Form 10-Q
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

 

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                     

Commission file number 1-06732

COVANTA HOLDING CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   95-6021257

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

 
445 South Street, Morristown, NJ   07960
(Address of Principal Executive Office)   (Zip Code)

(862) 345-5000

(Registrant’s 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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  þ  No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  þ   Accelerated filer  ¨    Non-accelerated filer  ¨   Smaller reporting company  ¨
     (Do not check if a smaller reporting company)  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  þ

Applicable Only to Corporate Issuers:

The number of shares of the registrant’s Common Stock outstanding as of the last practicable date.

 

Class

 

Outstanding at October 13, 2011

Common Stock, $0.10 par value   137,683,203 shares

 

 

 


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

FORM 10-Q QUARTERLY REPORT

For the Quarter Ended September 30, 2011

PART I. FINANCIAL INFORMATION

 

     Page  

Cautionary Note Regarding Forward-Looking Statements

     3   

Item 1.

 

Financial Statements

     4   
  Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010 (Unaudited)      4   
  Condensed Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010      5   
  Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010 (Unaudited)      6   
  Condensed Consolidated Statements of Equity for the Nine Months Ended September 30, 2011 and 2010 (Unaudited)      7   
  Notes to Condensed Consolidated Financial Statements (Unaudited)      8   
 

Note 1. 

  Organization and Basis of Presentation      8   
 

Note 2.

  Recent Accounting Pronouncements      9   
 

Note 3.

  Business Development, Assets Held for Sale and Dispositions      9   
 

Note 4.

  Earnings Per Share      11   
 

Note 5.

  Financial Information by Business Segments      12   
 

Note 6.

  Changes in Capitalization      12   
 

Note 7.

  Income Taxes      15   
 

Note 8.

  Supplementary Information      16   
  Note 9.  

Benefit Obligations

     18   
  Note 10.  

Stock-Based Compensation

     18   
  Note 11.  

Financial Instruments

     19   
  Note 12.  

Derivative Instruments

     23   
  Note 13.  

Commitments and Contingencies

     24   
  Note 14.  

Subsequent Events

     26   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      27   
 

Overview

     27   
 

Results of Operations

     33   
 

Liquidity and Capital Resources

     41   
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      49   
Item 4.   Controls and Procedures      49   

PART II. OTHER INFORMATION

  
Item 1.   Legal Proceedings      49   
Item 1A.   Risk Factors      49   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      49   
Item 3.   Defaults Upon Senior Securities      50   
Item 4.   Removed and Reserved      50   
Item 5.   Other Information      50   
Item 6.   Exhibits      50   

OTHER

  

Signatures

     51   

 

2


Table of Contents

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 or 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. Risk Factors of Covanta’s Annual Report on Form 10-K for the year ended December 31, 2010 and in other filings by Covanta with the SEC.

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. Covanta’s 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.

 

3


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Three Months  Ended
September 30,
    Nine Months  Ended
September 30,
 
     2011     2010     2011     2010  
           (Unaudited)        
     (In millions, except per share amounts)  

OPERATING REVENUES:

        

Waste and service revenues

   $         273      $         257      $         800      $         766   

Electricity and steam sales

     109        115        301        316   

Other operating revenues

     50        31        119        82   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenues

     432        403        1,220        1,164   
  

 

 

   

 

 

   

 

 

   

 

 

 

OPERATING EXPENSES:

        

Plant operating expenses

     221        218        740        715   

Other operating expenses

     44        28        102        77   

General and administrative expenses

     24        22        74        76   

Depreciation and amortization expense

     48        47        142        142   

Net interest expense on project debt

     8        10        24        30   

Write-down of assets

            32               32   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     345        357        1,082        1,072   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     87        46        138        92   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense):

        

Investment income

     1        1        1        1   

Interest expense

     (16     (11     (50     (32

Non-cash convertible debt related expense

     (9     (10     (20     (30

Other expenses, net

     (11            (14       
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expenses

     (35     (20     (83     (61
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income tax expense and equity in net income from unconsolidated investments

     52        26        55        31   

Income tax expense

     (2     (15     (3     (18

Equity in net income from unconsolidated investments

     1        1        3        1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     51        12        55        14   

(Loss) income from discontinued operations, net of income tax expense of $0, $1, $3 and $5, respectively

     (7     11        144        32   
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME

     44        23        199        46   
  

 

 

   

 

 

   

 

 

   

 

 

 

Less: Net income from continuing operations attributable to noncontrolling interests in subsidiaries

     (2     (2     (3     (4

Less: Net income from discontinued operations attributable to noncontrolling interests in subsidiaries

            (1     (3     (3
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to noncontrolling interests in subsidiaries

     (2     (3     (6     (7
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME ATTRIBUTABLE TO COVANTA HOLDING CORPORATION

   $ 42      $ 20      $ 193      $ 39   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts Attributable to Covanta Holding Corporation stockholders’:

        

Continuing operations

   $ 49      $ 10      $ 52      $ 10   

Discontinued operations

     (7     10        141        29   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income Attributable to Covanta Holding Corporation

   $ 42      $ 20      $ 193      $ 39   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (Loss) Per Share Attributable to Covanta Holding Corporation stockholders’:

        

Basic

        

Continuing operations

   $ 0.35      $ 0.07      $ 0.37      $ 0.07   

Discontinued operations

     (0.05     0.06        0.98        0.18   
  

 

 

   

 

 

   

 

 

   

 

 

 

Covanta Holding Corporation

   $ 0.30      $ 0.13      $ 1.35      $ 0.25   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted Average Shares

     139        153        143        154   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

        

Continuing operations

   $ 0.35      $ 0.07      $ 0.36      $ 0.07   

Discontinued operations

     (0.05     0.06        0.98        0.18   
  

 

 

   

 

 

   

 

 

   

 

 

 

Covanta Holding Corporation

   $ 0.30      $ 0.13      $ 1.34      $ 0.25   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted Average Shares

     140        154        144        155   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash Dividend Declared Per Share:

   $ 0.075      $      $ 0.225      $ 1.50   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

4


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     As of  
     September 30,
2011
    December 31,
2010
 
     (Unaudited)        
    

(In millions, except per

share amounts)

 

ASSETS

    

Current:

    

Cash and cash equivalents

   $         195      $         126   

Restricted funds held in trust

     154        126   

Receivables (less allowances of $4 and $3, respectively)

     240        272   

Unbilled service receivables

     20        23   

Deferred income taxes

     36        27   

Prepaid expenses and other current assets

     123        110   

Assets held for sale

     60        191   
  

 

 

   

 

 

 

Total Current Assets

     828        875   

Property, plant and equipment, net

     2,444        2,478   

Investments in fixed maturities at market (cost: $27 and $29, respectively)

     28        29   

Restricted funds held in trust

     107        107   

Unbilled service receivables

     26        32   

Waste, service and energy contracts, net

     442        472   

Other intangible assets, net

     80        79   

Goodwill

     232        230   

Investments in investees and joint ventures

     45        46   

Other assets

     292        328   
  

 

 

   

 

 

 

Total Assets

   $ 4,524      $ 4,676   
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Current:

    

Current portion of long-term debt

   $ 31      $ 7   

Current portion of project debt

     99        141   

Accounts payable

     25        23   

Deferred revenue

     82        72   

Accrued expenses and other current liabilities

     233        186   

Liabilities held for sale

     19        34   
  

 

 

   

 

 

 

Total Current Liabilities

     489        463   

Long-term debt

     1,474        1,558   

Project debt

     635        662   

Deferred income taxes

     637        605   

Waste and service contracts

     79        89   

Other liabilities

     113        140   
  

 

 

   

 

 

 

Total Liabilities

     3,427        3,517   
  

 

 

   

 

 

 

Commitments and Contingencies (Note 13)

    

Equity:

    

Covanta Holding Corporation stockholders’ equity:

    

Preferred stock ($0.10 par value; authorized 10 shares; none issued and outstanding)

              

Common stock ($0.10 par value; authorized 250 shares; issued 158 and 157 shares; outstanding 138 and 150 shares)

     16        16   

Additional paid-in capital

     830        893   

Accumulated other comprehensive (loss) income

     (5     5   

Accumulated earnings

     243        213   

Treasury stock, at par

     (2     (1
  

 

 

   

 

 

 

Total Covanta Holding Corporation stockholders’ equity

     1,082        1,126   
  

 

 

   

 

 

 

Noncontrolling interests in subsidiaries

     15        33   
  

 

 

   

 

 

 

Total Equity

     1,097        1,159   
  

 

 

   

 

 

 

Total Liabilities and Equity

   $ 4,524      $ 4,676   
  

 

 

   

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

5


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     For the Nine Months Ended
September 30,
 
     2011     2010  
     (Unaudited)  
     (In millions)  

OPERATING ACTIVITIES:

    

Net income

   $                              199      $                                  46   

Less: Income from discontinued operations, net of tax expense

     144        32   
  

 

 

   

 

 

 

Income from continuing operations

     55        14   
  

 

 

   

 

 

 

Adjustments to reconcile net income from continuing operations to net cash provided by operating activities from continuing operations:

    

Depreciation and amortization expense

     142        142   

Amortization of long-term debt deferred financing costs

     4        5   

Amortization of debt premium and discount

     (4     (6

Write-down of assets

            32   

Loss on extinguishment of debt

     1          

Non-cash convertible debt related expense

     20        30   

Stock-based compensation expense

     13        13   

Equity in net income from unconsolidated investments

     (3     (1

Dividends from unconsolidated investments

     5        4   

Deferred income taxes

     23        21   

Other, net

     (3     7   

Change in restricted funds held in trust

     (35     (21

Reversal of uncertain tax positions related to pre-emergence tax matters

     (24       

Change in restricted funds-other related to contractual liability to pre-petition creditors

     5          

Change in working capital, net of effects of acquisitions

     77        53   
  

 

 

   

 

 

 

Total adjustments for continuing operations

     221        279   
  

 

 

   

 

 

 

Net cash provided by operating activities from continuing operations

     276        293   

Net cash provided by operating activities from discontinued operations

     1        35   
  

 

 

   

 

 

 

Net cash provided by operating activities

     277        328   
  

 

 

   

 

 

 

INVESTING ACTIVITIES:

    

Proceeds from the sale of investment securities

     10        10   

Purchase of investment securities

     (9     (10

Purchase of property, plant and equipment

     (91     (83

Acquisition of noncontrolling interests in subsidiaries

            (2

Acquisition of businesses, net of cash acquired

     (10     (128

Acquisition of land use rights

     (8     (19

Other, net

     (7     (16
  

 

 

   

 

 

 

Net cash used in investing activities from continuing operations

     (115     (248

Net cash provided by investing activities from discontinued operations

     227          
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     112        (248
  

 

 

   

 

 

 

FINANCING ACTIVITIES:

    

Principal payments on long-term debt

     (37     (5

Principal payments on project debt

     (83     (102

Payments of borrowings on revolving credit facility

            (56

Proceeds from borrowings on project debt

     15        5   

Proceeds from borrowings on revolving credit facility

            56   

Change in restricted funds held in trust

     7        (41

Proceeds from the exercise of options for common stock, net

            1   

Cash dividends paid to stockholders

     (22     (233

Common stock repurchased

     (203     (37

Distributions to partners of noncontrolling interests in subsidiaries

     (5     (4

Other, net

     (3     6   
  

 

 

   

 

 

 

Net cash used in financing activities from continuing operations

     (331     (410

Net cash provided by (used in) financing activities from discontinued operations

     8        (28
  

 

 

   

 

 

 

Net cash used in financing activities

     (323     (438
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (4       
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     62        (358

Cash and cash equivalents at beginning of period

     141        434   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

     203        76   

Less: Cash and cash equivalents of discontinued operations at end of period

     8        22   
  

 

 

   

 

 

 

Cash and cash equivalents of continuing operations at end of period

   $ 195      $ 54   
  

 

 

   

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

6


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

 

    Covanta Holding Corporation Stockholders’ Equity              
          Additional
Paid-In

Capital
    Accumulated
Other
Comprehensive

Income (Loss)
    Accumulated
Earnings
    Treasury Stock     Noncontrolling
Interests in

Subsidiaries
       
    Common Stock                  
    Shares     Amount           Shares     Amount       Total  
    (Unaudited, in millions)  

Balance as of December 31, 2010

    157      $     16      $     893      $ 5      $ 213        7      $     (1   $ 33      $     1,159   

Stock-based compensation expense

        13                  13   

Deferred tax adjustment on stock-based compensation

        (1               (1

Dividends declared

            (32           (32

Common stock repurchased

        (75       (129     13        (1       (205

Shares issued in non-vested stock award

    1                        

Dividends for vested stock awards

        1          (1             

Shares repurchased for tax withholdings for vested stock awards

        (1       (1           (2

Elimination due to sale of controlling interests in subsidiaries

                  (18     (18

Distributions to partners of noncontrolling interests in subsidiaries

                  (5     (5

Comprehensive income, net of income taxes:

