictability of Covanta Energys
receipt of cash from projects differs, depending upon various
factors, including whether restrictions on distributions exist
in applicable project debt arrangements or in debt arrangements
at Covanta Energys intermediate-level subsidiaries,
whether a project is domestic or international, and whether a
project has been able to operate at historical levels of
production.
A material portion of Covanta Energys domestic cash flows
are expected to be derived from projects where financial tests
and other covenants contained in respective debt arrangements
must be satisfied in order for project subsidiaries to make cash
distributions to intermediate Covanta Energy subsidiaries, and
for such intermediate-level subsidiaries to make cash
distributions to Covanta Energy. Distributions from these
intermediate-level subsidiaries may only be made quarterly, if
such financial tests and other covenants are satisfied.
Historically all such financial tests and covenants have been
satisfied. Covanta Energys remaining domestic projects
generally are not restricted in making cash distributions, and
no restrictions exist at intermediate Covanta Energy subsidiary
levels. As a result, Covanta Energy generally receives cash from
these projects on a monthly basis.
Covanta Energys receipt of cash from its international
projects is also subject to satisfaction of financial tests and
other covenants contained in applicable project debt
arrangements. A material portion of cash from Covanta
Energys international projects are received semi-annually,
during the second and fourth quarters.
Covanta believes that when combined with its other sources of
liquidity, Covanta Energys operations generate sufficient
cash to meet operational needs, capital expenditures, and
service debt due prior to maturity. Management will also seek to
enhance Covanta Energys cash flow from renewals or
replacement of existing contracts, from new contracts to expand
existing facilities or operate additional facilities and by
investing in new projects. Covanta Energys financing
arrangements place certain restrictions on its ability to make
investments in new projects or expansions of existing projects.
Financing
Arrangements
Covanta does not have any outstanding debt for borrowed money.
Covanta Energy and several of its subsidiaries have outstanding
debt obligations, which are summarized below. Covanta has
guaranteed Covanta Energys debt obligations described
below.
As part of the ARC Holdings acquisition on June 24, 2005,
Covanta Energy entered into new credit arrangements which
totaled approximately $1.1 billion and are guaranteed by
Covanta and certain domestic subsidiaries of Covanta Energy.
These credit arrangements consisted of a first priority senior
secured credit facility and a second priority senior secured
credit facility. The first priority senior secured credit
facility was initially comprised of a $275 million first
lien term loan, a $100 million revolving credit facility,
and a $340 million funded letter of credit facility. The
second priority senior secured credit facility was initially a
$400 million second lien term loan facility.
On May 26, 2006, Covanta Energy entered into agreements
which amended its existing credit agreements. All material terms
of Covanta Energys first priority senior secured credit
facility and second priority senior secured credit facility
remain unchanged except for the following:
|
|
|
|
|
Interest rates applicable to the existing first lien term loan
and to credit linked deposits applicable to its first lien
funded letter of credit facility were reduced from LIBOR plus
3.00% to LIBOR plus 2.25%.
|
|
|
|
The amount available for the issuance of letters of credit under
the existing $100 million first lien revolving credit
facility was increased from $75 million to $90 million.
|
48
|
|
|
|
|
New term loan commitments were provided which allowed Covanta
Energy to increase the principal amount outstanding under its
first lien term loan facility by up to $140 million, and
use the proceeds to prepay up to $140 million under the
existing second lien term loan.
|
|
|
|
Certain covenants restricting Covanta Energys ability to
invest available cash and enter into limited recourse borrowings
have been modified to provide additional flexibility in the
context of permitted acquisitions.
|
On June 30, 2006, Covanta Energy utilized the new term loan
commitment of $140 million on its first lien loan facility
to prepay $140 million under the second lien term loan
facility. Covanta Energy incurred a call premium of
$2.8 million which was paid on June 30, 2006. Covanta
Energy recognized a loss on extinguishment of debt of
$2.3 million which was classified as other expense on the
condensed consolidated statement of operations and a write-off
to interest expense of a portion of the second lien term loan
facility deferred financing costs of $4.5 million in the
three months ended June 30, 2006 related to the
$140 million prepayment under the second lien term loan
facility. See Note 12. Changes in Capitalization of the
Notes for a more detailed discussion.
