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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, 2016
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:
Indicate the number of shares of the registrant’s Common Stock outstanding as of the latest practicable date.
 
Class
  
Outstanding at October 21, 2016  
Common Stock, $0.10 par value
  
130,415,290





Table of Contents

COVANTA HOLDING CORPORATION AND SUBSIDIARIES
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended September 30, 2016
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
OTHER
 

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Table of Contents

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are those that address activities, events or developments that we or our management intends, expects, projects, believes or anticipates will or may occur in the future. They are based on management’s assumptions and assessments in the light of past experience and trends, current economic and industry conditions, expected future developments and other relevant factors. They are not guarantees of future performance, and actual results, developments and business decisions may differ from those envisaged by our forward-looking statements. Our forward-looking statements are also subject to risks and uncertainties, which can affect our performance in both the near- and long-term. These forward-looking statements should be considered in the light of the information included in this report and our other filings with the Securities and Exchange Commission, including, without limitation, the Risk Factors, as well as the description of trends and other factors in Management’s Discussion and Analysis of Financial Condition and Results of Operations, set forth in our 2015 Annual Report on Form 10-K.



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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,
 
2016
 
2015
 
2016
 
2015
 
(Unaudited)
(In millions, except per share amounts)
OPERATING REVENUE:
 
 
 
 
 
 
 
Waste and service revenue
$
299

 
$
283

 
$
875

 
$
805

Energy revenue
92

 
108

 
279

 
319

Recycled metals revenue
14

 
16

 
44

 
49

Other operating revenue
16

 
15

 
44

 
40

Total operating revenue
421

 
422

 
1,242

 
1,213

OPERATING EXPENSE:
 
 
 
 
 
 
 
Plant operating expense
272

 
260

 
901

 
849

Other operating expense
14

 
18

 
45

 
55

General and administrative expense
23

 
20

 
71

 
71

Depreciation and amortization expense
52


50


155


148

Impairment charges

 

 
19

 
24

Total operating expense
361

 
348

 
1,191

 
1,147

Operating income
60

 
74

 
51

 
66

Other income (expense):
 
 
 
 
 
 
 
Interest expense, net
(35
)

(34
)

(103
)

(102
)
Gain on asset sales
43

 

 
43

 

Loss on extinguishment of debt






(2
)
Other expense, net
(1
)
 

 
(1
)
 
(1
)
Total other income (expense)
7

 
(34
)
 
(61
)
 
(105
)
Income (loss) before income tax (expense) benefit and equity in net (loss) income from unconsolidated investments
67

 
40

 
(10
)
 
(39
)
Income tax (expense) benefit
(12
)

(11
)

(5
)

19

Equity in net (loss) income from unconsolidated investments
(1
)
 
5

 
3

 
11

NET INCOME (LOSS) ATTRIBUTABLE TO COVANTA HOLDING CORPORATION
$
54


$
34


$
(12
)

$
(9
)
 
 
 
 
 
 
 
 
Weighted Average Common Shares Outstanding:
 
 
 
 
 
 
 
Basic
129

 
132

 
129


132

Diluted
131

 
134

 
129


132

 
 
 
 
 
 
 
 
Income (Loss) Per Share Attributable to Covanta Holding Corporation Stockholders:
 
 
 
 
 
 
 
Basic
$
0.42

 
$
0.26

 
$
(0.09
)

$
(0.07
)
Diluted
$
0.42


$
0.25

 
$
(0.09
)

$
(0.07
)
 
 
 
 
 
 
 
 
Cash Dividend Declared Per Share:
$
0.25

 
$
0.25

 
$
0.75

 
$
0.75




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

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
 
Three Months Ended
September 30,

Nine Months Ended
September 30,
 
2016

2015

2016

2015
 
(Unaudited)
(In millions)
Net income (loss) attributable to Covanta Holding Corporation
$
54

 
$
34

 
$
(12
)
 
$
(9
)
Foreign currency translation
(5
)
 
(5
)
 
1

 
(14
)
Net unrealized (loss) gain on derivative instruments, net of tax expense(benefit) of $1, $1, $(4) and $3, respectively

 

 
(20
)
 
6

Other comprehensive loss attributable to Covanta Holding Corporation
(5
)
 
(5
)
 
(19
)
 
(8
)
Comprehensive income (loss) attributable to Covanta Holding Corporation
$
49

 
$
29

 
$
(31
)
 
$
(17
)


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

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
 
 
 
September 30,
2016

December 31,
2015
 
(Unaudited)
 
 
 
(In millions, except per
share amounts)
ASSETS
 
 
 
Current:
 
 
 
Cash and cash equivalents
$
113

 
$
94

Restricted funds held in trust
62

 
77

Receivables (less allowances of $9 million and $7 million, respectively)
299

 
312

Prepaid expenses and other current assets
73

 
114

   Assets held for sale

 
97

Total Current Assets
547

 
694

Property, plant and equipment, net
2,997

 
2,690

Restricted funds held in trust
57

 
83

Waste, service and energy contracts, net
269

 
284

Other intangible assets, net
35

 
38

Goodwill
303

 
301

Other assets
67

 
121

Total Assets
$
4,275

 
$
4,211

LIABILITIES AND EQUITY
 
 
 
Current:
 
 
 
Current portion of long-term debt
$
9

 
$
8

Current portion of project debt
23

 
16

Accounts payable
52

 
90

Accrued expenses and other current liabilities
234

 
234

Liabilities held for sale

 
23

Total Current Liabilities
318

 
371

Long-term debt
2,286

 
2,255

Project debt
381

 
159

Deferred income taxes
595

 
595

Waste and service contracts, net
8

 
13

Other liabilities
187

 
178

Total Liabilities
3,775

 
3,571

Commitments and Contingencies (Note 12)

 
 
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 136 shares, outstanding 130 and 131, respectively)
14

 
14

Additional paid-in capital
804

 
801

Accumulated other comprehensive loss
(53
)
 
(34
)
Accumulated deficit
(264
)
 
(143
)
Treasury stock, at par
(1
)
 

Total Covanta Holding Corporation stockholders' equity
500

 
638

Noncontrolling interests in subsidiaries

 
2

Total Equity
500

 
640

Total Liabilities and Equity
$
4,275

 
$
4,211


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

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
 
For the Nine Months Ended
September 30,
 
2016
 
2015
 
(Unaudited, in millions)
OPERATING ACTIVITIES:
 
 
 
Net loss
$
(12
)
 
$
(9
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization expense
155

 
148

Amortization of long-term debt deferred financing costs
5

 
6

Gain on asset sales
(43
)
 

Impairment charges
19

 
24

Loss on extinguishment of debt

 
2

Stock-based compensation expense
13

 
15

Equity in net income from unconsolidated investments
(3
)
 
(11
)
Dividends from unconsolidated investments
2

 
3

Deferred income taxes
3

 
(22
)
Other, net
(3
)
 

Change in restricted funds held in trust
22

 
14

Change in working capital
(12
)
 
(16
)
Net cash provided by operating activities
146

 
154

INVESTING ACTIVITIES:
 
 
 
Purchase of property, plant and equipment
(282
)
 
(267
)
Acquisition of businesses, net of cash acquired
(9
)
 
(70
)
Proceeds from asset sales
107



Property insurance proceeds
2

 

Other, net
4

 

Net cash used in investing activities
(178
)
 
(337
)
FINANCING ACTIVITIES:
 
 
 
