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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-K
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2007
    or
o
  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. Employee
Identification No.)
     
40 Lane Road, Fairfield, N.J.   07004
(Address of Principal Executive Offices)
  (Zip Code)
 
Registrant’s telephone number, including area code:
(973) 882-9000
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
 
Common Stock, $0.10 par value per share   New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act: N/A
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
 
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 o   Non-accelerated filer o   Smaller reporting Company o
        (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 o     No þ
 
As of June 29, 2007, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $2,962,710,442. The aggregate market value was computed by using the closing price of the common stock as of that date on the New York Stock Exchange. (For purposes of calculating this amount only, all directors and executive officers of the registrant have been treated as affiliates.)
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
 
     
Class
 
February 14, 2008
 
Common Stock, $0.10 par value per share
  153,921,882 shares
 
Documents Incorporated By Reference:
 
     
Part of Form 10-K of Covanta Holding Corporation
 
Documents Incorporated by Reference
 
Part III
  Portions of the Proxy Statement to be filed with the Securities and Exchange Commission in connection with the Annual Meeting of Stockholders.
 


 

 
TABLE OF CONTENTS
 
                 
        Page
 
    3  
    3  
      Business     4  
        About Covanta Holding Corporation     4  
        Our Business Strategy     4  
        Business Segments     5  
        Domestic Business     6  
        International Business     10  
        Markets, Competition And Business Conditions     15  
        Regulation Of Business     17  
        Employees     22  
        Executive Officers     22  
      Risk Factors     23  
      Unresolved Staff Comments     34  
      Properties     34  
      Legal Proceedings     35  
      Submission Of Matters To A Vote Of Security Holders     35  
      Market For Registrant’s Common Equity, Related Stockholder Matters, And Issuer Purchases Of Equity Securities     36  
      Selected Financial Data     36  
      Management’s Discussion And Analysis Of Financial Condition And Results Of Operations     37  
        Overview     37  
        Results Of Operations     43  
            Year Ended December 31, 2007 vs. Year Ended December 31, 2006     44  
            Year Ended December 31, 2006 vs. Year Ended December 31, 2005     48  
        Liquidity And Capital Resources     56  
      Quantitative And Qualitative Disclosures About Market Risk     67  
      Financial Statements And Supplementary Data     71  
      Changes In And Disagreements With Accountants On Accounting And Financial Disclosure     129  
      Controls And Procedures     129  
      Other Information     133  
      Directors, Executive Officers And Corporate Governance     133  
      Executive Compensation     133  
      Security Ownership Of Certain Beneficial Owners And Management And Related Stockholder Matters     133  
      Certain Relationships And Related Transactions, And Director Independence     134  
      Principal Accountant Fees And Services     134  
      Exhibits And Financial Statement Schedules     134  
OTHER
        Signatures     140  
 Summary of Cash Bonus Program
 Computation of Ratio of Earnings to Fixed Charges
 List of Subsidiaries
 Consent of Ernst & Young LLP
 Consent of Sycip Gorres Velayo & Co.
 302 Certification of Chief Executive Officer
 302 Certification of Chief Financial Officer
 Section 906 Certification


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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
Certain statements in this Annual Report on Form 10-K 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 its businesses described in Item 1A. Risk Factors of this Annual Report on Form 10-K for the year ended December 31, 2007 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 Annual Report on Form 10-K 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.
 
AVAILABILITY OF INFORMATION
 
You may read and copy any materials Covanta files with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Copies of such materials also can be obtained at the SEC’s website, www.sec.gov or by mail from the Public Reference Room of the SEC, at prescribed rates. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. Covanta’s SEC filings are also available to the public, free of charge, on its corporate website, www.covantaholding.com as soon as reasonably practicable after Covanta electronically files such material with, or furnishes it to, the SEC. Covanta’s common stock is traded on the New York Stock Exchange. Material filed by Covanta can be inspected at the offices of the New York Stock Exchange at 20 Broad Street, New York, N.Y. 10005.


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PART I
 
Item 1.   BUSINESS
 
The terms “we,” “our,” “ours,” “us,” “Covanta” and “Company” refer to Covanta Holding Corporation and its subsidiaries and the term “Covanta Energy” refers to our subsidiary Covanta Energy Corporation and its subsidiaries.
 
About Covanta Holding Corporation
 
We are a leading developer, owner and operator of infrastructure for the conversion of waste to energy (known as “energy-from-waste”), as well as other waste disposal and renewable energy production businesses in the United States, Europe and Asia. We are organized as a holding company which was incorporated in Delaware on April 16, 1992. We conduct all of our operations through subsidiaries which are engaged predominantly in the businesses of waste and energy services. We also engage in the independent power production business outside the United States.
 
We own, have equity investments in, and/or operate 57 energy generation facilities, 47 of which are in the United States and 10 of which are located outside the United States. Our energy generation facilities use a variety of fuels, including municipal solid waste, wood waste (biomass), landfill gas, water (hydroelectric), natural gas, coal, and heavy fuel-oil. We also own or operate several businesses that are associated with our energy-from-waste business, including a waste procurement business, three landfills, and several waste transfer stations.
 
Revenues were $1,433 million, $1,269 million and $979 million and operating income was $237 million, $227 million and $146 million for the years ended December 31, 2007, 2006 and 2005, respectively. The increase in revenues and operating income over the past three years is primarily attributable to the successful execution of our operating and growth strategies described below and in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview — Acquisitions and Business Development.
 
Our Business Strategy
 
Our mission is to be the world’s leading energy-from-waste company, with a complementary network of other renewable energy generation and waste disposal assets. We expect to build value for our stockholders by satisfying our clients’ waste disposal and energy generation needs with safe, reliable and environmentally superior solutions. In order to accomplish this mission and create additional value for our stockholders, we are focused on:
 
  •  providing customers with superior service and effectively managing our existing businesses;
  •  generating sufficient cash to meet our liquidity needs and invest in the business; and
  •  developing new projects and making acquisitions to grow our business in the United States, Europe and Asia.
 
Our business is capital intensive because it is based on building and operating municipal solid waste processing and energy generating facilities. In order to provide meaningful growth through development, we must be able to invest our funds, obtain equity and/or debt financing, and provide support to our operating subsidiaries. During the first quarter of 2007, we completed a comprehensive recapitalization utilizing a series of equity and debt financings. With this refinancing, we now have greater flexibility to pursue strategic opportunities by investing in our business and making acquisitions. Additional information related to our recapitalization is described in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — 2007 Recapitalization and Note 6. Long-Term Debt of the Notes to the Consolidated Financial Statements (“Notes”).
 
Our senior management team has extensive experience in developing, constructing, operating, acquiring and integrating waste and energy services businesses. We intend to continue to focus our efforts on pursuing development and acquisition-based growth. We anticipate that a part of our future growth will come from acquiring or investing in additional energy-from-waste, waste disposal and renewable energy production businesses in the United States, Europe and Asia.
 
Our domestic project development efforts include working with our client communities to expand existing energy-from-waste project capacities, new energy-from-waste and other renewable energy projects, contract


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extensions, and businesses ancillary to our existing businesses, such as additional waste transfer, transportation, processing and landfill businesses.
 
We are pursuing international waste and/or energy business opportunities, particularly in markets where the market demand, regulatory environment or other factors encourage technologies such as energy-from-waste in order to reduce dependence on landfilling. In particular, we are focusing on the United Kingdom, Ireland and China, as well as Italy, Canada and certain other countries.
 
During 2007, we expanded our network of waste and energy services businesses through acquisitions, equity investments and additional operating and development contracts. In our domestic business, we added three energy-from-waste facilities, one ash landfill, five transfer stations and two biomass projects. In addition, we completed the expansion of the energy-from-waste facility located in and owned by Lee County, Florida, and continued to make progress on the expansion of the Hillsborough County, Florida energy-from-waste facility. In our international business, we announced that we have entered into definitive agreements for the development of a 1,700 metric ton per day (“tpd”) energy-from-waste project serving the City of Dublin, Ireland and surrounding communities. We also purchased an equity interest in one company and agreed to acquire an equity interest in another company both of which are located in China and will be used to develop energy-from-waste projects in China, and one of which has equity interests in two existing energy-from-waste facilities. Additional information related to our acquisitions and business development during 2007 is described in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview — Acquisitions and Business Development.
 
We believe that our business offers solutions to public sector leaders around the world in two related elements of critical infrastructure: waste disposal and renewable energy generation. We believe that the environmental benefits of energy-from-waste, as an alternative to landfilling, are clear and compelling: utilizing energy-from-waste reduces greenhouse gas (“GHG”) emissions, lowers the risk of groundwater contamination, and conserves land. At the same time, energy-from-waste generates clean, reliable energy from a renewable fuel source, thus reducing dependence on fossil fuels, the combustion of which is itself a major contributor to GHG emissions. As public planners in the United States, Europe and Asia address their needs for more environmentally sensitive waste disposal and energy generation in the years ahead, we believe that energy-from-waste will be an increasingly attractive alternative.
 
Business Segments
 
Prior to January 1, 2007, we had two reportable business segments — Waste and Energy Services and Other Services. Given our increased focus on developing our international business, during the first quarter of 2007, we segregated what we previously reported as our Waste and Energy Services segment into two new segments: Domestic and International. Our remaining operations, which we previously reported as our Other Services segment and was comprised of the holding company and insurance subsidiaries’ operations, did not meet the quantitative thresholds which required separate disclosure as a reportable segment. Therefore, our reportable segments are now Domestic and International, which are comprised of our domestic and international waste and energy services operations, respectively.
 
The financial results of the holding company primarily consist of interest expense and income. General and administrative expenses related to officer salaries, legal and other professional fees and insurance are reimbursed by the operating subsidiaries.
 
Our predominant business is the waste and energy services business, however our historical consolidated operations were conducted in the insurance industry prior to the acquisition of Covanta Energy in March 2004. Our insurance business continues to represent an important element of our structure in that our net operating loss carryforwards (“NOLs”) were primarily generated through the operations of these former subsidiaries. See Note 9. Income Taxes of the Notes for more information about our NOLs.
 
Additional information about our business segments is contained in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview — Business Segments and in Note 5. Financial Information by Business Segments of the Notes.


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DOMESTIC BUSINESS
 
Energy-From-Waste Projects
 
Energy-from-waste projects have two essential purposes: to provide waste disposal services, typically to municipal clients who sponsor the projects, and to use that waste as a fuel source to generate renewable energy. The electricity or steam generated is generally sold to local utilities or industrial customers, and most of the resulting revenues reduce the overall cost of waste disposal services to the municipal clients. These projects are capable of providing waste disposal services and generating electricity or steam, if properly operated and maintained, for several decades. Generally, we provide these waste disposal services and sell the electricity and steam generated under long-term contracts, which expire on various dates between 2008 and 2034. Many of our service contracts may be renewed for varying periods of time, at the option of the municipal client.
 
We receive revenue in the form of fees pursuant to the service or waste contracts, and in some cases, energy purchase agreements, at facilities we own or operate. We market waste disposal services to third parties predominantly to efficiently utilize that portion of the waste disposal capacity of our energy-from-waste projects which is not dedicated to municipal clients.
 
We currently operate energy-from-waste projects in 15 states. 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:
 
  •  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.
  •  For the domestic 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 issuer loans the bond proceeds 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 consolidated financial statements. Generally, project debt is secured by the revenues pledged under the respective indentures and is collateralized by the facility and the contracts and other assets of our project subsidiary.
  •  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. We have 24 energy-from-waste projects at which we receive a fixed fee (which escalates over time pursuant to contractual indices) which we refer to as having a “Service Fee” structure. We also have 10 energy-from-waste projects at which we receive a per-ton fee under contracts for processing waste, which we refer to as having a “Tip Fee” structure. At our Tip Fee projects, we contract on both a long-term and short-term basis to utilize project disposal capacity, and as such we have a greater exposure to waste market price fluctuation, as well as a greater exposure to project operating disruptions that may cause us to reduce waste acceptance.
  •  At projects we own where a Service Fee structure exists, a portion of the revenue we receive represents payments by the client community of debt service on project debt, which we pass along to a bond trustee for payment to bondholders of principal and interest when due. These payments will continue until cash in project debt service reserves is sufficient to pay all remaining debt service payments. Generally, this occurs in the final year of the service contracts, and during that year we will receive little or no payments representing project debt principal, and as a result we record little or no cash provided by operating activities during that period with respect to the debt for such projects.
  •  We generally sell the energy output from our projects to local utilities pursuant to long-term contracts. Where a Service Fee structure exists, our client community usually retains most (generally 90%) of the energy revenues generated and pays the balance to us. Where Tip Fee structures exist, we retain 100% of the


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  energy revenues. At three of our projects, we sell energy output under short-term contracts or on a spot-basis into the regional electricity grid. At our Tip Fee projects, we generally have a greater exposure to energy market price fluctuation, as well as a greater exposure to variability in project operating performance.
  •  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. In circumstances where one or more contracts have been 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.
  •  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. 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 but without cause.
 
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 begin to 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. See discussion under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview — Contract Duration for additional information concerning the expiration of existing contracts.
 
To date, we have been successful in extending 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 discussion under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview — Acquisitions and Business Development for additional information concerning development projects. 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 cash flow and profitability. See Item 1A. Risk Factors — We may face increased risk of market influences on our revenues after our contracts expire.
 
In conjunction with our domestic energy-from-waste business, we also operate ten transfer stations and three landfills in the northeast United States, which we utilize to supplement and manage more efficiently the fuel and ash


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disposal requirements at our energy-from-waste operations. We provide waste procurement services to our waste disposal and transfer 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 residue management for our energy-from-waste projects.
 
Other Renewable Energy Projects
 
We also engage domestically in developing, owning and/or operating renewable energy production facilities utilizing a variety of energy sources including waste wood (biomass), water (hydroelectric), and landfill gas. We sell the electrical output from each facility, with one exception, to local utilities. We derive our revenues from these facilities primarily from the sale of energy and capacity under energy contracts.
 
Biomass — We own five wood-fired generation facilities and have a 55% interest in a partnership which owns a sixth wood-fired generation facility, all of which are located in California. We procure fuel for the facilities from local sources, primarily through short-term supply agreements. The price of the fuel varies depending on the time of the year, supply and price of energy. These projects sell energy and capacity to utilities under energy contracts that expire between 2014 and 2017.
 
Hydroelectric — We own a 50% equity interest in two run-of-river hydroelectric facilities which have a combined gross generating capacity of 17 megawatts (“MW”). Both facilities are located in the State of Washington and both sell energy and capacity to Puget Sound Energy under long-term energy contracts. We provide operation and maintenance services at one of the facilities under a cost plus fixed-fee agreement.
 
Landfill Gas — We own and operate four landfill gas projects located in California and one in Massachusetts which produce electricity by burning methane gas produced in landfills. These projects sell energy to various utilities. Upon the expiration of the energy contracts, we expect that these projects will enter into new power off-take arrangements or will be shut down.
 
Summary information with respect to our domestic projects that are currently operating is provided in the following table:
 
                                             
            Design Capacity         Contract Expiration Dates  
            Waste
    Gross
        Service/
       
            Disposal
    Electric
        Waste
       
        Location   (TPD)     (MW)     Nature of Interest   Disposal     Energy  
 
A.
  ENERGY-FROM-WASTE PROJECTS
    TIP FEE STRUCTURES
1.
  Alexandria/Arlington   Virginia     975       22.0     Owner/Operator     2013       2023  
2.
  Delaware Valley   Pennsylvania     2,688       87.0     Lessee/Operator     2017       2016  
3.
  Haverhill   Massachusetts     1,650       44.6     Owner/Operator     N/A       2019  
4.
  Hempstead(1)   New York     2,671       75.0     Owner/Operator     2034       2009  
5.
  Niagara(2)   New York     2,250       50.0     Owner/Operator     N/A       2014  
6.
  Pittsfield   Massachusetts     240       8.6     Owner/Operator     2015       2015  
7.
  Southeast Massachusetts(3)   Massachusetts     2,700       78.0     Owner/Operator     N/A       2015  
8.
  Springfield   Massachusetts     400       9.4     Owner/Operator     2014       2010  
9.
  Union County   New Jersey     1,440       42.1     Lessee/Operator     2023       N/A  
10.
  Warren County   New Jersey     450       13.5     Owner/Operator     N/A       2013  
    SERVICE FEE STRUCTURES
11.
  Babylon   New York     750       16.8     Owner/Operator     2019       2019  
12.
  Bristol   Connecticut     650       16.3     Owner/Operator     2014       2014  
13.
  Detroit(2)(3)(4)   Michigan     2,832       68.0     Lessee/Operator     2009       2008  
14.
  Essex County   New Jersey     2,700       64.0     Owner/Operator     2020       2020  
15.
  Fairfax County   Virginia     3,000       93.0     Owner/Operator     2011       2015  
16.
  Harrisburg(5)   Pennsylvania     800       20.8     Operator     2018       2009  
17.
  Hartford(3)(6)   Connecticut     2,000       68.5     Operator     2012       2012  
18.
  Hennepin County   Minnesota     1,212       38.7     Operator     2018       2018  
19.
  Hillsborough County(7)   Florida     1,800       46.5     Operator     2027       2010  
20.
  Honolulu(3)(4)   Hawaii     2,160       57.0     Lessee/Operator     2010       2015  
21.
  Huntington(8)   New York     750       24.3     Owner/Operator     2012       2012  


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            Design Capacity         Contract Expiration Dates  
            Waste
    Gross
        Service/
       
            Disposal
    Electric
        Waste
       
        Location   (TPD)     (MW)     Nature of Interest   Disposal     Energy  
 
22.
  Huntsville(2)   Alabama     690           Operator     2016       2014  
23.
  Indianapolis(2)(9)   Indiana     2,362       6.5     Owner/Operator     2008       2028  
24.
  Kent County(2)   Michigan     625       16.8     Operator     2010       2022  
25.
  Lake County   Florida     528       14.5     Owner/Operator     2014       2014  
26.
  Lancaster County   Pennsylvania     1,200       33.1     Operator     2016       2016  
27.
  Lee County   Florida     1,836       57.3     Operator     2024       2015  
28.
  Marion County   Oregon     550       13.1     Owner/Operator     2014       2014  
29.
  Montgomery County   Maryland     1,800       63.4     Operator     2016       2010  
30.
  Onondaga County   New York     990       36.8     Owner/Operator     2015       2025  
31.
  Pasco County   Florida     1,050       29.7     Operator     2011       2024  
32.
  Southeast Connecticut   Connecticut     689       17.0     Owner/Operator     2015       2017  
33.
  Stanislaus County   California     800       22.4     Owner/Operator     2010       2010  
34.
  Wallingford   Connecticut     420       11.0     Owner/Operator     2010       2010  
                                             