Covanta
Energy Long-Term Debt
Long-term debt is comprised of credit facilities and
intermediate debt as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
As of
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
Covanta Energy Senior Secured
Credit Facilities
|
|
|
|
|
|
|
|
|
First Lien Term Loan Facility
|
|
$
|
369,312
|
|
|
$
|
229,312
|
|
Second Lien Term Loan Facility
|
|
|
260,000
|
|
|
|
400,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
629,312
|
|
|
|
629,312
|
|
|
|
|
|
|
|
|
|
|
Intermediate Subsidiary
Debt
|
|
|
|
|
|
|
|
|
6.26% Senior Notes due 2015
|
|
|
211,600
|
|
|
|
234,000
|
|
8.50% Senior Secured Notes
due 2010
|
|
|
195,785
|
|
|
|
195,785
|
|
7.375% Senior Secured Notes
due 2010
|
|
|
224,100
|
|
|
|
224,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
631,485
|
|
|
|
653,885
|
|
Unamortized debt premium
|
|
|
21,311
|
|
|
|
24,726
|
|
|
|
|
|
|
|
|
|
|
Total intermediate subsidiary debt
|
|
|
652,796
|
|
|
|
678,611
|
|
|
|
|
|
|
|
|
|
|
Other long-term debt
|
|
|
135
|
|
|
|
196
|
|
|
|
|
|
|
|
|
|
|
Total long-term debt
|
|
|
1,282,243
|
|
|
|
1,308,119
|
|
Less: current portion (includes
$4,971 and $4,807 of unamortized premium)
|
|
|
(36,478
|
)
|
|
|
(47,549
|
)
|
|
|
|
|
|
|
|
|
|
Total long-term debt
|
|
$
|
1,245,765
|
|
|
$
|
1,260,570
|
|
|
|
|
|
|
|
|
|
|
49
Amortization
Terms
The amended credit agreements include mandatory annual
amortization of the first lien term loan facility to be paid in
quarterly installments beginning September 30, 2006,
through the date of maturity as follows (in thousands of
dollars):
|
|
|
|
|
|
|
Annual
|
|
|
|
Remaining
|
|
|
|
Amortization
|
|
|
2006
|
|
$
|
1,847
|
|
2007
|
|
|
3,693
|
|
2008
|
|
|
3,693
|
|
2009
|
|
|
3,693
|
|
2010
|
|
|
3,693
|
|
2011
|
|
|
177,270
|
|
2012
|
|
|
175,423
|
|
|
|
|
|
|
Total
|
|
$
|
369,312
|
|
|
|
|
|
|
The September 30, 2006 scheduled principal payment on the
amended first lien term loan facility was made on
October 2, 2006 (the next business day). The second lien
term loan facility has no mandatory amortization requirements
and is required to be repaid in full on its maturity date in
2013.
Covanta
Energy Short-Term Liquidity
Covanta Energy had available credit for liquidity as follows (in
thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
Available
|
|
|
Available
|
|
|
|
As of
|
|
|
Under Facility
|
|
Maturing
|
|
September 30, 2006
|
|
Revolving credit facility(1)
|
|
$
|
100,000
|
|
|
|
2011
|
|
|
$
|
100,000
|
|
Funded letter of credit facility
|
|
$
|
320,000
|
|
|
|
2012
|
|
|
$
|
31,045
|
|
|
|
|
(1) |
|
Up to $90 million of which may be utilized for letters of
credit. |
As of September 30, 2006, Covanta Energy had neither drawn
on the revolving credit facility nor caused to be issued any
letters of credit under the revolving credit facility. On
March 21, 2006, Covantas availability under the
funded letter of credit facility was voluntarily reduced to
$320 million from $340 million. As of
September 30, 2006, Covanta Energy had approximately
$289 million outstanding letters of credit under the funded
letter of credit facility.
Debt
Covenants and Defaults
The loan documentation under the credit facilities contains
customary affirmative and negative covenants and financial
covenants. During the term of the credit facilities, Covanta
expects that the negative covenants will restrict the ability of
Covanta Energy and its subsidiaries to take specified actions,
subject to exceptions. As of September 30, 2006, Covanta
Energy was in compliance with covenants under the credit
facilities.
Interest
and Fee Terms
Under the amended credit arrangements, the borrowing margins for
first lien term loan facility and the funded letter of credit
facility are 2.25% for Eurodollar rate loans and 1.25% for base
rate loans. The borrowing margins under the second lien term
loan facility are 5.50% for Eurodollar rate loans and 4.50% for
base rate loans. The borrowing margins for the revolving credit
facility remain unchanged from the existing agreements.
50
Intermediate
Subsidiary Debt
Three ARC Holdings subsidiaries identified below have
outstanding non-project debt facilities, which are described
below.
MSW I
Financing
As of September 30, 2006, MSW Energy Holdings LLC,
collectively with MSW Energy Finance Co., Inc., referred to
herein after as MSW I, had outstanding debt
financing consisting of $196 million of 8.50% senior
secured notes due 2010 (MSW I notes). Interest on
the MSW I notes is payable semi-annually in arrears on
March 1st and September 1st of each year.
The MSW I notes mature on September 1, 2010.
The MSW I notes are general obligations of MSW I and are secured
by a first priority lien on substantially all the assets of
MSW I, including a first priority pledge of the membership
interest in MSW Is subsidiaries and of Covanta Ref-Fuel
Holdings LLC indirectly owned by MSW I.
The indenture under which the MSW I notes were issued (MSW
I Indenture) provides for certain restrictive covenants
including, among other things, restrictions on incurrence of
indebtedness, creation of liens, certain payments to related and
unrelated parties, acquisitions, asset sales and transactions
with affiliates.