Proceeds from borrowings on long-term debt

 
294

Proceeds from borrowings on revolving credit facility
658

 
655

Proceeds from equipment financing capital leases

 
15

Proceeds from borrowings on project debt

 
59

Proceeds from borrowings on Dublin project financing
139

 
85

Payments on long-term debt
(2
)
 
(196
)
Payments of borrowings on revolving credit facility
(623
)
 
(509
)
Payments on equipment financing capital leases
(3
)
 
(3
)
Payments on project debt
(17
)
 
(63
)
Payments of deferred financing costs
(5
)
 
(8
)
Cash dividends paid to stockholders
(98
)
 
(100
)
Change in restricted funds held in trust
19

 
(62
)
Common stock repurchased
(20
)
 

Net cash provided by financing activities
48

 
167

Effect of exchange rate changes on cash and cash equivalents
1


(4
)
Net increase (decrease) in cash and cash equivalents
17

 
(20
)
Cash and cash equivalents at beginning of period
96

 
91

Cash and cash equivalents at end of period
113

 
71

Less: Cash and cash equivalents of assets held for sale at end of period

 
2

Cash and cash equivalents of continuing operations at end of period
$
113

 
$
69


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

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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, LLC and its subsidiaries.
Organization
Covanta is 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”), and also owns and operates related waste transport and disposal and other renewable energy production businesses. EfW serves two key markets as both a sustainable waste management 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.
Our EfW facilities earn revenue from both the disposal of waste and the generation of electricity and/or steam, generally under contracts, as well as from the sale of metal recovered during the EfW process. We process approximately 20 million tons of solid waste annually. We operate and/or have ownership positions in 42 energy-from-waste facilities, which are primarily located in North America. In total, these assets produce approximately 10 million megawatt hours (“MWh”) of baseload electricity annually. We also operate a waste management infrastructure that is complementary to our core EfW business.
We have one reportable segment, North America, which is comprised of waste and energy services operations located primarily in the United States and Canada. We are currently constructing an energy-from-waste facility in Dublin, Ireland, which we own and will operate upon completion. We hold equity interests in China and Italy.
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 notes thereto required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for fair presentation have been included in our condensed consolidated 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 ending December 31, 2016. 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, 2015 (“Form 10-K”).
Reclassification
During the nine months ended September 30, 2016, certain amounts have been reclassified in our prior period balance sheet and cash flows to conform to current year presentation and such amounts were not material to current and prior periods. We concluded that it was appropriate to include Net interest expense on project debt within Interest expense, net on our consolidated statement of operations. Previously, Net interest expense on project debt was reported separately, as a component of Operating expense. For the three and nine months ended September 30, 2015, Net interest expense on project debt of $3 million and $10 million, respectively, was included in Interest expense, net on our condensed consolidated statement of operations and as a result, Operating income increased accordingly for those periods.
Change in Accounting Principle
Effective January 1, 2016, we adopted guidance concerning the presentation of debt issuance costs, which are required to be presented as a direct reduction from the carrying amount of the related debt liability. We adopted this guidance retrospectively, which resulted in a reduction in our December 31, 2015 current and non-current asset balances of $8 million and $40 million, respectively, along with a corresponding reduction in current and long-term debt balances. For additional information, see Note 6. Consolidated Debt.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
In August 2016, the Financial Accounting Standards Board ("FASB") issued updated guidance on eight specific cash flow issues with regard to how cash receipts and cash payments are presented and classified in the statement of cash flows in order to clarify existing guidance and reduce diversity in practice. The guidance is required to be adopted in the first quarter of 2018 on a retrospective basis, unless it is impracticable to apply, in which case it should be applied prospectively as of the earliest date practicable. Early adoption is permitted. We are currently evaluating the impact this guidance will have on our consolidated statement of cash flows.

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


In March 2016, the FASB issued amended guidance for employee share-based compensation.  The updated guidance changes how companies account for certain aspects of share-based payment awards to employees, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The guidance, which is required to be adopted in the first quarter of 2017, may be early adopted. We are currently evaluating the impact this guidance will have on our consolidated financial statements.
In February 2016, the FASB issued amended guidance for lease arrangements in order to increase transparency and comparability by providing additional information to users of financial statements regarding an entity's leasing activities. The revised guidance seeks to achieve this objective by requiring reporting entities to recognize lease assets and lease liabilities on the balance sheet for substantially all lease arrangements. The guidance, which is required to be adopted in the first quarter of 2019, will be applied on a modified retrospective basis beginning with the earliest period presented. Early adoption is permitted. We are currently evaluating the impact of adopting this guidance on our consolidated financial statements.
In January 2016, the FASB issued accounting guidance that would require equity investments not accounted for as an equity method investment or that result in consolidation to be recorded at their fair value with changes in fair value recognized in our consolidated statements of operations. Those equity investments that do not have a readily determinable fair value may be measured at cost less impairment, if any, plus or minus changes resulting from observable price changes. This standard is required to be adopted in the first quarter of 2018, with early adoption prohibited. We are currently evaluating the impact this guidance will have on our consolidated financial statements and related disclosures.
In May 2014, the FASB issued guidance based on the principle that revenue is recognized in an amount expected to be collected and to which the entity expects to be entitled in exchange for the transfer of goods or services. In August 2015, the FASB deferred the effective date by one year to January 1, 2018, while providing the option to early adopt the standard on the original effective date of January 1, 2017. We do not intend to early adopt. We will first adopt the guidance of ASC606 in the first quarter of 2018, as required. The guidance can be adopted either retrospectively or as a cumulative-effect adjustment as of the date of adoption. We are currently evaluating the adoption alternatives, which include utilizing a bottom-up approach to analyze the standard’s impact on our contract portfolio, comparing historical accounting policies and practices to the new standard to identify potential differences from applying the requirements of the new standard to our contracts. We have not yet selected a transition method nor have we yet determined the effect of the standard on our consolidated financial statements. We expect this determination will near completion in late 2016 or early 2017. Because the new standard will impact our business processes, systems and controls, we are in the process of developing a comprehensive change management project plan to guide the implementation.
NOTE 3. DISPOSITIONS AND OTHER
China Investments
Our interests in China included an 85% ownership of an EfW facility located in Jiangsu Province ("Taixing"), a 49% equity interest in an EfW facility located in Sichuan Province and a 40% equity interest in Chongqing Sanfeng Covanta Environmental Industry Co., a company located in the Chongqing Municipality that is engaged in the business of providing design and engineering, procurement, construction services and equipment sales for EfW facilities in China, as well as operating services for EfW facilities.
During March 2016, we completed the exchange of our ownership interests in China for a 15% ownership interest in Chongqing Sanfeng Covanta Environmental Industrial Group, Co., Ltd ("Sanfeng Environment") pursuant to agreements entered into in July 2015. During September 2016, we completed the sale of approximately 90% of the aforementioned ownership interest in Sanfeng Environment to a third-party, a subsidiary of CITIC Limited ("CITIC"), a leading Chinese industrial conglomerate and investment company, pursuant to the July 2015 agreements. As a result, during the three months ended September 30, 2016, we recorded a pre-tax gain of $41 million. We received pre-tax proceeds of $105 million. The gain resulted from the excess of pre-tax proceeds over the cost-method book value of $70 million, plus $5 million of realized gains on the related cumulative foreign currency translation adjustment, that were reclassified out of other comprehensive income.
In connection with these transactions, we entered into foreign currency exchange collars and forwards to hedge against rate fluctuations that impacted the cash proceeds in U.S. dollar terms. For more information, see Note 11. Derivative Instruments.
As of September 30, 2016, our remaining cost-method investment in Sanfeng Environment totaled $7 million and was included in our condensed consolidated balance sheet as a component of "Other assets". Cost-method investments are carried at historical cost unless indicators of impairment are identified. There were no impairment indicators related to our cost-method investment during the nine months ended September 30, 2016. As of December 31, 2015, the assets and liabilities associated with our China investments were presented in our condensed consolidated balance sheets as Current "Assets held for sale” and Current "Liabilities held for sale.”