        SUBTOTAL     47,658       1,265.7                      
B.
  ANCILLARY WASTE PROJECTS
    LANDFILLS                                        
35.
  Haverhill   Massachusetts     555       N/A     Lessee/Operator     N/A       N/A  
36.
  CMW — Semass   Massachusetts     1,700       N/A     Operator     2016       N/A  
37.
  Springfield   Massachusetts     175       N/A     Owner/Operator     N/A       N/A  
                                             
        SUBTOTAL     2,430       N/A                      
    TRANSFER STATIONS                                        
38.
  Braintree   Massachusetts     1,200       N/A     Owner/Operator     2015       N/A  
39.
  Canaan   New York     600       N/A     Owner/Operator     N/A       N/A  
40.
  Derwood   Maryland     2,500       N/A     Operator     2015       N/A  
41.
  Danvers   Massachusetts     250       N/A     Operator     2011       N/A  
42.
  Essex   Massachusetts     6       N/A     Operator     2015       N/A  
43.
  Holliston   Massachusetts     700       N/A     Owner/Operator     N/A       N/A  
44..
  Lynn   Massachusetts     885       N/A     Owner/Operator     N/A       N/A  
45.
  Mamaroneck   New York     800       N/A     Owner/Operator     2015       N/A  
46.
  Mt. Kisco   New York     350       N/A     Owner/Operator     2018       N/A  
47.
  Springfield   Massachusetts     500       N/A     Owner/Operator     N/A       N/A  
                                             
        SUBTOTAL     7,791       N/A                      
C.
  OTHER RENEWABLE ENERGY PROJECTS
    BIOMASS                                        
48.
  Burney Mountain   California     N/A       11.4     Owner/Operator     N/A       2015  
49.
  Delano   California     N/A       49.5     Owner/Operator     N/A       2017  
50.
  Mendota   California     N/A       25.0     Owner/Operator     N/A       2014  
51.
  Mount Lassen   California     N/A       11.4     Owner/Operator     N/A       2015  
52.
  Pacific Oroville   California     N/A       18.7     Owner/Operator     N/A       2016  
53.
  Pacific Ultrapower Chinese
    Station(10)
  California     N/A       25.6     Part Owner     N/A       2017  
                                             
        SUBTOTAL     N/A       141.6                      
    HYDROELECTRIC                                        
54.
  Koma Kulshan(11)   Washington     N/A       12.0     Part Owner/Operator     N/A       2037  
55.
  Weeks Falls(11)   Washington     N/A       5.0     Part Owner     N/A       2022  
                                             
        SUBTOTAL     N/A       17.0                      
    LANDFILL GAS                                        
56.
  Haverhill   Massachusetts     N/A       1.6     Lessee/Operator     N/A       N/A  
57.
  Otay   California     N/A       7.4     Owner/Operator     N/A       2009-2015  
58.
  Oxnard   California     N/A       5.6     Owner/Operator     N/A       2009  
59.
  Salinas   California     N/A       1.5     Owner/Operator     N/A       2012  
60.
  Stockton   California     N/A       0.8     Owner/Operator     N/A       2012  
                                             
        SUBTOTAL     N/A       16.9                      
 
 
(1) We entered into a new contract with the Town of Hempstead for a term of 25 years commencing upon expiration of the existing contract in 2009.
 
(2) These facilities have been designed to export steam for sale.
 
(3) These facilities use a refuse-derived fuel technology.
 
(4) We lease these projects from third party lessors under arrangements where the lease benefits and burdens are primarily those of the related client community.
 
(5) We entered into a ten year agreement to maintain and operate an 800 tpd energy-from-waste facility located in Harrisburg, Pennsylvania and have a right of first refusal to purchase the facility.


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(6) Under contracts with the Connecticut Resource Recovery Authority, we operate only the boilers and turbines for this facility.
 
(7) With respect to this project, we have entered into agreements to expand waste processing capacity from 1,200 tpd to 1,800 tpd and to increase gross electricity capacity from 29.0 MW to 46.5 MW. The agreements also extended the contract term from 2007 to 2027.
 
(8) Owned by a limited partnership in which the limited partners are not affiliated with us.
 
(9) The service contract for this facility expires on November 30, 2008. Negotiations for a contract extension are ongoing.
 
(10) On October 18, 2007, we acquired an additional 5% ownership interest in this facility increasing our equity ownership interest to 55%. See Note 3. Acquisitions, Business Development and Dispositions of the Notes.
 
(11) We have a 50% ownership interest in these projects.
 
INTERNATIONAL BUSINESS
 
General Approach to International Projects
 
We conduct our international waste and energy businesses through our foreign subsidiaries and affiliates. In general, these projects provide cash returns primarily from equity distributions and, to a lesser extent, operating fees. The projects sell the electricity and steam they generate under either short-term or long-term contracts or market concessions to utilities, governmental agencies providing power distribution, creditworthy industrial users, or local governmental units. Energy-from-waste facilities also sell waste disposal services. In developing our international business, we have employed the same general approach to projects as is described above with respect to domestic projects. We intend to seek to develop or participate in additional international projects, particularly energy-from-waste projects, where the regulatory or market environment is attractive. The ownership and operation of facilities in foreign countries potentially entails significant political and financial uncertainties that typically are not encountered in such activities in the United States, as described below and discussed in Item 1A. Risk Factors. With respect to some international energy-from-waste projects, ownership transfer to the sponsoring municipality, for nominal consideration, is required following expiration of the project’s long-term operating contract.
 
  •  Some of the countries in which we currently operate are lesser developed countries or developing countries where the political, social and economic conditions are quite different, and often less stable, than those conditions prevailing in the United States or other developed countries. In order to mitigate these risks both at the outset of project development and over time, we often develop projects jointly with experienced and respected local companies.
  •  When a project is developed, we undertake a credit analysis of the proposed power purchaser and/or fuel suppliers (which for energy-from-waste projects are often municipal governments).
  •  We have typically sought to negotiate long-term contracts for the supply of fuel with reliable suppliers. For our projects that are not energy-from-waste facilities, we have sought, to the extent practicable, to shift the consequences of interruptions in the delivery of fuel (whether due to the fault of the fuel supplier or due to reasons beyond the fuel supplier’s control) to the electricity purchaser or service recipient by securing a suspension of the project’s operating responsibilities under the applicable agreements and an extension of our operating concession under such agreements. In some instances, we require the energy purchaser or service recipient to continue to make payments of fixed costs if such interruptions occur. In order to mitigate the effect of short-term interruptions in the supply of fuel, we have also endeavored to provide on-site storage of fuel in sufficient quantities to address such interruptions.
  •  For our energy-from-waste projects in international markets, we expect that a significant portion of each project’s waste supply would be under long-term contracts with sponsoring municipalities, thus reducing the risk of fuel supply interruptions or price instability. Where market conditions are favorable, we may also reserve a portion of a facility’s capacity for shorter term contracts, or receive waste on a spot basis.
  •  Payment for services that we provide will often be made in whole or in part in the domestic currencies of the host countries. Local governments generally do not assure conversion of such currencies into U.S. dollars, which may be subject to limitations in the currency markets, as well as restrictions of the host country. In addition, fluctuations in the value of such currencies against the value of the U.S. dollar may cause our participation in such projects to yield less return than expected. Transfer of earnings, capital and profits in


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  any form beyond the borders of the host country may be subject to special taxes or limitations imposed by host country laws. We have sought to participate in projects where the host country has allowed the convertibility of its currency into U.S. dollars and repatriation of earnings, capital and profits subject to compliance with local regulatory requirements. In some cases, components of project costs incurred or funded in U.S. dollars are recovered without risk of currency fluctuation through negotiated contractual adjustments to the price charged for electricity or service provided. This contractual structure may cause the cost in local currency to the project’s power purchaser or service recipient to rise from time to time in excess of local inflation, and consequently there is risk in such situations that such power purchaser or service recipient will, at least in the near-term, be less able or willing to pay for the project’s power or service.
 
We have sought to manage and mitigate these risks through all appropriate means, including:
 
  •  developing projects jointly with experienced local partners; political and financial analysis of the host countries and the key participants in each project;
  •  guarantees of relevant agreements with creditworthy entities;
  •  political risk and other forms of insurance; and/or
  •  participation by United States and/or international development finance institutions in the financing of projects.
 
We determine which mitigation measures to apply based on our ability to balance the risks presented, the availability of such measures and their cost.
 
We have generally participated in projects which provide services that are treated as a matter of national or key economic importance by the laws and politics of the host country. Therefore, there is a risk that the assets constituting the facilities of these projects could be temporarily or permanently expropriated or nationalized by a host country, made subject to local or national control or be subject to unfavorable legislative action, regulatory decisions or changes in taxation. We believe that working with experienced and reputable local joint venture partners mitigates this risk as well.
 
In certain cases, we have issued guarantees on behalf of our international operating subsidiaries with respect to contractual obligations to operate certain international power projects and energy-from-waste projects. The potential damages we may owe under such arrangements may be material. 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 any material liabilities under such guarantees on international projects.
 
International Projects
 
We presently have interests in international power projects with an aggregate generating capacity of approximately 969 MW (gross), with our portion of the ownership in these facilities representing approximately 365 MW. In addition to our headquarters in Fairfield, New Jersey, our international business is facilitated through field offices in Shanghai and Guangzhou, China; Chennai, India; Manila, Philippines; Bangkok, Thailand; and Birmingham, England. The following describes the important features of these projects, by fuel type:
 
Energy-From-Waste
 
We own a 40% equity interest in Sanfeng Covanta Environmental Industry Co., Ltd. (“Sanfeng”), a company located in Chongqing Municipality, Peoples Republic of China. Sanfeng is engaged in the business of owning and operating energy-from-waste projects and providing design and engineering, procurement and construction services for energy-from-waste facilities in China. Sanfeng currently owns minority equity interests in two 1,200 metric tpd, 24 MW mass-burn energy-from-waste projects. Chongqing Iron & Steel Company (Group) Limited holds the remaining 60% equity interest in Sanfeng. The solid waste supply for the projects comes from municipalities under long-term contracts. The municipalities also have the obligation to coordinate the purchase of power from the facilities as part of the long-term contracts for waste disposal. The electrical output from these projects is sold at governmentally established preferential rates under short-term arrangements with local power bureaus.


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We entered into an agreement to acquire a 40% equity interest in Guangzhou Development Covanta Environmental Energy Co., Ltd (“GDC Environmental Energy”), a company to be located in Guangzhou Municipality, Peoples Republic of China. GDC Environmental Energy will be a newly-formed entity involved in developing energy-from-waste projects in Guangdong Providence in Southeast China. Guangzhou Development Industry (Holdings) Co. Ltd. holds the remaining 60% equity interest in GDC Environmental Energy through a wholly-owned subsidiary. Our investment in GDC Environmental Energy is subject to various regulatory approvals and is expected to be completed during early 2008.
 
We own a 13% equity interest in a 500 metric tpd, 18 MW mass-burn energy-from-waste project at Trezzo sull’Adda in the Lombardy Region of Italy. The remainder of the equity in the project is held by a subsidiary of Falck S.p.A. and the municipality of Trezzo sull’Adda. The project is operated by Ambiente 2000 S.r.l., an Italian special purpose limited liability company of which we own 40%. The solid waste supply for the project comes from municipalities and privately-owned waste haulers under long-term contracts. The electrical output from the Trezzo project is sold at governmentally established preferential rates under a long-term purchase contract to Italy’s state-owned electricity grid operator, Gestore della Rete di Trasmissione Nazionale S.p.A.
 
Hydroelectric
 
We operate two hydroelectric facilities in Costa Rica through an operating subsidiary pursuant to long-term contracts. We also have a nominal equity investment in each project. The electric output from both of these facilities is sold to Instituto Costarricense de Electricidad, a Costa Rica national electric utility.
 
Coal
 
A partnership, in which we hold a 26% equity interest, owns a 510 MW (gross) coal-fired electric power generation facility located in Mauban, Quezon Province, the Philippines (“Quezon”). The remaining equity interests are held by an affiliate of International Generating Company, an affiliate of General Electric Capital Corporation, and an entity owned by the original project developer. The Quezon project sells electricity to the Manila Electric Company (“Meralco”), the largest electric distribution company in the Philippines, which serves the area surrounding and including metropolitan Manila.
 
Under an energy contract expiring in 2025, Meralco is obligated to take-or-pay for stated minimum annual quantities of electricity at an all-in price which consists of capacity, operating, energy, transmission and other fees adjusted for inflation, fuel cost and foreign exchange fluctuations. The Quezon project has entered into two coal supply contracts expiring in 2015 and 2022. Under these supply contracts, the cost of coal is determined using a base energy price adjusted to fluctuations of specified international benchmark prices. Our wholly-owned subsidiary, Covanta Philippines Operating, Inc., operates the project under a long-term agreement with the Quezon project and we have obtained political risk insurance for our equity investment in this project.
 
On February 21, 2008, the Quezon project and Meralco executed agreements which effect a settlement of various issues which had been pending for several years, including certain amendments to the contract to modify certain commercial terms and to resolve issues relating to the project’s performance during its first year of operation. The settlement primarily includes payment by Meralco of approximately $8.5 million of prior uncollected receivables, a reduction in the capital cost rate recovery payable by Meralco and other terms.
 
We also have a majority equity interest in a 24 MW (gross) coal-fired cogeneration facility in the Peoples Republic of China. The project entity, in which we hold a majority interest, operates this project. The party holding a minority position in the project is an affiliate of the local municipal government. While the steam produced at this project is intended to be sold under a long-term contract to its industrial host, in practice, steam has been sold on either a short-term basis to local industries or the industrial host, in each case at varying rates and quantities. The electric power is sold at an “average grid rate” to a subsidiary of the provincial power bureau. During 2007, we sold our interest in a second coal-fired project in China.


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Natural Gas
 
We hold a 45% equity interest in a barge-mounted 126 MW (gross) diesel/natural gas-fired electric power generation facility located near Haripur, Bangladesh. The remaining equity interests are held by Pendekar Energy (L) Ltd (a consortium of Tanjong Energy Holdings Sdn Bhd (Malaysia) and Al-Jomaih Group (Saudi Arabia)) and an affiliate of Wartsila North America, Inc. The electrical output of the project is sold to the Bangladesh Power Development Board (“BPDB”) pursuant to an energy contract with minimum energy off-take provisions at an all-in price divided into a fuel component and an “other” component. The fuel component reimburses the fuel cost incurred by the project up to a specified heat rate. The “other” component consists of a pre-determined base rate which is adjusted for the actual load factor and foreign exchange fluctuations. The BPDB also supplies all of the project’s natural gas requirements at a pre-determined base cost adjusted for fluctuations on actual landed cost of the fuel in Bangladesh. The Government of Bangladesh guarantees the BPDB’s contractual obligations. We operate the project under a long-term agreement with the project company and we have obtained political risk insurance for our equity interest in this project.
 
Heavy Fuel-Oil
 
We hold majority equity interests in two 106 MW (gross) heavy fuel-oil fired electric power generation facilities in India. We hold a 60% equity interest in the first project (the “Samalpatti project”), which is located near Samalpatti, in the state of Tamil Nadu. The remaining equity interests in the Salmalpatti project are held by affiliates of Shapoorji Pallonji Infrastructure Capital Co. Ltd. and by Wartsila India Power Investment, LLC. We hold a 77% equity interest in the second project (the “Madurai project”), which is located in Samayanallur, also in the state of Tamil Nadu. The remaining equity interest in the Madurai project is held by an Indian company controlled by the original project developer. Both projects sell their electrical output to the Tamil Nadu Electricity Board (“TNEB”) pursuant to long-term agreements with a full pass-through all-in pricing structure that takes into account specified heat rates, operation and maintenance costs, and equity returns. TNEB’s obligations are guaranteed by the government of the state of Tamil Nadu. Indian oil companies supply the oil requirements of both projects through 15-year fuel supply agreements based on market prices. We operate both projects through subsidiaries under long-term agreements with the project companies.
 
Disputing several contractual provisions, TNEB has, since 2001, failed to pay the full amount due under the energy contracts for both the Samalpatti and Madurai projects. To date, TNEB has paid the undisputed portion of its payment obligations (approximately 94% of total billings) representing each project’s operating costs, fuel costs, debt service and some equity return. Similar to many Indian state electricity boards, TNEB has also failed to fund an escrow account or post a letter of credit required under the project energy contracts, which failure constitutes a default under the project finance documents. Project lenders for both projects have either granted periodic waivers of such default or potential default and/or otherwise approved scheduled equity distributions. Neither such default nor potential default in the project financing arrangements constitutes a default under our financing arrangements. It is possible that the issue of the escrow account and/or letter of credit requirement will be resolved as part of the overall negotiation with TNEB with respect to the disputed receivables in both projects.
 
During 2007, we disposed of our interest in a 7 MW heavy fuel-oil fired electric power generation facility located in the Philippines.


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Summary information with respect to our international projects that are currently operating is provided in the following table:
 
                                             
            Design Capacity                  
            Waste
              Contract Expiration Dates  
            Disposal
    Gross
        Service/
       
            (Metric
    Electric
        Waste
       
        Location   TPD)     (MW)     Nature of Interest   Disposal     Energy  
 
A.
  ENERGY-FROM-WASTE                                        
    TIP FEE STRUCTURES                                        
1.
  Fuzhou(1)   China     1,200       24     Part Owner     2032       N/A  
2.
  Tongqing(1)   China     1,200       24     Part Owner/Operator     2027       N/A  
3.
  Trezzo(2)   Italy     500       18     Part Owner/Operator     2023       2023  
                                             
        SUBTOTAL     2,900       66                      
B.
  HYDROELECTRIC                                        
4.
  Don Pedro(3)   Costa Rica     N/A       14     Part Owner/Operator     N/A       2009  
5.
  Rio Volcan(3)   Costa Rica     N/A       17     Part Owner/Operator     N/A       2009  
                                             
        SUBTOTAL             31                      
C.
  COAL                                        
6.
  Quezon(4)   Philippines     N/A       510     Part Owner/Operator     N/A       2025  
7.
  Yanjiang(5)   China     N/A       24     Part Owner/Operator     N/A       N/A  
                                             
        SUBTOTAL             534                      
D.
  NATURAL GAS                                        
8.
  Haripur(6)   Bangladesh     N/A       126     Part Owner/Operator     N/A       2014  
                                             
E.
  HEAVY FUEL-OIL                                        
9.
  Madurai(7)   India     N/A       106     Part Owner/Operator     N/A       2016  
10.
  Samalpatti(8)   India     N/A       106     Part Owner/Operator     N/A       2016  
                                             
        SUBTOTAL     N/A       212                      
 
 
(1) We have a 40% equity interest in Sanfeng, which owns equity interests of approximately 32% and 25% in the Fuzhou and Tongqing projects, respectively. Sanfeng operates the Tongqing project. The Fuzhou project company, in which Sanfeng has a 32% interest, operates the Fuzhou project. Ownership of these projects transfers to the applicable municipality at the expiration of the applicable waste disposal agreement.
 