The MSW I Indenture provides that MSW I is not permitted to make
certain distributions or other restricted payments, subject to
certain exceptions, unless, and at the time of and after giving
effect to such restricted payment, MSW Is proportionate
consolidated interest coverage ratio for its most recently ended
four full fiscal quarters would have been at least 2.0 to 1.0 on
a pro forma basis as if the restricted payment had been made at
the beginning of such four-quarter period, and the projected
proportionate consolidated interest coverage ratio for MSW
Is four full fiscal quarters commencing with the first
full fiscal quarter after the date of the proposed restricted
payment would be at least 2.0 to 1.0. The consolidated interest
coverage ratio of MSW I was approximately 3.6x for the
twelve-month period ended September 30, 2006.
MSW II
Financing
As of September 30, 2006, MSW Energy Holdings II LLC,
collectively with MSW Energy Finance Co. II, Inc., referred
to herein after as MSW II, had outstanding debt
financing consisting of $224 million aggregate principal
amount of 7.375% senior secured notes due 2010
(MSW II notes). All terms and indenture
descriptions for the MSW II notes are consistent with those
terms and indenture descriptions as described above for the MSW
I notes. The consolidated interest coverage ratio of MSW II
was approximately 3.5x for the twelve-month period ended
September 30, 2006.
ARC LLC
Financing
As of September 30, 2006, Covanta ARC LLC (ARC
LLC) had outstanding debt financing consisting of
$212 million aggregate principal amount of
6.26% senior notes due 2015 (ARC notes).
Interest on the ARC notes is payable June 30th and
December 31st of each year through maturity.
The indenture under which the ARC notes were issued (ARC
Indenture) provides for certain restrictive covenants
including, among other things, restrictions on the incurrence of
indebtedness, certain payments to related and unrelated parties,
acquisitions and asset sales. In addition, the ARC Indenture
provides that distributions of cash to parent entities
(including Covanta Energy) may occur quarterly and only if
certain financial covenants are satisfied.
See Note 18. Long-Term Debt of the Notes to the
Consolidated Financial Statements in Covantas Annual
Report on
Form 10-K
for the year ended December 31, 2005 for detailed
descriptions of long-term debt agreements and applicable
covenants.
Covanta
Energy Project Debt
Domestic
Project Debt
Financing for Covanta Energys
waste-to-energy
projects is generally accomplished through tax-exempt and
taxable municipal revenue bonds issued by or on behalf of the
municipal client. For such facilities that are owned by Covanta
Energys subsidiary, the issuer of the bonds loans the bond
proceeds to Covanta Energys subsidiary to pay for facility
construction. For such facilities, project-related debt is
included as Project debt (short- and long-term)
51
in Covantas condensed consolidated financial statements.
Generally, such project debt is secured by the revenues
generated by the project and other project assets including the
related facility. The only potential recourse to Covanta Energy
with respect to project debt arises under the operating
performance guarantees described below under Other
Commitments.
Certain subsidiaries have recourse liability for project debt
which is recourse to ARC LLC, but is non-recourse to Covanta
Energy as of September 30, 2006 as follows (in thousands of
dollars):
|
|
|
|
|
Covanta Niagara, L.P.
Series 2001 Bonds
|
|
$
|
165,010
|
|
Covanta Southeastern Connecticut
Company Corporate Credit Bonds
|
|
|
43,500
|
|
Covanta Hempstead Company
Corporate Credit Bonds
|
|
|
42,670
|
|
International
Project Debt
Financing for projects in which Covanta Energy has an ownership
or operating interest is generally accomplished through
commercial loans from local lenders or financing arranged
through international banks, bonds issued to institutional
investors and from multilateral lending institutions based in
the United States. Such debt is generally secured by the
revenues generated by the project and other project assets and
is without recourse to CPIH or Covanta Energy. Project debt
relating to two CPIH projects in India is included as
Project debt (short- and long-term) in
Covantas condensed consolidated financial statements. In
most projects, the instruments defining the rights of debt
holders generally provide that the project subsidiary may not
make distributions to its parent until periodic debt service
obligations are satisfied and other financial covenants complied
with.
Other
Services Segment
Net cash used by operating activities was $1.7 million for
the nine months ended September 30, 2006 primarily due to
Covantas executed agreements in January 2006 with the
California Commissioner regarding the final administration and
conclusion of grantor trusts associated with predecessor
insurance entities. For the nine months ended September 30,
2006, Covanta, at the holding company level, held cash and
investments of approximately $63.4 million, an increase of
$24.1 million from December 31, 2005. This increase
was primarily due to proceeds received on February 24, 2006
from the 9.25% Offering in which 5,696,911 shares were
issued for $20.8 million in gross proceeds as described in
Note 12. Changes in Capitalization of the Notes. Of the
$63.4 million held in cash and investments,
$56.7 million was available to pay general corporate
expenses and for general working capital purposes. Covanta is
required to maintain a separate cash fund of approximately
$6.6 million to provide potential liquidity to its
insurance business. Cash deposited for this purpose is
restricted and is not available for general corporate expenses
or for working capital requirements.