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


Pittsfield EfW Facility
In March 2016, we exercised an early termination option available under the steam sale agreement at our Pittsfield EfW facility that would have been effective in March 2017.  Upon termination of the steam agreement, we intended to cease operations at the Pittsfield facility. As a result, during the first quarter of 2016, we recorded a non-cash impairment charge of $13 million, pre-tax, which was calculated based on the estimated cash flows for this facility during its remaining operations utilizing Level 3 inputs. For more information regarding fair value measurements, see Note 10. Financial Instruments.
In October 2016, we withdrew our termination notice. The City of Pittsfield has agreed to fund upgrades to the facility and the State of Massachusetts will provide energy tax credits, both of which will serve to improve the economics of the facility. In addition, we will continue to sell steam generated by the facility under an amended agreement.
Tartech Investment
We are party to a joint venture that was formed to recover and recycle metals from EfW ash monofills in North America. During the nine months ended September 30, 2016, due to operational difficulties and the decline in the scrap metal market, a valuation of the entity was conducted. As a result, we recorded a net impairment of our investment in this joint venture of $3 million, pre-tax, which represents our portion of the carrying value of the entity in excess of the fair value. Such amount was calculated based on the estimated liquidation value of the tangible equipment utilizing Level 3 inputs. For more information regarding fair value measurements, see Note 10. Financial Instruments.
NOTE 4. EARNINGS PER SHARE (“EPS”) AND EQUITY
Earnings Per Share
We calculate basic earnings per share ("EPS") using net earnings for the period and the weighted average number of outstanding shares of our common stock, par value $0.10 per share, during the period. Basic weighted average shares outstanding have decreased due to share repurchases. 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 and restricted stock units whether or not currently exercisable. Diluted earnings per share does not include securities if their effect was anti-dilutive. Basic and diluted weighted average shares outstanding were as follows (in millions):
 
Three Months Ended
September 30,

Nine Months Ended
September 30,
 
2016

2015

2016

2015
Basic weighted average common shares outstanding
129

 
132

 
129

 
132

Dilutive effect of stock options, restricted stock and restricted stock units (1)
2

 
2

 

 

Diluted weighted average common shares outstanding
131

 
134

 
129

 
132


(1) Excludes the following securities because their inclusion would have been anti-dilutive:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Stock options
1

 
1

 
1

 
1

Restricted stock

 

 
1

 

Restricted stock units

 

 
1

 
1


Equity
Share Repurchases
In January 2016, we repurchased approximately 1.2 million shares of our common stock at a weighted average cost of $15.29 per share for an aggregate amount of $18 million.

Dividends per Share
Dividends declared per share were $0.25 for each of the three-month periods ended September 30, 2016 and 2015 and $0.75 for each of the nine month periods ended September 30, 2016 and 2015. Cash dividends declared were $33 million and $34 million for the three month periods ended September 30, 2016 and 2015, respectively and $99 million and $101 million for the nine month periods ended September 30, 2016 and 2015, respectively.

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


Accumulated Other Comprehensive Income (Loss) ("AOCI")
The changes in accumulated other comprehensive loss are as follows (in millions):
 
Foreign Currency Translation
 
Pension and Other Postretirement Plan Unrecognized Net Gain
 
Net Unrealized (Loss) Gain on Derivatives
 
Net Unrealized Gain on Securities
 
Total
Balance December 31, 2014
$
(12
)
 
$
2

 
$
(12
)
 
$

 
$
(22
)
Other comprehensive (loss) income before reclassifications
(14
)
 

 
6

 

 
(8
)
Amounts reclassified from accumulated other comprehensive loss

 

 

 

 

Net current period comprehensive (loss) income
(14
)
 

 
6

 

 
(8
)
Balance September 30, 2015
$
(26
)
 
$
2

 
$
(6
)
 
$

 
$
(30
)
 
 
 
 
 
 
 
 
 
 
Balance December 31, 2015
$
(34
)
 
$
2

 
$
(2
)
 
$

 
$
(34
)
Other comprehensive income (loss) before reclassifications
6

 

 
(20
)
 

 
(14
)
Amounts reclassified from accumulated other comprehensive loss
(5
)
 

 

 

 
(5
)
Net current period comprehensive income (loss)
1

 

 
(20
)
 

 
(19
)
Balance September 30, 2016
$
(33
)
 
$
2

 
$
(22
)
 
$

 
$
(53
)
Amount Reclassified from Accumulated Other Comprehensive Income
Accumulated Other Comprehensive Income Component
 
Nine Months Ended September 30, 2016
 
Affected Line Item in the Consolidated Statement of Operations
 
 
 
 
 
Foreign currency translation
 
$
5

 
Gain on asset sales
 
 
5

 
Total before tax
 
 

 
Tax benefit
Total reclassifications
 
$
5

 
Net of tax
 
 
 
 
 

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


NOTE 5. FINANCIAL INFORMATION BY BUSINESS SEGMENTS
We have one reportable segment, North America, which is comprised of waste and energy services operations located primarily in the United States and Canada. The results of our reportable segment are as follows (in millions):
 
North America  
 
All Other (1)
 
Total      
Three Months Ended September 30, 2016
 
 
 
 
 
Operating revenue
$
421

 
$

 
$
421

Depreciation and amortization expense
52

 

 
52

Impairment charges

 

 

Operating income (loss)
62

 
(2
)
 
60

 
 
 
 
 
 
Three Months Ended September 30, 2015
 
 
 
 
 
Operating revenue
$
411

 
$
11

 
$
422

Depreciation and amortization expense
52

 
(2
)
 
50

Impairment charges

 

 

Operating income
71

 
3

 
74

 
 
 
 
 
 
 
North America  
 
All Other  (1)
 
Total      
Nine Months Ended September 30, 2016
 
 
 
 
 
Operating revenue
$
1,235

 
$
7

 
$
1,242

Depreciation and amortization expense
155

 

 
155

Impairment charges
19

 

 
19

Operating income (loss)
55

 
(4
)
 
51

 
 
 
 
 
 
Nine Months Ended September 30, 2015
 
 
 
 
 
Operating revenue
$
1,184

 
$
29

 
$
1,213

Depreciation and amortization expense
147

 
1

 
148

Impairment charges
24

 

 
24

Operating income
66

 

 
66

(1)
All other is comprised of the financial results of our operations outside of North America.