               

Net income

            193            6        199   

Foreign currency translation

          (10           (1     (11
       

 

 

   

 

 

       

 

 

   

 

 

 

Total comprehensive (loss) income

          (10     193            5        188   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2011

    158      $ 16      $ 830      $ (5   $ 243        20      $ (2   $     15      $ 1,097   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    Covanta Holding Corporation Stockholders’ Equity              
          Additional
Paid-In

Capital
    Accumulated
Other
Comprehensive

Income
    Accumulated
Earnings
    Treasury Stock     Noncontrolling
Interests in

Subsidiaries
       
    Common Stock                  
    Shares     Amount           Shares     Amount       Total  
    (Unaudited, in millions)  

Balance as of December 31, 2009

    156      $     16      $     917      $ 7      $ 444        1      $     (1   $     34      $     1,417   

Stock-based compensation expense

        13                  13   

Cash dividend declared

            (233           (233

Common stock repurchased

        (15       (22     3            (37

Exercise of options to purchase common stock

        1                  1   

Shares issued in non-vested stock award

    1                        

Acquisition of noncontrolling interests in subsidiaries

        (1             (1     (2

Distributions to partners of noncontrolling interests in subsidiaries

                  (7     (7

Comprehensive income, net of income taxes:

                 

Net income

            39            7        46   

Foreign currency translation

          1              1        2   

Pension and other postretirement plan unrecognized net loss

            (1             (1

Net unrealized loss on derivatives

          1                1   

Net unrealized gain on securities

          1                1   
       

 

 

   

 

 

       

 

 

   

 

 

 

Total comprehensive income

          2        39            8        49   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2010

    157      $ 16      $ 915      $ 9      $ 228          4      $ (1   $ 34      $ 1,201   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

7


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

The terms “we,” “our,” “ours,” “us” and “Company” refer to Covanta Holding Corporation and its subsidiaries; the term “Covanta Energy” refers to our subsidiary Covanta Energy Corporation and its subsidiaries.

Organization

We are one of the world’s largest owners and operators of infrastructure for the conversion of waste to energy (known as “energy-from-waste” or “EfW”), as well as other waste disposal and renewable energy production businesses. Energy-from-waste serves two key markets as both a sustainable waste disposal solution that is environmentally superior to landfilling and as a source of clean energy that reduces overall greenhouse gas emissions and is considered renewable under the laws of many states and under federal law. Our facilities are critical infrastructure assets that allow our customers, which are principally municipal entities, to provide an essential public service.

We operate and/or have ownership positions in 44 energy-from-waste facilities, which are primarily located in North America, and 17 additional energy generation facilities, including other renewable energy production facilities in North America (wood biomass, landfill gas and hydroelectric) and an independent power production (“IPP”) facility in Asia. We hold equity interests in energy-from-waste facilities in China and Italy. We also operate waste management infrastructure that is complementary to our core EfW business.

We have one reportable segment which is Americas and is comprised of waste and energy services operations primarily in the United States and Canada. For additional information, see Note 5. Financial Information by Business Segments.

In 2010, we adopted a plan to sell our interests in our fossil fuel independent power production facilities in the Philippines, India, and Bangladesh. During the first quarter of 2011, we completed the sale of our interests in a 510 megawatt (“MW”) (gross) coal-fired electric power generation facility in the Philippines (“Quezon”) and we completed the sale of our majority equity interests in a 106 MW (gross) heavy fuel-oil fired electric power generation facility in Tamil Nadu, India (“Samalpatti”). In October 2011, we completed the sale of our majority equity interests in our 106 MW (gross) heavy fuel-oil fired electric power generation facility, also in Tamil Nadu, India (“Madurai”). The remaining asset held for sale is our interest in a barge-mounted 126 MW (gross) diesel/natural gas-fired electric power generation facility located near Haripur, Bangladesh. See Note 3. Assets Held for Sale and Dispositions and Note 14. Subsequent Events for additional information.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States Generally Accepted Accounting Principles (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for fair presentation have been included in our financial statements. All intra-entity accounts and transactions have been eliminated. Operating results for the interim period are not necessarily indicative of the results that may be expected for the fiscal year ended December 31, 2011. This Form 10-Q should be read in conjunction with the Audited Consolidated Financial Statements and accompanying Notes in our Annual Report on Form 10-K for the year ended December 31, 2010 (“Form 10-K”).

We use the equity method to account for our investments for which we have the ability to exercise significant influence over the operating and financial policies of the investee. Consolidated net income includes our proportionate share of the net income or loss of these companies. Such amounts are classified as “equity in net income from unconsolidated investments” in our condensed consolidated financial statements. Investments in companies in which we do not have the ability to exercise significant influence are carried at the lower of cost or estimated realizable value. We monitor investments for other-than-temporary declines in value and make reductions when appropriate.

Reclassifications

As more fully described in Note 3. Business Development, Assets Held for Sale and Dispositions, during the fourth quarter of 2010, the operations of our fossil fuel independent power production facilities held for sale met the criteria to be classified as discontinued operations. The assets and liabilities associated with these businesses are presented in our condensed consolidated balance sheets as “Current Assets Held for Sale” and “Current Liabilities Held for Sale.” The results of operations of these businesses are included in the condensed consolidated statements of operations as “Income from discontinued operations, net of tax.” The cash flows of these businesses are also presented separately in our condensed consolidated statements of cash flows. All corresponding prior year periods presented in our condensed consolidated financial statements and accompanying notes have been reclassified to reflect the discontinued operations presentation.

 

8


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

During the first quarter of 2011, we corrected our presentation of the condensed consolidated balance sheet at December 31, 2010 to adjust a portion of the excess of purchase price over par value for treasury stock transactions from additional paid-in capital to retained earnings. We have adjusted approximately $22 million and $66 million to retained earnings from additional paid-in capital as of September 30, 2010 and December 31, 2010, respectively. This change had no impact on total equity.

NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS

In May 2011, the Financial Accounting Standards Board (“FASB”) issued guidance related to amendments to disclosures about fair value measurements. The amendments in this update improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards. We are required to adopt this standard for the first quarter of 2012. Early adoption is not permitted. We do not expect this accounting standard to have a material impact on our condensed consolidated financial statements.

In June 2011, the FASB issued guidance related to the presentation of comprehensive income. This guidance eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all other comprehensive income changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments do not affect how earnings per share is calculated or presented. We are required to adopt this standard for the first quarter of 2012, however early adoption is permitted. The amendments should be applied retrospectively. We are currently evaluating the presentational changes to our condensed consolidated financial statements required by this guidance.

In September 2011, the FASB issued guidance related to testing goodwill for impairment. The amendments provide an option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under that option, an entity no longer would be required to calculate the fair value of a reporting unit unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. We are required to adopt this standard for the first quarter of 2012. Early adoption is permitted and we expect to adopt this guidance during the fourth quarter of 2011. We do not expect this accounting standard to have an impact on our condensed consolidated financial statements.

NOTE 3. BUSINESS DEVELOPMENT, ASSETS HELD FOR SALE AND DISPOSITIONS

Business Development

Durham-York Energy-from-Waste Facility

During the third quarter of 2011, we received the notice to proceed with design, construction and operation of a municipally-owned 140,000 tonne-per-year greenfield energy-from-waste facility to be built in Clarington, Ontario, located in Durham Region, Canada. The facility will process waste from the Regions of Durham and York. The fixed-price construction contract for the project is for approximately C$250 million. The project will be funded and owned by the Durham and York Regions. During the third quarter of 2011, we acquired a $267 million performance surety bond for this project which will expire in June 2014. After construction, we will operate the facility under a 20 year contract.

Assets Held for Sale and Dispositions

In 2010, we adopted a plan to sell our interests in our fossil fuel independent power production facilities in the Philippines, India, and Bangladesh.

During the first quarter of 2011, we completed the sale of our majority equity interests in a 106 MW (gross) heavy fuel-oil fired electric power generation facility in Tamil Nadu, India (“Samalpatti”) and we completed the sale of our interests in a 510 MW (gross) coal-fired electric power generation facility in the Philippines (“Quezon”). The Quezon assets sold consisted of our entire interest in Covanta Philippines Operating, Inc., which provided operation and maintenance services to the facility, as well as our 26% ownership interest in the project company, Quezon Power, Inc.

In October 2011, we completed the sale of our interests in a 106 MW (gross) heavy fuel-oil fired electric power generation facility in Tamil Nadu, India (“Madurai”). The Madurai assets sold included our entire interest in Covanta Madurai Operating Private Limited, which provided operation and maintenance services to the facility, as well as our approximately 77% ownership interest in the project company, Madurai Power Corporation Private Ltd. See Note 14. Subsequent Events.

The remaining asset held for sale is our interest in a barge-mounted 126 MW (gross) diesel/natural gas-fired electric power generation facility located near Haripur, Bangladesh.

 

9


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

During 2011, we have received a combined total of cash proceeds of $256 million, net of transaction costs, for our interests in the three fossil fuel independent power production facilities that we have sold.

The assets and liabilities associated with these businesses are presented in our condensed consolidated balance sheets as “Current Assets Held for Sale” and “Current Liabilities Held for Sale.” The results of operations of these businesses are included in the condensed consolidated statements of operations as “Income from discontinued operations, net of tax.” The cash flows of these businesses are also presented separately in our condensed consolidated statements of cash flows. All corresponding prior year periods presented in our condensed consolidated financial statements and accompanying notes have been reclassified to reflect the discontinued operations presentation.

The following table summarizes the operating results of the discontinued operations for the periods indicated (in millions):

 

     Three Months  Ended
September 30,
    Nine Months  Ended
September 30,
 
     2011     2010         2011              2010      

Revenues

   $             15      $             33      $             84       $             124   

Operating expenses, including net gain on disposal of assets held for sale and loss on assets held for sale (a)

   $ (23   $ (28   $ 55       $ (106

Income before income tax expense and equity in net income from unconsolidated investments

   $ (8   $ 7      $ 140       $ 20   

Equity in net income from unconsolidated investments

   $ 1      $ 6      $ 7       $ 17   

Income from discontinued operations, net of income tax expense of $0, $1, $3 and $5, respectively

   $ (7   $ 11      $ 144       $ 32   

 

  (a) During the three and nine months ended September 30, 2011, we recorded a net after-tax (loss) gain on assets held for sale of $(11) million and $121 million, respectively. We recorded a loss on assets held for sale of $8 million in 2010.

The following table sets forth the assets and liabilities of the assets held for sale included in the condensed consolidated balance sheets as of the dates indicated (in millions):

 

     As of  
     September 30,
2011
     December 31,
2010
 

Cash and cash equivalents

   $             8       $             14   

Restricted funds held in trust

             19   

Accounts receivable

     27         20   

Prepaid expenses and other assets

     10         26   

Property, plant and equipment, net

             30   

Investments in investees and joint ventures

     15         81   

Other long-term assets

             1   
  

 

 

    

 

 

 

Assets held for sale

   $ 60       $ 191   
  

 

 

    

 

 

 

Accounts payable

   $ 2       $ 3   

Accrued expenses and other

     3         12   

Project debt

     11         15   

Other noncurrent liabilities

     3         4   
  

 

 

    

 

 

 

Liabilities held for sale

   $ 19       $ 34   
  

 

 

    

 

 

 

 

10


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

NOTE 4. EARNINGS PER SHARE (“EPS”)

Per share data is based on the weighted average number of outstanding shares of our 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 awards, restricted stock units and warrants whether or not currently exercisable. Diluted earnings per share for all the periods presented does not include securities if their effect was anti-dilutive (in millions, except per share amounts).