Cash used in operations from the insurance business was
$4.2 million and $10.0 million for the nine months
ended September 30, 2006 and 2005, respectively. The
ongoing use of cash in operations was due to the insurance
business continuing to make payments related to discontinued
lines and territories in excess of premium receipts from
existing lines. This negative cash flow restricted the insurance
business from fully re-investing bond maturity proceeds and in
some circumstances required the sale of bonds in order to meet
obligations as they arose. Cash provided from investing
activities was $5.4 million for the nine months ended
September 30, 2006 compared with $10.0 million for the
comparable period in 2005. The $4.6 million decrease in
cash provided by investing activities in 2006 was due primarily
to a reduction in reinvestment activity in conjunction with
reduced cash used in operations. There were no financing
activities related to Covantas insurance business in
either nine month period ended September 30, 2006 or 2005.
Covantas insurance business, which comprises a portion of
Covantas Other Services segment, requires both readily
liquid assets and adequate capital to meet ongoing obligations
to policyholders and claimants, as well as to pay ordinary
operating expenses. The insurance business meets both its
short-term and long-term liquidity requirements through
operating cash flows that include premium receipts, investment
income and reinsurance recoveries. To the extent operating cash
flows do not provide sufficient cash flow, the insurance
business relies on the sale of invested assets. Its investment
policy guidelines require that all loss and LAE liabilities be
matched by a comparable amount of investment grade assets.
Covanta believes that the insurance business has both adequate
capital resources and sufficient reinsurance to meet its current
operating requirements.
52
CAPITAL
REQUIREMENTS
Covanta believes that when combined with its other sources of
liquidity, Covanta Energys operations generate sufficient
cash to meet operational needs, capital expenditures, and debt
service due prior to maturity. Management will also seek to
enhance Covanta Energys cash flow from renewals or
replacement of existing contracts, from new contracts to expand
existing facilities or operate additional facilities and by
investing in new projects. Covanta Energys new financing
arrangements place certain restrictions on its ability to make
investments in new projects or expansions of existing projects.
Covantas projected contractual obligations are consistent
with amounts disclosed in Covantas Annual Report on
Form 10-K
for the year ended December 31, 2005, with the exception of
changes resulting from the amended credit agreements described
above and the reduction of certain other long-term obligations.
For additional information, see Note 10. Other Noncurrent
Liabilities and Note 12. Changes in Capitalization of the
Notes to the Condensed Consolidated Financial Statements. The
following table summarizes Covantas gross contractual
obligations as of September 30, 2006 (in thousands of
dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
|
Remainder
|
|
|
|
|
|
|
|
|
2011 and
|
|
|
|
Total
|
|
|
of 2006
|
|
|
2007 and 2008
|
|
|
2009 and 2010
|
|
|
Beyond
|
|
|
Domestic Covanta project debt
|
|
$
|
1,374,674
|
|
|
$
|
60,507
|
|
|
$
|
294,218
|
|
|
$
|
319,708
|
|
|
$
|
700,241
|
|
CPIH project debt
|
|
|
76,689
|
|
|
|
15,864
|
|
|
|
28,215
|
|
|
|
27,538
|
|
|
|
5,072
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total project debt
|
|
|
1,451,363
|
|
|
|
76,371
|
|
|
|
322,433
|
|
|
|
347,246
|
|
|
|
705,313
|
|
First Lien Term Loan facility
|
|
|
369,312
|
|
|
|
1,847
|
|
|
|
7,386
|
|
|
|
7,386
|
|
|
|
352,693
|
|
Second Lien Term Loan facility
|
|
|
260,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
260,000
|
|
6.26% Senior Notes
|
|
|
211,600
|
|
|
|
19,600
|
|
|
|
62,000
|
|
|
|
17,000
|
|
|
|
113,000
|
|
8.50% Senior Secured Notes
|
|
|
195,785
|
|
|
|
|
|
|
|
|
|
|
|
195,785
|
|
|
|
|
|
7.375% Senior Secured Notes
|
|
|
224,100
|
|
|
|
|
|
|
|
|
|
|
|
224,100
|
|
|
|
|
|
Other long-term debt
|
|
|
135
|
|
|
|
114
|
|
|
|
21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total debt obligations of
Covanta(1)
|
|
|
2,712,295
|
|
|
|
97,932
|
|
|
|
391,840
|
|
|
|
791,517
|
|
|
|
1,431,006
|
|
Less: Non-recourse debt(2)
|
|
|
2,082,983
|
|
|
|
96,085
|
|
|
|
384,454
|
|
|
|
784,131
|
|
|
|
818,313
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Covanta recourse debt
|
|
$
|
629,312
|
|
|
$
|
1,847
|
|
|
$
|
7,386
|
|
|
$
|
7,386
|
|
|
$
|
612,693
|
|
Operating leases
|
|
|
422,237
|
|
|
|
8,509
|
|
|
|
67,390
|
|
|
|
93,141
|
|
|
|
253,197
|
|
Less: Non-recourse rental payments
|
|
|
252,639
|
|
|
|
3,889
|
|
|
|
35,028
|
|
|
|
46,427
|
|
|
|
167,295
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Covanta recourse rental payments
|
|
$
|
169,598
|
|
|
$
|
4,620
|
|
|
$
|
32,362
|
|
|
$
|
46,714
|
|
|
$
|
85,902
|
|
Interest payments(3)
|
|
|
967,020
|
|
|
|
52,600
|
|
|
|
340,716
|
|
|
|
277,145
|
|
|
|
296,559
|
|
Less: Non-recourse interest
payments
|
|
|
574,822
|
|
|
|
33,712
|
|
|
|
219,263
|
|
|
|
159,037
|
|
|
|
162,810