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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)



NOTE 6. CONSOLIDATED DEBT
Consolidated debt is as follows (in millions):
 
As of
 
September 30,
2016

December 31,
2015
LONG-TERM DEBT:
 
 
 
Revolving credit facility (2.95% - 3.20%)(1)
$
384

 
$
348

Term loan, net (2.45%)
198

 
200

Credit Facilities Sub-total
$
582

 
$
548

7.25% Senior notes due 2020
$
400

 
$
400

6.375% Senior notes due 2022
400

 
400

5.875% Senior notes due 2024
400

 
400

  Less: deferred financing costs related to senior notes
(15
)
 
(16
)
Senior Notes Sub-total
$
1,185

 
$
1,184

4.00% - 5.25% Tax-exempt bonds due 2024 through 2045
$
464

 
$
464

  Less: deferred financing costs related to tax-exempt bonds
(5
)
 
(6
)
Tax-Exempt Bonds Sub-total
$
459

 
$
458

3.48% - 4.52% Equipment financing capital leases due 2024 through 2027
$
69

 
$
73

Total long-term debt
$
2,295

 
$
2,263

Less: current portion
(9
)
 
(8
)
Noncurrent long-term debt
$
2,286

 
$
2,255

PROJECT DEBT:
 
 
 
North America project debt:
 
 
 
1.75% - 6.45% project debt related to service fee structures due 2017 through 2035
$
108

 
$
117

5.00% Union capital lease due 2016 through 2053
101

 

5.248% - 6.20% project debt related to tip fee structures due 2016 through 2020
16

 
23

Unamortized debt premium, net
4

 
5

  Less: deferred financing costs related to North America project debt
(1
)
 
(1
)
Total North America project debt
$
228

 
$
144

Other project debt:
 
 
 
Dublin senior loan due 2021 (5.72% - 6.41%)(2)
$
142

 
$

Debt discount related to Dublin senior loan
(7
)
 
(8
)
  Less: deferred financing cost related to Dublin senior loan
(19
)
 
(15
)
Dublin senior loan, net
$
116

 
$
(23
)
Dublin junior loan due 2022 (9.23% - 9.73%)
$
61

 
$
57

Debt discount related to Dublin junior loan

 
(1
)
  Less: deferred financing costs related to Dublin junior loan
(1
)
 
(2
)
Dublin junior loan, net
$
60

 
$
54

Total other project debt, net
$
176

 
$
31

Total project debt
$
404

 
$
175

Less: Current portion, includes $1 of net unamortized premium
(23
)
 
(16
)
Noncurrent project debt
$
381

 
$
159

TOTAL CONSOLIDATED DEBT
$
2,699

 
$
2,438

        Less: Current debt
(32
)
 
(24
)
TOTAL NONCURRENT CONSOLIDATED DEBT
$
2,667

 
$
2,414

(1) Eurodollar rates only; excludes base rate borrowings.
(2) Reflects hedged fixed rates.

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)



Credit Facilities
Our subsidiary, Covanta Energy, has $1.2 billion in senior secured credit facilities consisting of a $1.0 billion revolving credit facility, expiring 2019 through 2020, (the “Revolving Credit Facility”) and a $200 million term loan due 2020 (the “Term Loan”) (collectively referred to as the "Credit Facilities").
Availability under Revolving Credit Facility
As of September 30, 2016, we had availability under the Revolving Credit Facility as follows (in millions):
 
Total
Available
Under  Credit Facility
 
Expiring (1)
 
Direct Borrowings as of
September 30, 2016
 
Outstanding Letters of Credit as of
September 30, 2016
 
Availability as of
September 30, 2016
Revolving Credit Facility
$
1,000

 
2020
 
$
384

 
$
148

 
$
468

(1) The Revolving Credit Facility consists of two tranches; Tranche A ($950 million), which expires in 2020, and Tranche B ($50 million), which expires in March 2019.
Repayment Terms
As of September 30, 2016, the Term Loan has mandatory remaining amortization payments of $1 million in 2016, $5 million in each of the years 2017 through 2019 and $182 million in 2020. The Credit Facilities are pre-payable at par at our option at any time.
Guarantees and Security
The Credit Facilities are guaranteed by us and by certain of our subsidiaries. The subsidiaries that are party to the Credit Facilities agreed to secure all of the obligations under the Credit Facilities by granting, for the benefit of secured parties, a first priority lien on substantially all of their assets, to the extent permitted by existing contractual obligations; a pledge of substantially all of the capital stock of each of our domestic subsidiaries and 65% of substantially all the capital stock of each of our foreign subsidiaries which are directly owned, in each case to the extent not otherwise pledged.
Credit Agreement Covenants
The loan documentation governing the Credit Facilities contains various affirmative and negative covenants, as well as financial maintenance covenants (financial ratios), that limit our ability to engage in certain types of transactions. We were in compliance with all of the affirmative and negative covenants under the Credit Facilities as of September 30, 2016.

Union County EfW Capital Lease Arrangement
In June 2016, we extended the lease term related to the Union County EfW facility through 2053, which resulted in capital lease treatment for the revised lease. We recorded lease liability of $104 million, calculated utilizing an incremental borrowing rate of 5.0%. The lease includes certain periods of contingent rentals based upon plant performance as either a share of revenue or a share of plant profits. These contingent payments have been excluded from the calculation of the lease liability and instead will be treated as a period expense when incurred. As of September 30, 2016, the outstanding borrowings under the capital lease have mandatory amortization payments remaining as follows (in millions):
 
 
Remainder of 2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
Annual Remaining Amortization
 
$
2

 
$
5

 
$
5

 
$
5

 
$
6

 
$
78


Other Non-current Liabilities
As of September 30, 2016, the Dublin convertible preferred instrument of $91 million was included in other noncurrent liabilities in our condensed consolidated balance sheet.

Capitalized Interest
Interest expense paid and costs amortized to interest expense related to project financing are capitalized during the construction and start-up phase of the project. Total interest expense capitalized was $7 million and $2 million during the three months ended September 30, 2016 and 2015, respectively, and $20 million and $4 million during the nine months ended September 30, 2016 and 2015, respectively.

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NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


NOTE 7. INCOME TAXES
We record our interim tax provision based upon our estimated annual effective tax rate ("ETR") and account for tax effects of discrete events in the period in which they occur. We review the ETR on a quarterly basis as projections are revised and laws are enacted. The ETRs were (50)% and 48% for the nine months ended September 30, 2016 and September 30, 2015, respectively. The decrease in the ETR was primarily attributable to the gain from the sale of ownership interests in China, which was tax effected discretely as it was deemed unusual and infrequent. In addition, the changes in the mix of earnings and the change from forecasted pre-tax income in 2015 to forecasted pre-tax loss in 2016 also contributed to the ETR change.

NOTE 8. SUPPLEMENTARY INFORMATION
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 $9 million and $13 million for the three months ended September 30, 2016 and 2015, respectively, and $28 million and $34 million for the nine months ended September 30, 2016 and 2015, respectively.
Impairment charges
During the nine months ended September 30, 2016, we recorded non-cash impairment charges of $19 million, pre-tax, of which $13 million, related to the previously planned closure of our Pittsfield EfW facility and $3 million, pre-tax, related to our Tartech investment. See Note 3. Dispositions and Other for additional information.
During the nine months ended September 30, 2015, we identified indicators of impairment associated with our biomass facilities, primarily due to a decline in energy market pricing. As a result of these developments, we recorded a non-cash impairment charge of $24 million, pre-tax, which was calculated based on a range of potential outcomes utilizing various estimated cash flows for these facilities utilizing Level 3 inputs.
NOTE 9. STOCK-BASED COMPENSATION
During the nine months ended September 30, 2016, we awarded certain employees grants of 748,569 shares of restricted stock and 437,275 restricted stock units ("RSUs"). 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 restricted stock awards generally vest during March of 2017, 2018, and 2019.
Additionally, during the nine months ended September 30, 2016, we awarded certain employees grants of 390,728 RSUs that will vest based upon the Company’s cumulative Free Cash Flow per share over a three year performance period.
During the nine months ended September 30, 2016, we withheld 210,169 shares of our common stock in connection with tax withholdings for vested stock awards.
On May 5, 2016, we awarded 9,000 shares of restricted stock and 54,591 restricted stock units for annual director compensation. We determined the service vesting condition of these restricted stock awards and restricted stock units to be non-substantive and, in accordance with accounting principles for stock compensation, recorded the entire fair value of the awards as compensation expense on the grant date.
On September 22, 2016, the Board of Directors appointed two new board members. We awarded 5,550 restricted stock units for the prorated portion of their annual director compensation. We determined the service vesting condition of these restricted stock awards and restricted stock units to be non-substantive and, in accordance with accounting principles for stock compensation, recorded the entire fair value of the awards as compensation expense on the grant date.
Compensation expense related to our stock-based awards totaled $4 million and $4 million for the three months ended September 30, 2016 and 2015, respectively and $13 million and $15 million for the nine months ended September 30, 2016 and 2015, respectively. The stock-based award compensation for the nine months ended September 30, 2015 included expense recognized for stock awards and accelerated vesting of stock awards pursuant to separation agreements in connection with the departure of two executive offers during the nine months ended September 30, 2015.