 

     Three Months  Ended
September 30,
     Nine Months  Ended
September 30,
 
     2011     2010      2011      2010  

Net income from continuing operations

   $         49      $         10       $         52       $         10   

Net (loss) income from discontinued operations

     (7     10         141         29   
  

 

 

   

 

 

    

 

 

    

 

 

 

Net income attributable to Covanta Holding Corporation

   $ 42      $ 20       $ 193       $ 39   
  

 

 

   

 

 

    

 

 

    

 

 

 

Basic earnings per share:

          

Weighted average basic common shares outstanding

     139        153         143         154   
  

 

 

   

 

 

    

 

 

    

 

 

 

Continuing operations

   $ 0.35      $ 0.07       $ 0.37       $ 0.07   

Discontinued operations

     (0.05     0.06         0.98         0.18   
  

 

 

   

 

 

    

 

 

    

 

 

 

Covanta Holding Corporation

   $ 0.30      $ 0.13       $ 1.35       $ 0.25   
  

 

 

   

 

 

    

 

 

    

 

 

 

Diluted earnings per share:

          

Weighted average basic common shares outstanding

     139        153         143         154   

Dilutive effect of stock options

                              

Dilutive effect of restricted stock

     1        1         1         1   

Dilutive effect of convertible debentures

                              

Dilutive effect of warrants

                              
  

 

 

   

 

 

    

 

 

    

 

 

 

Weighted average diluted common shares outstanding

     140        154         144         155   
  

 

 

   

 

 

    

 

 

    

 

 

 

Continuing operations

   $ 0.35      $ 0.07       $ 0.36       $ 0.07   

Discontinued operations

     (0.05     0.06         0.98         0.18   
  

 

 

   

 

 

    

 

 

    

 

 

 

Covanta Holding Corporation

   $ 0.30      $ 0.13       $ 1.34       $ 0.25   
  

 

 

   

 

 

    

 

 

    

 

 

 

Securities excluded from the weighted average dilutive common shares outstanding because their inclusion would have been antidilutive:

          

Stock options

     2        2         2         2   
  

 

 

   

 

 

    

 

 

    

 

 

 

Restricted stock

                              
  

 

 

   

 

 

    

 

 

    

 

 

 

Restricted stock units

                              
  

 

 

   

 

 

    

 

 

    

 

 

 

Warrants

     27        27         27         27   
  

 

 

   

 

 

    

 

 

    

 

 

 

In 2007, we issued 1.00% Senior Convertible Debentures due 2027 (the “Debentures”). The Debentures are convertible under certain circumstances if the closing sale price of our common stock exceeds a specified conversion price before February 1, 2025. As of September 30, 2011, the conversion rate for the Debentures was 38.9883 shares of our common stock per $1,000 principal amount of Debentures, which is equivalent to a conversion price of $25.65 per share. In connection with the quarterly cash dividend payable on October 14, 2011, the conversion rate for the Debentures was adjusted to 39.5441 shares of our common stock per $1,000 principal amount of the Debentures. The adjusted conversion rate is equivalent to an adjusted conversion price of $25.29 per share and became effective on October 4, 2011. As of September 30, 2011, the Debentures did not have a dilutive effect on earnings per share because the average market price during the periods presented was below the strike price.

In 2009, we entered into privately negotiated warrant transactions in connection with the issuance of 3.25% Cash Convertible Senior Notes due 2014 (the “3.25% Notes”). These warrants could have a dilutive effect to the extent that the price of our common stock exceeds the applicable strike price of $23.12. As of September 30, 2011, the warrants did not have a dilutive effect on earnings per share because the average market price during the periods presented was below the strike price.

 

11


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

NOTE 5. FINANCIAL INFORMATION BY BUSINESS SEGMENTS

We have one reportable segment, Americas, which is comprised of waste and energy services operations primarily in the United States and Canada. The results of our reportable segment are as follows (in millions):

 

     Americas     

All Other(a)

    Total  

Three Months Ended September 30, 2011:

       

Operating revenues

   $ 421       $ 11      $ 432   

Depreciation and amortization expense

     48                48   

Operating income (loss)

     93         (6     87   

Three Months Ended September 30, 2010:

       

Operating revenues

   $ 394       $ 9      $ 403   

Depreciation and amortization expense

     47                47   

Operating income (loss)

     80         (34     46   

Nine Months Ended September 30, 2011:

       

Operating revenues

   $ 1,188       $ 32      $ 1,220   

Depreciation and amortization expense

     141         1        142   

Operating income (loss)

     157         (19     138   

Nine Months Ended September 30, 2010:

       

Operating revenues

   $  1,134       $ 30      $  1,164   

Depreciation and amortization expense

     141         1        142   

Operating income (loss)

     141         (49     92   

 

(a)

All other is comprised of the financial results of our insurance subsidiaries’ operations and our remaining international assets that are not classified as assets held for sale. See Note 3. Business Development, Assets Held for Sale and Dispositions.

NOTE 6. CHANGES IN CAPITALIZATION

Long-Term Debt

Long-term debt is as follows (in millions):

 

     As of  
    

September 30,

2011

   

December 31,

2010

 

7.25% Senior Notes due 2020

   $ 400      $ 400   

3.25% Cash Convertible Senior Notes due 2014

     460        460   

Debt discount related to Cash Convertible Senior Notes

     (74     (91

Cash conversion option derivative at fair value

     73        116   
  

 

 

   

 

 

 

3.25% Cash Convertible Senior Notes, net

     459        485   

1.00% Senior Convertible Debentures due 2027

     25        57   

Debt discount related to Convertible Debentures

            (3
  

 

 

   

 

 

 

1.00% Senior Convertible Debentures, net

     25        54   

Term Loan Facility due 2014

     621        626   
  

 

 

   

 

 

 

Total

     1,505        1,565   

Less: current portion

     (31     (7
  

 

 

   

 

 

 

Total long-term debt

   $  1,474      $  1,558   
  

 

 

   

 

 

 

 

12


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Credit Facilities

We have credit facilities which are comprised of a $300 million revolving credit facility (the “Revolving Credit Facility”), a $320 million funded letter of credit facility (the “Funded L/C Facility”), and a $650 million term loan (the “Term Loan Facility”) (collectively referred to as the “Credit Facilities”). As of September 30, 2011, we had available credit for liquidity as follows (in millions):

 

     Total
Available
Under Facility
     Maturing      Outstanding Letters
of Credit as of
September 30, 2011
     Available as of
September  30, 2011
 

Revolving Credit Facility(a)

   $                 300         2013       $               —       $               300   

Funded L/C Facility

   $ 320         2014       $ 279       $ 41   

 

(a)

Up to $200 million of which may be utilized for letters of credit.

7.25% Senior Notes due 2020 (the “7.25% Notes”)

For specific criteria related to redemption features of the 7.25% Notes, refer to Note 12 of the Notes to Consolidated Financial Statements in our Form 10-K.

3.25% Cash Convertible Senior Notes due 2014 (the “3.25% Notes”)

Under limited circumstances, the 3.25% Notes are convertible by the holders thereof into cash only, based on a conversion rate of 59.4517 shares of our common stock per $1,000 principal amount of 3.25% Notes (which represents a conversion price of approximately $16.82 per share) subject to certain customary adjustments as provided in the indenture for the 3.25% Notes. We will not deliver common stock (or any other securities) upon conversion under any circumstances.

For specific criteria related to contingent interest, conversion or redemption features of the 3.25% Notes and details related to the cash conversion option, cash convertible note hedge and warrants related to the 3.25% Notes, refer to Note 12 of the Notes to Consolidated Financial Statements in our Form 10-K.

For details related to the fair value for the contingent interest feature, cash conversion option, and cash convertible note hedge related to the 3.25% Notes, see Note 12. Derivative Instruments.

1.00% Senior Convertible Debentures due 2027 (the “Debentures”)

In November 2010, we commenced a tender offer to purchase for cash any and all of our outstanding 1.00% Senior Convertible Debentures due 2027. We offered to purchase the Debentures at a purchase price of $990 for each $1,000 principal amount of Debentures. During the nine months ended September 30, 2011, an additional $32 million of the Debentures were purchased. As of September 30, 2011, there was $25 million aggregate principal amount of the Debentures outstanding. We may purchase Debentures that remained outstanding following expiration of the tender offer in the open market, in privately negotiated transactions, through tender offers, exchange offers, by redemption or otherwise.

As of September 30, 2011, under limited circumstances, prior to February 1, 2025, the Debentures are convertible by the holders into cash and shares of our common stock, if any, based on a conversion rate of 38.9883 shares of our common stock per $1,000 principal amount of Debentures, (which represents a conversion price of approximately $25.65 per share) or approximately 1 million issuable shares. In connection with the quarterly cash dividend payable on October 14, 2011, the conversion rate for the Debentures was adjusted to 39.5441 shares of our common stock per $1,000 principal amount of the Debentures. The adjusted conversion rate is equivalent to an adjusted conversion price of $25.29 per share and became effective on October 4, 2011. As of September 30, 2011, if the Debentures were converted, no shares would have been issued since the trading price of our common stock was below the conversion price of the Debentures.

For specific criteria related to contingent interest, conversion or redemption features of the Debentures, refer to Note 12 of the Notes to Consolidated Financial Statements in our Form 10-K.

For details related to the fair value for the contingent interest feature related to the Debentures, see Note 12. Derivative Instruments.

 

13


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Debt Discount for the 3.25% Notes

The debt discount related to the 3.25% Notes is accreted over their term and recognized as non-cash convertible debt related expense. The following table details the amount of the accretion of debt discount as of September 30, 2011 expected to be included in our condensed consolidated financial statements for each of the periods indicated (in millions):

 

     For the Years Ended  
     Remainder of
2011
     2012      2013      2014  

3.25% Cash Convertible Senior Notes due 2014

   $         6       $         26       $         29       $         13   

Loss on Extinguishment of Debt

During the nine months ended September 30, 2011, we recorded a loss on extinguishment of debt of $1 million related to the additional $32 million of the outstanding Debentures purchased under the tender offer. The loss on extinguishment of debt was comprised of the difference between the fair value and carrying value of the liability component of the Debentures tendered.

Equity

During the nine months ended September 30, 2011, we granted 755,962 restricted stock awards and 36,210 restricted stock units. For information related to stock-based award plans, see Note 10. Stock-Based Compensation.

During the nine months ended September 30, 2011, we repurchased 216,605 shares of our common stock in connection with tax withholdings for vested stock awards.

During each quarter of 2011, the Board of Directors approved a regular quarterly cash dividend of $0.075 per share which was paid on April 12, 2011, July 6, 2011, and October 14, 2011, respectively. During the second quarter of 2010, the Board of Directors declared a special cash dividend of $1.50 per share which was paid on July 20, 2010.

Dividends declared to stockholders are as follows (in millions, except per share amounts):

 

     Three Months  Ended
September 30,
     Nine Months  Ended
September 30,
 
             2011                      2010                      2011                      2010          

Regular cash dividend

           

Declared

   $ 10       $       $ 32       $   

Per Share

   $         0.075       $         —       $         0.225       $   

Special cash dividend

           

Declared

   $       $       $       $ 233   

Per Share

   $       $       $       $         1.50   

During the nine months ended September 30, 2011, the Board of Directors approved an additional $250 million share repurchase authorization, bringing the total authorized amount to $400 million. Under the program, common stock repurchases may be made in the open market, in privately negotiated transactions from time to time, or by other available methods, at management’s discretion in accordance with applicable federal securities laws. The timing and amounts of any repurchases will depend on many factors, including our capital structure, the market price of our common stock and overall market conditions. As of September 30, 2011, the amount remaining under our currently authorized share repurchase program was $100 million.

Common stock repurchased is as follows (in millions, except per share amounts):

 

     Amount      Shares
Repurchased
     Weighted
Average  Cost
per Share
 

Three months ended March 31, 2011

   $         54         3.2       $         16.84   

Three months ended June 30, 2011

   $ 70         4.2       $ 16.58   

Three months ended September 30, 2011 (a)

   $ 81         5.2       $ 15.58   
  

 

 

    

 

 

    

Nine months ended September 30, 2011

   $ 205         12.6       $ 16.24   
  

 

 

    

 

 

    

 

(a)

Approximately $2 million of common stock repurchased during the three months ended September 30, 2011 was paid in October 2011.

 

14


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

NOTE 7. INCOME TAXES

We record our interim tax provision based upon our estimated annual effective tax rate and account for the tax effects of discrete events in the period in which they occur. We file a federal consolidated income tax return with our eligible subsidiaries. Our federal consolidated income tax return also includes the taxable results of certain grantor trusts described below.

We currently estimate our annual effective tax rate for the year ending December 31, 2011 to be approximately 27.4%. We review the annual effective tax rate on a quarterly basis as projections are revised and laws are enacted. The effective income tax rate was approximately 6.0 % and 58.3% for the nine months ended September 30, 2011 and 2010, respectively. The decrease in the effective tax rate is primarily due to the impact of the reversal of uncertain tax positions discussed below and the impact of state tax law changes enacted in the current year on deferred state income taxes. The liability for uncertain tax positions, exclusive of interest and penalties, was $114 million as of September 30, 2011 and $130 million as of December 31, 2010. Included in the balance of unrecognized tax benefits as of September 30, 2011 are potential benefits of $114 million that, if recognized, would impact the effective tax rate.

For the three months ended September 30, 2011, the income tax provision includes a $24 million benefit due to the reversal of uncertain tax positions, following the expiration of applicable statutes of limitations related to pre-emergence tax matters in the Covanta Energy bankruptcy. We had held since March 2004 $20 million in restricted funds intended to cover those uncertain tax positions. The restricted funds were included in other assets on our condensed consolidated balance sheet. The expiration of the statutes of limitations triggered a liability to pre-petition claimants of approximately 73% of the restricted fund balance. Therefore, we recorded approximately $15 million as other expense during the three months ended September 30, 2011. As of September 30, 2011, $15 million of the non-current restricted funds was reclassified to other current assets on our condensed consolidated balance sheet and is expected to be paid to third party claimants in the fourth quarter of 2011. The remaining $5 million was reclassified to cash and cash equivalents on our condensed consolidated balance sheet as of September 30, 2011.