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Covanta recourse interest payments
|
|
$
|
392,198
|
|
|
$
|
18,888
|
|
|
$
|
121,453
|
|
|
$
|
118,108
|
|
|
$
|
133,749
|
|
Retirement plan obligations(4)
|
|
$
|
21,311
|
|
|
$
|
6,364
|
|
|
$
|
3,584
|
|
|
$
|
3,673
|
|
|
$
|
7,690
|
|
Other long-term obligations
|
|
$
|
9,411
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
9,411
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Covanta contractual
obligations
|
|
$
|
1,221,830
|
|
|
$
|
31,719
|
|
|
$
|
164,785
|
|
|
$
|
175,881
|
|
|
$
|
849,445
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Excludes $71 million of Covanta Energys unamortized
debt premium. |
|
(2) |
|
Payment obligations for the project debt associated with
waste-to-energy
facilities owned by Covanta Energy are limited recourse to the
operating subsidiary and non-recourse to Covanta Energy, subject
to operating performance guarantees and commitments. |
|
(3) |
|
Interest payments and letter of credit fees are estimated based
on current rates. |
|
(4) |
|
Retirement plan obligations are based on actuarial estimates for
the defined contribution plan, pension plan obligations and
post-retirement plan obligations as of December 31, 2005. |
53
Other
Commitments
Covanta Energys other commitments as of September 30,
2006 were as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments Expiring by Period
|
|
|
|
|
|
|
Less Than
|
|
|
More Than
|
|
|
|
Total
|
|
|
One Year
|
|
|
One Year
|
|
|
Letters of credit
|
|
$
|
292,374
|
|
|
$
|
19,827
|
|
|
$
|
272,547
|
|
Surety bonds
|
|
|
51,651
|
|
|
|
51,651
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other
commitments net
|
|
$
|
344,025
|
|
|
$
|
71,478
|
|
|
$
|
272,547
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The letters of credit were issued pursuant to the facilities to
secure Covanta Energys performance under various
contractual undertakings related to its domestic and
international projects, or to secure obligations under its
insurance program. Each letter of credit relating to a project
is required to be maintained in effect for the period specified
in related project contracts, and generally may be drawn if it
is not renewed prior to expiration of that period.
As of September 30, 2006, Covanta Energy had approximately
$31 million in available capacity for additional letters of
credit under its funded letter of credit facility and
$90 million available capacity for letters of credit under
its revolving credit facility. Covanta Energy believes that it
will be able to fully perform its contracts to which these
existing letters of credit relate, and that it is unlikely that
letters of credit would be drawn because of a default of its
performance obligations. If any of Covanta Energys letters
of credit were to be drawn under its current debt facilities,
the amount drawn would be immediately repayable to the issuing
bank. If Covanta Energy were unable to immediately repay such
amounts drawn under letters of credit, unreimbursed amounts
would be treated under the credit facilities as additional term
loans.
The surety bonds listed on the table above relate primarily to
performance obligations under contracts ($42.1 million) and
possible closure costs for various energy projects when such
projects cease operating ($9.6 million). Were these bonds
to be drawn upon, Covanta Energy would have a contractual
obligation to indemnify the surety company.
Covanta Energy and certain of its subsidiaries have issued or
are party to performance guarantees and related contractual
support obligations undertaken mainly pursuant to agreements to
construct and operate certain
waste-to-energy
facilities and a water facility. With respect to its domestic
businesses, Covanta Energy and certain of its subsidiaries have
issued guarantees to municipal clients and other parties that
Covanta Energys subsidiaries will perform in accordance
with contractual terms, including, where required, the payment
of damages or other obligations. Such contractual damages or
other obligations could be material, and in circumstances where
one or more subsidiarys contract has been terminated for
its default, such damages could include amounts sufficient to
repay project debt. For facilities owned by municipal clients
and operated by Covanta Energy, Covanta Energys potential
maximum liability as of September 30, 2006 associated with
the repayment of the municipalities project debt on such
facilities was in excess of $1 billion. This amount was not
recorded as a liability in Covanta Energys consolidated
balance sheet as of September 30, 2006 as Covanta Energy
believes that it had not incurred such liability at the date of
the financial statements. Additionally, damages payable under
such guarantees on Covanta Energy-owned
waste-to-energy
facilities could expose Covanta Energy to recourse liability on
project debt. Covanta Energy also believes that it has not
incurred such liabilities at the date of the financial
statements. If Covanta Energy is asked to perform under one or
more of such guarantees, its liability for damages upon contract
termination would be reduced by funds held in trust and proceeds
from sales of the facilities securing the project debt, which is
presently not estimable.