(2) We have a 13% interest in this project and a 40% interest in the operator Ambiente 2000 S.r.l.
 
(3) We have nominal ownership interests in these projects.
 
(4) We have an approximate 26% ownership interest in this project.
 
(5) We have an approximate 96% ownership interest in this project. Assets of this project revert back to the local Chinese partner at the expiration of the Joint Venture Agreement in 2017.
 
(6) We have an approximate 45% ownership interest in this project. This project is capable of operating through combustion of diesel oil in addition to natural gas.
 
(7) We have an approximate 77% ownership interest in this project.
 
(8) We have a 60% ownership interest in this project.


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MARKETS, COMPETITION AND BUSINESS CONDITIONS
 
General Business Conditions
 
Our business can be adversely affected by general economic conditions, war, inflation, adverse competitive conditions, governmental restrictions and controls, changes in laws, natural disasters, energy shortages, fuel costs, weather, the adverse financial condition of customers and suppliers, various technological changes and other factors over which we have no control. As global populations and consequent economic activity increase, we expect that demand for energy and effective waste management technologies will increase. We expect this to create generally favorable conditions for our existing business and for our efforts to grow our business. We expect that any cyclical or structural downturns in general economic activity may adversely affect both our existing businesses and our ability to grow through development or acquisitions. The domestic marketplace for renewable energy projects, including energy-from-waste projects, may be affected by the current policy debates described below under Regulation of Business — Regulations Affecting our Domestic Business — Recent Policy Debate Regarding Climate Change. We are actively engaged in the current discussion among policy makers regarding the benefits of energy-from-waste and other renewable energy technologies. The extent to which any resulting legislation will affect the markets in which we compete may depend in part on the extent to which any such legislation recognizes those benefits.
 
Competition for new contracts and projects is intense in all markets in which we conduct or intend to conduct business, and our businesses are subject to a variety of competitive, regulatory and market influences.
 
With respect to our waste-related businesses, including our energy-from-waste and waste procurement business, we compete in waste disposal markets, which are highly competitive. In the United States, the market for waste disposal is almost entirely price-driven and is greatly influenced by economic factors within regional “waste sheds.” These factors include:
 
  •  regional population and overall waste production rates;
  •  the number of other waste disposal sites (including principally landfills and transfer stations) in existence or in the planning or permitting process;
  •  the available disposal capacity (in terms of tons of waste per day) that can be offered by other regional disposal sites; and
  •  the availability and cost of transportation options (rail, inter-modal, trucking) to provide access to more distant disposal sites, thereby affecting the size of the waste shed itself.
 
In the domestic waste disposal market, disposal service providers seek to obtain waste supplies to their facilities by competing on disposal price (usually on a per-ton basis) with other disposal service providers. At all but ten of our energy-from-waste facilities, we typically do not compete in this market because we do not have the contractual right to solicit waste. At these facilities, the client community is responsible for obtaining the waste, if necessary by competing on price to obtain the tons of waste it has contractually promised to deliver to us. At ten of our energy-from-waste facilities and at our waste procurement services businesses, we are responsible for obtaining material amounts of waste supply, and therefore, actively compete in these markets to enter into spot, medium- and long-term contracts. These energy-from-waste projects are generally in densely populated areas, with high waste generation rates and numerous large and small participants in the regional market. Our waste operations are largely concentrated in the northeastern United States. See Item 1A. Risk Factors — Our waste operations are concentrated in one region, and expose us to regional economic or market declines for additional information concerning this geographic concentration. Certain of our competitors in these markets are vertically-integrated waste companies which include waste collection operations, and thus have the ability to control supplies of waste which may restrict our ability to offer disposal services at attractive prices. Our business does not include waste collection operations.
 
If a long-term contract expires and is not renewed or extended by a client community, our percentage of contracted disposal capacity will decrease, and we will need to compete in the regional market for waste disposal. At that point, we will compete on price with landfills, transfer stations, other energy-from-waste facilities and other waste disposal technologies that are then offering disposal service in the region. See discussion under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview — Contract Duration for additional information concerning the expiration of existing contracts.


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Both domestically and internationally, we may develop or acquire, ourselves or jointly with others, additional waste or energy projects and/or businesses. If we were to do so in a competitive procurement, we would face competition in the selection process from other companies, some of which may have greater financial resources, or more experience in the regional waste and/or energy markets. If we were selected, the amount of market competition we would thereafter face would depend upon the extent to which the revenue at any such project or business would be committed under contract. If we were to develop or acquire additional projects or businesses not in the context of a competitive procurement, we would face competition in the regional market and compete on price with landfills, transfer stations, other energy-from-waste facilities, other energy producers and other waste disposal or energy generation technologies that are then offering service in the region.
 
In our international energy-from-waste business, we compete principally for new energy-from-waste contracts and projects in China and the United Kingdom, generally in response to public tenders. In both of these markets, there are numerous local and foreign companies with whom we compete for such contracts and projects. If we were to be successful in obtaining such contracts or projects, we expect that a significant portion of each project’s waste disposal capacity would be under long-term contracts, thus reducing the competition to which we would be subject in waste disposal markets.
 
With respect to our electricity sales from most of our energy-from-waste projects and other energy projects, we primarily sell our output pursuant to long-term contracts. Accordingly, we generally do not sell our output into markets where we must compete on price. As these contracts expire, we will participate in such markets if we are unable to enter into new or renewed long-term contracts. In certain countries where we are seeking new waste and energy projects, such as China and the United Kingdom, we may sell our electricity output on short term arrangements to local or regional government entities, or directly into the local electricity grid, rather than pursuant to contract. In these markets we will have greater exposure to electricity price fluctuations. As energy prices continue to rise in the United States and other countries, we may sell our output pursuant to short-term agreements or directly into regional electricity grids, in which case we would have relatively greater exposure to energy market fluctuations. See discussion under Item 1A. Risk Factors — We may face increased risk of market influences on our revenues after our contracts expire for additional information concerning the expiration of existing contracts.
 
Once a contract is awarded or a project is financed and constructed, our business can be impacted by a variety of risk factors which can affect profitability over the life of a project. Some of these risks are at least partially within our control, such as successful operation in compliance with laws and the presence or absence of labor difficulties or disturbances. Other risk factors are largely out of our control and may have an adverse impact on a project over a long-term. See Item 1A. Risk Factors for more information on these types of risks.
 
Technology, Research and Development
 
We have the exclusive right to market the proprietary mass-burn technology of Martin GmbH fur Umwelt und Energietechnik, referred to herein as “Martin” in the United States, Canada, Mexico, Bermuda and certain Caribbean countries (the “Territory”). Through our investment in Sanfeng, we also have access to the Martin Sity 2000 mass-burn technology in China. The principal feature of the Martin technology is the reverse-reciprocating stoker grate upon which the waste is burned. The patent for the basic stoker grate technology used in the Martin technology has expired and there are various other expired and unexpired patents relating to the Martin technology. We believe that it is Martin’s know-how and worldwide reputation in the energy-from-waste industry, and our know-how in designing, constructing and operating energy-from-waste facilities, rather than the use of patented technology, that is important to our competitive position in the energy-from-waste industry. We do not believe that the expiration of the remaining patents covering portions of the Martin technology will have a material adverse effect on our financial condition or competitive position.
 
Since 1984, our rights to the Martin technology have been provided pursuant to a cooperation agreement with Martin which gives us exclusive rights to market, and distribute parts and equipment for the Martin technology in the Territory. Martin is obligated to assist us in installing, operating and maintaining facilities incorporating the Martin technology. The cooperation agreement renews automatically each year unless notice of termination is given, in which case, the cooperation agreement would terminate ten years after such notice. Any termination would


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not affect our rights to design, construct, operate, maintain or repair energy-from-waste facilities for which contracts have been entered into or proposals made prior to the date of termination.
 
We believe that mass-burn technology is now the predominant technology used for the combustion of municipal solid waste. We believe that the Martin technology is a proven and reliable mass-burn technology, and that our association with Martin has created significant name recognition and value for our domestic energy-from-waste business. Through facility acquisitions, we own and/or operate energy-from-waste facilities which utilize additional technologies, including non-Martin mass-burn technologies and refuse-derived fuel technologies which include pre-combustion waste processing not required with a mass-burn design. As we continue our efforts to develop and/or acquire additional energy-from-waste projects internationally, we will consider mass-burn and other technologies, including technologies other than those offered by Martin, which best fit the needs of the local environment of a particular project.
 
We believe that energy-from-waste technologies offer an environmentally superior solution to waste disposal and energy challenges faced by leaders around the world, and that our efforts to expand our domestic and international businesses will be enhanced by the development of additional technologies in such fields as emission controls, residue disposal, alternative waste treatment processes, and combustion controls. During 2007, we advanced our research and development efforts in these areas, and have developed new and cost-effective technologies that represented major advances in controlling nitrogen oxide (NOx) emissions. These technologies, for which patents are pending, have been tested at existing facilities and we are now operating and/or installing such systems at several of our facilities. We also developed and have patents pending for a proprietary process to improve the handling of the residue from our energy-from-waste facilities. We intend to maintain a focus in the years ahead on research and development of technologies in these and other areas that we believe will enhance our competitive position, and offer new technical solutions to waste and energy problems that augment and complement our business.
 
REGULATION OF BUSINESS
 
Regulations Affecting Our Domestic Business
 
Environmental Regulations
 
Our business activities in the United States are pervasively regulated pursuant to federal, state and local environmental laws. Federal laws, such as the Clean Air Act and Clean Water Act, and their state counterparts, govern discharges of pollutants to air and water. Other federal, state and local laws comprehensively govern the generation, transportation, storage, treatment and disposal of solid and hazardous waste and also regulate the storage and handling of chemicals and petroleum products (such laws and regulations are referred to collectively as the “Environmental Regulatory Laws”).
 
Other federal, state and local laws, such as the Comprehensive Environmental Response Compensation and Liability Act commonly known as “CERCLA,” and collectively referred to with such other laws as the “Environmental Remediation Laws,” make us potentially liable on a joint and several basis for any onsite or offsite environmental contamination which may be associated with our activities and the activities at our sites. These include landfills we have owned, operated or leased, or at which there has been disposal of residue or other waste generated, handled or processed by our facilities. Some state and local laws also impose liabilities for injury to persons or property caused by site contamination. Some service agreements provide us with indemnification from certain liabilities. In addition, our landfill gas projects have access rights to landfill sites pursuant to certain leases that permit the installation, operation and maintenance of landfill gas collection systems. A portion of these landfill sites have been federally-designated “Superfund” sites. Each of these leases provide us with indemnification from some liabilities associated with these sites.
 
The Environmental Regulatory Laws require that many permits be obtained before the commencement of construction and operation of any waste, renewable energy project or water facility, and further require that permits be maintained throughout the operating life of the facility. We can provide no assurance that all required permits will be issued or re-issued, and the process of obtaining such permits can often cause lengthy delays, including


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delays caused by third-party appeals challenging permit issuance. Our failure to meet conditions of these permits or of the Environmental Regulatory Laws can subject us to regulatory enforcement actions by the appropriate governmental unit, which could include fines, penalties, damages or other sanctions, such as orders requiring certain remedial actions or limiting or prohibiting operation. See Item 1A. Risk Factors — Compliance with environmental laws could adversely affect our results of operations. To date, we have not incurred material penalties, been required to incur material capital costs or additional expenses, or been subjected to material restrictions on our operations as a result of violations of Environmental Regulatory Laws or permit requirements.
 
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 Regulatory Laws. 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 CERCLA and/or analogous state Environmental Remediation Laws. Our ultimate 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 have also sent waste to a given site and, in the case of divested operations, our contractual arrangement with the purchaser of such operations.
 
The Environmental Regulatory Laws may change. New technology may be required or stricter standards may be established for the control of discharges of air or water pollutants, for storage and handling of petroleum products or chemicals, or for solid or hazardous waste or ash handling and disposal. Thus, as new technology is developed and proven, we may be required to incorporate it into new facilities or make major modifications to existing facilities. This new technology may often be more expensive than the technology we use currently.
 
In 2006, the Environmental Protection Agency (“EPA”) issued revisions to the New Source Performance Standards (“NSPS”) and Emission Guidelines (“EG”) applicable to new and existing municipal waste combustion (“MWC”) units (the “Revised MACT Rule”). The Revised MACT Rule lowered the emission limits for most of the regulated air pollutants emitted by MWCs. The general compliance deadline for the revised EG is April 28, 2009; however, the actual compliance date for a particular facility may be earlier or later depending on the state in which the facility is located. We expect that one existing energy-from-waste facility, which we operate on behalf of a municipality, will require certain capital improvements to comply with revised EG. Most existing facilities also will incur increased operating and maintenance costs to meet the revised EG requirements, none of which are expected to be material.
 
In February 2008, in response to a lawsuit, EPA was granted a voluntary remand of the Revised MACT Rule for the purpose of reconsidering the MWC emission limits. A new rulemaking is expected which may result in more stringent MWC emission limits than are currently included in the Revised MACT Rule; however, pending any such revisions, the requirements and compliance deadlines included in the Revised MACT Rule, discussed above, would remain applicable to subject MWCs. We are not able to predict the timing and potential outcome of any such new rulemaking with respect to MWC emission limits at this time.
 
Also in 2006, EPA issued a final rule to implement the revised National Ambient Air Quality Standards for fine particulate matter, or PM2.5 (“Revised PM2.5 Rule”). Unlike the Revised MACT Rule discussed above, the Revised PM2.5 Rule is not specific to energy-from-waste facilities, but instead is a nationwide standard for ambient air quality. The primary impact of the Revised PM2.5 Rule will be on those counties in certain states that are designated by EPA as “non-attainment” with respect to those standards. EPA’s Revised PM2.5 Rule will guide state implementation plan (“SIP”) revisions and could result in more stringent regulation of certain energy-from-waste facility emissions that already are regulated by the Revised MACT Rule. EPA is expected to make “non-attainment” designations pursuant to the Revised PM2.5 Rule by November 2009; however, SIP revisions to meet the Revised PM2.5 Rule will not be due until April 2013.
 
The costs to meet new rules for existing facilities owned by municipal clients generally will be borne by the municipal clients. For projects we own or lease, some municipal clients have the obligation to fund such capital improvements, and at certain of our projects we may be required to fund a portion of the related costs. In certain cases, we are required to fund the full cost of capital improvements.


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We believe that most costs incurred to meet the Revised MACT Rule and Revised PM2.5 Rule at facilities we operate may be recovered from municipal clients and other users of our facilities through increased fees permitted to be charged under applicable contracts.
 
The Environmental Remediation Laws prohibit disposal of regulated hazardous waste at our municipal solid waste facilities. The service agreements recognize the potential for inadvertent and improper deliveries of hazardous waste and specify procedures for dealing with hazardous waste that is delivered to a facility. Under some service agreements, we are responsible for some costs related to hazardous waste deliveries. We have not incurred material hazardous waste disposal costs to date.
 
Energy Regulations
 
Our businesses are subject to the provisions of federal, state and local energy laws applicable to the development, ownership and operation of domestic facilities. Pursuant to the Public Utility Regulatory Policies Act of 1978 (“PURPA”), the Federal Energy Regulatory Commission (“FERC”) has promulgated regulations that exempt qualifying facilities (cogeneration facilities and other facilities making use of non-fossil fuel power sources such as waste, which meet certain size, ownership and other applicable requirements, referred to as “QFs”) from compliance with certain provisions of the Federal Power Act (“FPA”), the Public Utility Holding Company Act of 1935 (“PUHCA”) (repealed effective February 2006), and certain state laws regulating the rates charged by, or the financial and organizational activities of, electric utilities. PURPA was enacted in 1978 to encourage the development of, among other things, utility electricity generating facilities by requiring electric utilities to offer to purchase electric energy from and sell electric energy to QFs at non-discriminatory rates. The exemptions afforded by PURPA to QFs from regulation under the FPA and most aspects of state electric utility regulation are of great importance to us and our competitors in the energy-from-waste and independent power industries. Except with respect to energy-from-waste facilities with a net power production capacity in excess of 30 MW (where rates are set by the FERC), state public utility commissions must approve the rates, and in some instances other contract terms, by which public utilities purchase electric power from QFs.
 
The Energy Policy Act of 2005, passed in August 2005, made certain changes to the federal energy laws applicable to our business, the most significant of which are described below:
 
  •  The Energy Policy Act repealed PUHCA, effective February 2006. PUHCA previously imposed extensive, utility-type regulation and reporting requirements on non-exempt PUHCA holding companies. The repeal of PUHCA has been balanced with increased FERC authority to cause record keeping and conduct investigations under appropriate circumstances. As a company that owns only QFs, exempt wholesale generators and/or foreign utility companies, we are generally exempt from such record keeping and such investigations.
  •  The Energy Policy Act amended certain provisions of PURPA. It terminated PURPA’s mandatory purchase (and sale) obligation imposed on utilities for the benefit of QFs where the QF has non-discriminatory access to competitive power markets. Existing contracts are grandfathered, but many expansions, renewals and new development projects must rely on competitive power markets, rather than the mandatory purchase (and sale) obligations of PURPA in establishing and maintaining their viability in most geographic regions in which we operate. The Energy Policy Act also eliminated the limitations on utility ownership of QFs. In October 2006, FERC issued final regulations under the Energy Policy Act providing for, among other things, a rebuttable presumption that (1) the competitive power market requirement is satisfied in regions served by Midwest Independent Transmission System Operator, PJM Interconnection, L.L.C., ISO New England, Inc., New York Independent System Operator and the Electric Reliability Council of Texas, and (2) QFs with a capacity greater than 20 MW have non-discriminatory access to those markets. As to QFs with a capacity at or below 20 MW, the regulations provide for a rebuttable presumption that such QFs do not have non-discriminatory access to any market.
  •  The Energy Policy Act’s elimination of the limitation on utility ownership of QFs could result in greater utility ownership of QFs than previously was the case due to PURPA and PUHCA restrictions and considerations. If these transactions and development projects occur in the areas of energy-from-waste


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  or other renewable energy, it could serve to increase competition with our businesses by bringing greater utility participation to these markets.
  •  The Energy Policy Act extends or establishes certain renewable energy incentives and tax credits which might be helpful to expand our businesses or for new development.
 