For the three months ended September 30, 2011 and 2010, we recognized a net tax benefit of $7 million and a net tax expense of $0, respectively, and for the nine months ended September 30, 2011 and 2010, we recognized net tax benefits of $6 million and $1 million, respectively, for interest and penalties on uncertain tax positions. As of September 30, 2011 and December 31, 2010, we had accrued interest and penalties associated with liabilities for unrecognized tax positions of $2 million and $7 million, respectively. We continue to reflect interest accrued on uncertain tax positions and penalties as part of the tax provision.

In the ordinary course of our business, the Internal Revenue Service (“IRS”) and state tax authorities will periodically audit our federal and state tax returns. As issues are examined by the IRS and state auditors, we may decide to adjust the existing liability for uncertain tax positions for issues that were not previously deemed an exposure. Federal income tax returns for Covanta Energy are closed for the years through 2003. However, to the extent net operating loss carryforwards (“NOLs”) are utilized from earlier years, federal income tax returns for Covanta Holding Corporation, formerly known as Danielson Holding Corporation, are still open. State income tax returns are generally subject to examination for a period of three to five years after the filing of the respective return. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states. We have various state income tax returns in the process of examination, administrative appeals or litigation.

Our NOLs predominantly arose from our predecessor insurance entities (which were subsidiaries of our predecessor, formerly named Mission Insurance Group, Inc., “Mission”). These Mission insurance entities have been in state insolvency proceedings in California and Missouri since the late 1980’s. The amount of NOLs available to us will be reduced by any taxable income or increased by any taxable losses generated by current members of our consolidated tax group, which include grantor trusts associated with the Mission insurance entities.

While we cannot predict what amounts, if any, may be includable in taxable income as a result of the final administration of these grantor trusts, substantial actions toward such final administration have been taken and we believe that neither arrangements with the California Commissioner nor the final administration by the Missouri Director will result in a material reduction in available NOLs.

We have consolidated federal NOLs estimated to be approximately $525 million for federal income tax purposes as of December 31, 2010, based on the income tax returns filed. An election was made to defer certain income resulting in an increase in the amount previously reported. The federal NOLs will expire in various amounts from December 31, 2023 through December 31, 2030, if not used. In addition to the consolidated federal NOLs, as of December 31, 2010, we had state NOL carryforwards of approximately $189 million, which expire between 2011 and 2027, capital loss carryforwards of $0.2 million expiring in 2013, and additional federal credit carryforwards, including production tax credits and minimum tax credits, of $46 million. These deferred tax assets are offset by a valuation allowance of approximately $20 million.

For further information, refer to Note 17. Income Taxes of the Notes to the Consolidated Financial Statements in our Form 10-K.

 

15


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

NOTE 8. SUPPLEMENTARY INFORMATION

Operating Costs

Pass through costs

Pass through costs are costs for which we receive a direct contractually committed reimbursement from the municipal client which sponsors an energy-from-waste 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 our condensed consolidated financial statements. Total pass through costs were $19 million and $21 million for the three months ended September 30, 2011 and 2010, respectively and $62 million and $65 million for the nine months ended September 30, 2011 and 2010, respectively.

Other operating expenses

The components of other operating expenses are as follows (in millions):

 

     Other Operating Expenses  
     For the Three  Months
  Ended September 30,  
     For the Nine Months
   Ended September 30,  
 
     2011     2010      2011     2010  

Construction expense

   $             44      $             22       $             100      $             63   

Insurance subsidiary operating expenses (a)

     4        6         12        15   

Foreign exchange gain

     (1             (3     (1

Other

     (3             (7       
  

 

 

   

 

 

    

 

 

   

 

 

 

Total other operating expenses

   $ 44      $ 28       $ 102      $ 77   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(a)

Insurance subsidiary operating expenses are primarily comprised of incurred but not reported loss reserves, loss adjustment expenses and policy acquisition costs.

Amortization of waste, service and energy contracts

Our waste, service and energy contracts are intangible assets and liabilities relating to long-term operating contracts at acquired facilities and are recorded upon acquisition at their estimated fair market values based upon discounted cash flows. Intangible assets and liabilities are amortized using the straight line method over their remaining useful lives.

The following table details the amount of the actual/estimated amortization expense and contra-expense associated with these intangible assets and liabilities as of September 30, 2011 included or expected to be included in our condensed consolidated statement of income for each of the years indicated (in millions):

 

     Waste, Service and
Energy Contracts
(Amortization Expense)
     Waste and  Service
Contracts
     (Contra-Expense)     
 

Nine Months ended September 30, 2011

   $                 28       $                 (9
  

 

 

    

 

 

 

Remainder of 2011

   $ 9       $ (3

2012

     36         (12

2013

     32         (12

2014

     29         (13

2015

     26         (8

2016

     22         (8

Thereafter

     288         (23
  

 

 

    

 

 

 

Total

   $ 442       $ (79
  

 

 

    

 

 

 

 

16


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Write-down of Assets

During the three months ended September 30, 2010, we recorded the following non-cash impairment charges:

 

  Ÿ  

$7 million, pre-tax, to write-down the receivable from The Harrisburg Authority to $13 million, which was calculated based on a range of potential outcomes utilizing various estimated cash flows for the receivable (see Note 14. Subsequent Events for additional information);

  Ÿ  

$3 million, pre-tax, to write-down of real estate for our corporate office to estimated fair value; and

  Ÿ  

$23 million, pre-tax, comprised of the entire capitalized pre-construction and construction costs for the Dublin Joint Venture project, net of approximately $8 million in recoverable assets net of liabilities, of which approximately $5 million remain on the condensed consolidated balance sheet as of September 30, 2011 and primarily related to recoverable premiums under project insurance.

For additional information, see Note 16 of the Notes to Consolidated Financial Statements in our Form 10-K.

Non-Cash Convertible Debt Related Expense

The components of non-cash convertible debt related expense are as follows (in millions):

 

     Non-Cash Convertible Debt Related Expense  
     For the Three  Months
    Ended September 30,    
    For the Nine Months
     Ended September 30,    
 
     2011     2010     2011     2010  

Debt discount accretion related to the 3.25% Notes

   $             6      $             5      $             17      $             16   

Debt discount accretion related to the Debentures

     1        5        3        15   

Fair value changes related to the cash convertible note hedge

     19        (10     43        34   

Fair value changes related to the cash conversion option derivative

     (17     10        (43     (35
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-cash convertible debt related expense

   $ 9      $ 10      $ 20      $ 30   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive Income

The components of comprehensive income are as follows (in millions):

 

       Three Months Ended  
September 30,
       Nine Months Ended  
September 30,
 
     2011     2010      2011     2010  

Comprehensive income, net of income taxes:

         

Net income attributable to Covanta Holding Corporation

   $         42      $         20       $         193      $         39   
  

 

 

   

 

 

    

 

 

   

 

 

 

Foreign currency translation

     (19     10         (10     1   

Pension and other postretirement plan unrecognized net loss

                           (1

Net unrealized gain on derivatives

     1        1                1   

Net unrealized gain (loss) on available-for-sale securities

     (1     1                1   
  

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive (loss) income attributable to Covanta Holding Corporation

     (19     12         (10     2   
  

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income attributable to Covanta Holding Corporation

   $ 23      $ 32       $ 183      $ 41   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income attributable to noncontrolling interests in subsidiaries

   $ 2      $ 3       $ 6      $ 7   

Other comprehensive (loss) income — Foreign currency translation

     (1     1         (1     1   
  

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income attributable to noncontrolling interests in subsidiaries

   $ 1      $ 4       $ 5      $ 8   
  

 

 

   

 

 

    

 

 

   

 

 

 

The components of net unrealized foreign currency translation consist of the following (in millions, net of tax):

 

     Three Months
     Ended September 30,    
     Nine Months
     Ended September 30,    
 
     2011     2010      2011     2010  

Net unrealized foreign currency translation adjustments arising during the period

   $         (19   $         10       $         (10   $         1   

Reclassification adjustment for foreign currency translation included in net income

                    (1       
  

 

 

   

 

 

    

 

 

   

 

 

 

Net unrealized foreign currency translation adjustment

   $ (19   $ 10       $ (11   $ 1   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

17


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

NOTE 9. BENEFIT OBLIGATIONS

Pension and Other Benefit Obligations

The components of net periodic (credit) benefit costs are as follows (in millions):

 

     Pension Benefits  
     For the Three
Months Ended
    September 30,    
    For the Nine
    Months Ended    
September 30,
 
     2011     2010     2011     2010  

Interest cost

   $             1      $             1      $             3      $             3   

Expected return on plan assets

     (1     (1     (4     (4
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $      $      $ (1   $ (1
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest costs and the expected return on plan assets for other post-retirement benefits were not material for the three and nine months ended September 30, 2011.

Effective December 31, 2005, we froze service accruals in the defined benefit pension plan for employees in the United States who did not participate in retirement plans offered by collective bargaining units or our insurance subsidiaries. All active employees who were eligible participants in the defined benefit pension plan, as of December 31, 2005, became 100% vested and have a non-forfeitable right to these benefits as of such date. During the second quarter of 2011, we informed employees who were eligible participants in the pension plan of our plan to terminate the pension plan, subject to approval by the IRS, with the intention of fully distributing plan assets as promptly as practicable following such approval. As of December 2010, the fair value of plan assets exceeded accumulated benefit obligations for the pension plan. The actual settlement amount will fluctuate based on future market performance, such as the interest rate at the final settlement, actual return on plan assets, and employees’ disbursement elections. We anticipate the actual settlement will take place in the second half of 2012.

Defined Contribution Plans

Substantially all of our employees in the United States are eligible to participate in defined contribution plans we sponsor. Our costs related to defined contribution plans were $4 million for both the three months ended September 30, 2011 and 2010, respectively and $11 million and $12 million for the nine months ended September 30, 2011 and 2010, respectively.

NOTE 10. STOCK-BASED COMPENSATION

During the nine months ended September 30, 2011, we awarded certain employees 719,962 restricted stock awards. The restricted stock awards will be expensed over the requisite service period, subject to an assumed 12% average forfeiture rate. The terms of the restricted stock awards include vesting provisions based solely on continued service. If the service criteria are satisfied, the majority of the restricted stock awards vest during March of 2012, 2013, and 2014.

On May 5, 2011, in accordance with our existing program for annual director compensation, we awarded 36,000 shares of restricted stock under the Directors Plan. We determined that the service vesting condition of these restricted stock awards to be non-substantive and, in accordance with accounting principles for stock compensation, recorded the entire fair value of the award as compensation expense on the grant date.

During the nine months ended September 30, 2011, we awarded certain employees 36,210 restricted stock units in connection with specified projects. Vesting for these restricted stock units will occur at the earlier of three years or upon satisfactory completion of such projects.

Compensation expense related to our stock-based awards totaled $4 million for both the three months ended September 30, 2011 and 2010 and $13 million for both the nine months ended September 30, 2011 and 2010. Compensation expense for the nine months ended September 30, 2010 includes additional expense of $1 million resulting from the reduction of the exercise price of outstanding options resulting from the special cash dividend which was paid on July 20, 2010.

As of September 30, 2011, we had approximately $12 million, $4 million and $1 million of unrecognized compensation expense related to our unvested restricted stock, unvested restricted stock units, and unvested stock options, respectively. We expect this compensation expense to be recognized over a weighted average period of approximately 2 years for both our unvested restricted stock awards and our unvested restricted stock units and approximately 1 year for our unvested stock options.

 

18


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

NOTE 11. FINANCIAL INSTRUMENTS

Fair Value Measurements

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

 

  Ÿ  

For cash and cash equivalents, restricted funds, and marketable securities, the carrying value of these amounts is a reasonable estimate of their fair value. The fair value of restricted funds held in trust is based on quoted market prices of the investments held by the trustee.

  Ÿ  

Fair values for long-term debt and project debt are determined using quoted market prices.

  Ÿ  

The fair value of the note hedge and the cash conversion option are determined using an option pricing model based on observable inputs such as implied volatility, risk free interest rate, and other factors. The fair value of the note hedge is adjusted to reflect counterparty risk of non-performance, and is based on the counterparty’s credit spread in the credit derivatives market. The contingent interest features related to the Debentures and the 3.25% Notes are valued quarterly using the present value of expected cash flow models incorporating the probabilities of the contingent events occurring.

The estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that we would realize in a current market exchange. The fair-value estimates presented herein are based on pertinent information available to us as of September 30, 2011. However, such amounts have not been comprehensively revalued for purposes of these financial statements since September 30, 2011, and current estimates of fair value may differ significantly from the amounts presented herein.