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


Unrecognized stock-based compensation expense and weighted-average years to be recognized are as follows (in millions, except for weighted average years):
 
As of September 30, 2016
 
Unrecognized stock-
based compensation    
 
    Weighted-average years    
to be recognized
Restricted stock awards
$ 9
 
1.5
Restricted stock units
$ 9
 
2.3
NOTE 10. FINANCIAL INSTRUMENTS
Fair Value Measurements
Authoritative guidance associated with fair value measurements provides a framework for measuring fair value and establishes a fair value hierarchy that prioritizes the inputs used to measure fair value, giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs), then significant other observable inputs (Level 2 inputs) and the lowest priority to significant unobservable inputs (Level 3 inputs).The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
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.
Fair values for long-term debt and project debt are determined using quoted market prices.
The fair value for interest rate swaps were determined by obtaining quotes from two counterparties (one is a holder of the long position and the other is in the short) and extrapolating those across the long and short notional amounts.  The fair value of the interest rate swaps was adjusted to reflect counterparty risk of non-performance, and was based on the counterparty’s credit spread in the credit derivatives market.
The fair values of our energy hedges were determined using the spread between our fixed price and the forward curve information available within the market.
The fair value of our foreign currency hedge was determined by obtaining quotes from two counterparties and is based on market accepted option pricing methodology which utilizes inputs such as the currency spot rate as of the balance sheet date, the strike price of the options and volatility.
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, 2016. Such amounts have not been comprehensively revalued for purposes of these financial statements since September 30, 2016, and current estimates of fair value may differ significantly from the amounts presented herein.

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NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


The following table presents information about the fair value measurement of our assets and liabilities as of September 30, 2016 and December 31, 2015:
 
 
 
 
As of
Financial Instruments Recorded at Fair Value on a Recurring Basis:
 
Fair Value Measurement Level
 
September 30, 2016

December 31, 2015
 
 
 
 
(In millions)
Assets:
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
Bank deposits and certificates of deposit
 
1
 
$
109

 
$
89

Money market funds
 
1
 
4

 
5

Total cash and cash equivalents:
 
 
 
113

 
94

Restricted funds held in trust:
 
 
 
 
 
 
Bank deposits and certificates of deposit
 
1
 
18

 
9

Money market funds
 
1
 
38

 
66

   U.S. Treasury/Agency obligations (1)
 
1
 
15

 
18

State and municipal obligations
 
1
 
46

 
59

Commercial paper/Guaranteed investment contracts/Repurchase agreements
 
1
 
2

 
8

Total restricted funds held in trust:
 
 
 
119

 
160

Investments:
 
 
 
 
 
 
Mutual and bond funds (2)
 
1
 
2

 
2

Derivative asset — Energy hedges
 
2
 
11

 
21

Total assets:
 
 
 
$
245

 
$
277

Liabilities:
 
 
 
 
 
 
Derivative liability — Interest rate swaps
 
2
 
$
27

 
$
14

Total liabilities:
 
 
 
$
27

 
$
14

 
The following financial instruments are recorded at their carrying amount (in millions):
 
 
As of September 30, 2016
 
As of December 31, 2015
Financial Instruments Recorded at Carrying Amount:
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Assets:
 
 
 
 
 
 
 
 
Accounts receivable (3)
 
$
300

 
$
300

 
$
314

 
$
314

Liabilities:
 
 
 
 
 
 
 
 
Long-term debt 
 
$
2,295

 
$
2,341

 
$
2,263

 
$
2,244

Project debt
 
$
404

 
$
412

 
$
175

 
$
183

(1)
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.
(2)
Included in other noncurrent assets in the condensed consolidated balance sheets.
(3)
Includes $1 million and $2 million of noncurrent receivables recorded in "Other assets" in the condensed consolidated balance sheets as September 30, 2016 and December 31, 2015, respectively.

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NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


NOTE 11. 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 operations (in millions):
Derivative Instruments Not Designated
As Hedging Instruments
 
 
 
Fair Value as of
Balance Sheet Location
 
September 30,
2016
 
December 31,
2015
Asset Derivatives:
 
 
 
 
 
 
Foreign currency
 
Prepaid expenses and other current assets
 
$

 
$
6

 
 
 
 
Amount of Gain or (Loss) Recognized In Income on Derivatives
Effect on Income of Derivative Instruments Not Designated As Hedging Instruments
 
Location of Gain or (Loss)
Recognized in Income on
Derivatives
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
2016
 
2015
 
2016
 
2015
Foreign currency
 
Other income (expense), net
 
$
(1
)
 
$
3

 
$
(2
)
 
$
3

Effect on income of derivative instruments not designated as hedging instruments
 
$
(1
)
 
$
3

 
$
(2
)
 
$
3

Foreign Exchange Risk
In order to hedge the risk of adverse foreign currency exchange rate fluctuations impacting the expected sale proceeds from our equity transfer agreement in China (See Note 3. Dispositions and Other), we entered into foreign currency exchange forwards with two financial institutions, covering approximately $100 million of notional, to protect against further rate fluctuations pending the expected close of the sale of our ownership interest to CITIC. The foreign currency forwards were accounted for as derivative instruments and, accordingly, were recorded at fair value quarterly with any change in fair value recognized in our condensed consolidated statements of operations as "Other expense, net." During the nine months ended September 30, 2016, cash provided by foreign currency exchange settlements totaled $5 million and was included in net cash used in investing activities on our condensed consolidated statement of cash flows.
As of September 30, 2016, we received $105 million of gross sale proceeds relating to the aforementioned sale of our ownership interests to CITIC and therefore, settled or canceled remaining foreign currency exchange derivatives related to this hedged transaction, resulting in a current asset balance of zero. The table below summarizes foreign currency derivatives that have settled or canceled to date (in millions):
Settled FX Derivatives
Instrument
 
Notional Amount
 
Maturity
 
Settlement Received
FX Collar
 
$50
 
March 2016
 
$2
FX Collar
 
$50
 
April 2016
 
$1
FX Forward
 
$50
 
June 2016
 
$—
FX Forward
 
$50
 
July 2016
 
$1
FX Forward
 
$50
 
September 2016
 
$1
FX Forward
 
$49
 
September 2016
 
$—
FX Forward
 
$49
 
September 2016
 
$—
We have also entered into foreign currency forwards to manage foreign currency exchange rate fluctuations associated with a series of fixed payments to be made by an international subsidiary through the end of 2017. This foreign currency forward is accounted for as a derivative instrument at fair value in our quarterly condensed consolidated balance sheet with any changes in fair value recognized in our condensed consolidated statements of operations as "Other expense, net." This derivative instrument was not material to our condensed consolidated statement of operations nor was it material to our condensed consolidated balance sheet as of September 30, 2016.