With respect to its international businesses, Covanta Energy has
issued guarantees on behalf of certain of CPIHs operating
subsidiaries with respect to contractual obligations to operate
independent power projects. The potential damages owed under
such arrangements for international projects may be material.
Depending upon the circumstances giving rise to such domestic
and international damages, the contractual terms of the
applicable contracts, and the contract counterpartys
choice of remedy at the time a claim against a guarantee is
made, the amounts owed pursuant to one or more of such
guarantees could be greater than Covanta
54
Energys then-available sources of funds. To date, Covanta
Energy has not incurred material liabilities under its
guarantees, either on domestic or international projects.
Discussion
of Critical Accounting Policies
In preparing its condensed consolidated financial statements in
accordance with United States generally accepted accounting
principles, Covanta is required to use its judgment in making
estimates and assumptions that affect the amounts reported in
its financial statements and related notes. Management bases its
estimates on historical experience and on various other
assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making
judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Many of
Covantas critical accounting policies are those subject to
significant judgments and uncertainties which could potentially
result in materially different results under different
conditions and assumptions. Future events rarely develop exactly
as forecast, and the best estimates routinely require
adjustment. See Covantas Discussion of Critical Accounting
Policies in Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations of its
Annual Report on
Form 10-K
for the year ended December 31, 2005.
Effective January 1, 2006, Covanta adopted the fair value
recognition provisions of Statement of Financial Accounting
Standards (SFAS) No. 123 (revised 2004),
Share-Based Payment (SFAS 123R)
using the modified prospective transition method and therefore
has not restated results for prior periods. Under this
transition method, stock-based compensation expense for the
three and nine months ended September 30, 2006 included
compensation expense for all stock-based compensation awards
granted prior to, but not yet vested as of December 31,
2005, based on the grant date fair value estimated in accordance
with the original provision of SFAS No. 123,
Accounting for Stock-Based Compensation. Stock-based
compensation expense for all stock-based compensation awards
granted after December 31, 2005 is based on the grant date
fair value estimated in accordance with the provisions of
SFAS 123R.
Management must use subjective assumptions in calculating the
fair value of its share-based payment awards including the
expected life of the award and stock price volatility. In
addition, management must also estimate expected forfeitures and
the probability of achieving specific performance factors
affecting the vesting of its share-based awards. Based on
Covantas current share-based awards, managements
estimate of a forfeiture rate and determination of achieving
stated performance vesting factors will have the most
significant impact on the compensation cost it must recognize.
Covanta recognized compensation expense based upon the number of
stock options and restricted stock awards expected to vest,
which was determined based on historical turnover experience of
various Covanta Energy employee populations from the Covanta
Energy pension plan. During the quarter ended September 30,
2006, Covanta adjusted the number of stock options and
restricted stock awards expected to vest due to additional stock
option and restricted stock grants and increased forfeitures of
stock options and restricted stock awards as compared to
previous estimations. Covanta will review its forfeiture rate at
least annually and revise its compensation expense, if
necessary. Covanta recognizes these compensation costs using the
graded vesting attribution method over the requisite service
period of the award, which is generally the vesting term of
three years.
Beginning in the second quarter of 2006, Covanta adopted the
permanent reinvestment exception under APB Opinion No. 23,
Accounting for Income Taxes Special
Areas whereby Covanta will no longer provide deferred
taxes on the undistributed earnings of its international
subsidiaries. Covanta intends to permanently reinvest its
international earnings outside of the United States in its
existing international operations and in any new international
business it may develop or acquire.
Recent
Accounting Pronouncements
See Note 2. New Accounting Pronouncements of the Notes for
information related to new accounting pronouncements.
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ITEM 3.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|
In the normal course of business, Covantas subsidiaries
are party to financial instruments that are subject to market
risks arising from changes in interest rates, foreign currency
exchange rates, and commodity prices.
55
Covantas use of derivative instruments is very limited and
it does not enter into derivative instruments for trading
purposes.
Except as described below, management believes there have been
no material changes during the nine months ended
September 30, 2006 to the items discussed in Item 7A.
Quantitative and Qualitative Disclosures About Market Risk in
Covantas Annual Report on
Form 10-K
for the year ended December 31, 2005.
Interest
Rate Swaps
Covanta Energy is required to enter into hedging arrangements
with respect to a portion of its exposure to interest rate
changes with respect to its borrowing under the Credit
Facilities. On July 8, 2005, Covanta Energy entered into
two pay fixed, receive floating interest rate swap agreements
with a total notional amount of $300 million. On
March 21, 2006, Covanta entered into one additional pay
fixed, receive floating interest rate swap agreement with a
notional amount of $37.5 million. These swaps were
designated as cash flow hedges in accordance with
SFAS No. 133 Accounting for Derivative
Instruments and Hedging Activities, and accordingly,
unrealized gains or losses will be deferred in other
comprehensive income until the hedged cash flows affect
earnings. Covanta Energy does not seek to make a profit from
changes in interest rates. Covanta Energy manages interest rate
sensitivity by measuring potential increases in interest expense
that would result from a probable change in interest rates. When
the potential increase in interest expense exceeds an acceptable
amount, Covanta Energy reduces risk by entering into interest
rate swap agreements. The impact of the swaps increased interest
expense for the three months ended September 30, 2005 by
$0.5 million. The impact of the swaps decreased interest
expense for the three months and nine months ended
September 30, 2006 by $0.9 million and
$1.6 million, respectively. As of September 30, 2006,
the net after-tax deferred gain in other comprehensive income
was $2.1 million ($3.5 million before income taxes)
which was recorded in other assets.