Recent Policy Debate Regarding Climate Change
 
Increased public and political debate has occurred recently over the need for additional regulation of greenhouse gas (“GHG”) emissions (principally carbon dioxide (“CO2”) and methane) as a contributor to climate change. Such regulations could in the future affect our business. As is the case with all combustion, our facilities do emit CO2, however we believe that energy-from-waste creates net reductions in GHG emissions, because it also avoids CO2 emissions from fossil fuel power plants, methane emissions from landfills, and GHG emissions from mining and processing metal. In addition, energy-from-waste facilities typically are located closer to the source of the waste and thus typically reduce fossil fuel consumption and air emissions associated with long-haul transportation of waste to landfills. For policy makers at the local level, who make decisions on waste disposal alternatives, we believe that using energy-from-waste instead of landfilling will result in significantly lower net GHG emissions, while also introducing more control over the cost of waste disposal and supply of local electrical power. We are actively engaged in encouraging policy makers at state and federal levels to enact legislation that supports energy-from-waste as a superior choice for communities to avoid both the environmental harm caused by landfilling waste, and reduce local reliance on fossil fuels as a source of energy.
 
During 2007, substantial debate occurred in Congress in the context of energy legislation with respect to proposed policy changes designed to encourage electricity generation from renewable sources. While the final energy legislation, enacted during December 2007, did not include specific requirements for electricity generation from renewable sources, Congress is expected to continue to debate and ultimately enact some form of legislation regarding the need to encourage renewable electricity generation. The extent to which such potential legislation will affect our business will depend in part on whether energy-from-waste and our other renewable technologies are included within the range of renewable technologies that could benefit from such legislation.
 
Congress is also expected to debate proposed legislation addressing climate change, which would require regulation of a broad range of activities affecting climate, potentially including the operation of our facilities. Certain proposed legislation would establish a “cap and trade” program for CO2 emissions with a market-based emissions trading system aimed at reducing emissions of CO2 below baseline levels. We cannot predict at this time whether our facilities would be included within the scope of potential regulation under such climate change legislation, or whether our business will otherwise be affected positively or negatively.
 
While the political discussion in Congress, as well as at the state and regional levels, has not been aimed specifically at waste or energy-from-waste businesses, regulatory initiatives developed to date have been broad in scope and designed generally to promote renewable energy, develop a certified GHG inventory, and ultimately reduce GHG emissions. Many of these more developed initiatives have been at the state or regional levels, and some initiatives exist in regions where we have projects. For example, during 2006, a group of seven northeastern states, including Connecticut, New Jersey and New York, acting through the Regional Greenhouse Gas Initiative (“RGGI”), issued a “model rule” to implement reductions in GHG emissions. The RGGI model rule also featured a “cap and trade” program for regional CO2 emissions, initially fixed at 1990 levels, followed by incremental reductions below those levels after 2014. To date, RGGI has been focused on fossil fuel-fired electric generators and does not directly affect energy-from-waste facilities; however, we continue to monitor developments with respect to state implementation of RGGI and intend to participate in rulemaking.
 
We expect that initiatives intended to reduce GHG, such as RGGI and any federal legislation that would impose similar “cap and trade” programs, may cause electricity prices to rise, thus potentially affecting the prices at which we sell electricity from our facilities which sell into the market.
 
Among states, California has assumed a leadership role in curtailing GHG emissions. During 2006, California enacted the California Global Warming Solutions Act of 2006 (“AB 32”). AB 32 requires annual reporting of GHG emissions for sources deemed “significant” by California’s Air Resources Board (“CARB”) and sets emission limits to cut California’s emissions to 1990 levels by 2020. During 2006, we joined the California Climate Action


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Registry, certifying our GHG emissions from our California facilities. As a member, we will participate in the evolving regulatory process by which the CARB will implement the requirements of AB 32. Until CARB issues its regulatory GHG emission reduction program, we cannot predict with certainty the impact of AB 32 on our California facilities.
 
We have also joined The Climate Registry, a voluntary, collaborative North American GHG emissions registry that is directed by environmental regulators from member states and is supported by regional air quality consortiums. The mission of The Climate Registry is to create a single GHG emissions reporting and verification platform for use throughout North America, using a reporting protocol similar to that already in place in California. The Climate Registry presently includes 39 states (including all but one of the states in which we have operations), the District of Columbia, three Native American tribes, six Canadian Provinces and two Mexican states. In joining The Climate Registry, we will voluntarily report GHG emissions from our energy-from-waste and other technologies. We also plan to participate in rulemaking efforts at the state and federal level which may rely on The Climate Registry as the basis for GHG regulation. To date, at least 54 corporations, state and local governments, and other organizations have joined The Climate Registry as voluntary reporters of GHG emissions.
 
Regulations Affecting Our International Business
 
We have ownership and operating interests in energy generation facilities outside the United States. Most countries have expansive systems for the regulation of the energy business. These generally include provisions relating to ownership, licensing, rate setting and financing of generation and transmission facilities.
 
We provide waste and energy services through environmentally protective project designs, regardless of the location of a particular project. Compliance with environmental standards comparable to those of the United States are often conditions to credit agreements by multilateral banking agencies, as well as other lenders or credit providers. The laws of various countries include pervasive regulation of emissions into the environment, and provide governmental entities with the authority to impose sanctions for violations, although these requirements are generally different from those applicable in the United States. See Item 1A. Risk Factors — Exposure to international economic and political factors may materially and adversely affect our international businesses and — Compliance with environmental laws could adversely affect our results of operations.
 
Climate Change Policies
 
Certain international markets in which we compete have recently adopted regulatory or policy frameworks that encourage energy-from-waste projects as important components of GHG reduction strategies, as well as waste management planning and practice. For example, the European Union has adopted regulations which require member countries to reduce utilization of and reliance upon landfill disposal. The legislation emanating from the European Union is primarily in the form of “Directives,” which are not directly applicable within the member countries. Rather, they need enabling legislation to implement them, which results in significant variance between the legislative schemes introduced by member countries. Certain Directives notably affect the regulation of energy-from-waste facilities across the European Union. These include (1) Directive 96/61/EC concerning integrated pollution prevention and control (known as the “PPC Directive”) which governs emissions to air, land and water from certain large industrial installations, (2) Directive 1999/31/EC concerning the landfill of waste (known as the “Landfill Directive”) which imposes operational and technical controls on landfills and restricts, on a reducing scale to the year 2020, the amount of biodegradable municipal waste which member countries may dispose of to landfill, and (3) Directive 2000/76/EC concerning the incineration of waste (known as the “Waste Incineration Directive” or “WID”), which imposes limits on emissions to air from the incineration and co-incineration of waste. Member countries have begun to implement measures such as imposing incremental fees on landfill disposal and providing rate subsidies for energy generated at energy-from-waste projects.
 
In response to these directives and in furtherance of its policies to reduce GHG, the United Kingdom now imposes substantial taxes on landfilling of waste: currently £24/ton, increasing annually to £48/ton in 2010. In addition, each local waste authority in the United Kingdom is limited in the amount of biodegradable waste it may landfill each year by the Landfill Allowance Trading Scheme (known as “LATS”). LATS is structured as a cap-and-trade program which reduces the capped amount of this waste that can be landfilled each year, through


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2016 when capped amounts will be fixed at 35% of 1995 levels. LATS allowances are tradable with other waste authorities, and substantial penalties of £150/ton are levied against authorities not in compliance.
 
Similarly, China currently has a favorable regulatory environment for the development of energy-from-waste projects. The National Plan issued by the Ministry of Construction sets guidelines for an increase in energy-from-waste capacity from 1.65% (2005 estimate) to 30% by 2030. The Chinese central government has further called for an increase in energy-from-waste output generation from 200 MW (2005 estimate) to 500 MW by 2010, and to three gigawatts by 2020. Energy-from-waste is designated by the Chinese central government as an “encouraged industry”, and accordingly, China has various promotional laws and policies in place to promote energy-from-waste projects including exemptions and reductions of corporate income tax, value added tax refunds, prioritized commercial bank loans, state subsidies for loan interest, and a guaranteed subsidized price for the sale of electricity.
 
EMPLOYEES
 
As of December 31, 2007, we employed approximately 3,500 full-time employees worldwide, of which a majority are employed in the United States.
 
Of our employees in the United States, approximately 10% are represented by organized labor. Currently, we are party to seven collective bargaining agreements: three expired in 2007 and are pending extensions; one expires in 2008, two expire in 2009, and one expires in 2010.
 
We consider relations with our employees to be good and do not anticipate any significant labor disputes in 2008.
 
EXECUTIVE OFFICERS
 
A list of our executive officers and their business experience follows. Ages shown are as of February 22, 2008.
 
Anthony J. Orlando was named President and Chief Executive Officer in October 2004. Mr. Orlando was elected as one of our directors in September 2005 and is a member of the Public Policy Committee and the Finance Committee. Previously, he had been President and Chief Executive Officer of Covanta Energy since November 2003. From March 2003 to November 2003, he served as Senior Vice President, Business and Financial Management of Covanta Energy. From January 2001 until March 2003, Mr. Orlando served as Covanta Energy’s Senior Vice President, Waste-to-Energy. Previously, he served as Executive Vice President of Covanta Energy Group, Inc. Mr. Orlando joined Covanta Energy in 1987. Age: 48.
 
Mark A. Pytosh was appointed as Executive Vice President and Chief Financial Officer in December 2007. Mr. Pytosh served as Senior Vice President and Chief Financial Officer since September 2006. Previously, Mr. Pytosh served as Executive Vice President from February 2004 to August 2006 and Chief Financial Officer from May 2005 to August 2006 of Waste Services, Inc., a publicly-traded integrated waste services company. Prior to his tenure with Waste Services Inc., Mr. Pytosh served as a Managing Director in Investment Banking at Lehman Brothers where he led the firm’s Global Industrial Group, from November 2000 to February 2004. Before joining Lehman Brothers in 2000, Mr. Pytosh had 15 years of investment banking experience at Donaldson, Lufkin & Jenrette and Kidder, Peabody. Age: 43.
 
John M. Klett was appointed as our Executive Vice President and Chief Operating Officer in December 2007. Mr. Klett served as Senior Vice President and Chief Operating Officer of Covanta Energy since May 2006 and as Covanta Energy’s Senior Vice President, Operations since March 2003. Prior thereto, he served as Executive Vice President of Covanta Waste to Energy, Inc. for more than five years. Mr. Klett joined Covanta Energy in 1986. Mr. Klett has been in the energy-from-waste business since 1977. He has been in the power business since 1965. Age: 61.
 
Seth Myones was appointed as Covanta Energy’s President, Americas, in November 2007, which is comprised principally of Covanta Energy’s domestic business. Mr. Myones served as Covanta Energy’s Senior Vice President, Business Management, since January 2004. From September 2001 until January 2004, Mr. Myones served as Vice


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President, Waste-to-Energy Business Management for Covanta Projects, Inc., a wholly-owned subsidiary of Covanta Energy. Mr. Myones joined Covanta Energy in 1989. Age: 49.
 
Timothy J. Simpson was appointed as Executive Vice President, General Counsel and Secretary in December 2007. Mr. Simpson served as Senior Vice President, General Counsel and Secretary since October 2004. Previously, he served as Senior Vice President, General Counsel and Secretary of Covanta Energy since March 2004. From June 2001 to March 2004, Mr. Simpson served as Vice President, Associate General Counsel and Assistant Secretary of Covanta Energy. Previously, he served as Senior Vice President, Associate General Counsel and Assistant Secretary of Covanta Energy Group, Inc. Mr. Simpson joined Covanta Energy in 1992. Age: 49.
 
Thomas E. Bucks has served as Vice President and Chief Accounting Officer since April 2005. Mr. Bucks served as Controller from February 2005 to April 2005. Previously, Mr. Bucks served as Senior Vice President — Controller of Centennial Communications Corp., a leading provider of regional wireless and integrated communications services in the United States and the Caribbean, from March 1995 through February 2005, where he was the principal accounting officer and was responsible for accounting operations and external financial reporting. Age: 51.
 
Item 1A.   RISK FACTORS
 
The following risk factors could have a material adverse effect on our business, financial condition and results of operations.
 
We cannot be certain that our NOLs will continue to be available to offset tax liability.
 
Our NOLs will expire in various amounts, if not used, between 2009 and 2026. The Internal Revenue Service (“IRS”) has not audited any of our tax returns for any of the years during the carryforward period including those returns for the years in which the losses giving rise to the NOLs were reported. We cannot assure you that we would prevail if the IRS were to challenge the availability of the NOLs. If the IRS were successful in challenging our NOLs, all or some portion of the NOLs would not be available to offset our future consolidated taxable income.
 
As of December 31, 2007, we estimated that we had approximately $275 million of NOLs. In order to utilize the NOLs, we must generate consolidated taxable income which can offset such carryforwards. The NOLs are also used to offset income from certain grantor trusts that were established as part of the reorganization in 1990 of certain of our subsidiaries engaged in the insurance business and are administered by state regulatory agencies. During or at the conclusion of the administration of these grantor trusts, taxable income could result, which could utilize a portion of our NOLs and, in turn, could accelerate the date on which we may be otherwise obligated to pay incremental cash taxes.
 
In addition, if our existing insurance business were to require capital infusions from us in order to meet certain regulatory capital requirements, and we were to fail to provide such capital, some or all of our subsidiaries comprising our insurance business could enter insurance insolvency or bankruptcy proceedings. In such event, such subsidiaries may no longer be included in our consolidated tax return, and a portion, which could constitute a significant portion, of our remaining NOLs may no longer be available to us. In such event, there may be a significant inclusion of taxable income in our federal consolidated income tax return.
 
Changes in public policies and legislative initiatives could materially affect our business and prospects.
 
There has been substantial debate recently in the United States and abroad in the context of environmental and energy policies affecting climate change, the outcome of which could have a positive or negative influence on our existing business and our prospects for growing our business. The United States Congress has recently considered the enactment of new laws that would encourage electricity generation from renewable technologies and discourage such generation from fossil fuels. For example, during 2007 Congress considered proposed legislation which would have established new “renewable portfolio standards” which are designed to increase the proportion of the nation’s electricity that is generated from renewable technologies. Congress also considered extending existing tax benefits to renewable energy technologies, which will expire without such an extension. Both of these policy initiatives, and potentially others that may be considered, could provide material financial and competitive benefits to those


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technologies which are included among those defined as renewable in any legislation that is enacted. Our business could be adversely affected if renewable technologies we use were not included among those technologies identified in any final law as being entitled to the benefits of such laws.
 
Changes in technology may have a material adverse effect on our profitability.
 
Research and development activities are ongoing to provide alternative and more efficient technologies to dispose of waste, produce by-products from waste, or to produce power. We and many other companies are pursuing these technologies, and an increasing amount of capital is being invested to find new approaches to waste disposal, waste treatment, and power generation. It is possible that this deployment of capital may lead to advances in these or other technologies which will reduce the cost of waste disposal or power production to a level below our costs and/or provide new or alternative methods of waste disposal or energy generation that become more accepted than those we currently utilize. Unless we are able to participate in these advances, any of these changes could have a material adverse effect on our revenues, profitability and the value of our existing facilities.
 
Operation of our facilities involves significant risks.
 
The operation of our facilities involves many risks, including:
 
  •  the inaccuracy of our assumptions with respect to the timing and amount of anticipated revenues;
  •  supply interruptions;
  •  the breakdown or failure of equipment or processes;
  •  difficulty or inability to find suitable replacement parts for equipment;
  •  increases in the prices of commodities we need to continue operating our facilities;
  •  the unavailability of sufficient quantities of waste or fuel;
  •  decreases in the fees for solid waste disposal and electricity generated;
  •  decreases in the demand or market prices for recovered ferrous or non-ferrous metal;
  •  disruption in the transmission of electricity generated;
  •  permitting and other regulatory issues, license revocation and changes in legal requirements;
  •  labor disputes and work stoppages;
  •  unforeseen engineering and environmental problems;
  •  unanticipated cost overruns;
  •  weather interferences, catastrophic events including fires, explosions, earthquakes, droughts and acts of terrorism;
  •  the exercise of the power of eminent domain; and
  •  performance below expected levels of output or efficiency.
 
We cannot predict the impact of these risks on our business or operations. These risks, if they were to occur, could prevent us from meeting our obligations under our operating contracts and have an adverse affect on our results of operations.
 
Development and construction of new projects and expansions may not commence as anticipated, or at all.
 
The development and construction of new waste and energy facilities involves many risks including:
 
  •  difficulties in identifying, obtaining and permitting suitable sites for new projects;
  •  the inaccuracy of our assumptions with respect to the cost of and schedule for completing construction;
  •  difficulty, delays or inability to obtain financing for a project on acceptable terms;
  •  delays in deliveries of, or increases in the prices of, equipment sourced from other countries;
  •  the unavailability of sufficient quantities of waste or other fuels for startup;
  •  permitting and other regulatory issues, license revocation and changes in legal requirements;
  •  labor disputes and work stoppages;
  •  unforeseen engineering and environmental problems;
  •  unanticipated cost overruns; and


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  •  weather interferences, catastrophic events including fires, explosions, earthquakes, droughts and acts of terrorism.
 
In addition, new facilities have no operating history and may employ recently developed technology and equipment. Our businesses maintain insurance to protect against risks relating to the construction of new projects; however, such insurance may not be adequate to cover lost revenues or increased expenses. As a result, a new facility may be unable to fund principal and interest payments under its debt service obligations or may operate at a loss. In certain situations, if a facility fails to achieve commercial operation, at certain levels or at all, termination rights in the agreements governing the facility’s financing may be triggered, rendering all of the facility’s debt immediately due and payable. As a result, the facility may be rendered insolvent and we may lose our interest in the facility.
 