 

19


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The following table presents information about the fair value measurement of our assets and liabilities as of September 30, 2011:

 

0,000 0,000 0,000 0,000 0,000
     As of September 30, 2011     Fair Value Measurements at Reporting Date Using  
      Quoted Prices in
Active Markets for
    Significant Other     Significant
Unobservable
 

Financial Instruments Recorded at Fair Value
on a Recurring Basis:

  Carrying
Amount
    Estimated
Fair Value
    Identical Assets
(Level 1)
    Observable Inputs
(Level 2)
    Inputs
(Level 3)
 
    (In millions)  

Assets:

         

Cash and cash equivalents:

         

Bank deposits and certificates of deposit

  $         166      $         166      $         166      $      $   

Money market funds

    29        29        29                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents:

    195        195        195                 

Restricted funds held in trust:

         

Bank deposits and certificates of deposit

    2        2        2                 

Money market funds

    171        171        171                 

U.S. Treasury/Agency obligations (a)

    16        16        16                 

State and municipal obligations

    12        12        12                 

Commercial paper/Guaranteed investment contracts/Repurchase agreements

    60        60        60                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total restricted funds held in trust:

    261        261        261                 

Restricted funds — other:

         

Bank deposits and certificates of deposit (b)

    16        16        16                 

Money market funds (c)

    13        13        13                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total restricted funds other:

    29        29        29                 

Investments:

         

Mutual and bond funds (b)

    2        1        1                 

Investments available for sale:

         

U.S. Treasury/Agency obligations (d)

    5        5        5                 

Residential mortgage-backed securities (d)

    5        5        5                 

Other government obligations (d)

    4        4        4                 

Corporate investments (d)

    14        14        14                 

Equity securities (c)

    1        1        1                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments:

    31        30        30                 

Derivative Asset — Note Hedge

    69        69               69          
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets:

  $ 585      $ 584      $ 515      $             69      $             —   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

         

Derivative Liability — Cash Conversion Option

  $ 73      $ 73      $      $ 73      $   

Derivative Liabilities — Contingent interest features of the Notes and Debentures

    0        0               0          
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities:

  $ 73      $ 73      $      $ 73      $   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financial Instruments Recorded at Carrying Amount:

                             

Assets:

         

Accounts receivables (e)

  $ 262      $ 262         

Liabilities:

         

Long-term debt (excluding Cash Conversion Option)

  $ 1,432      $ 1,459         

Project debt

  $ 734      $ 747         

 

(a)

The U.S. Treasury/Agency obligations in restricted funds held in trust are primarily comprised of Federal Home Loan Mortgage Corporation securities at fair value.

(b)

Included in other noncurrent assets in the condensed consolidated balance sheets.

(c)

Included in prepaid expenses and other current assets in the condensed consolidated balance sheets.

(d)

Included in investments in fixed maturities at market in the condensed consolidated balance sheets.

(e)

Includes $24 million of noncurrent receivables in other noncurrent assets in the condensed consolidated balance sheets.

 

20


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The following table presents information about the fair value measurement of our assets and liabilities as of December 31, 2010:

 

0,0000 0,0000 0,0000 0,0000 0,0000
     As of December 31, 2010     Fair Value Measurements at Reporting Date Using  
      Quoted Prices in
Active Markets for
    Significant Other
Observable
    Significant
Unobservable
 

Financial Instruments Recorded at Fair Value
on a Recurring Basis:

  Carrying
Amount
    Estimated
Fair Value
    Identical Assets
(Level 1)
    Inputs
(Level 2)
    Inputs
(Level 3)
 
    (In millions)  

Assets:

         

Cash and cash equivalents:

         

Bank deposits and certificates of deposit

  $         48      $         48      $         48      $             —      $             —   

Money market funds

    78        78        78                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total cash and cash equivalents:

    126        126        126                 

Restricted funds held in trust:

         

Bank deposits and certificates of deposit

    4        4        4                 

Money market funds

    117        117        117                 

U.S. Treasury/Agency obligations (a)

    56        56        56                 

State and municipal obligations

    7        7        7                 

Commercial paper/Guaranteed investment contracts/Repurchase agreements

    49        49        49                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total restricted funds held in trust:

    233        233        233                 

Restricted funds — other:

         

Bank deposits and certificates of deposit (b)

    22        22        22                 

Money market funds (c)

    11        11        11                 

Residential mortgage-backed securities (c)

    1        1        1                 

Other government obligations (c)

    1        1        1                 

Corporate investments (c)

    1        1        1                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total restricted funds other:

    36        36        36                 

Investments:

         

Mutual and bond funds (b)

    3        3        3                 

Investments available for sale:

         

U.S. Treasury/Agency obligations (d)

    6        6        6                 

Residential mortgage-backed securities (d)

    5        5        5                 

Other government obligations (d)

    2        2        2                 

Corporate investments (d)

    16        16        16                 

Equity securities (c)

    1        1        1                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investments:

    33        33        33                 

Derivative Asset — Note Hedge

    113        113               113          
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets:

  $ 541      $ 541      $ 428      $ 113      $   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

         

Derivative Liability — Energy Hedges

  $ 1      $ 1      $      $ 1      $   

Derivative Liability — Cash Conversion Option

    116        116               116          

Derivative Liabilities — Contingent interest features of the 3.25% Notes and Debentures

    0        0               0          
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities:

  $ 117      $ 117      $      $ 117      $   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financial Instruments Recorded at Carrying Amount:

                             

Assets:

         

Accounts receivables (e)

  $ 293      $ 293         

Liabilities:

         

Long-term debt (excluding Cash Conversion Option)

  $ 1,448      $ 1,497         

Project debt

  $ 803      $ 823         

 

(a)

The U.S. Treasury/Agency obligations in restricted funds held in trust are primarily comprised of Federal Home Loan Mortgage Corporation securities at fair value.

(b)

Included in other noncurrent assets in the condensed consolidated balance sheets.

(c)

Included in prepaid expenses and other current assets in the condensed consolidated balance sheets.

(d)

Included in investments in fixed maturities at market in the condensed consolidated balance sheets.

(e)

Includes $25 million of noncurrent receivables in other noncurrent assets in the condensed consolidated balance sheets.

 

21


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Investments

Our insurance subsidiaries’ fixed maturity debt and equity securities portfolio are classified as “available-for-sale” and are carried at fair value. Equity securities that are traded on a national securities exchange are stated at the last reported sales price on the day of valuation. Debt securities values are determined by third party matrix pricing based on the last days trading activity. Changes in fair values are credited or charged directly to Accumulated Other Comprehensive Income (“AOCI”) in the condensed consolidated statements of equity as unrealized gains or losses, respectively. Investment gains or losses realized on the sale of securities are determined using the specific identification method. Realized gains and losses are recognized in the condensed consolidated statements of income based on the amortized cost of fixed maturities and the cost basis for equity securities on the date of trade, subject to any previous adjustments for other-than-temporary declines. Other-than-temporary declines in fair value are recorded as realized losses in the condensed consolidated statements of income to the extent they relate to credit losses, and to AOCI to the extent they are related to other factors. The cost basis of the security is also reduced. We consider the following factors in determining whether declines in the fair value of securities are other-than-temporary:

 

  Ÿ  

the significance of the decline in fair value compared to the cost basis;

  Ÿ  

the time period during which there has been a significant decline in fair value;

  Ÿ  

whether the unrealized loss is credit-driven or a result of changes in market interest rates;

  Ÿ  

a fundamental analysis of the business prospects and financial condition of the issuer; and

  Ÿ  

our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value.

Other investments, such as investments in companies in which we do not have the ability to exercise significant influence, are carried at the lower of cost or estimated realizable value.

The cost or amortized cost, unrealized gains, unrealized losses and the fair value of our investments categorized by type of security, were as follows (in millions):

 

    As of September 30, 2011     As of December 31, 2010  
    Cost or
Amortized
Cost
    Unrealized
Gain
    Unrealized
Loss
    Fair
Value
    Cost or
Amortized
Cost
    Unrealized
Gain
    Unrealized
Loss
    Fair
Value
 

Current investments:

               

Fixed maturities

  $     —      $     —      $     —      $     —      $     —      $     —      $     —      $     —   

Equity securities — insurance business

    1                      1        1                      1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current investments

  $ 1      $      $      $ 1      $ 1      $      $      $ 1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noncurrent investments:

               

Fixed maturities — insurance business:

               

U.S. government agencies/ obligations

  $ 5      $      $      $ 5      $ 6      $      $      $ 6   

Residential mortgage-backed securities

    5                      5        5                      5   

Other government obligations

    3        1               4        2                      2   

Corporate investments

    14                      14        16                      16   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities — insurance business

    27        1               28        29                      29   

Mutual and bond funds

    2               1        1        3                      3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total noncurrent investments

  $ 29      $ 1      $ 1      $ 29      $ 32      $      $      $ 32   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table sets forth a summary of temporarily impaired investments held by our insurance subsidiary (in millions):

 

     As of September 30, 2011      As of December 31, 2010  

Description of Investments

   Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 

U.S. Treasury and other direct U.S. Government obligations

   $     —       $     —       $     1       $     —   

Federal agency mortgage-backed securities

     1                 2           

Other government obligations

                     1           

Corporate bonds

     8                 3           
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     9                 7           

Equity securities

                               
  

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired investments

   $ 9       $       $ 7       $   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

22


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

The number of U.S. Treasury and federal agency obligations, mortgage-backed securities, other government obligations, and corporate bonds temporarily impaired are 1, 1, 0, and 22, respectively. As of September 30, 2011, all of the temporarily impaired fixed maturity investments had maturities greater than 12 months.

Our fixed maturities held by our insurance subsidiary include mortgage-backed securities and collateralized mortgage obligations, collectively (“MBS”) representing 17.6%, and 15.4% of the total fixed maturities as of September 30, 2011 and December 31, 2010, respectively. Our MBS holdings are issued by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association all of which are rated “AAA” by Moody’s Investors Services. MBS and callable bonds, in contrast to other bonds, are more sensitive to market value declines in a rising interest rate environment than to market value increases in a declining interest rate environment.

The expected maturities of fixed maturity securities, by amortized cost and fair value are shown below (in millions):

 

     As of September 30, 2011  
     Amortized Cost      Fair Value  

Available-for-sale:

     

One year or less

   $             3       $             3   

Over one year to five years

     20         21   

Over five years to ten years

     4         4   

More than ten years

               
  

 

 

    

 

 

 

Total fixed maturities

   $ 27       $ 28   
  

 

 

    

 

 

 

The change in net unrealized gain on securities included as a separate component of AOCI in the condensed consolidated statements of equity was not material for the three and nine months ended September 30, 2011.

NOTE 12. DERIVATIVE INSTRUMENTS

The following disclosures summarize the fair value of derivative instruments not designated as hedging instruments in the condensed consolidated balance sheets and the effect of changes in fair value related to those derivative instruments not designated as hedging instruments on the condensed consolidated statements of income.

 

          Fair Value as of  

Derivative Instruments Not Designated

As Hedging Instruments

  

Balance Sheet Location

   September 30,
2011
     December 31,
2010
 
          (In millions)  

Asset Derivatives:

        

Note Hedge

   Other noncurrent assets    $         69       $         113   

Liability Derivatives:

        

Cash Conversion Option

   Long-term debt    $ 73       $ 116   

Contingent interest features of the Debentures and 3.25% Notes

   Other noncurrent liabilities    $ 0       $ 0   

 

         Amount of Gain or (Loss) Recognized in Income on Derivative  

Effect on Income of Derivative

Instruments Not Designated

As Hedging Instruments

  

Location of Gain or

(Loss) Recognized in

Income on Derivatives

  For the Three
Months Ended
September 30, 2011
    For the Three
Months Ended
September 30, 2010
    For the Nine
Months Ended
September 30, 2011
    For the Nine
Months Ended
September 30, 2010
 
         (In millions)  

Note Hedge

   Non-cash convertible debt related expense   $ (19   $               10      $ (43   $ (34

Cash Conversion Option

   Non-cash convertible debt related expense                 17        (9                     43                      35   

Contingent interest features of the Debentures and Notes

   Non-cash convertible debt related expense                            
    

 

 

   

 

 

   

 

 

   

 

 

 

Effect on income of derivative instruments not designated as hedging instruments

  $ (2   $ 1      $      $ 1   
    

 

 

   

 

 

   

 

 

   

 

 

 

Cash Conversion Option, Note Hedge and Contingent Interest features related to the 3.25% Cash Convertible Senior Notes

The cash conversion option is a derivative instrument which is recorded at fair value quarterly with any change in fair value being recognized in our condensed consolidated statements of income as non-cash convertible debt related expense. The note hedge is accounted for as a derivative instrument and, as such, is recorded at fair value quarterly with any change in fair value being recognized in our condensed consolidated statements of income as non-cash convertible debt related expense.

 

23


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

We expect the gain or loss associated with changes to the valuation of the Note Hedge to substantially offset the gain or loss associated with changes to the valuation of the cash conversion option. However, they will not be completely offsetting as a result of changes in the credit valuation adjustment related to the note hedge. Our most significant credit exposure arises from the note hedge. The fair value of the note hedge reflects the maximum loss that would be incurred should the option counterparties fail to perform according to the terms of the Note Hedge agreement. For specific details related to the cash conversion option, note hedge and contingent interest features of the 3.25% Notes, refer to Note 12 of the Notes to Consolidated Financial Statements in our Form 10-K.