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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


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 have entered into contractual arrangements that will mitigate our exposure to short-term volatility through a variety of hedging techniques, and will continue to do so in the future. Our efforts in this regard will involve only mitigation of price volatility for the energy we produce, and will not involve taking positions (either long or short) on energy prices in excess of our physical generation. The amount of energy generation for which we have hedged under agreements with various financial institutions is indicated in the following table (in millions):
Calendar Year
 
Hedged MWh
2016
 
0.6
2017
 
2.2
2018
 
0.3
Total
 
3.1
As of September 30, 2016, the fair value of the energy derivatives of $11 million, pre-tax, was recorded as a $9 million current asset and a $2 million noncurrent asset. The change in fair value was recorded as a component of AOCI. As of September 30, 2016, the amount of hedge ineffectiveness was not material. During the nine months ended September 30, 2016, cash provided by and used in energy derivative settlements of $26 million and zero, respectively, was included in net cash provided by operating activities on our condensed consolidated statement of cash flows. During the nine months ended September 30, 2015, cash provided by and used in energy derivative settlements of $11 million and $7 million, respectively, was included in the change in net cash provided by operating activities on our condensed consolidated statement of cash flows.
Interest Rate Swaps
In order to hedge the risk of adverse variable interest rate fluctuations associated with the Dublin senior term loan, we have entered into floating to fixed rate swap agreements with various financial institutions terminating between 2016 and 2021, denominated in Euros, for the full €250 million loan amount. This interest rate swap is designated as a cash flow hedge which is recorded at fair value with changes in fair value recorded as a component of AOCI. As of September 30, 2016, the fair value of the interest rate swap derivative of $27 million, pre-tax, was recorded as a $2 million and $25 million current and noncurrent liability, respectively. There was an immaterial amount of ineffectiveness recorded during the quarter recognized in our condensed consolidated statements of operations as interest expense.
NOTE 12. 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, the 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.

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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


Lower Passaic River Matter. In August 2004, the United States Environmental Protection Agency (the “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’s LPRSA costs to date are not material to its financial position and results of operations; however, to date the EPA has not sought any LPRSA remedial costs or natural resource damages against PRPs. On March 3, 2016, the EPA released the Record of Decision (“ROD”) for its Focused Feasibility Study of the lower 8 miles of the LPRSA; the EPA’s selected remedy includes capping/dredging of sediment, institutional controls and long-term monitoring. The Essex facility started operating in 1990 and Essex does not believe there have been any releases to the LPRSA, but in any event believes any releases would have been de minimis considering the history of the LPRSA; however, it is not possible at this time to predict that outcome or to estimate the range of possible loss relating to Essex’s liability in the matter, including for LPRSA remedial costs and/or natural resource damages.
North Carolina Transformer Site Matter. In December 2012, our subsidiary, Covanta Dade Power Corp. (“Dade”) received a letter from the EPA indicating Dade was named as a PRP, along with numerous other unidentified PRPs, relating to the cleanup of the Ward Transformer Superfund Site in Raleigh, North Carolina (“Ward Site”). Dade's alleged liability as a PRP stems from the 1994 servicing at the Ward Site of a transformer alleged to have contained PCB-contaminated oil. The EPA is seeking reimbursement from PRPs for its oversight costs in connection with ongoing cleanup activities at the Ward Site. While our investigation in this matter is continuing, based on information obtained to date, we believe Dade's responsibility, if any, in connection with this matter to be de minimis; and subject to indemnity by Veolia Environmental Services North America, LLC, from which we acquired Dade in 2010; however, it is not possible at this time to estimate the range of possible loss relating to Dade's ultimate liability, if any, in this matter.
Tulsa Matter. In January 2016, we were informed by the office of the United States Attorney for the Northern District of Oklahoma (“U.S. Attorney”) that our subsidiary, Covanta Tulsa Renewable Energy LLC, is the target of a criminal investigation being conducted by the EPA. We understand that the EPA plans to allege improprieties in the recording and reporting of emissions data during an October 2013 incident involving one of the three municipal waste combustion units at our Tulsa, Oklahoma facility.  We believe that our operations in Tulsa were and are in compliance with existing laws and regulations in all material respects.  While we can provide no assurance as to the outcome of this matter, we do not believe that the investigation or any issues arising therefrom will have a material adverse effect on our financial position, cash flows or results of operations.
Other Matters
Durham-York Contractor Arbitration
We are seeking to resolve outstanding disputes with our primary contractor for the Durham-York construction project regarding (i) claims by the contractor for change orders and other expense reimbursement and (ii) claims by us for charges and liquidated damages for project completion delays.  Our contract with this contractor contemplates binding arbitration to resolve these disputes, which we expect may conclude in 2017. While we do not expect resolution of these disputes to have a material adverse impact on our financial position, it could be material to our results of operations and or cash flows in any given accounting period.
Other Commitments
Other commitments as of September 30, 2016 were as follows (in millions):
 
 
Commitments Expiring by Period

 
Total
 
Less Than
One Year
 
More Than
One Year
Letters of credit issued under the Revolving Credit Facility
 
$
148

 
$
1

 
$
147

Letters of credit - other
 
65

 

 
65

Surety bonds
 
162

 

 
162

Total other commitments — net
 
$
375

 
$
1

 
$
374

The letters of credit were issued 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 letters of credit issued under the Revolving Credit Facility, unreimbursed amounts would be treated under the Credit Facilities as either additional term loans or as revolving loans.

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NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)


The surety bonds listed in the table above relate primarily to construction and performance obligations and support for other obligations, including closure requirements of various energy projects when such projects cease operating. 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, 6.375% Notes, 5.875% Notes, and Tax-Exempt Bonds. Holders may require us to repurchase their 7.25% Notes, 6.375% Notes, 5.875% Notes and Tax-Exempt Bonds if a fundamental change occurs. For specific criteria related to the redemption features of the 5.875% Notes, 7.25% Notes or 6.375% Notes, see Item 8. Financial Statements And Supplementary Data — Note 11. Consolidated Debt of our Annual Report on 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 revenue is insufficient to do so, or to obtain or guarantee financing for a 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.
Benefit Obligations - 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 $5 million and $4 million for the three months ended September 30, 2016 and 2015, respectively, and $13 million and $12 million for the nine months ended September 30, 2016 and 2015, respectively.
Dublin EfW Facility
In connection with the financing of the Dublin EfW facility, Covanta Energy has made commitments for contingent support as follows: (1) lending commitments up to €25 million to fund working capital shortfalls in the project company under certain circumstances during operations; and (2) up to €75 million commitment in the aggregate to provide support payments to the project company, under certain circumstances, in the event waste revenue falls below minimum levels (set far below anticipated levels).
Essex County EfW Facility
We are implementing significant operational improvements at our Essex County EfW facility at a total estimated cost of approximately $90 million. Construction commenced in 2014 and is expected to be substantially completed in 2016. As of September 30, 2016, we have approximately $18 million of capital expenditures remaining to be incurred related to these improvements.
New York City Waste Transport and Disposal Contract
In 2013, New York City awarded us a contract to handle waste transport and disposal from two marine transfer stations located in Queens and Manhattan. Service for the Manhattan marine transfer station is expected pending approval from New York City. As of September 30, 2016, we expect to incur approximately $32 million of additional capital expenditures, primarily for transportation equipment.