Construction activities may cost more and take longer than we estimate.
 
The design and construction of new projects or expansions requires us to contract for services from engineering and construction firms, and make substantial purchases of equipment such as boilers, turbine generators and other components that require large quantities of steel to fabricate. In part because of the high world-wide demand for new energy generating facilities and waste disposal facilities, steel prices have risen sharply and may continue to do so. In addition, this increased demand affects not only the cost of obtaining the services necessary to design and construct these facilities, but also the availability of quality firms to perform the services. These conditions may adversely affect our ability to successfully compete for new projects, or construct and complete such projects on time and within budget.
 
The rapid growth of our operations could strain our resources and cause our business to suffer.
 
We have experienced rapid growth and intend to further grow our business. This growth has placed, and potential future growth will continue to place, a strain on our management systems, infrastructure and resources. Our ability to successfully offer services and implement our business plan in a rapidly evolving market requires an effective planning and management process. We expect that we will need to continually evaluate and maintain our financial and managerial controls, reporting systems and procedures. We will also need to expand, train and manage our workforce worldwide. Furthermore, we expect that we will be required to manage an increasing number of relationships with various customers and other third parties. Failure to expand in any of the foregoing areas efficiently and effectively could interfere with the growth and current operation of our business as a whole.
 
Our efforts to grow our business will require us to incur significant costs in business development, often over extended periods of time, with no guarantee of success.
 
Our efforts to grow our waste and energy business will depend in part on how successful we are in developing new projects and expanding existing projects. The development period for each project may occur over several years, during which we incur substantial expenses relating to siting, design, permitting, community relations, financing and professional fees associated with all of the foregoing. Not all of our development efforts will be successful, and we may decide to cease developing a project for a variety of reasons. If the cessation of our development efforts were to occur at an advanced stage of development, we may have incurred a material amount of expenses for which we will realize no return.
 
A failure to identify suitable acquisition candidates and to complete acquisitions could have an adverse effect on our business strategy and growth plans.
 
As part of our business strategy, we intend to continue to pursue acquisitions of complementary businesses. Although we regularly evaluate acquisition opportunities, we may not be able to successfully identify suitable acquisition candidates, obtain sufficient financing on acceptable terms to fund acquisitions or complete acquisitions.


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Our insurance and contractual protections may not always cover lost revenues, increased expenses or liquidated damages payments.
 
Although our businesses maintain insurance, obtain warranties from vendors, require contractors to meet certain performance levels and, in some cases, pass risks we cannot control to the service recipient or output purchaser, the proceeds of such insurance, warranties, performance guarantees or risk sharing arrangements may not be adequate to cover lost revenues, increased expenses or liquidated damages payments.
 
Performance reductions could materially and adversely affect us and our projects may operate at lower levels than expected.
 
Most service agreements for our energy-from-waste facilities provide for limitations on damages and cross-indemnities among the parties for damages that such parties may incur in connection with their performance under the service agreement. In most cases, such contractual provisions excuse our businesses from performance obligations to the extent affected by uncontrollable circumstances and provide for service fee adjustments if uncontrollable circumstances increase our costs. We cannot assure you that these provisions will prevent our businesses from incurring losses upon the occurrence of uncontrollable circumstances or that if our businesses were to incur such losses they would continue to be able to service their debt.
 
We have issued or are party to performance guarantees and related contractual obligations associated with our energy and waste facilities. With respect to our domestic and international businesses, we have issued guarantees to our municipal clients and other parties that we will perform in accordance with contractual terms, including, where required, the payment of damages or other obligations. The obligations guaranteed will depend upon the contract involved. Many of our subsidiaries have contracts to operate and maintain energy-from-waste facilities. In these contracts, the subsidiary typically commits to operate and maintain the facility in compliance with legal requirements; to accept minimum amounts of solid waste; to generate a minimum amount of electricity per ton of waste; and to pay damages to contract counterparties under specified circumstances, including those where the operating subsidiary’s contract has been terminated for default. Any contractual damages or other obligations incurred by us could be material, and in circumstances where one or more subsidiary’s contract has been terminated for its default, such damages could include amounts sufficient to repay project debt. Additionally, damages payable under such guarantees on our owned energy-from-waste facilities could expose us to recourse liability on project debt. Certain of our operating subsidiaries which have issued these guarantees may not have sufficient sources of cash to pay such damages or other obligations. We cannot assure you that we will be able to continue to avoid incurring material payment obligations under such guarantees or that, if we did incur such obligations, that we would have the cash resources to pay them.
 
Our businesses generate their revenue primarily under long-term contracts and must avoid defaults under those contracts in order to service their debt and avoid material liability to contract counterparties.
 
We must satisfy performance and other obligations under contracts governing energy-from-waste facilities. These contracts typically require us to meet certain performance criteria relating to amounts of waste processed, energy generation rates per ton of waste processed, residue quantity and environmental standards. Our failure to satisfy these criteria may subject us to termination of operating contracts. If such a termination were to occur, we would lose the cash flow related to the projects and incur material termination damage liability, which may be guaranteed by us. In circumstances where the contract has been terminated due to our default, we may not have sufficient sources of cash to pay such damages. We cannot assure you that we will be able to continue to perform our respective obligations under such contracts in order to avoid such contract terminations, or damages related to any such contract termination, or that if we could not avoid such terminations that we would have the cash resources to pay amounts that may then become due.
 
We have provided guarantees and financial support in connection with our projects.
 
We are obligated to guarantee or provide financial support for our projects in one or more of the following forms:
 
  •  support agreements in connection with service or operating agreement-related obligations;


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  •  direct guarantees of certain debt relating to our facilities;
  •  contingent obligations to pay lease payment installments in connection with certain of our facilities;
  •  agreements to arrange financing for projects under development;
  •  contingent credit support for damages arising from performance failures;
  •  environmental indemnities; and
  •  contingent capital and credit support to finance costs, in most cases in connection with a corresponding increase in service fees, relating to uncontrollable circumstances.
 
Many of these contingent obligations cannot readily be quantified, but, if we were required to provide this support, it may be material to our cash flow and financial condition.
 
We may face increased risk of market influences on our revenues after our contracts expire.
 
Our contracts to operate energy-from-waste projects expire on various dates between 2008 and 2034, and our contracts to sell energy output generally expire when the project’s operating contract expires. Expiration of these contracts will subject us to greater market risk in entering into new or replacement contracts at pricing levels which will generate comparable or enhanced revenues. As our operating contracts at municipally-owned projects approach expiration, we will seek to enter into renewal or replacement contracts to continue operating such projects. However, we cannot assure you that we will be able to enter into renewal or replacement contracts on favorable terms, or at all. We will seek to bid competitively for additional contracts to operate other facilities as similar contracts of other vendors expire. The expiration of existing energy sales contracts, if not renewed, will require us to sell project energy output either into the electricity grid or pursuant to new contracts.
 
At some of our facilities, market conditions may allow us to effect extensions of existing operating contracts along with facility expansions. Such extensions and expansions are currently being considered at a limited number of our facilities in conjunction with our clients. If we are unable to reach agreement with our municipal clients on the terms under which they would implement such extensions and expansions, or if the implementation of these extensions, including renewals and replacement contracts, and expansions are materially delayed, this may adversely affect our cash flow and profitability. We cannot assure you that we will be able to enter into such contracts or that the terms available in the market at the time will be favorable to us.
 
Our businesses depend on performance by third parties under contractual arrangements.
 
Our waste and energy businesses depend on a limited number of third parties to, among other things, purchase the electric and steam energy produced by our facilities, and supply and deliver the waste and other goods and services necessary for the operation of our energy facilities. The viability of our facilities depends significantly upon the performance by third parties in accordance with long-term contracts, and such performance depends on factors which may be beyond our control. If those third parties do not perform their obligations, or are excused from performing their obligations because of nonperformance by our waste and energy businesses or other parties to the contracts, or due to force majeure events or changes in laws or regulations, our businesses may not be able to secure alternate arrangements on substantially the same terms, if at all, for the services provided under the contracts. In addition, the bankruptcy or insolvency of a participant or third party in our facilities could result in nonpayment or nonperformance of that party’s obligations to us.
 
Concentration of suppliers and customers may expose us to heightened financial exposure.
 
Our waste and energy services businesses often rely on single suppliers and single customers at our facilities, exposing such facilities to financial risks if any supplier or customer should fail to perform its obligations.
 
For example, our businesses often rely on a single supplier to provide waste, fuel, water and other services required to operate a facility and on a single customer or a few customers to purchase all or a significant portion of a facility’s output. In most cases our businesses have long-term agreements with such suppliers and customers in order to mitigate the risk of supply interruption. The financial performance of these facilities depends on such customers and suppliers continuing to perform their obligations under their long-term agreements. A facility’s financial results could be materially and adversely affected if any one customer or supplier fails to fulfill its contractual obligations and we are unable to find other customers or suppliers to produce the same level of


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profitability. We cannot assure you that such performance failures by third parties will not occur, or that if they do occur, such failures will not adversely affect the cash flows or profitability of our businesses.
 
In addition, we rely on the municipal clients as a source not only of waste for fuel but also of revenue from the fees for disposal services we provide. Because our contracts with municipal clients are generally long-term, we may be adversely affected if the credit quality of one or more of our municipal clients were to decline materially.
 
Our business is subject to pricing fluctuations caused by the waste disposal and energy markets.
 
While we sell the majority of our waste disposal capacity and energy output pursuant to long-term contracts, a material portion of this capacity and output is subject to market price fluctuation. Consequently, our operating results may be adversely affected by fluctuations in waste disposal and energy prices.
 
Our waste operations are concentrated in one region, and expose us to regional economic or market declines.
 
The majority of our waste disposal facilities are located in the northeastern United States, primarily along the Washington, D.C. to Boston, Massachusetts corridor. Adverse economic developments in this region could affect regional waste generation rates and demand for waste disposal services provided by us. Adverse market developments caused by additional waste disposal capacity in this region could adversely affect waste disposal pricing. Either of these developments could have a material adverse effect on our revenues and cash generation.
 
Some of our energy contracts involve greater risk of exposure to performance levels which could result in materially lower revenues.
 
Some of our energy-from-waste facilities receive 100% of the energy revenues they generate. As a result, if we are unable to operate these facilities at their historical performance levels for any reason, our revenues from energy sales could materially decrease.
 
Exposure to international economic and political factors may materially and adversely affect our international businesses.
 
Our international operations expose us to political, legal, tax, currency, inflation, convertibility and repatriation risks, as well as potential constraints on the development and operation of potential business, any of which can limit the benefits to us of an international project.
 
Our projected cash distributions from most of our existing international facilities come from facilities located in countries with sovereign ratings below investment grade. The financing, development and operation of projects outside the United States can entail significant political and financial risks, which vary by country, including:
 
  •  changes in law or regulations;
  •  changes in electricity pricing;
  •  changes in foreign tax laws and regulations;
  •  changes in United States federal, state and local laws, including tax laws, related to foreign operations;
  •  compliance with United States federal, state and local foreign corrupt practices laws;
  •  changes in government policies or personnel;
  •  changes in general economic conditions affecting each country, including conditions in financial markets;
  •  changes in labor relations in operations outside the United States;
  •  political, economic or military instability and civil unrest;
  •  expropriation and confiscation of assets and facilities; and
  •  credit quality of entities that purchase our power.
 
The legal and financial environment in foreign countries in which we currently own assets or projects could also make it more difficult for us to enforce our rights under agreements relating to such projects.


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Any or all of the risks identified above with respect to our international projects could adversely affect our revenue and cash generation. As a result, these risks may have a material adverse effect on our business, consolidated financial condition and results of operations.
 
Our reputation could be adversely affected if opposition to our efforts to grow our business results in adverse publicity or our businesses were to fail to comply with United States or foreign laws or regulations.
 
With respect to our efforts to renew our contracts and grow our waste and energy business both domestically and internationally, we sometimes experience opposition from advocacy groups or others intended to halt a development effort or other opportunity we may be pursuing. Such opposition is often intended to discourage third parties from doing business with us and may be based on inaccurate, incomplete or inflammatory assertions. We cannot provide any assurance that our reputation would not be adversely affected as a result of adverse publicity resulting from such opposition. Some of our projects and new business may be conducted in countries where corruption has historically penetrated the economy to a greater extent than in the United States. It is our policy to comply, and to require our local partners and those with whom we do business to comply, with all applicable anti-bribery laws, such as the U.S. Foreign Corrupt Practices Act and with applicable local laws of the foreign countries in which we operate. We cannot provide any assurance that our reputation would not be adversely affected if we were reported to be associated with corrupt practices or if we or our local partners failed to comply with such laws.
 
Exposure to foreign currency fluctuations may affect our results from operations.
 
We have sought to participate in projects where the host country has allowed the convertibility of its currency into U.S. dollars and repatriation of earnings, capital and profits subject to compliance with local regulatory requirements. As we grow our business in other countries and enter new international markets, currency volatility may impact the amount we are required to invest in new projects, as well our reported results.
 
In some cases, components of project costs incurred or funded in the currency of the United States are recovered with limited exposure to currency fluctuations through negotiated contractual adjustments to the price charged for electricity or service provided. This contractual structure may cause the cost in local currency to the project’s power purchaser or service recipient to rise from time to time in excess of local inflation. As a result, there is a risk in such situations that such power purchaser or service recipient will, at least in the near term, be less able or willing to pay for the project’s power or service.
 
Exposure to fuel supply prices may affect our costs and results of operations for our international projects.
 
Changes in the market prices and availability of fuel supplies to generate electricity may increase our cost of producing power, which could adversely impact our energy businesses’ profitability and financial performance.
 
The market prices and availability of fuel supplies for some of our international facilities fluctuate. Any price increase, delivery disruption or reduction in the availability of such supplies could affect our ability to operate the facilities and impair their cash flow and profitability. We may be subject to further exposure if any of our future international operations are concentrated in facilities using fuel types subject to fluctuating market prices and availability. We may not be successful in our efforts to mitigate our exposure to supply and price swings.
 
Our inability to obtain resources for operations may adversely affect our ability to effectively compete.
 
Our energy-from-waste facilities depend on solid waste for fuel, which provides a source of revenue. For most of our facilities, the prices we charge for disposal of solid waste are fixed under long-term contracts and the supply is guaranteed by sponsoring municipalities. However, for some of our energy-from-waste facilities, the availability of solid waste to us, as well as the tipping fee that we must charge to attract solid waste to our facilities, depends upon competition from a number of sources such as other energy-from-waste facilities, landfills and transfer stations competing for waste in the market area. In addition, we may need to obtain waste on a competitive basis as our long-term contracts expire at our owned facilities. There has been consolidation and there may be further consolidation in the solid waste industry which would reduce the number of solid waste collectors or haulers that are


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competing for disposal facilities or enable such collectors or haulers to use wholesale purchasing to negotiate favorable below-market disposal rates. The consolidation in the solid waste industry has resulted in companies with vertically integrated collection activities and disposal facilities. Such consolidation may result in economies of scale for those companies as well as the use of disposal capacity at facilities owned by such companies or by affiliated companies. Such activities can affect both the availability of waste to us for disposal at some of our energy-from-waste facilities and market pricing.
 
Compliance with environmental laws could adversely affect our results of operations.
 
Costs of compliance with federal, state, local and foreign existing and future environmental regulations could adversely affect our cash flow and profitability. Our waste and energy businesses are subject to extensive environmental regulation by federal, state and local authorities, primarily relating to air, waste (including residual ash from combustion) and water. We are required to comply with numerous environmental laws and regulations and to obtain numerous governmental permits in operating our facilities. Our businesses may incur significant additional costs to comply with these requirements. Environmental regulations may also limit our ability to operate our facilities at maximum capacity or at all. If our businesses fail to comply with these requirements, we could be subject to civil or criminal liability, damages and fines. Existing environmental regulations could be revised or reinterpreted and new laws and regulations could be adopted or become applicable to us or our facilities, and future changes in environmental laws and regulations could occur. This may materially increase the amount we must invest to bring our facilities into compliance, or impose additional expense on our operations, or otherwise impose structural changes to markets which would adversely affect our competitive positioning in those markets.
 
In addition, lawsuits or enforcement actions by federal, state and/or foreign regulatory agencies may materially increase our costs. Stricter environmental regulation of air emissions, solid waste handling or combustion, residual ash handling and disposal, and waste water discharge could materially affect our cash flow and profitability. Certain environmental laws make us potentially liable on a joint and several basis for the remediation of contamination at or emanating from properties or facilities we currently or formerly owned or operated or properties to which we arranged for the disposal of hazardous substances. Such liability is not limited to the cleanup of contamination we actually caused. Although we seek to obtain indemnities against liabilities relating to historical contamination at the facilities we own or operate, we cannot provide any assurance that we will not incur liability relating to the remediation of contamination, including contamination we did not cause.
 
Our businesses may not be able to obtain or maintain, from time to time, all required environmental regulatory approvals. If there is a delay in obtaining any required environmental regulatory approvals or if we fail to obtain and comply with them, the operation of our facilities could be jeopardized or become subject to additional costs.
 
Energy regulation could adversely affect our revenues and costs of operations.
 
Our waste and energy businesses are subject to extensive energy regulations by federal, state and foreign authorities. We cannot predict whether the federal, state or foreign governments will modify or adopt new legislation or regulations relating to the solid waste or energy industries. The economics, including the costs, of operating our facilities may be adversely affected by any changes in these regulations or in their interpretation or implementation or any future inability to comply with existing or future regulations or requirements.
 
The Federal Power Act (“FPA”) regulates energy generating companies and their subsidiaries and places constraints on the conduct of their business. The FPA regulates wholesale sales of electricity and the transmission of electricity in interstate commerce by public utilities. Under PURPA, our domestic facilities are exempt from most provisions of the FPA and state rate regulation. Our foreign projects are also exempt from regulation under the FPA.
 
The Energy Policy Act of 2005 enacted comprehensive changes to the domestic energy industry which may affect our businesses. The Energy Policy Act removed certain regulatory constraints that previously limited the ability of utilities and utility holding companies to invest in certain activities and businesses, which may have the effect over time of increasing competition in energy markets in which we participate. In addition, the Energy Policy Act includes provisions that may remove some of the benefits provided to non-utility electricity generators, like us, after our existing energy sale contracts expire. As a result, we may face increased competition after such expirations occur.