Contingent Interest feature of the 1.00% Senior Convertible Debentures

The contingent interest feature in the Debentures is an embedded derivative instrument. The first contingent cash interest payment period would not commence until February 1, 2012, and the fair value for the embedded derivative was zero as of September 30, 2011. For specific criteria related to the contingent interest features of the Debentures, refer to Note 12 of the Notes to Consolidated Financial Statements in our Form 10-K.

Energy Price Risk

Following the expiration of certain long-term energy sales contracts, we may have exposure to market risk, and therefore revenue fluctuations, in energy markets. We may enter into contractual arrangements that will mitigate our exposure to this volatility through a variety of hedging techniques. Our efforts in this regard will involve only mitigation of price volatility for the energy we produce, and will not involve speculative energy trading. Consequently, we have entered into swap agreements with various financial institutions to hedge our exposure to market risk. The fair value of the energy derivatives was not material as of September 30, 2011.

NOTE 13. COMMITMENTS AND CONTINGENCIES

We and/or our subsidiaries are party to a number of claims, lawsuits and pending actions, most of which are routine and all of which are incidental to our business. We assess the likelihood of potential losses on an ongoing basis and when losses are considered probable and reasonably estimable, record as a loss an estimate of the outcome. If we 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.

Environmental Matters

Our operations are subject to environmental regulatory laws and environmental remediation laws. Although our 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, we believe that we are in substantial compliance with existing environmental laws and regulations.

We 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, we may be exposed to joint and several liabilities for remedial action or damages. Our liability in connection with such environmental claims will depend on many factors, including our 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.

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 our responsibility. Although the ultimate outcome and expense of any litigation, including environmental remediation, is uncertain, we believe that the following proceedings will not have a material adverse effect on our condensed consolidated financial position or results of operations.

Wallingford Matter. In 2010, compliance stack testing indicated that one of the three combustion units at the Wallingford energy-from-waste facility had exceeded the permit limit for dioxin/furan emissions. We promptly shut down the affected combustion unit and self-reported the test results to the Connecticut Department of Energy and Environmental Protection (“CTDEEP”). On August 18, 2010, the Connecticut Office of the Attorney General (“AG”), on behalf of the CTDEEP, commenced an enforcement action in Connecticut Superior Court (Hartford) with respect to the results of the compliance stack testing. We, the CTDEEP and AG reached agreement on a restart and test program to demonstrate that the affected combustion unit has been returned to compliance and to settle all claims relating to this matter. That agreement became final as of July 20, 2011, and we have since restarted the affected unit, consistent with the approved agreement.

 

24


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

 

Lower Passaic River Matter. In August 2004, the United States Environmental Protection Agency (“EPA”) notified Covanta Essex Company (“Essex”) that it was a potentially responsible party (“PRP”) for Superfund 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 71 PRPs named thus far that have joined the LPRSA PRP group, which is undertaking a Remedial Investigation/Feasibility Study (“Study”) of the LPRSA under EPA oversight. Essex’s share of the Study costs to date are not material to its financial position and results of operations; however, the Study costs are exclusive of any LPRSA remedial costs or natural resource damages that may ultimately be assessed against PRPs. In February 2009, Essex and over 300 other PRPs were named as third-party defendants in a suit brought by the State of New Jersey Department of Environmental Protection (“NJDEP”) in New Jersey Superior Court of Essex County against Occidental Chemical Corporation and certain related entities (“Occidental”) with respect to alleged contamination of the LPRSA by Occidental. The Occidental third-party complaint seeks contribution with respect to any award to NJDEP of damages against Occidental in the matter. Considering the history of industrial and other discharges into the LPRSA from other sources, including named PRPs, Essex believes any releases to the LPRSA from its facility to be de minimis; however, it is not possible at this time to predict that outcome or to estimate Essex’s ultimate liability in the matter, including for LPRSA remedial costs and/or natural resource damages and/or contribution claims made by Occidental and/or other PRPs.

Other Matters

Other commitments as of September 30, 2011 were as follows (in millions):

 

     Commitments Expiring by Period  
     Total      Less Than
One Year
     More Than
One Year
 

Letters of credit

   $             279       $             3       $             276   

Surety bonds

     354                 354   
  

 

 

    

 

 

    

 

 

 

Total other commitments — net

   $ 633       $ 3       $ 630   
  

 

 

    

 

 

    

 

 

 

The letters of credit were issued under various credit facilities (primarily the Funded L/C Facility) to secure our performance under various contractual undertakings related to our domestic and international projects or to secure obligations under our 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.

We believe that we will be able to fully perform under our 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 our performance obligations. If any of these letters of credit were to be drawn by the beneficiary, the amount drawn would be immediately repayable by us to the issuing bank. If we do not immediately repay such amounts drawn under these letters of credit, unreimbursed amounts would be treated under the Credit Facilities as additional term loans in the case of letters of credit issued under the Funded L/C Facility, or as revolving loans in the case of letters of credit issued under the Revolving Credit Facility.

The surety bonds listed on the table above relate primarily to performance obligations ($341 million) and support for closure obligations of various energy projects when such projects cease operating ($13 million). Were these bonds to be drawn upon, we would have a contractual obligation to indemnify the surety company.

We have certain contingent obligations related to the 7.25% Notes and the 3.25% Notes. These arise as follows:

 

  Ÿ  

holders may require us to repurchase their 7.25% Notes and their 3.25% Notes if a fundamental change occurs; and

  Ÿ  

holders may exercise their conversion rights upon the occurrence of certain events, which would require us to pay the conversion settlement amount in cash.

We have certain contingent obligations related to the Debentures. These arise as follows:

 

  Ÿ  

holders may require us to repurchase their Debentures on February 1, 2012, February 1, 2017 and February 1, 2022;

  Ÿ  

holders may require us to repurchase their Debentures if a fundamental change occurs; and

  Ÿ  

holders may exercise their conversion rights upon the occurrence of certain events, which would require us to pay the conversion settlement amount in cash and/or our common stock.

For specific criteria related to contingent interest, conversion or redemption features of the Debentures, the 7.25% Notes and the 3.25% Notes, refer to Note 12 of the Notes to Consolidated Financial Statements in our Form 10-K.

We have issued or are party to guarantees and related contractual support obligations undertaken pursuant to agreements to construct and operate waste and energy facilities. For some projects, such performance guarantees include obligations to repay certain financial obligations if the project revenues are insufficient to do so, or to obtain or guarantee financing for a

 

25


Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Concluded)

 

project. With respect to our businesses, we have issued guarantees to municipal clients and other parties that our subsidiaries will perform in accordance with contractual terms, including, where required, the payment of damages or other obligations. Additionally, damages payable under such guarantees for our energy-from-waste facilities could expose us to recourse liability on project debt. If we must perform under one or more of such guarantees, our 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 and is presently not estimable. Depending upon the circumstances giving rise to such damages, the contractual terms of the applicable contracts, and the contract counterparty’s 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 our then-available sources of funds. To date, we have not incurred material liabilities under such guarantees.

NOTE 14. SUBSEQUENT EVENTS

In October 2011, we completed the sale of our interests in a 106 MW (gross) heavy fuel-oil fired electric power generation facility in Tamil Nadu, India (“Madurai”) for $31 million in cash proceeds, net of transaction costs. The Madurai assets sold included our entire interest in Covanta Madurai Operating Private Limited, which provided operation and maintenance services to the facility, as well as our approximately 77% ownership interest in the project company, Madurai Power Corporation Private Ltd. See Note 3. Business Development, Assets Held for Sale and Dispositions for additional information.

In connection with the quarterly cash dividend payable on October 14, 2011, the conversion rate for the Debentures was adjusted to 39.5441 shares of our common stock per $1,000 principal amount of the Debentures. The adjusted conversion rate is equivalent to an adjusted conversion price of $25.29 per share and became effective on October 4, 2011.

In 2008, we entered into a ten year agreement with The Harrisburg Authority to maintain and operate an 800 tpd energy-from-waste facility located in Harrisburg, Pennsylvania. We also agreed to provide construction management services and to advance up to $26 million in funding to The Harrisburg Authority for certain facility improvements required to enhance facility performance, which improvements were substantially completed during 2010. The repayment of this funding is guaranteed by the City of Harrisburg, but is otherwise unsecured, and is junior to project bondholders’ rights. We had advanced $22 million, of which $20 million was outstanding as of December 31, 2010 under this funding arrangement. On October 5, 2010, we filed suit against the City of Harrisburg in the Dauphin County Court of Common Pleas seeking to enforce our rights under the City’s guaranty. On December 15, 2010, the City of Harrisburg was formally admitted to the State oversight program for distressed municipalities known as Act 47. During the year ended December 31, 2010, we recorded a non-cash impairment charge of $7 million, pre-tax, to write-down the receivable to $13 million, which was calculated based on a range of potential outcomes utilizing various estimated cash flows for the receivable. On October 13, 2011, the City of Harrisburg filed for protection under the bankruptcy laws. We do not believe that the bankruptcy filing will impact our expected recovery. We intend to continue to pursue our lawsuit in parallel with efforts to work with the City of Harrisburg and other stakeholders to protect the full recovery of our advance and to maintain our position in the project.

 

26


Table of Contents
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The terms “we,” “our,” “ours,” “us,” “Covanta” and “Company” refer to Covanta Holding Corporation and its subsidiaries; the term “Covanta Energy” refers to our subsidiary Covanta Energy Corporation and its subsidiaries. The following discussion addresses our financial condition as of September 30, 2011 and our results of operations for the three and nine months ended September 30, 2011, compared with the same periods last year. It should be read in conjunction with our Audited Consolidated Financial Statements and Notes thereto for the year ended December 31, 2010 and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Form 10-K for the year ended December 31, 2010 (“Form 10-K”), 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 our waste and energy services business, as well as competitive and other market conditions, we do 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

We are one of the world’s largest owners and operators of infrastructure for the conversion of waste to energy (known as “energy-from-waste” or “EfW”), as well as other waste disposal and renewable energy production businesses. Energy-from-waste serves two key markets as both a sustainable waste disposal solution that is environmentally superior to landfilling and as a source of clean energy that reduces overall greenhouse gas emissions and is considered renewable under the laws of many states and under federal law. Our facilities are critical infrastructure assets that allow our customers, which are principally municipal entities, to provide an essential public service.

We operate and/or have ownership positions in 44 energy-from-waste facilities, which are primarily located in North America, and 17 additional energy generation facilities, including other renewable energy production facilities in North America (wood biomass, landfill gas and hydroelectric) and an independent power production (“IPP”) facility in Asia. We also operate waste management infrastructure that is complementary to our core EfW business. We have one reportable segment which is Americas and we are organized as a holding company and conduct all of our operations through subsidiaries which are engaged predominantly in the businesses of waste and energy services.

We also hold equity interests in energy-from-waste facilities in China and Italy. We are pursuing additional growth opportunities in parts of Europe, where the market demand, regulatory environment or other factors encourage technologies such as energy-from-waste to reduce dependence on landfilling for waste disposal and fossil fuels for energy production in order to reduce greenhouse gas emissions. We are focusing primarily on the United Kingdom where we continue to pursue several billion dollars worth of energy-from-waste development opportunities.

During the third quarter of 2011, we received notice to proceed with design, construction and operation of a municipally-owned 140,000 tonne-per-year greenfield energy-from-waste facility to be built in Clarington, Ontario, located in Durham Region, Canada. After construction, we will operate the facility under a 20 year contract. For additional information, see Projects Under Advanced Development or Construction below.

In 2010, we adopted a plan to sell our interests in our fossil fuel independent power production facilities in the Philippines, India, and Bangladesh. During the first quarter of 2011, we completed the sale of our interests in a 510 megawatt (“MW”) (gross) coal-fired electric power generation facility in the Philippines (“Quezon”) and we completed the sale of our majority equity interests in a 106 MW (gross) heavy fuel-oil fired electric power generation facility in Tamil Nadu, India (“Samalpatti”). In October 2011, we completed the sale of our majority equity interests in our 106 MW (gross) heavy fuel-oil fired electric power generation facility also in Tamil Nadu, India (“Madurai”). The remaining asset held for sale is our interest in a barge-mounted 126 MW (gross) diesel/natural gas-fired electric power generation facility located near Haripur, Bangladesh. For additional information, see Assets Held for Sale and Dispositions below.

We plan to allocate capital to maximize stockholder value by investing in: our existing businesses to maintain and enhance assets, high value core business development projects and strategic acquisitions when available, and by returning surplus capital to our stockholders. During each quarter of 2011, the Board of Directors approved a regular quarterly cash dividend of $0.075 per share which was paid on April 12, 2011, July 6, 2011, and October 14, 2011, respectively. During the nine months ended September 30, 2011, the Board of Directors approved an additional $250 million share repurchase authorization, bringing the total authorized amount to $400 million. During the nine months ended September 30, 2011, we repurchased 13 million shares of our common stock at a weighted average cost of $16.24 per share for an aggregate amount of approximately $205 million. For additional information, see Liquidity and Capital Resources below.