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Table of Contents

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

The following MD&A is intended to help the reader understand the results of operations and financial condition of Covanta Holding Corporation and its subsidiaries; ("Covanta" or the "Company") for the three and nine months ended September 30, 2016. The term "Covanta Energy" refers to our subsidiary Covanta Energy, LLC and its subsidiaries. The financial information as of September 30, 2016 should be read in conjunction with the financial statements for the year ended December 31, 2015 contained in our 2015 Annual Report on Form 10-K.
Factors Affecting Business Conditions and Financial Results
The following are various published pricing indices relating to the U.S. economic drivers that are relevant to those aspects of our business where we have market exposure; however, there is not an exact correlation between our results and changes in these metrics.
 
 
September 30, 2016
 
September 30, 2015
Consumer Price Index (1)
 
1.5
%
 
%
PJM Pricing (Electricity) (2)
 
$
27.90

 
$
28.03

NE ISO Pricing (Electricity) (3)
 
$
31.76

 
$
29.22

Henry Hub Pricing (Natural Gas) (4)
 
$
2.88

 
$
2.74

#1 HMS Pricing (Ferrous Metals) (5)
 
$
212

 
$
219

Scrap Metals - Old Sheet & Old Cast (6)
 
$
0.58

 
$
0.60

(1)
Represents the year-over-year percent change in the Headline CPI number. The Consumer Price Index (CPI-U) data is provided by the U.S. Department of Labor Bureau of Labor Statistics.
(2)
Average price per MWh for Q3 2016 and Q3 2015. Pricing for the PJM PSEG Zone is provided by the PJM ISO.
(3)
Average price per MWh for Q3 2016 and Q3 2015. Pricing for the Mass Hub Zone is provided by the NE ISO.
(4)
Average price per MMBtu for Q3 2016 and Q3 2015. The Henry Hub Pricing data is provided by the Natural Gas Weekly Update, Energy Information Administration, Washington, DC. Nebraska Energy Office, Lincoln, NE.
(5)
Average price per gross ton for Q3 2016 and Q3 2015. The #1 Heavy Melt Steel ("HMS") composite index ($/gross ton) price is published by American Metal Market.
(6)
Average price per pound for Q3 2016 and Q3 2015. Calculated using the high and low prices for Old Sheet & Old Cast Scrap Metals ($/lb.) published by American Metal Market.
Seasonal - Our quarterly operating income (loss) within the same fiscal year typically differs substantially due to seasonal factors, primarily as a result of the timing of scheduled plant maintenance. We 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 expense and receive less revenue until the boiler and/or turbine units resume operations. This scheduled maintenance usually occurs during periods of off-peak electric demand and/or lower waste volumes, which are our first, second and fourth fiscal quarters. The scheduled maintenance period in the first half of the year (primarily first quarter and early second quarter) is typically the most extensive, while the third quarter scheduled maintenance period is the least extensive. Given these factors, we normally experience our lowest operating income from our projects during the first half of each year.
Our operating income may also be affected by seasonal weather extremes during summers and winters. Increased demand for electricity and natural gas during unusually hot or cold periods may affect certain operating expenses and may trigger material price increases for a portion of the electricity and steam we sell.
Quarter Updates
China Investments
During March 2016, we completed the exchange of our ownership interests in China for a 15% ownership interest in Chongqing Sanfeng Covanta Environmental Industrial Group, Co., Ltd ("Sanfeng Environment") pursuant to agreements entered into in July 2015. During September 2016, we sold approximately 90% of the aforementioned ownership interest in Sanfeng Environment to a subsidiary of CITIC Limited ("CITIC"), a leading Chinese industrial conglomerate and investment company, pursuant to the July 2015 agreements. As a result, during the three months ended September 30, 2016, we recorded pre-tax gain of $41 million. The gain results from pre-tax proceeds of $105 million in excess of the cost-method book value of $70 million, plus $5 million of realized gains on the related cumulative foreign currency translation adjustment.


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Table of Contents

Pittsfield EfW Facility
In March, we exercised an early termination option available under our steam sale agreement for our Pittsfield EfW facility that would have been effective in March 2017.  Upon termination of the steam agreement, we intended to cease operations at the Pittsfield facility. As a result, during the first quarter of 2016 we recorded a non-cash impairment charge of $13 million, pre-tax, which was calculated based on the estimated cash flows for this facility during its remaining operations utilizing Level 3 inputs. Assumptions used in determining future operating results and cash flows include current and expected market conditions and future operations forecasts. It is possible that these assumptions and estimates may change resulting in the need to adjust our determination of fair value. For more information regarding fair value measurements, see Note 10. Financial Instruments.
In October 2016, we withdrew our termination notice. The city agreed to fund upgrades to the facility and the state will provide energy tax credits, both of which will serve to improve the economics of the facility. In addition, we will continue to sell steam generated by the facility under an amended agreement.
Tartech Investment
We are party to a joint venture that was formed to recover and recycle metals from EfW ash monofills in North America. During the nine months ended September 30, 2016, due to operational difficulties and the decline in the scrap metals market, a valuation of the entity was conducted. As a result, we recorded a net impairment of our investment in this joint venture of $3 million, pre-tax, which represents our portion of the fair value of entity in excess of the carrying value.
Contract Extensions
In September 2016, we extended our waste services agreement with the City of Huntsville to September 2020. In October, we extended our waste disposal agreement with the City of Indianapolis to December 2025. Both were extended under similar terms of the existing agreements.
CONSOLIDATED RESULTS OF OPERATIONS
The following general discussions should be read in conjunction with the condensed consolidated financial statements, the notes to the condensed consolidated financial statements and other financial information appearing and referred to elsewhere in this report. Additional detail relating to changes in operating revenue and operating expense and the quantification of specific factors affecting or causing such changes is provided in the segment discussion below. We have one reportable segment, North America, which is comprised of waste and energy services operations located primarily in the United States and Canada.
The comparability of the information provided below with respect to our revenue, expense and certain other items for the periods presented was affected by several factors. As outlined in Item 8. Financial Statements And Supplementary Data — Note 3. New Business and Asset Management of our Annual Report on Form 10-K, our business development initiatives, contract transitions, and acquisitions resulted in various transactions that are reflected in comparative revenue and expense. These factors must be taken into account in developing meaningful comparisons between the periods compared below.
The following terms used within the Results of Operations discussion are defined as follows:
“Same store”: reflects the performance at each facility on a comparable period-over-period basis, excluding the impacts of transitions and transactions.
Contract “transitions”: includes the impact of the expiration of: (a) long-term major waste and service contracts, most typically representing the transition to a new contract structure, and (b) long-term energy contracts.
“Transactions”: includes the impacts of acquisitions, divestitures, and the addition or loss of operating contracts.