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If our businesses lose existing exemptions under the FPA, the economics and operations of our energy projects could be adversely affected, including as a result of rate regulation by the Federal Energy Regulatory Commission, with respect to our output of electricity, which could result in lower prices for sales of electricity. In addition, depending on the terms of the project’s power purchase agreement, a loss of our exemptions could allow the power purchaser to cease taking and paying for electricity under existing contracts. Such results could cause the loss of some or all contract revenues or otherwise impair the value of a project and could trigger defaults under provisions of the applicable project contracts and financing agreements. Defaults under such financing agreements could render the underlying debt immediately due and payable. Under such circumstances, we cannot assure you that revenues received, the costs incurred, or both, in connection with the project could be recovered through sales to other purchasers.
 
Failure to obtain regulatory approvals could adversely affect our operations.
 
Our waste and energy businesses are continually in the process of obtaining or renewing federal, state, local and foreign approvals required to operate our facilities. While our businesses currently have all necessary operating approvals, we may not always be able to obtain all required regulatory approvals, and we may not be able to obtain any necessary modifications to existing regulatory approvals or maintain all required regulatory approvals. If there is a delay in obtaining any required regulatory approvals or if we fail to obtain and comply with any required regulatory approvals, the operation of our facilities or the sale of electricity to third parties could be prevented, made subject to additional regulation or subject our businesses to additional costs or a decrease in revenue.
 
The energy industry is becoming increasingly competitive, and we might not successfully respond to these changes.
 
We may not be able to respond in a timely or effective manner to the changes resulting in increased competition in the energy industry in both domestic and international markets. These changes may include deregulation of the electric utility industry in some markets, privatization of the electric utility industry in other markets and increasing competition in all markets. To the extent competitive pressures increase and the pricing and sale of electricity assumes more characteristics of a commodity business, the economics of our business may be subject to greater volatility.
 
Our substantial indebtedness could adversely affect our business, financial condition and results of operations and our ability to meet our payment obligations under our indebtedness.
 
The level of our consolidated indebtedness could have significant consequences on our future operations, including:
 
  •  making it difficult for us to meet our payment and other obligations under our outstanding indebtedness, including the 1.00% Senior Convertible Debentures (the “Debentures”);
  •  limiting our ability to obtain additional financing to fund working capital, capital expenditures, acquisitions and other general corporate purposes;
  •  subjecting us to the risk of increased sensitivity to interest rate increases on indebtedness under our credit facilities;
  •  limiting our flexibility in planning for, or reacting to, and increasing our vulnerability to, changes in our business, the industries in which we operate and the general economy; and
  •  placing us at a competitive disadvantage compared to our competitors that have less debt or are less leveraged.
 
Any of the above-listed factors could have an adverse effect on our business, financial condition and results of operations and our ability to meet our payment obligations under our consolidated debt, and the price of our common stock.


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We cannot assure you that our cash flow from operations will be sufficient to service our indebtedness.
 
Our ability to meet our obligations under our indebtedness depends on our ability to generate cash and our ability to receive dividends and distributions from our subsidiaries in the future. This, in turn, is subject to many factors, some of which are beyond our control, including the following:
 
  •  the continued operation and maintenance of our facilities, consistent with historical performance levels;
  •  maintenance or enhancement of revenue from renewals or replacement of existing contracts and from new contracts to expand existing facilities or operate additional facilities;
  •  market conditions affecting waste disposal and energy pricing, as well as competition from other companies for contract renewals, expansions and additional contracts, particularly after our existing contracts expire; and
  •  general economic, financial, competitive, legislative, regulatory and other factors.
 
We cannot assure you that our business will generate cash flow from operations, or that future borrowings will be available to us under our credit facilities or otherwise, in an amount sufficient to enable us to meet our payment obligations under our outstanding indebtedness and to fund other liquidity needs. If we are not able to generate sufficient cash flow to service our debt obligations, we may need to refinance or restructure our debt, sell assets, reduce or delay capital investments, or seek to raise additional capital. If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations under our outstanding indebtedness, and which could have a material and adverse affect on our financial condition.
 
Our debt agreements contain covenant restrictions that may limit our ability to operate our business.
 
Our credit facilities contain operating and financial restrictions and covenants that impose operating and financial restrictions on us and require us to meet certain financial tests. Complying with these covenant restrictions may have a negative impact on our business, results of operations and financial condition by limiting our ability to engage in certain transactions or activities, including:
 
  •  incurring additional indebtedness or issuing guarantees, in excess of specified amounts;
  •  creating liens, in excess of specified amounts;
  •  making certain investments, in excess of specified amounts;
  •  entering into transactions with our affiliates;
  •  selling certain assets, in excess of specified amounts;
  •  making cash distributions or paying dividends to us, in excess of specified amounts;
  •  redeeming capital stock or making other restricted payments to us, in excess of specified amounts; and
  •  merging or consolidating with any person.
 
Our ability to comply with these covenants is dependent on our future performance, which will be subject to many factors, some of which are beyond our control, including prevailing economic conditions. As a result of these covenants, our ability to respond to changes in business and economic conditions and to obtain additional financing, if needed, may be restricted, and we may be prevented from engaging in transactions that might otherwise be beneficial to us, or in declaring and paying dividends to our stockholders. In addition, the failure to comply with these covenants in our credit facilities could result in a default thereunder and a default under the Debentures. Upon the occurrence of such an event of default, the lenders under our credit facilities could elect to declare all amounts outstanding under such agreement, together with accrued interest, to be immediately due and payable. If the lenders accelerate the payment of the indebtedness under our credit facilities, we cannot assure you that the assets securing such indebtedness would be sufficient to repay in full that indebtedness and our other indebtedness, including the Debentures, and which could have a material and adverse affect on our financial condition.
 
Our controls and procedures may not prevent or detect all errors or acts of fraud.
 
Our management, including our Chief Executive Officer and Chief Financial Officer, believes that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must consider the benefits of controls relative to their costs. Inherent limitations within a


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control system include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by an unauthorized override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Accordingly, because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and may not be prevented or detected.
 
Failure to maintain an effective system of internal control over financial reporting may have an adverse effect on our stock price.
 
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, and the rules and regulations promulgated by the Securities and Exchange Commission (“SEC”) to implement Section 404, we are required to furnish a report by our management to include in our annual report on Form 10-K regarding the effectiveness of our internal control over financial reporting. The report includes, among other things, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management.
 
We have in the past discovered, and may potentially in the future discover, areas of internal control over financial reporting which may require improvement. If we are unable to assert that our internal control over financial reporting is effective now or in any future period, or if our auditors are unable to express an opinion on the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.
 
Provisions of our certificate of incorporation and Debentures could discourage an acquisition by a third party.
 
Provisions of our restated certificate of incorporation could make it more difficult for a third party to acquire control of us. For example, our restated certificate of incorporation authorizes our Board of Directors to issue preferred stock without requiring any stockholder approval, and preferred stock could be issued as a defensive measure in response to a takeover proposal. These provisions could make it more difficult for a third party to acquire us even if an acquisition might be in the best interest of our stockholders. In addition, certain provisions of the Debentures could make it more difficult or more expensive for a third party to acquire us. Upon the occurrence of certain transactions constituting a fundamental change, the holders of the Debentures will have the right to require us to repurchase their Debentures. We may also be required to issue additional shares upon conversion or provide for conversion based on the acquirer’s capital stock in the event of certain fundamental changes. These possibilities could discourage an acquisition of us.
 
The market price of our common stock may fluctuate significantly, and this may make it difficult for holders to resell our common stock when they want or at prices that they find attractive.
 
The price of our common stock on the New York Stock Exchange constantly changes. We expect that the market price of our common stock will continue to fluctuate. In addition, because the Debentures are convertible into our common stock, volatility or depressed prices for our common stock could have a similar effect on the trading price of the Debentures. Consequently, there can be no assurance as to the liquidity of an investment in our common stock.
 
The market price of our common stock may fluctuate as a result of a variety of factors, many of which are beyond our control. These factors include:
  •  changes in the waste and energy market conditions;
  •  quarterly variations in our operating results;
  •  our operating results that vary from the expectations of management, securities analysts and investors;
  •  changes in expectations as to our future financial performance;
  •  announcements of strategic developments, significant contracts, acquisitions and other material events by us or our competitors;


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  •  the operating and securities price performance of other companies that investors believe are comparable to us;
  •  future sales of our equity or equity-related securities;
  •  changes in the economy and the financial markets;
  •  departures of key personnel;
  •  changes in governmental regulations; and
  •  geopolitical conditions, such as acts or threats of terrorism or military conflicts.
 
In addition, in recent years, the stock market in general has experienced extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons often unrelated to their operating performance. These broad market fluctuations may adversely affect the market price of our common stock, regardless of our operating results.
 
Future issuances of our common stock will dilute the ownership interests of stockholders and may adversely affect the trading price of our common stock.
 
We are not restricted from issuing additional shares of our common stock, or securities convertible into or exchangeable for our common stock. Future sales of substantial amounts of our common stock or equity-related securities in the public market, or the perception that such sales could occur, could materially and adversely affect prevailing trading prices of our common stock. In addition, the conversion of some or all of the Debentures will dilute the ownership interests of our existing stockholders. Any sales in the public market of our common stock issuable upon such conversion could adversely affect prevailing market prices of our common stock. In addition, the existence of the Debentures may encourage short selling by market participants because the conversion of the Debentures could depress the trading price of our common stock.
 
Concentrated stock ownership may discourage unsolicited acquisition proposals.
 
As of February 14, 2008, SZ Investments, L.L.C., together with its affiliate, EGI-Fund (05-07) Investors, L.L.C., referred to as “Fund 05-07” and, collectively with SZ Investments, L.L.C. “SZ Investments,” and Third Avenue Trust, on behalf of Third Avenue Value Fund, referred to as “Third Avenue,” separately own approximately 15.1% and 5.7%, respectively, or when aggregated, approximately 20.8% of our outstanding common stock. Although there are no agreements among SZ Investments and Third Avenue regarding their voting or disposition of shares of our common stock, the level of their combined ownership of shares of our common stock could have the effect of discouraging or impeding an unsolicited acquisition proposal. Further, as a result, these stockholders may continue to have the ability to influence the election or removal of our directors and influence the outcome of matters presented for approval by our stockholders. Circumstances may occur in which the interests of these stockholders could be in conflict with the holders of the Debentures.
 
Item 1B.   UNRESOLVED STAFF COMMENTS
 
None.
 
Item 2.   PROPERTIES
 
We own 5.4 acres in Fairfield, New Jersey where our corporate offices reside. In addition, we lease various office facilities in California aggregating approximately 25,539 square feet and we own undeveloped land in Massachusetts and California aggregating approximately 95 acres. As of December 31, 2007, we owned or operated 60 domestic projects consisting of 34 energy-from-waste operations, three landfills, ten transfer stations, six wood waste (biomass) energy projects, two water (hydroelectric) energy projects, and five landfill gas energy projects. Principal projects are described above under Item 1. Business — Domestic Business. Domestic projects noted which we own or lease are conducted at properties, which we also own or lease, aggregating approximately 921 acres, of which approximately 580 acres are owned and approximately 341 acres are leased.


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We operate our international projects through a network of offices located in Shanghai and Guangzhou, China; Chennai, India; Manila, Philippines; Bangkok, Thailand; and Birmingham, England, where we lease office space aggregating approximately 23,370 square feet. As of December 31, 2007, we are the part owner/operator of ten international projects of which three are owned or controlled by subsidiaries with businesses conducted at leased properties aggregating approximately 65.8 acres. Principal projects are described above under Item 1. Business — International Business.
 
Item 3.   LEGAL PROCEEDINGS
 
For information regarding legal proceedings, see Note 21. Commitments and Contingencies of the Notes to the Consolidated Financial Statements in Item 8, which information is incorporated herein by reference.
 
Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted to a vote of stockholders, through the solicitation of proxies or otherwise, during the quarter ended December 31, 2007.


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PART II
 
Item 5.   MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our common stock is traded on the New York Stock Exchange under the symbol “CVA”. On February 14, 2008, there were approximately 1,033 holders of record of our common stock. On February 14, 2008, the closing price of our common stock on the New York Stock Exchange was $26.49 per share. The following table sets forth the high and low stock prices of our common stock for the last two years.
 
                                 
    2007     2006  
    High     Low     High     Low  
 
First Quarter
  $  24.22     $  21.29     $  18.15     $  14.61  
Second Quarter
  $ 26.35     $ 21.69     $ 18.60     $ 14.36  
Third Quarter
  $ 26.50     $ 20.60     $ 21.84     $ 16.04  
Fourth Quarter
  $ 28.82     $ 23.16     $ 22.84     $ 18.52  
 
We have not paid dividends on our common stock and do not expect to declare or pay any dividends in the foreseeable future. We currently intend to retain all earnings to fund operations and expansion of our business. Under current financing arrangements, there are restrictions on the ability of our subsidiaries to transfer funds to us in the form of cash dividends, loans or advances that would likely limit the future payment of dividends on our common stock. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — 2007 Recapitalization.
 
Item 6.   SELECTED FINANCIAL DATA
 
                                         
    For the Years Ended December 31,  
    2007     2006     2005(1)     2004(2)     2003(3)  
    (In thousands of dollars, except per share amounts)  
 
Statements of Operations Data
                                       
Operating revenues
  $  1,433,087     $  1,268,536     $  978,763     $  576,196     $ 41,123  
Equity in net income (loss) from unconsolidated investments
  $ 22,196     $ 28,636     $ 25,609     $ 17,024     $  (54,877 )
Net income (loss)
  $ 130,513     $ 105,789     $ 59,326     $ 34,094     $ (69,225 )
Income (loss) per share:
                                       
Basic
  $ 0.85     $ 0.73     $ 0.49     $ 0.39     $ (1.05 )
Diluted
  $ 0.85     $ 0.72     $ 0.46     $ 0.37     $ (1.05 )
Weighted average common shares outstanding:
                                       
Basic
    152,653       145,663       122,209       88,543       66,073  
Diluted
    153,997       147,030       127,910       91,199       66,073  
 
                                         
    As of December 31,  
    2007     2006     2005(1)     2004(2)     2003(3)  
    (In thousands of dollars, except per share amounts)  
 
Balance Sheet Data
                                       
Cash and cash equivalents
  $ 149,406     $ 233,442     $ 128,556     $ 96,148     $ 17,952  
Restricted funds held in trust
  $ 379,864     $ 407,921     $ 447,432     $ 239,918     $  
Property, plant and equipment, net
  $ 2,620,507     $ 2,637,923     $ 2,724,843     $ 819,400     $ 254  
Total assets
  $  4,368,499     $  4,437,820     $  4,702,165     $ 1,939,081     $  162,648  
Long-term debt
  $ 1,019,432     $ 1,260,123     $ 1,308,119     $ 312,896     $ 40,000  
Project debt
  $ 1,280,275     $ 1,435,947     $ 1,598,284     $ 944,737     $  
Stockholders’ equity
  $ 1,026,062     $ 739,152     $ 599,241     $ 134,815     $ 27,791  
Book value per share of common stock(4)
  $ 6.67     $ 5.01     $ 4.24     $ 1.84     $ 0.50  
Shares of common stock outstanding
    153,922       147,500       141,166       73,430       55,105  
 
 
(1) For the year ended December 31, 2005, Covanta ARC Holdings, Inc.’s results of operations were included in our consolidated results subsequent to June 24, 2005.


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(2) For the year ended December 31, 2004, Covanta Energy Corporation’s results of operations were included in our consolidated results subsequent to March 10, 2004.
 
(3) For the year ended December 31, 2003, equity in net loss from unconsolidated investments consisted of our equity in the net loss of former investees in the marine services business.
 
(4) Book value per share of common stock is calculated by dividing stockholders’ equity by the number of shares of common stock outstanding.
 
Item 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
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.
 
OVERVIEW
 
We are a leading developer, owner and operator of infrastructure for the conversion of waste to energy (known as “energy-from-waste”), as well as other waste disposal and renewable energy production businesses in the United States, Europe and Asia. 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 engage in the independent power production business outside the United States.
 
We own, have equity investments in, and/or operate 57 energy generation facilities, 47 of which are in the United States and 10 of which are located outside the United States. Our energy generation facilities use a variety of fuels, including municipal solid waste, wood waste (biomass), landfill gas, water (hydroelectric), natural gas, coal, and heavy fuel-oil. We also own or operate several businesses that are associated with our energy-from-waste business, including a waste procurement business, three landfills, and several waste transfer stations.
 
Our mission is to be the world’s leading energy-from-waste company, with a complementary network of renewable energy generation and waste disposal assets. We expect to build value for our stockholders by satisfying our clients’ waste disposal and energy generation needs with safe, reliable and environmentally superior solutions. In order to accomplish this mission and create additional value for our stockholders, we are focused on:
 
  •  providing customers with superior service and effectively managing our existing businesses;
  •  generating sufficient cash to meet our liquidity needs and invest in the business; and
  •  developing new projects and making acquisitions to grow our business in the United States, Europe and Asia.
 
We believe that our business offers solutions to public sector leaders around the world in two related elements of critical infrastructure: waste disposal and renewable energy generation. We believe that the environmental benefits of energy-from-waste, as an alternative to landfilling, are clear and compelling: utilizing energy-from-waste reduces greenhouse gas emissions, lowers the risk of groundwater contamination, and conserves land. At the same time, energy-from-waste generates clean, reliable energy from a renewable fuel source, thus reducing dependence on fossil fuels, the combustion of which is itself a major contributor to greenhouse gas emissions. As public planners in the United States, Europe and Asia address their needs for more environmentally sensitive waste disposal and energy generation in the years ahead, we believe that energy-from-waste will be an increasingly attractive alternative.
 
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. The extent to which we are successful in growing our business will depend in part on our ability to effectively communicate the benefits of energy-from-waste to public planners seeking waste disposal solutions, and to policy makers seeking to encourage renewable energy technologies as viable alternatives to reliance on fossil fuels as a source of energy.
 