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ITEM 4.
|
CONTROLS
AND PROCEDURES
|
Covantas management, with the participation of its Chief
Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of Covantas disclosure controls and
procedures, as required by
Rule 13a-15(b)
and
15d-15(b)
under the Exchange Act as of September 30, 2006.
Covantas disclosure controls and procedures are designed
to reasonably assure that information required to be disclosed
by Covanta in reports it files or submits under the Exchange Act
is accumulated and communicated to Covantas management,
including its Chief Executive Officer and Chief Financial
Officer, as appropriate to allow timely decisions regarding
disclosure and is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and
forms. Accordingly, Covantas management has concluded that
Covantas disclosure controls and procedures were effective
as of September 30, 2006.
Covantas management, with the participation of its Chief
Executive Officer and Chief Financial Officer, believes that its
disclosure controls and procedures are effective to provide such
reasonable assurance.
Covantas management, including the Chief Executive Officer
and Chief Financial Officer, believe that any disclosure
controls and procedures or internal controls and procedures, no
matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system
must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control
systems, they cannot provide absolute assurance that all control
issues and instances of fraud, if any, within Covanta have been
prevented or detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and
that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by
unauthorized override of the control. The design of any system
of controls is also based in part upon certain assumptions about
the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under
all potential future conditions. Accordingly, because of the
inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and may not be
detected.
During the second quarter of 2006, Covanta began implementation
of a new operating system for the recording of information
relating to its business. That effort is underway and is
expected to continue into 2007. Covanta
56
initiated this effort as part of a routine system upgrade and as
part of its integration efforts related to the ARC Holdings
acquisition. Covanta believes the new operating system, when
fully implemented, will maintain and enhance its system of
internal controls over financial reporting and its ability to
record, process, summarize and report information required to be
disclosed within the time periods specified in the SECs
rules and forms.
PART II
OTHER INFORMATION
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ITEM 1.
|
LEGAL
PROCEEDINGS
|
See Note 16. Commitments and Contingencies of the Notes to
the Condensed Consolidated Financial Statements.
Except as set forth below, there have been no material changes
during the nine months ended September 30, 2006 to the risk
factors discussed in Item 1A Risk Factors in
Covanta Holding Corporations (Covanta) Annual
Report on
Form 10-K
for the year ended December 31, 2005.
1. The following risk factors relating to Covantas
business amend and replace in their entirety these risk factors
with the same title included in Item 1A. Risk Factors in
Covantas Annual Report on
Form 10-K
for the year ended December 31, 2005:
We
cannot be certain that our net operating loss carryforwards
(NOLs) will continue to be available to offset our
tax liability.
Our NOLs will expire in various amounts, if not used, between
2006 and 2023. The Internal Revenue Service (IRS)
has not audited any of our tax returns for any of the years
during the carryforward period including those returns for the
years in which the losses giving rise to the NOLs were reported.
We cannot assure you that we would prevail if the IRS were to
challenge the availability of the NOLs. If the IRS were
successful in challenging our NOLs, all or some portion of the
NOLs would not be available to offset our future consolidated
taxable income and we may not be able to satisfy our obligations
to Covanta Energy under a tax sharing agreement described below
or to pay taxes that may be due from our consolidated tax group.
As of December 31, 2005, we estimated that we had
approximately $489 million of NOLs. In order to utilize the
NOLs, we must generate consolidated taxable income which can
offset such carryforwards. The NOLs are also utilized by income
from certain grantor trusts that were established as part of the
reorganization in 1990 of certain of our subsidiaries engaged in
the insurance business.
In addition, if our existing insurance business were to require
capital infusions from us in order to meet certain regulatory
capital requirements and we were to fail to provide such
capital, some or all of our subsidiaries comprising our
insurance business could enter insurance insolvency or
bankruptcy proceedings. In such event, such subsidiaries may no
longer be included in our consolidated tax return, and a
portion, which could constitute a significant portion, of our
remaining NOLs may no longer be available to us. In such event,
there may be a significant inclusion of taxable income in our
federal consolidated income tax return.
Concentrated
stock ownership and a restrictive certificate of incorporation
provision may discourage unsolicited acquisition
proposals.