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Table of Contents

CONSOLIDATED RESULTS OF OPERATIONS — OPERATING INCOME
Three Months Ended September 30, 2016 and 2015
 
Consolidated
 
North America
 
Variance
Increase (Decrease)
 
2016
 
2015
 
2016
 
2015
 
Consolidated
 
North America
 
(In millions)
OPERATING REVENUE:
 
 
 
 
 
 
 
 
 
 
 
Waste and service revenue
$
299

 
$
283

 
$
299

 
$
282

 
$
16

 
$
17

Energy revenue
92

 
108

 
92

 
98

 
(16
)
 
(6
)
Recycled metals revenue
14

 
16

 
14

 
16

 
(2
)
 
(2
)
Other operating revenue
16

 
15

 
16

 
15

 
1

 
1

Total operating revenue
421

 
422

 
421

 
411

 
(1
)
 
10

OPERATING EXPENSE:
 
 
 
 
 
 
 
 
 
 
 
Plant operating expense
272

 
260

 
270

 
251

 
12

 
19

Other operating expense
14

 
18

 
14

 
18

 
(4
)
 
(4
)
General and administrative expense
23

 
20

 
23

 
19

 
3

 
4

Depreciation and amortization expense
52

 
50

 
52

 
52

 
2

 

Total operating expense
361

 
348

 
359

 
340

 
13

 
19

Operating income
$
60

 
$
74

 
$
62

 
$
71

 
$
(14
)
 
$
(9
)

Nine Months Ended September 30, 2016 and 2015
 
Consolidated
 
North America
 
Variance
Increase (Decrease)
 
2016
 
2015
 
2016
 
2015
 
Consolidated
 
North America
 
(In millions)
OPERATING REVENUE:
 
 
 
 
 
 
 
 
 
 
 
Waste and service revenue
$
875

 
$
805

 
$
874

 
$
803

 
$
70

 
$
71

Energy revenue
279

 
319

 
273

 
292

 
(40
)
 
(19
)
Recycled metals revenue
44

 
49

 
44

 
49

 
(5
)
 
(5
)
Other operating revenue
44

 
40

 
44

 
40

 
4

 
4

Total operating revenue
1,242

 
1,213

 
1,235

 
1,184

 
29

 
51

OPERATING EXPENSE:
 
 
 
 
 
 
 
 
 
 
 
Plant operating expense
901

 
849

 
892

 
825

 
52

 
67

Other operating expense
45

 
55

 
45

 
55

 
(10
)
 
(10
)
General and administrative expense
71

 
71

 
69

 
67

 

 
2

Depreciation and amortization expense
155

 
148

 
155

 
147

 
7

 
8

Impairment charges
19

 
24

 
19

 
24

 
(5
)
 
(5
)
Total operating expense
1,191

 
1,147

 
1,180

 
1,118

 
44

 
62

Operating income
$
51

 
$
66

 
$
55

 
$
66

 
$
(15
)
 
$
(11
)




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Table of Contents

Operating Revenue
Waste and Service Revenue
Consolidated (in millions):
Three Months Ended
September 30,

Nine Months Ended
September 30,

Variance
Increase (Decrease)
 
2016

2015

2016

2015

Three Month

Nine Month
Waste and service revenue unrelated to project debt
$
297


$
280


$
868


$
795


$
17


$
73

Revenue earned explicitly to service project debt - principal
1


2


4


8


(1
)

(4
)
Revenue earned explicitly to service project debt - interest
1


1


3


2




1

Total waste and service revenue
$
299


$
283


$
875


$
805


16


70


North America segment - EfW facilities - Tons (1)
(in millions):
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Variance
Increase (Decrease)
 
2016
 
2015
 
2016
 
2015
 
Three Month
 
Nine Month
Contracted
4.6

 
4.4

 
13.0

 
12.7

 
0.2

 
0.3

Uncontracted
0.5

 
0.5

 
1.6

 
1.7

 

 
(0.1
)
Total tons
5.1

 
4.9

 
14.6

 
14.4

 
0.2

 
0.2

(1) Includes solid tons only. Certain amounts may not total due to rounding.
For the three month comparative period, waste and service revenue on a consolidated and North America segment basis increased by $16 million and $17 million, respectively.
Waste and service revenue from EfW operations increased by $10 million year-over-year, impacted by the following:
Same store revenue increased by $8 million, or 3.4%, driven by $6 million of price improvement and $2 million of volume improvement;
Transaction activity increased revenue by $3 million; and
Revenue earned explicitly to service project debt decreased by $1 million.
Waste and service revenue from non-EfW operations in the North America segment increased by $7 million primarily due to the contribution from newly acquired environmental services businesses.
For the nine month comparative period, waste and service revenue on a consolidated and North America segment basis increased by $70 million and $71 million, respectively.
Waste and service revenue from EfW operations increased by $18 million year-over-year, impacted by the following:
Same store revenue increased by $18 million, or 2.5%, driven by $16 million of price improvement and $2 million of volume improvement;
Transaction activity increased revenue by $6 million;
Waste processing revenue decreased by $2 million as a result of contract transitions; and
Revenue earned explicitly to service project debt decreased by $4 million.
Waste and service revenue from non-EfW operations in the North America segment increased by $53 million primarily due to the contribution from newly acquired environmental services businesses and the New York City MTS contract.


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Table of Contents

Energy Revenue
Energy revenue and MWh by contract status and facility type (in millions):
 
Three Months Ended September 30,
 
 
 
 
 
2016
 
2015
 
Variance
Increase (Decrease)
North America Segment:
Revenue (1)
 
Volume (1) (2)
 
% of Total Volume
 
Revenue (1)
 
Volume (1) (2)
 
% of Total Volume
 
Revenue
 
Volume
EfW
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    At Market
$
9

 
0.3

 
16
%
 
$
12

 
0.4

 
23
%
 
 
 
 
    Contracted
65

 
0.8

 
53
%
 
59

 
0.8

 
47
%
 
 
 
 
    Hedged
18

 
0.5

 
31
%
 
15

 
0.3

 
20
%
 
 
 
 
Total EfW
$
92

 
1.6

 
100
%
 
86

 
1.5

 
90
%
 
$
6

 
0.1

Biomass
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   At Market
$

 

 
%
 
$
2

 
0.1

 
5
%
 
 
 
 
   Contracted

 

 
%
 
10

 
0.1

 
5
%
 
 
 
 
   Hedged

 

 
%
 

 

 
%
 
 
 
 
Total Biomass
$

 

 
%
 
$
12

 
0.2

 
10
%
 
$
(12
)
 
(0.2
)
Total
$
92

 
1.6

 
100
%
 
$
98

 
1.7

 
100
%
 
$
(6
)
 
(0.1
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
    
(1) Covanta share only. Represents the sale of electricity and steam based upon output delivered and capacity provided.
(2) Steam converted to MWh at an assumed average rate of 11 klbs of steam / MWh.

For the three month comparative period, energy revenue on a consolidated basis decreased by $16 million.
Energy revenue from EfW operations increased by $5 million year-over-year driven by contract transitions, which contributed $4 million primarily due to additional energy revenue sharing, and an increase in same store revenue of $1 million.
Energy revenue from non-EfW operations decreased by $21 million, representing the contribution from biomass facilities and China operations in the prior year.
For the nine month comparative period, energy revenue on a consolidated basis decreased by $40 million.
Energy revenue from EfW operations increased $11 million year-over-year driven by contract transitions, which contributed $17 million due to additional energy revenue sharing, partially offset by decreased same store revenue of $6 million, primarily due to lower energy production.
Energy revenue from non-EfW operations decreased by $51 million, representing the contribution from biomass facilities and China operations in the prior year.




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Table of Contents

Recycled Metals Revenue
Recycled Metals Revenue by Type (in millions):
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
Variance
Increase (Decrease)
 
2016
 
2015
 
2016
 
2015
 
Three Month
 
Nine Month
Ferrous Metal
$
8

 
$
10

 
$
27

 
$
31

 
(2
)
 
(4
)
Non-Ferrous Metal
6

 
6

 
17

 
18

 

 
(1
)