Our business is capital intensive because it is based upon building and operating municipal solid waste processing and energy generating projects. In order to provide meaningful growth through development, we must be able to invest our funds, obtain equity and/or debt financing, and provide support to our operating subsidiaries. During the first quarter of 2007, we completed a comprehensive recapitalization utilizing a series of equity and debt financings. With this refinancing, we have greater flexibility to pursue strategic opportunities by investing in the


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business, and making acquisitions. Additional information related to our recapitalization is described below under Liquidity and Capital Resources — 2007 Recapitalization and Note 6. Long-Term Debt of the Notes to the Consolidated Financial Statements (“Notes”).
 
We continue to focus on enhancing stockholder value by implementing our financial, operating and growth strategies. Revenues were $1,433 million, $1,269 million and $979 million and operating income was $237 million, $227 million and $146 million for the years ended December 31, 2007, 2006, and 2005, respectively. The increase in revenues and operating income over the past three years is primarily attributable to the successful execution of our operating and growth strategies.
 
Acquisitions and Business Development
 
In our domestic business, we are pursuing additional growth opportunities through project expansions, new energy-from-waste and other renewable energy projects, contract extensions, acquisitions, and businesses ancillary to our existing business, such as additional waste transfer, transportation, processing and landfill businesses.
 
We are also pursuing international waste and/or renewable energy business opportunities, particularly in markets where the market demand, regulatory environment or other factors encourage technologies such as energy-from-waste in order to reduce dependence on landfilling for waste disposal and fossil fuels in order to reduce GHG production. In particular, we are focusing on the United Kingdom, Ireland and China, and are also pursuing opportunities in certain markets in Europe, such as Italy, and in Canada and other markets in the Americas.
 
During 2007, we continued to grow our business via acquisitions, investments, project expansions, contract extensions and new contracts as described below.
 
Domestic Business
 
  •  We acquired the operating businesses of EnergyAnswers Corporation (“EnergyAnswers”) for approximately $41 million in cash. We also assumed net debt of $21 million ($23 million of consolidated indebtedness net of $2 million of restricted funds held in trust). These businesses include a 400 ton per day (“tpd”) energy-from-waste facility in Springfield, Massachusetts and a 240 tpd energy-from-waste facility in Pittsfield, Massachusetts. Both energy-from-waste projects have “tip fee” type contracts. Approximately 75% of waste revenues are contracted for at these facilities. In addition, we acquired businesses that include a landfill operation in Springfield, Massachusetts, which is used for ash disposal; and two transfer stations, one in Canaan, New York, permitted to transfer 600 tpd of waste, and the other located at the Springfield energy-from-waste facility, permitted to transfer 500 tpd of waste. We subsequently sold certain assets acquired in this transaction for a total consideration of $5.8 million during the fourth quarter of 2007 and during the first quarter of 2008.
  •  We acquired Central Valley Biomass Holdings, LLC (“Central Valley”) from The AES Corporation. Under the terms of the purchase agreement, we paid $51 million in cash, plus approximately $5 million in cash related to post-closing adjustments and transaction costs. Central Valley owns two biomass energy facilities and a biomass energy fuel management business, all located in California’s Central Valley. These facilities added 75 megawatts (“MW”) to our portfolio of renewable energy plants. In addition, we invested approximately $8 million prior to December 31, 2007, and expect to invest an additional $7 million to $12 million during 2008, in capital improvements to increase the facilities’ productivity and improve environmental performance.
  •  We entered into a new “tip fee” type contract with the Town of Hempstead in New York for a term of 25 years commencing upon expiration of the existing contract in 2009.
  •  We acquired two waste transfer stations in Westchester County, New York from Regus Industries, LLC for cash consideration of approximately $7.3 million. These facilities increased our total waste capacity by approximately 1,150 tpd and enhance our portfolio of transfer stations in the Northeast United States.
  •  We acquired a waste transfer station in Holliston, Massachusetts from Casella Waste Systems Inc. for cash consideration of approximately $7.5 million. This facility increased our total waste capacity by approximately 700 tpd.


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  •  We completed the expansion and commenced the operation of the expanded energy-from-waste facility located in and owned by Lee County in Florida. We expanded waste processing capacity from 1,200 tpd to 1,836 tpd and increased gross electricity capacity from 36.9 MW to 57.3 MW. As part of the agreement to implement this expansion, we received a long-term operating contract extension expiring in 2024.
  •  We entered into a ten year agreement to maintain and operate an 800 tpd energy-from-waste facility located in Harrisburg, Pennsylvania and obtained a right of first refusal to purchase the facility. Under the agreement, we will earn a base annual service fee of approximately $10.5 million, which is subject to annual escalation and certain performance-based adjustments. Under the agreement, we have agreed to provide construction management services and to advance up to $25.5 million in funding for certain facility improvements required to enhance facility performance.
  •  We designed, constructed, operate and maintain the 1,200 tpd mass-burn energy-from-waste facility located in and owned by Hillsborough County in Florida. In August 2005, we entered into agreements with Hillsborough County to implement an expansion, and to extend the agreement under which we operate the facility from 2007 to 2027. During 2006, environmental and other project related permits were secured and the expansion construction commenced on December 29, 2006. Completion of the expansion, and commencement of the operation of the expanded project, is expected in early 2009.
  •  We acquired an additional 5% ownership interest in Pacific Ultrapower Chinese Station, a biomass energy facility located in California, which increased our equity ownership interest to 55%.
 
International Business
 
  •  We entered into an agreement to acquire a 40% equity interest in Guangzhou Development Covanta Environmental Energy Co., Ltd (“GDC Environmental Energy”), a company to be located in Guangzhou Municipality, Peoples Republic of China. GDC Environmental Energy will be a newly-formed entity involved in developing energy-from-waste projects in Guangdong Providence in Southeast China. Guangzhou Development Industry (Holdings) Co., Ltd. holds the remaining 60% equity interest in GDC Environmental Energy through a wholly-owned subsidiary. Our investment in GDC Environmental Energy is subject to various regulatory approvals and is expected to be completed during early 2008.
  •  We purchased a 40% equity interest in Sanfeng Covanta Environmental Industry Co., Ltd. (“Sanfeng”), a company located in Chongqing Municipality, Peoples Republic of China. Sanfeng is engaged in the business of owning and operating energy-from-waste projects and providing design and engineering, procurement and construction services for energy-from-waste facilities in China. Sanfeng currently owns minority equity interests in two 1,200 metric tpd 24 MW mass-burn energy-from-waste projects. Chongqing Iron & Steel Company (Group) Limited holds the remaining 60% equity interest in Sanfeng. We paid approximately $10 million in connection with our investment in Sanfeng. We expect to utilize Sanfeng as a key component of our effort to grow our energy-from-waste business in China. We expect to make additional investments as and when Sanfeng is successful in developing additional projects.
  •  We announced that we have entered into definitive agreements for the development of a 1,700 metric tpd energy-from-waste project serving the City of Dublin, Ireland and surrounding communities. The Dublin project, which marks our most significant entry to date into the European waste and renewable energy markets, is being developed and will be owned by Dublin Waste to Energy Limited, which is co-owned by us and DONG Energy Generation A/S. As part of the transaction, we purchased a controlling stake in Dublin Waste to Energy Limited. Under the Dublin project agreements, several customary conditions must be satisfied before construction can begin, including the issuance of all required licenses and permits. The permitting process is underway and construction is expected to commence in late 2008.
 
    We are responsible for the design and construction of the project, which is estimated to cost approximately 300 million euros and will require 36 months to complete. We will operate and maintain the project for Dublin Waste to Energy Limited, which has a 25-year “Tip Fee” type contract with Dublin to provide disposal service for approximately 320,000 metric tons of waste annually. The project is structured on a build-own-operate-transfer model, where ownership will transfer to Dublin after the 25-year term, unless extended. The project is expected to sell electricity into the local grid under short-term arrangements. We have committed to provide financing for all phases of the project, along with DONG Energy Generation A/S;


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  however, we expect that numerous project financing structures will be available once the initial development phase is complete.
 
Business Segments
 
Prior to January 1, 2007, we had two reportable business segments — Waste and Energy Services and Other Services. Given our increased focus on developing our international business, during the first quarter of 2007, we segregated what we previously had reported as our Waste and Energy Services segment into two new segments: Domestic and International. Our remaining operations, which we previously reported as our Other Services segment and was comprised of the holding company and insurance subsidiaries’ operations, did not meet the quantitative thresholds which required separate disclosure as a reportable segment. Therefore, our reportable segments are now Domestic and International, which are comprised of our domestic and international waste and energy services operations, respectively.
 
The financial results of the holding company primarily consist of interest expense and income. General and administrative expenses related to legal and other professional fees and insurance are reimbursed by the operating subsidiaries under an administrative services agreement.
 
Our predominant business is the waste and energy services business, however our historical consolidated operations were conducted in the insurance industry prior to the acquisition of Covanta Energy in March 2004. Our insurance business continues to represent an important element of our structure in that our net operating loss carryforwards (“NOLs”) were primarily generated through the operations of these former subsidiaries. See Note 9. Income Taxes of the Notes for more information about our NOLs.
 
Domestic
 
For all energy-from-waste projects, we receive 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 disposal fees or operating fees. In addition, we own and in some cases operate, other renewable energy projects in the United States which generate electricity from wood waste (biomass), landfill gas, and hydroelectric resources. The electricity from these projects is sold to utilities. For these projects, we receive revenue from electricity sales, and in some cases cash from equity distributions.
 
International
 
We also engage in the independent power production and energy-from-waste businesses outside the United States, through field offices where local management is focused on operating existing businesses and pursuing growth opportunities. Through subsidiaries, we have ownership interests in, and/or operate facilities in the Philippines, China, Bangladesh, India, Costa Rica, and Italy. The Costa Rica facilities generate electricity from hydroelectric resources while the other independent power production facilities generate electricity and steam by combusting coal, natural gas, or heavy fuel oil. In addition, two facilities in China and one facility in Italy generate electricity by processing waste received. For these projects, our international subsidiary receives revenue from operating fees, electricity and steam sales, and in some cases cash from equity distributions.
 
Contract Structures
 
We have 24 energy-from-waste projects where we charge a fixed fee (which escalates over time pursuant to contractual indices that we believe are appropriate to reflect price inflation) for operation and maintenance services. We refer to these projects as having a “Service Fee” structure. Our contracts at Service Fee projects provide revenue that does not materially vary based on the amount of waste processed or energy generated and as such is relatively stable for the contract term. In addition, at most of our Service Fee projects, the operating subsidiary retains only a fraction of the energy revenues generated, with the balance used to provide a credit to the municipal client against its disposal costs. Therefore, in these projects, the municipal client derives most of the benefit and risk of energy production and changing energy prices.


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We also have 13 energy-from-waste projects where we receive a per-ton fee under contracts for processing waste. We refer to these projects as having a “Tip Fee” structure. At Tip Fee projects, we generally enter into long-term waste disposal contracts for a substantial portion of project disposal capacity and retain all of the energy revenue generated. These Tip Fee service agreements include stated fixed fees earned by us for processing waste up to certain base contractual amounts during specified periods. These Tip Fee service agreements also set forth the per-ton fees that are payable if we accept waste in excess of the base contractual amounts. The waste disposal and energy revenue from these projects is more dependent upon operating performance and, as such, is subject to greater revenue fluctuation to the extent performance levels fluctuate.
 
Under both structures, 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 domestic renewable energy projects and international independent power 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.
 
At some of our domestic renewable energy and international independent power projects, our operating subsidiaries purchase fuel in the open markets which exposes us to fuel price risk. At other plants, fuel costs are contractually included in our electricity revenues, or fuel is provided by our customers. In some of our international projects, the project entity (which in some cases is not our subsidiary) has entered into long-term fuel purchase contracts that protect the project from changes in fuel prices, provided counterparties to such contracts perform their commitments.
 
Contract Duration
 
We operate energy-from-waste projects under long-term agreements. For those projects we own, our contract to sell the project’s energy output (either electricity or steam) generally expires at or after the date when the initial term of our contract to operate or receive waste also expires. Expiration of these contracts will subject us to greater market risk in maintaining and enhancing revenues as we enter into new contracts. Following the expiration of the initial contracts, we intend to enter into replacement or additional contracts for waste supplies and will sell our energy output either into the regional electricity grid or pursuant to new contracts. Because project debt on these facilities will be paid off at such time, we believe that we will be able to offer disposal services at rates that will attract sufficient quantities of waste and provide acceptable revenues. For those projects we operate but do not own, prior to the expiration of the initial term of our operating contract, we will seek to enter into renewal or replacement contracts to continue operating such projects. We will seek to bid competitively in the market for additional contracts to operate other facilities as similar contracts of other vendors expire.
 
Energy-from-Waste Project Ownership
 
In our domestic business, we operate many publicly-owned energy-from-waste facilities and own and operate many other energy-from-waste facilities. In addition, as a result of acquisitions of additional projects originally owned or operated by other vendors, we operate several projects under a lease structure where a third party lessor owns the project. Regardless of ownership structure, we provide the same service to our municipal clients and customers.
 
Under any of these ownership structures, the municipalities typically borrow funds to pay for the facility construction by issuing bonds. In a private ownership structure, the municipal entity loans the bond proceeds to the project subsidiary, the facility is recorded as an asset, and the project debt is recorded as a liability, on our consolidated balance sheet. In a public ownership structure, the municipality would fund the construction costs without loaning the bond proceeds to us.
 
At all projects where a Service Fee structure exists (regardless of ownership structure), our municipal clients are generally responsible contractually for paying the project debt after construction is complete. At the 11 publicly-owned Service Fee projects we operate, the municipality pays periodic debt service directly to a trustee under an


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indenture. We own 13 projects where a Service Fee structure exists, and at these projects the municipal client pays debt service as a component of a monthly service fee payment to us.
 
Under these service agreements, we bill municipalities fees to service project debt (principal and interest). The amounts billed, and the amount of cash we receive from these municipalities, are based on the actual principal amortization schedule for the project bonds. However, we recognize revenue on a levelized basis over the term of the applicable service agreement. In the beginning of the service agreement, principal billed and cash received is less than the amount of levelized revenue recognized related to principal. At some point during the service agreement, the amount we bill will exceed the levelized revenue. In the final year(s) of a contract, cash is utilized from debt service reserve accounts to pay remaining principal amounts due to project bondholders and such amounts are no longer billed to or paid by municipalities. Generally, therefore, in the last year of the applicable service agreement, little or no cash is received from municipalities relating to project debt, while our levelized service revenue continues to be recognized until the expiration date of the term of the service agreement.
 
For all projects where a Tip Fee structure exists and neither debt service nor lease rent is expressly included in the fee paid to us. Accordingly, we do not record revenue reflecting principal on this project debt or on lease rent. In most cases, our operating subsidiaries for these projects make equal monthly deposits with their respective project trustees in amounts sufficient for the trustees to pay principal and interest, or lease rent, when due.
 
The term of our operating contracts with municipal clients generally coincides with the term of the bonds issued to pay for the project construction. In many cases, the municipality has contractual rights (not obligations) to extend the contract. If a contract is not extended on a publicly-owned project, our role, and our revenue, with respect to that project would cease. If a contract is not extended on a project that we own, we would be free to enter into new revenue generating contracts for waste supply (with the municipality, other municipalities, or private waste haulers) and for electricity or steam sales. We would, in such cases, have no remaining project debt to repay from project revenue, and would be entitled to retain 100% of energy sales revenue.
 
Seasonal Trends
 
Our quarterly operating income from domestic and international operations within the same fiscal year typically differs substantially due to seasonal factors, primarily as a result of the timing of scheduled plant maintenance. We typically conduct scheduled maintenance periodically each year, which requires that individual boiler units temporarily cease operations. During these scheduled maintenance periods, we incur material repair and maintenance expenses and receive less revenue, until the boiler units resume operations. This scheduled maintenance typically occurs during periods of off-peak electric demand in the spring and fall. The spring scheduled maintenance period is typically more extensive than scheduled maintenance conducted during the fall. As a result, we typically incur the highest maintenance expense in the first half of the year. Given these factors, we typically experience lower operating income from our projects during the first six months of each year and higher operating income during the second six months of each year.
 
Other Factors Affecting Performance
 
We have historically 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. With respect to projects acquired in acquisitions, we have assumed contracts where there is less contractual protection against such risks and more exposure to market influences. For additional information about such risks and damages that we may owe for unexcused operating performance failures, see Item 1A. Risk Factors. 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.
 
Our ability to meet or exceed historical levels of performance at projects, and our general financial performance, is affected by the following:
 
  •  Seasonal or long-term changes in market prices for waste, energy, or ferrous and non-ferrous metals, for projects where we sell into those markets;


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  •  Seasonal, geographic and other variations in the heat content of waste processed, and thereby the amount of waste that can be processed by a energy-from-waste facility;
  •  Our ability to avoid unexpected increases in operating and maintenance costs while ensuring that adequate facility maintenance is conducted so that historic levels of operating performance can be sustained;
  •  Contract counterparties’ ability to fulfill their obligations, including the ability of our various municipal customers to supply waste in contractually committed amounts, and the availability of alternate or additional sources of waste if excess processing capacity exists at our facilities; and
  •  The availability and adequacy of insurance to cover losses from business interruption in the event of casualty or other insured events.
 
General financial performance at our international projects is also affected by the following:
  •  Changes in fuel price for projects in which such costs are not completely passed through to the electricity purchaser through revenue adjustments, or delays in the effectiveness of revenue adjustments;
  •  The amounts of electricity actually requested by purchasers of electricity, and whether or when such requests are made, our facilities are then available to deliver such electricity;
  •  The financial condition and creditworthiness of purchasers of power and services provided by us;
  •  Fluctuations in the value of the domestic currency against the value of the U.S. dollar for projects in which we are paid in whole or in part in the domestic currency of the host country; and
  •  Political risks inherent to the international business which could affect both the ability to operate the project in conformance with existing agreements and the repatriation of dividends from the host country.
 
RESULTS OF OPERATIONS
 
As discussed above, during the first quarter of 2007, we segregated what we previously reported as our Waste and Energy Services segment into two new segments: Domestic and International. Certain prior period amounts have been reclassified in the consolidated financial statements to conform to the current period presentation.
 
The comparability of the information provided below with respect to our revenues, expenses and certain other items for periods during each of the years presented was affected by several factors, in addition to the Covanta ARC Holdings, Inc. (“ARC Holdings”) acquisition in June 2005. Our Warren County, New Jersey energy-from-waste facility emerged from bankruptcy on December 15, 2005 and was included as a consolidated subsidiary since its emergence date. Our Huantai and Linan coal facilities, both of which were located in China, were sold in June 2006 and September 2007, respectively, and were not included as consolidated subsidiaries since their respective disposition dates. As outlined above under Acquisitions and Business Development, our acquisition and business development initiatives in 2007 resulted in various additional projects which increased comparative 2007 revenues and expenses. These factors must be taken into account in developing meaningful comparisons between the periods compared below.