 

27


Table of Contents

Strategy

Our mission is to be the leading energy-from-waste company in the world, which we intend to pursue through the following key strategies:

 

  Ÿ  

Maximize and grow the value of our existing portfolio. We intend to maximize the long-term value of our existing portfolio by continuously improving safety, health and environmental performance, working in partnership with our client communities, continuing to operate at our historic production levels, maintaining our facilities in optimal condition, and managing our expenses. We also intend to effect organic growth through adding or extending waste and service contracts, seeking incremental revenue opportunities by investing in and enhancing the capabilities of our existing assets, deploying new or improved technologies targeted at increasing revenue or reducing costs and expanding facility capacities where appropriate.

 

  Ÿ  

Grow through development and/or acquisitions in selected attractive markets. We seek to grow our portfolio primarily through the development of new facilities and acquisitions where we believe that market and regulatory conditions will enable us to invest our capital at attractive risk-adjusted rates of return. We are currently focusing on development opportunities in the U.S., Canada and Europe, which we consider to be our core markets. We believe that there are numerous attractive opportunities in the United Kingdom in particular, where national policies, such as a substantial tax on landfill use, are intended to achieve compliance with the EU Landfill Directive.

 

  Ÿ  

We believe that our approach to development opportunities is highly-disciplined, both with regard to our required rates of return and the manner in which potential new projects will be structured and financed. In general, prior to the commencement of construction of a new facility, we intend to enter into long-term contracts with municipal and/or commercial customers for a substantial portion of the disposal capacity and obtain non-recourse project financing for a majority of the capital investment. We intend to finance new projects in a prudent manner, minimizing the impact on our balance sheet and credit profile at the parent company level where possible.

 

  Ÿ  

Develop and commercialize new technology. We believe that our efforts to protect and expand our business will be enhanced by the development of additional technologies in such fields as emission controls, residue disposal, alternative waste treatment processes, and combustion controls. We have advanced our research and development efforts in these areas, and have developed and have patents pending for major advances in controlling nitrogen oxide (“NOx”) emissions and have a patent for a proprietary process to improve the handling of the residue from our energy-from-waste facilities. We have also entered into various agreements with multiple partners to invest in the development, testing or licensing of new technologies related to the transformation of waste materials into renewable fuels or the generation of energy, as well as improved environmental performance.

 

  Ÿ  

Advocate for public policy favorable to energy-from-waste. We seek to educate policymakers about the environmental and economic benefits of energy-from-waste and advocate for policies that appropriately reflect these benefits. Energy-from-waste is a highly regulated business, and as such we believe that it is critically important for us, as an industry leader, to play an active role in the debates surrounding potential policy developments that could impact our business.

We are actively engaged in the current discussion among policy makers in the United States regarding the benefits of energy-from-waste and the reduction of our dependence on landfilling for waste disposal and fossil fuels for energy.

 

  Ÿ  

Allocate capital efficiently. We plan to allocate capital to maximize stockholder value by investing in: our existing businesses to maintain and enhance assets; effecting organic growth; investing in high value core business development projects and strategic acquisitions when available; and by returning surplus capital to our stockholders.

Factors Affecting Business Conditions and Financial Results

Economic - The general economic slowdown reduced demand for goods and services generally, which reduced overall volumes of waste requiring disposal and the pricing at which we can attract waste to fill available capacity. We receive the majority of our revenue under short- and long-term contracts, with little or no exposure to price volatility, but with adjustments intended to reflect changes in our costs. Where our revenue is received under other arrangements and depending upon the revenue source, we have varying amounts of exposure to price volatility.

The largest component of our revenue is waste revenue, which has generally been subject to less price volatility than our revenue derived from the sale of energy and metals. However, the downturn in economic activity has reduced waste generation rates in the northeast U.S. which subsequently caused market waste disposal prices to decline modestly. Furthermore, global demand and pricing of certain commodities, such as the scrap metals we recycle from our energy-from-waste facilities has been materially affected by economic activity. Pricing for recycled metals reached historically high levels during 2008, declined materially during 2009 and has rebounded substantially during 2010 and 2011.

 

28


Table of Contents

At the same time, the declines in U.S. natural gas prices have pushed electricity and steam pricing generally lower, which causes lower revenue for the portion of the energy we sell which is not under fixed-price contracts. During 2008, pricing for energy reached historically high levels and has subsequently declined materially during both 2009 and 2010. During 2011, pricing for energy has increased modestly. At our biomass facilities, lower energy prices combined with higher fuel prices have caused us to economically dispatch operations where continued operations are not currently profitable. We will continue to consider this practice as we study forward energy curves, fuel price forecasts, and the profitability of these facilities.

The downturn in economic activity has also affected many municipalities and public authorities, some of which are our customers. Many local and central governments are seeking to reduce expenses in order to address declining tax revenues. We work closely with these municipal customers, with many of whom we have shared a long-term relationship, to effectively counter some of these economic challenges.

Market Pricing for Waste, Energy and Metal - Global and regional economy activity, as well as technological advances, regulations and a variety of other factors, will affect market supply and demand and therefore prices for waste disposal services, energy (including electricity and steam) and other commodities such as ferrous and non-ferrous metals. As market prices for waste disposal, electricity, steam and recycled metal rise it benefits our existing business as well as our prospects for growth through expansions or new development. Conversely, market price declines for these services and commodities will adversely affect both our existing business and growth prospects.

Seasonal - Our quarterly operating income within the same fiscal year typically differs substantially due to seasonal factors, primarily as a result of the timing of scheduled plant maintenance. We typically conduct scheduled maintenance periodically each year, which requires that individual boiler and/or turbine units temporarily cease operations. During these scheduled maintenance periods, we incur material repair and maintenance expenses and receive less revenue until the boiler and/or turbine units resume operations. This scheduled maintenance typically occurs during periods of off-peak electric demand and/or lower waste volumes, which are our first, second and fourth fiscal quarters. The first half of the year scheduled maintenance period is typically the most extensive. The third quarter scheduled maintenance period is typically the least extensive. Given these factors, we typically experience our lowest operating income from our projects during our first half of each year.

In addition, at certain of our project subsidiaries, distributions of excess earnings (above and beyond monthly operation and maintenance service payments) are subject to periodic tests of project debt service coverage or requirements to maintain minimum working capital balances. While these distributions occur throughout the year based upon the specific terms of the relevant project debt arrangements, they are typically highest in the fourth quarter. Our net cash provided by operating activities exhibits seasonal fluctuations as a result of the timing of these distributions, including a benefit in the fourth quarter compared to the first nine months of the year.

Other Factors Affecting Performance — We historically have performed our operating obligations without experiencing material unexpected service interruptions or incurring material increases in costs. In addition, with respect to many of our contracts, we generally have limited our exposure for risks not within our control. For additional information about such risks and damages that we may owe for unexcused operating performance failures, see Item 1A. Risk Factors in our Form 10-K. In monitoring and assessing the ongoing operating and financial performance of our businesses, we focus on certain key factors: tons of waste processed, electricity and steam sold, and boiler availability.

Business Segment

We have one reportable segment which is Americas and is comprised of waste and energy services operations primarily in the United States and Canada.

The Americas segment is comprised primarily of energy-from-waste projects. For all of these projects, we earn revenue from two primary sources: fees charged for operating projects or processing waste received and payments for electricity and steam sales. We also operate, and in some cases have ownership interests in, transfer stations and landfills which generate revenue from waste and ash disposal fees or operating fees. In addition, we own, and in some cases operate, other renewable energy projects primarily in the United States which generate electricity from wood waste (biomass), landfill gas and hydroelectric resources. The electricity from these other renewable energy projects is sold to utilities. We may receive additional revenue from construction activity during periods when we are constructing new facilities or expanding existing facilities.

 

29


Table of Contents

Contract Structures

We currently operate energy-from-waste projects in 16 states and Canada. Most of our energy-from-waste projects were developed and structured contractually as part of competitive procurement processes conducted by municipal entities. As a result, many of these projects have common features. However, each service agreement is different reflecting the specific needs and concerns of a client community, applicable regulatory requirements and other factors. The following describes features generally common to these agreements, as well as important distinctions among them:

 

  Ÿ  

We design the facility, help to arrange for financing and then we either construct and equip the facility on a fixed price and schedule basis, or we undertake an alternative role, such as construction management, if that better meets the goals of our municipal client.

 

  Ÿ  

For the energy-from-waste projects we own, financing is generally accomplished through tax-exempt and taxable revenue bonds issued by or on behalf of the client community. For these facilities, the bond proceeds are loaned to us to pay for facility construction and to fund a debt service reserve for the project, which is generally sufficient to pay principal and interest for one year. Project-related debt is included as “project debt” and the debt service reserves are included as “restricted funds held in trust” in our condensed consolidated financial statements. Generally, project debt is secured by the project’s revenue, contracts and other assets of our project subsidiary.

 

  Ÿ  

Following construction and during operations, we receive revenue from two primary sources: fees we receive for operating projects or for processing waste received, and payments we receive for electricity and/or steam we sell.

 

  Ÿ  

We agree to operate the facility and meet minimum waste processing capacity and efficiency standards, energy production levels and environmental standards. Failure to meet these requirements or satisfy the other material terms of our agreement (unless the failure is caused by our client community or by events beyond our control), may result in damages charged to us or, if the breach is substantial, continuing and unremedied, termination of the applicable agreement. These damages could include amounts sufficient to repay project debt (as reduced by amounts held in trust and/or proceeds from sales of facilities securing project debt) and as such, these contingent obligations cannot readily be quantified. We have issued performance guarantees to our client communities and, in some cases other parties, which guarantee that our project subsidiaries will perform in accordance with contractual terms including, where required, the payment of such damages. If one or more contracts were terminated for our default, these contractual damages may be material to our cash flow and financial condition. To date, we have not incurred material liabilities under such performance guarantees.

 

  Ÿ  

The client community generally must deliver minimum quantities of municipal solid waste to the facility on a put-or-pay basis and is obligated to pay a fee for its disposal. A put-or-pay commitment means that the client community promises to deliver a stated quantity of waste and pay an agreed amount for its disposal, regardless of whether the full amount of waste is actually delivered. Client communities have consistently met their commitment to deliver the stated quantity of waste. Where a Service Fee structure exists, portions of the service fee escalate to reflect indices for inflation, and in many cases, the client community must also pay for other costs, such as insurance, taxes, and transportation and disposal of the ash residue to the disposal site. Generally, expenses resulting from the delivery of unacceptable and hazardous waste on the site are also borne by the client community. In addition, the contracts generally require the client community to pay increased expenses and capital costs resulting from unforeseen circumstances, subject to specified limits. At three publicly-owned facilities we operate, our client community may terminate the operating contract under limited circumstances without cause.

 

  Ÿ  

Our returns are expected to be stable if we do not incur material unexpected operation and maintenance costs or other expenses. In addition, most of our energy-from-waste project contracts are structured so that contract counterparties generally bear, or share in, the costs associated with events or circumstances not within our control, such as uninsured force majeure events and changes in legal requirements. The stability of our revenues and returns could be affected by our ability to continue to enforce these obligations. Also, at some of our energy-from-waste facilities, commodity price risk is mitigated by passing through commodity costs to contract counterparties. With respect to our other renewable energy projects, such structural features generally do not exist because either we operate and maintain such facilities for our own account or we do so on a cost-plus basis rather than a fixed-fee basis.

 

  Ÿ  

We receive the majority of our revenue under short- and long-term contracts, with little or no exposure to price volatility, but with adjustments intended to reflect changes in our costs. Where our revenue is received under other arrangements and depending upon the revenue source, we have varying amounts of exposure to price volatility. The largest component of our revenue is waste revenue, which has generally been subject to less price volatility than our revenue derived from the sale of energy and metals. During 2008, pricing for energy reached historically high levels and has subsequently declined materially during both 2009 and 2010. During 2011, pricing for energy has increased modestly. Similarly, pricing for recycled metals reached historically high levels during 2008, declined materially during 2009 and has rebounded substantially during 2010 and 2011. At some of our renewable energy projects, our operating subsidiaries purchase fuel in the open markets which exposes us to fuel price risk.

 

  Ÿ  

We generally sell the energy output from our projects to local utilities pursuant to long-term contracts. At several of our energy-from-waste projects, we sell energy output under short-term contracts or on a spot-basis to our customers.