As of October 10, 2006, SZ Investments, L.L.C., together
with its affiliate EGI-Fund (05-07) Investors, L.L.C., referred
to as Fund 05-07 and collectively with SZ
Investments, L.L.C. SZ Investments, Third Avenue
Trust, on behalf of Third Avenue Value Fund, referred to as
Third Avenue, and D. E. Shaw Laminar Portfolios,
L.L.C., referred to as Laminar, separately own or
will have the right to acquire approximately 15.71%, 5.98% and
13.40%, respectively, or when aggregated, approximately 35% of
our outstanding common stock. Although there are no agreements
among SZ Investments, Third Avenue and Laminar regarding their
voting or disposition of shares of our common stock, the level
of their combined ownership of shares of common stock could have
the effect of discouraging or impeding an unsolicited
acquisition proposal. In addition, the change in ownership
limitations
57
contained in Article FIFTH of our certificate of
incorporation could have the effect of discouraging or impeding
an unsolicited takeover proposal. We are in the process of
soliciting proxies for a special meeting of stockholders to be
held on November 16, 2006 to approve a proposal to remove
from our certificate of incorporation the prohibition against
the acquisition of 5% or more of our common stock. If the
proposal is approved, the 5% or more ownership limitation will
be removed promptly after the special meeting.
Future
sales of our common stock may depress our stock
price.
No prediction can be made as to the effect, if any, that future
sales of our common stock, or the availability of our common
stock for future sales, will have on the market price of our
common stock. Sales in the public market of substantial amounts
of our common stock, or the perception that such sales could
occur, could adversely affect prevailing market prices for our
common stock.
Our
Waste and Energy Services business is subject to pricing
fluctuations caused by the waste disposal and energy
markets.
While our Waste and Energy Services businesses sell the majority
of their waste disposal capacity and energy output pursuant to
long-term contracts, a portion of this capacity and output
representing approximately 30% of our anticipated Waste and
Energy Service revenue through 2009 is subject to market price
fluctuation.
2. The following is an additional risk factor relating to
Covantas business:
Our
reputation could be adversely affected if opposition to our
efforts to grow our business results in adverse publicity or our
businesses were to fail to comply with United States or foreign
laws or regulations.
With respect to our efforts to renew our contracts and grow our
business both domestically and internationally, we sometimes
experience opposition from advocacy groups or others intended to
halt a development effort or other opportunity we may be
pursuing. Such opposition is often intended to discourage third
parties from doing business with us and may be based on
inaccurate, incomplete or inflammatory assertions. We cannot
provide any assurance that our reputation would not be adversely
affected as a result of adverse publicity resulting from such
opposition. Some of our projects and new business may be
conducted in countries where corruption has historically
penetrated the economy to a greater extent than in the United
States. It is our policy to comply, and to require our local
partners and those with whom we do business to comply, with all
applicable anti-bribery laws, such as the U.S. Foreign
Corrupt Practices Act and with applicable local laws of the
foreign countries in which we operate. We cannot provide any
assurance that our reputation would not be adversely affected if
we were reported to be associated with corrupt practices or if
we or our local partners failed to comply with such laws.
58
3. Covanta no longer considers the following five risk
factors previously identified in Item 1A. Risk Factors in
Covantas Annual Report on Form
10-K for the
year ended December 31, 2005, to be material to its
business:
We may
be unable to integrate the operations of ARC Holdings and
Covanta Energy successfully and may not realize the full
anticipated benefits of the acquisition.
We
have incurred and will continue to incur significant transaction
and combination-related costs in connection with the acquisition
of ARC Holdings.
Insurance
regulations may affect NAICCs operations.
The
insurance products sold by NAICC are subject to intense
competition.
If
NAICCs loss experience exceeds its estimates, additional
capital may be required.
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ITEM 2.
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UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|
None.
|
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ITEM 3.
|
DEFAULTS
UPON SENIOR SECURITIES
|
None.
|
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ITEM 4.
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SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
|
None.
|
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ITEM 5.
|
OTHER
INFORMATION
|
(a) None.
(b) Not applicable.
|
|
|
|
|
Exhibit
|
|
|
Number
|
|
Description
|
|
|
10
|
.1 *
|
|
Employment Agreement, dated as of
August 17, 2006, among Covanta Holding Corporation, Covanta
Energy Corporation and Mark A. Pytosh (incorporated herein by
reference to Exhibit 10.1 of Covanta Holding
Corporations Current Report on
Form 8-K
dated August 17, 2006 and filed with the Securities and
Exchange Commission on August 17, 2006).
|
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31
|
.1
|
|
Certification pursuant to
Section 302 of Sarbanes-Oxley Act of 2002 by the Chief
Executive Officer.
|
|
31
|
.2
|
|
Certification pursuant to
Section 302 of Sarbanes-Oxley Act of 2002 by the Chief
Financial Officer.
|
|
32
|
|
|
Certification of periodic
financial report pursuant to Section 906 of Sarbanes-Oxley
Act of 2002 by the Chief Executive Officer and Chief Financial
Officer.
|
|
|
|
|
|
Not filed herewith, but incorporated herein by reference. |
|
* |
|
Management contract or compensatory plan or arrangement. |
59
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.
Covanta Holding
Corporation
(Registrant)
Mark A. Pytosh
Senior Vice President and Chief Financial Officer
Thomas E. Bucks
Vice President and Chief Accounting Officer
Date: October 30, 2006
60