 

30


Table of Contents

Contracted and Merchant Capacity

Our service and waste disposal agreements, as well as our energy contracts, expire at various times. The extent to which any such expiration will affect us will depend upon a variety of factors, including whether we own the project, market conditions then prevailing, and whether the municipal client exercises options it may have to extend the contract term. As our contracts expire, we will become subject to greater market risk in maintaining and enhancing our revenues. As service agreements at municipally-owned facilities expire, we intend to seek to enter into renewal or replacement contracts to operate such facilities. We will also seek to bid competitively in the market for additional contracts to operate other facilities as similar contracts of other vendors expire. As our service and waste disposal agreements at facilities we own or lease expire, we intend to seek replacement or additional contracts, and because project debt on these facilities will be paid off at such time, we expect to be able to offer rates that will attract sufficient quantities of waste while providing acceptable revenues to us. At facilities we own, the expiration of existing energy contracts will require us to sell our output either into the local electricity grid at prevailing rates or pursuant to new contracts. We may enter into contractual arrangements that will mitigate our exposure to revenue fluctuations in energy markets through a variety of hedging techniques.

To date, we have been successful in extending a majority of our existing contracts to operate energy-from-waste facilities owned by municipal clients where market conditions and other factors make it attractive for both us and our municipal clients to do so. See Growth and Development discussion below for additional information. The extent to which additional extensions will be attractive to us and to our municipal clients who own their projects will depend upon the market and other factors noted above. However, we do not believe that either our success or lack of success in entering into additional negotiated extensions to operate such facilities will have a material impact on our overall cash flow and profitability for the next several years.

As we seek to enter into extended or new contracts, we expect that medium- and long-term contracts for waste supply, at least for a substantial portion of facility capacity, will be available on acceptable terms in the marketplace. We also expect that medium- and long-term contracts for sales of electricity will be less available than in the past, while medium- and long-term contracts for sales of other energy products may be more attainable. As a result, following the expiration of these long-term contracts, we expect to have on a relative basis more exposure to market risk, and therefore revenue fluctuations, in energy markets than in waste markets.

In conjunction with our U.S. energy-from-waste business, we also own and/or operate 13 transfer stations, two ashfills and two landfills in the northeast United States, which we utilize to supplement and manage more efficiently the fuel and ash disposal requirements at our energy-from-waste operations. We provide waste procurement services to our waste disposal and transfer station facilities which have available capacity to receive waste. With these services, we seek to maximize our revenue and ensure that our energy-from-waste facilities are being utilized most efficiently, taking into account maintenance schedules and operating restrictions that may exist from time to time at each facility. We also provide management and marketing of ferrous and non-ferrous metals recovered from energy-from-waste operations, as well as services related to non-hazardous special waste destruction and ash residue management for our energy-from-waste projects.

Growth and Development

We are focusing our efforts on operating and enhancing our existing business and pursuing strategic growth opportunities through development and acquisitions with the goal of maximizing long-term stockholder return. We anticipate that a part of our future growth will come from investing in or acquiring additional energy-from-waste, waste disposal and renewable energy production businesses. We are pursuing additional growth opportunities particularly in locations where the market demand, regulatory environment or other factors encourage technologies such as energy-from-waste to reduce dependence on landfilling for waste disposal and fossil fuels for energy production in order to reduce greenhouse gas emissions. We are focusing on the United Kingdom, Ireland, Canada and the United States. Our growth opportunities include: new energy-from-waste and other renewable energy projects, existing project expansions, contract extensions, acquisitions, and businesses ancillary to our existing business, such as additional waste transfer, transportation, processing and disposal businesses. We also intend to maintain a focus on research and development of technologies that we believe will enhance our competitive position, and offer new technical solutions to waste and energy problems that augment and complement our business. We also intend to invest in and enhance the capabilities of our existing assets, deploying new or improved technologies targeted at increasing revenue or reducing costs.

We have a growth pipeline and continue to pursue several billion dollars worth of energy-from-waste development opportunities. However, much remains to be done and there is substantial uncertainty relating to the bidding and permitting process for each project opportunity. If, and when, these development efforts are successful, we plan to invest in these projects to achieve an attractive return on capital particularly when leveraged with project debt which we intend to utilize for our development projects.

 

31


Table of Contents

CONTRACT EXTENSIONS

Fairfax County Energy-from-Waste Facility

In August 2010, the service fee contract with Fairfax County was extended from 2011 to 2016 pursuant to a unilateral option held by the County. The terms of the contract remain unchanged under the extension; however, the project debt on the facility was repaid in February 2011, and since Fairfax County had previously paid debt service as a component of the service fee during the term of the original contract, the County will effectively retain the benefit of the debt repayment during the five year extension period.

ACQUISITION

Covanta Dade Metals Recycling Facility

In May 2011, we acquired a metals processing facility located on our Dade Florida energy-from-waste facility site. This facility shreds and processes recovered ferrous scrap metal to enhance marketability and price.

PROJECTS UNDER ADVANCED DEVELOPMENT OR CONSTRUCTION

Americas

Durham-York Energy-from-Waste Facility

During the third quarter of 2011, we received the notice to proceed with design, construction and operation of a municipally-owned 140,000 tonne-per-year greenfield energy-from-waste facility to be built in Clarington, Ontario, located in Durham Region, Canada. The facility will process waste from the Regions of Durham and York. The fixed-price construction contract for the project is for approximately C$250 million. The project will be funded and owned by the Durham and York Regions. During the third quarter of 2011, we acquired a $267 million performance surety bond for this project. After construction, we will operate the facility under a 20 year contract.

Honolulu Energy-from-Waste Facility

We operate and maintain the energy-from-waste facility located in and owned by the City and County of Honolulu, Hawaii. In December 2009, we entered into agreements with the City and County of Honolulu to expand the facility’s waste processing capacity from 2,160 tons per day (“tpd”) to 3,060 tpd and to increase gross electricity capacity from 57 MW to 90 MW. The agreements also extend the contract term by 20 years. The $302 million expansion project is a fixed-price construction contract which is funded and owned by the City and County of Honolulu. Construction commenced at the end of 2009.

Other

China Joint Ventures and Energy-from-Waste Facilities

We currently own 85% of the Taixing Covanta Yanjiang Cogeneration Co., Ltd. which, in 2009, entered into a 25 year concession agreement and waste supply agreements to build, own and operate a 350 metric tpd energy-from-waste facility for Taixing Municipality, in Jiangsu Province, People’s Republic of China. The project, which will be built on the site of our existing coal-fired facility in Taixing, will supply steam to an adjacent industrial park under short-term arrangements. We will continue to operate our existing coal-fired facility. The project company has obtained Rmb 165 million in project financing which, together with available cash from existing operations, will fund construction costs. Construction commenced in late 2009 and the facility began processing waste during the second quarter of 2011.

In 2008, we and Chongqing Iron & Steel Company (Group) Ltd. entered into an agreement to build, own, and operate an 1,800 metric tpd energy-from-waste facility for Chengdu Municipality in Sichuan Province, People’s Republic of China. We also executed a 25 year waste concession agreement for this project. In connection with this project, we acquired a 49% equity interest in the project company. Construction commenced in 2009 and the facility began processing waste during the third quarter of 2011. The project company has obtained Rmb 480 million in project financing, of which 49% is guaranteed by us and 51% is guaranteed by Chongqing Iron & Steel Company (Group) Ltd. until the project has been constructed and for one year after operations fully commence.

 

32


Table of Contents

ASSETS HELD FOR SALE AND DISPOSITIONS

In 2010, we adopted a plan to sell our interests in our fossil fuel independent power production facilities in the Philippines, India, and Bangladesh.

During the first quarter of 2011, we completed the sale of our majority equity interests in a 106 MW (gross) heavy fuel-oil fired electric power generation facility in Tamil Nadu, India (“Samalpatti”) and we completed the sale of our interests in a 510 MW (gross) coal-fired electric power generation facility in the Philippines (“Quezon”). The Quezon assets sold consisted of our entire interest in Covanta Philippines Operating, Inc., which provided operation and maintenance services to the facility, as well as our 26% ownership interest in the project company, Quezon Power, Inc.

In October 2011, we completed the sale of our interests in a 106 MW (gross) heavy fuel-oil fired electric power generation facility in Tamil Nadu, India (“Madurai”). The Madurai assets sold included our entire interest in Covanta Madurai Operating Private Limited, which provided operation and maintenance services to the facility, as well as our approximately 77% ownership interest in the project company, Madurai Power Corporation Private Ltd.

The remaining asset held for sale is our interest in a barge-mounted 126 MW (gross) diesel/natural gas-fired electric power generation facility located near Haripur, Bangladesh.

During 2011, we have received a combined total of cash proceeds of $256 million, net of transaction costs, for our interests in the three fossil fuel independent power production facilities that we have sold.

The assets and liabilities associated with these businesses are presented in our condensed consolidated balance sheets as “Current Assets Held for Sale” and “Current Liabilities Held for Sale.” The results of operations of these businesses are included in the condensed consolidated statements of operations as “Income (loss) earnings from discontinued operations, net of tax.” The cash flows of these businesses are also presented separately in our condensed consolidated statements of cash flows. All corresponding prior year periods presented in our condensed consolidated financial statements and accompanying notes have been reclassified to reflect the discontinued operations presentation. See Item 8. Financial Statements And Supplementary Data — Note 3. Business Development, Assets Held for Sale and Dispositions for additional information.

RESULTS OF OPERATIONS

The comparability of the information provided below with respect to our revenues, expenses and certain other items for the periods presented was affected by several factors. As outlined above under Overview — Growth and Development, our acquisition and business development initiatives resulted in various additional projects which increased comparative revenues and expenses. These factors must be taken into account in developing meaningful comparisons between the periods compared below.

 

33


Table of Contents

RESULTS OF OPERATIONS — Three and Nine Months Ended September 30, 2011 vs. Three and Nine Months Ended September 30, 2010

 

     For the
Three Months Ended

September 30,
     For the
Nine Months Ended
September 30,
    Variance
Increase/(Decrease)
 
     2011     2010      2011     2010     Three Month     Nine Month  
     (Unaudited, in millions)  

CONSOLIDATED RESULTS OF OPERATIONS:

             

Total operating revenues

   $ 432      $ 403       $ 1,220      $     1,164      $ 29      $ 56   

Total operating expenses

     345        357         1,082        1,072        (12     10   
  

 

 

   

 

 

    

 

 

   

 

 

     

Operating income

     87        46         138        92        41        46   
  

 

 

   

 

 

    

 

 

   

 

 

     

Other income (expense):

             

Investment income

     1        1         1        1                 

Interest expense

     (16     (11      (50     (32     5        18   

Non-cash convertible debt related expense

     (9     (10      (20     (30     (1     (10

Other expenses, net

     (11             (14            11        14   
  

 

 

   

 

 

    

 

 

   

 

 

     

Total other expenses

     (35     (20      (83     (61     15        22   
  

 

 

   

 

 

    

 

 

   

 

 

     

Income from continuing operations before income tax expense and equity in net income from unconsolidated investments

     52        26         55        31        26        24   

Income tax expense

     (2     (15      (3     (18     (13     (15

Equity in net income from unconsolidated investments

     1        1         3        1               2   
  

 

 

   

 

 

    

 

 

   

 

 

     

Income from continuing operations

     51        12         55        14        39        41   

(Loss) income from discontinued operations, net of income tax expense of $0, $1, $3 and $5, respectively

     (7     11         144        32        (18     112   
  

 

 

   

 

 

    

 

 

   

 

 

     

NET INCOME

     44        23         199        46        21        153   
  

 

 

   

 

 

    

 

 

   

 

 

     

Less: Net income from continuing operations attributable to noncontrolling interests in subsidiaries

     (2     (2      (3     (4            (1

Less: Net income from discontinued operations attributable to noncontrolling interests in subsidiaries

            (1      (3     (3     (1       
  

 

 

   

 

 

    

 

 

   

 

 

     

Total Net income attributable to noncontrolling interests in subsidiaries

     (2     (3      (6     (7     (1     (1
  

 

 

   

 

 

    

 

 

   

 

 

     

NET INCOME ATTRIBUTABLE TO COVANTA HOLDING CORPORATION

   $ 42      $ 20       $ 193      $ 39        22        154   
  

 

 

   

 

 

    

 

 

   

 

 

     

Amounts Attributable to Covanta Holding Corporation stockholders:

             

Continuing operations

   $ 49      $ 10       $ 52      $ 10        39        42   

Discontinued operations, net of tax expense

     (7     10         141        29        (17     112   
  

 

 

   

 

 

    

 

 

   

 

 

     

Covanta Holding Corporation

   $ 42      $ 20       $ 193      $ 39        22        154   
  

 

 

   

 

 

    

 

 

   

 

 

     

Earnings Per Share Attributable to Covanta Holding Corporation stockholders:

             

Basic:

             

Continuing operations

   $ 0.35      $ 0.07       $ 0.37      $ 0.07        0.28        0.30   

Discontinued operations, net of tax expense

     (0.05     0.06         0.98        0.18        (0.11     0.80   
  

 

 

   

 

 

    

 

 

   

 

 

     

Covanta Holding Corporation

   $ 0.30      $ 0.13       $ 1.35      $ 0.25        0.17