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RESULTS OF OPERATIONS — Year Ended December 31, 2007 vs. Year Ended December 31, 2006
 
Our consolidated results of operations are presented on a reported basis in the table below (in thousands of dollars, except per share amounts):
 
                         
    For the Years Ended
    Increase
 
    December 31,     (Decrease)  
    2007     2006     2007 vs 2006  
 
CONSOLIDATED RESULTS OF OPERATIONS:
                       
Total operating revenues
  $  1,433,087     $  1,268,536     $  164,551  
Total operating expenses
    1,196,477       1,041,776       154,701  
                         
Operating income
    236,610       226,760       9,850  
                         
Other income (expense):
                       
Investment income
    10,578       11,770       (1,192 )
Interest expense
    (67,104 )     (109,507 )     (42,403 )
Loss on extinguishment of debt
    (32,071 )     (6,795 )     25,276  
                         
Total other expenses
    (88,597 )     (104,532 )     (15,935 )
                         
Income before income tax expense, minority interests and equity in net income from unconsolidated investments
    148,013       122,228       25,785  
Income tax expense
    (31,040 )     (38,465 )     (7,425 )
Minority interests
    (8,656 )     (6,610 )     2,046  
Equity in net income from unconsolidated investments
    22,196       28,636       (6,440 )
                         
NET INCOME
  $ 130,513     $ 105,789       24,724  
                         
Weighted Average Common Shares Outstanding:
                       
Basic
    152,653       145,663       6,990  
                         
Diluted
    153,997       147,030       6,967  
                         
Earnings Per Share:
                       
Basic
  $ 0.85     $ 0.73     $ 0.12  
                         
Diluted
  $ 0.85     $ 0.72     $ 0.13  
                         
 
The following general discussions should be read in conjunction with the above table, the consolidated financial statements and the Notes thereto and other financial information appearing and referred to elsewhere in this report. Additional detail relating to changes in operating revenues and operating expenses, and the quantification of specific factors affecting or causing such changes, is provided in the Domestic and International segment discussions below.
 
Consolidated Results of Operations — Comparison of Reported Results for the Year Ended December 31, 2007 vs. Reported Results for the Year Ended December 31, 2006
 
Operating revenues increased by $164.6 million primarily due to the following:
 
  •  contribution from new businesses acquired,
  •  increased construction revenues relating to expansion of our Hillsborough County facility,
  •  higher waste and service revenues at our existing energy-from-waste facilities, and
  •  increased demand from the electricity offtaker at our Indian facilities and resulting higher electricity generation.
 
Operating expenses increased by $154.7 million primarily due to the following:
 
  •  operating costs of new businesses acquired,
  •  increased construction expenses relating to the expansion of our Hillsborough County facility,
  •  increased plant operating expenses due to normal escalations in costs, such as wages, materials, and plant maintenance,
  •  expenses incurred as a result of a fire at our SEMASS energy-from-waste facility on March 31, 2007, and


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  •  increased plant operating expenses at our Indian facilities primarily due to increased demand from the electricity offtaker and resulting higher generation.
 
Investment income decreased by $1.2 million primarily due to lower invested cash balances and lower interest rates on invested funds. Interest expense decreased by $42.4 million primarily due to lower loan balances and lower interest rates resulting from the 2007 recapitalization. As a result of the recapitalization in the first quarter of 2007, we recognized a loss on extinguishment of debt charge of approximately $32.1 million, pre-tax, which is comprised of the write-down of deferred financing costs, tender premiums paid for the intermediate subsidiary debt, and a call premium paid in connection with previously existing financing arrangements. These amounts were partially offset by the write-down of unamortized premiums relating to the intermediate subsidiary debt and a gain associated with the settlement of our interest rate swap agreements in February 2007. In May 2006, as a result of amendments to our financing arrangements that existed at that time, we recognized a loss on extinguishment of debt of $6.8 million for the year ended December 31, 2006. See Note 6. Long-Term Debt of the Notes for additional information.
 
Equity in net income from unconsolidated investments decreased by $6.4 million primarily due to the effects of the following factors relating to Quezon Power, Inc. (“Quezon”) in the Philippines:
 
  •  Quezon recorded a cumulative deferred income tax benefit in 2006 of $31.7 million, of which $7.0 million relates to our equity share in Quezon. The realization of this deferred tax benefit is subject to fluctuations in the value of the Philippine peso versus the U.S. dollar. During the year ended December 31, 2007, we reduced the cumulative deferred income tax benefit by approximately $4.3 million, as a result of the strengthening of the Philippine peso versus the U.S. dollar;
 
  •  A decrease in equity in net income from unconsolidated investments for the year ended December 31, 2007 of approximately $4.1 million due to increased tax expense for Quezon related to the conclusion of a six-year income tax holiday in May 2006;
 
  •  Quezon recorded a gain resulting from a settlement with Manila Electric Company (“Meralco”), the largest electric distribution company in the Philippines, related to various issues which had been pending for several years, including certain amendments to the contract to modify certain commercial terms and to resolve issues relating to the project’s performance during its first year of operation. The settlement primarily includes payment by Meralco to Quezon of approximately $8.5 million of prior uncollected receivables, of which $1.9 million relates to our equity share in Quezon.
 
See Note 8. Equity Method Investments of the Notes for additional information.
 
Income tax expense decreased by $7.4 million primarily due to a reduction of the valuation allowance by $35.0 million, as discussed in Note 9. Income Taxes of the Notes. This was partially offset by expiring NOL tax benefits of $6.0 million and taxes at the statutory rate on increased pre-tax income resulting primarily from lower interest expense. During 2006, we recorded a one-time tax benefit of $10 million associated with the adoption of the permanent reinvestment exception under Accounting Principles Board (“APB”) Opinion No. 23, “Accounting for Income Taxes — Special Areas” (“APB 23”) as discussed in Note 9. Income Taxes of the Notes.


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Domestic Business Results of Operations — Comparison of Reported Results for the Year Ended December 31, 2007 vs. Reported Results for the Year Ended December 31, 2006
 
The domestic business results of operations are presented on a reported basis in the table below (in thousands of dollars):
 
                         
    For the Years Ended December 31,     Increase (Decrease)  
    2007     2006     2007 vs 2006  
 
Waste and service revenues
  $ 860,252     $ 813,260     $ 46,992  
Electricity and steam sales
    325,804       301,339       24,465  
Other operating revenues
    59,561       3,328       56,233  
                         
Total operating revenues
     1,245,617        1,117,927        127,690  
                         
Plant operating expenses
    664,641       612,202       52,439  
Depreciation and amortization expense
    187,875       184,921       2,954  
Net interest expense on project debt
    48,198       53,270       (5,072 )
General and administrative expenses
    71,022       66,439       4,583  
Other operating expense (income)
    53,789       (5,388 )     59,177  
                         
Total operating expenses
    1,025,525       911,444       114,081  
                         
Operating income
  $ 220,092     $ 206,483       13,609  
                         
 
Operating Revenues
 
Variances in revenues for the domestic segment are as follows (in millions of dollars):
 
                         
    Domestic Segment
 
    Operating Revenue Variances  
    Existing
    New
       
    Business     Business     Total  
 
Waste and service revenues
                       
Service fee
  $ 5.2     $  14.9     $  20.1  
Tip fee
    4.7       13.9       18.6  
Scrap metal
    8.2       0.1       8.3  
                         
Total waste and service revenues
    18.1       28.9       47.0  
Electricity and steam sales
    9.7       14.8       24.5  
Other operating revenues
    56.2             56.2  
                         
Total operating revenues
  $  84.0     $ 43.7     $  127.7  
                         
 
  •  Revenues from Service Fee arrangements for existing businesses increased primarily due to contractual escalations, partially offset by lower revenues earned explicitly to service debt of $4.8 million.
  •  Revenues from Tip Fee arrangements for existing businesses increased primarily due to pricing escalations, partially offset by a decrease in waste volume and reduced revenues of $4.1 million at our SEMASS facility following its fire on March 31, 2007.
  •  Scrap metal revenues increased primarily due to higher pricing for ferrous and non-ferrous metal.
  •  Electricity and steam sales for existing business increased primarily due to higher energy rates. This increase was partially offset by energy rate settlements of $3.7 million related to prior years, and a decrease in revenues of $1.9 million due to lower waste volume resulting from the temporary suspension of operations at our SEMASS facility following its fire on March 31, 2007.
  •  Other operating revenues increased primarily due to construction revenues related to the expansion for the Hillsborough County facility.


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Operating Expenses
 
Variances in plant operating expenses for the domestic segment are as follows (in millions of dollars):
 
                         
    Domestic Segment
 
    Operating Expense Variances  
    Existing
    New
       
    Business     Business     Total  
 
Total plant operating expenses
  $  10.7     $  41.7     $  52.4  
                         
 
Existing business plant operating expenses increased by $10.7 million primarily due to normal escalations in costs such as wages, materials and plant maintenance, and higher stock-based compensation expense of $2.0 million. In addition, costs related to the fire at the SEMASS energy-from-waste facility were $3.3 million, which was net of $2.7 million and $2.0 million of insurance recoveries for clean-up costs and business interruption, respectively.
 
Depreciation and amortization expense increased by $3.0 million primarily due to additions of property, plant and equipment.
 
Net interest expense on project debt decreased by $5.1 million primarily due to lower project debt balances.
 
General and administrative expenses increased by $4.6 million primarily due to increased stock-based compensation expense and increased business development spending.
 
On March 31, 2007, our SEMASS energy-from-waste facility experienced a fire in the front-end receiving portion of the facility. Damage was extensive to this portion of the facility and operations at the facility were suspended completely for approximately 20 days. As a result of this loss, we recorded an asset impairment of $17.3 million, pre-tax, which represented the net book value of the assets destroyed. The cost of repair or replacement, and business interruption losses, were insured under the terms of applicable insurance policies, subject to deductibles. During the year ended December 31, 2007, we recorded insurance recoveries of $17.3 million related to repair and reconstruction, $2.7 million related to clean-up costs and $2.0 million related to business interruption losses. Insurance recoveries were recorded as a reduction to the loss related to the write-down of assets where such recoveries related to repair and reconstruction costs, or as a reduction to operating expenses where such recoveries related to other costs or business interruption losses.
 
Other operating expense increased by $59.2 million primarily due to costs related to expansion construction at the Hillsborough County facility. See Note 12. Supplementary Financial Information of the Notes for additional information.
 
International Business Results of Operations — Comparison of Reported Results for the Year Ended December 31, 2007 vs. Reported Results for the Year Ended December 31, 2006
 
The international business results of operations are presented on a reported basis in the table below (in thousands of dollars):
 
                         
    For the Years Ended
    Increase
 
    December 31,     (Decrease)  
    2007     2006     2007 vs 2006  
 
Waste and service revenues
  $ 4,144     $ 4,373     $ (229 )
Electricity and steam sales
     173,073        132,495        40,578  
                         
Total operating revenues
    177,217       136,868       40,349  
                         
Plant operating expenses
    136,919       99,954       36,965  
Depreciation and amortization expense
    8,998       8,193       805  
Net interest expense on project debt
    6,381       6,940       (559 )
General and administrative expenses
    8,584       4,394       4,190  
Other operating income
    (3,848 )     (2,452 )     1,396  
                         
Total operating expenses
    157,034       117,029       40,005  
                         
Operating income
  $ 20,183     $ 19,839       344  
                         


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Variances in revenues and plant operating expenses for the international segment are as follows (in millions of dollars):
 
                 
    International Segment  
    Operating Revenue
    Plant Operating Expense
 
    Variances     Variances  
 
Indian facilities energy sales
  $  49.1     $ 43.8  
Yanjiang steam sales
    (1.9 )     (1.5 )
Sale of Huantai facility
    (2.9 )     (2.6 )
Sale of Linan facility
    (3.7 )     (3.2 )
Other
    (0.3 )     0.5  
                 
Total
  $ 40.3     $  37.0  
                 
 
The increases in revenues and plant operating expenses under energy contracts at both Indian facilities resulted primarily from increased demand from the electricity offtaker and resulting higher electricity generation. The decreases in revenues and plant operating expenses from the Yanjiang facility in China resulted from lower steam sales. Additional decreases in revenues and plant operating expenses resulted from the sale of the Huantai coal facility in China during the second quarter of 2006 and the sale of the Linan coal facility in China during the third quarter of 2007.
 
Depreciation and amortization expense increased by $0.8 million primarily due to the foreign currency translation effects at our facilities in India.
 
Net interest expense on project debt decreased by $0.6 million primarily due to the scheduled quarterly pay down of project debt at both Indian facilities.
 
General and administrative expenses increased by $4.2 million primarily due to normal wage and benefit escalations and additional business development spending.
 
Other operating income increased by $1.4 million primarily due to the $1.7 million gain related to the sale of the Linan coal facility in China during the third quarter of 2007 combined with a $1.0 million re-measurement gain on the foreign currency denominated debt at one of the Indian facilities, compared to a $1.2 million gain related to the sale of the Huantai coal facility in China during the second quarter of 2006.
 
RESULTS OF OPERATIONS — Year Ended December 31, 2006 vs. Year Ended December 31, 2005
 
The results of operations for the year ended December 31, 2005 are not representative of our ongoing results since the results of operations for ARC Holdings’ were only included in our consolidated results of operations from June 25, 2005 forward. Therefore, given the significance of the ARC Holdings acquisitions to our results of operations and financial condition, we believe that an understanding of our reported results, trends and ongoing performance is enhanced by presenting results on a pro forma basis for the year ended December 31, 2005 at both the consolidated and Domestic and International segment levels. Our consolidated and segment results of operations, as reported and where applicable, on a pro forma basis, are summarized in the tables and discussions below. However, the pro forma results are equivalent to reported results for the year ended December 31, 2006 as there are no pro forma adjustments for this period. The pro forma based presentation for the year ended December 31, 2005 assumes that the acquisition of ARC Holdings occurred on January 1, 2005. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of 2005 or that may result in the future. In addition, the pro forma information provided has not been adjusted to reflect any operating efficiencies that have been realized as a result of the ARC Holdings acquisition. The pro forma adjustments are described starting on page 54.


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Our consolidated results of operations are presented on both a reported and pro forma basis in the table below (in thousands of dollars, except per share amounts):
 
                                 
    For the Years Ended December 31,  
    Reported     Pro Forma  
    2006     2005     2006     2005  
                (Unaudited)  
 
CONSOLIDATED RESULTS OF OPERATIONS:
                               
Total operating revenues
  $  1,268,536     $  978,763     $  1,268,536     $  1,209,075  
Total operating expenses
    1,041,776       832,547       1,041,776       1,016,431  
                                 
Operating income
    226,760       146,216       226,760       192,644  
                                 
OTHER INCOME (EXPENSE):
                               
Investment income
    11,770       6,129       11,770       7,354  
Interest expense
    (109,507 )     (89,973 )     (109,507 )     (119,244 )
Loss on extinguishment of debt
    (6,795 )           (6,795 )      
Gain on derivative instruments, ACL warrants
          15,193             15,193  
                                 
Total other expenses
    (104,532 )     (68,651 )     (104,532 )     (96,697 )
                                 
Income before income taxes, minority interests and equity in net income from unconsolidated investments
    122,228       77,565       122,228       95,947  
Income tax expense
    (38,465 )     (34,651 )     (38,465 )     (43,176 )
Minority interests
    (6,610 )     (9,197 )     (6,610 )     (9,253 )
Equity in net income from unconsolidated investments
    28,636       25,609       28,636       25,609  
                                 
NET INCOME
  $ 105,789     $ 59,326     $ 105,789     $ 69,127  
                                 
Weighted Average Common Shares Outstanding:
                               
Basic
    145,663       122,209       145,663       139,996  
                                 
Diluted
    147,030       127,910       147,030       145,698  
                                 
EARNINGS PER SHARE:
                               
Basic
  $ 0.73     $ 0.49     $ 0.73     $ 0.49  
                                 
Diluted
  $ 0.72     $ 0.46     $ 0.72     $ 0.47  
                                 
 
The following general discussions should be read in conjunction with the above table, the consolidated financial statements and the Notes thereto and other financial information appearing and referred to elsewhere in this report. Additional detail related to operating revenues and operating expenses, and the quantification of specific factors affecting or causing such changes, is provided in the Domestic and International segment discussions below.
 
Consolidated Results of Operations — Comparison of Reported Results for the Year Ended December 31, 2006 vs. Reported Results for the Year Ended December 31, 2005
 
Our operating revenues increased by $289.8 million primarily from increases in waste and service revenues of $179.1 million and increases in electricity and steam sales of $111.1 million. Our operating income increased by $80.5 million resulting primarily from impacts of the businesses acquired as part of the ARC Holdings acquisition in the second quarter of 2005, combined with increased operating revenues, cost reduction initiatives in 2006 in the Domestic segment and lower operating expenses due to the absence of an aggregate of $17.1 million of expenses in 2005 related to the California Grantor Trust Settlement, acquisition-related charges and restructuring charges. For additional information, see Note 3. Acquisitions, Business Development and Dispositions and Note 9. Income Taxes of the Notes.
 
Our total investment income increased by $5.6 million primarily due to higher invested cash balances. Interest expense increased by $19.5 million primarily due to financing arrangements put into place as part of the ARC Holdings acquisition in June 2005. As a result of amendments to our financing arrangements in May 2006, a loss on extinguishment of debt of $6.8 million was recognized for the year ended December 31, 2006. For the year ended December 31, 2005, we realized a pre-tax gain on derivative instruments of $15.2 million related to an investment in American Commercial Lines LLC (“ACL”) warrants which was liquidated in October 2005 as discussed in Note 19. Financial Instruments of the Notes.


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Equity in net income from unconsolidated investments increased by $3.0 million primarily due to $1.5 million related to earnings from domestic investments combined with $1.5 million related to the effects of the following factors relating to Quezon in the Philippines:
 
  •  the absence during 2006 of a major scheduled turbine-generator maintenance project that occurred during 2005 that is generally scheduled twice in a seven-year cycle combined with lower project debt interest expense;
  •  a $7.0 million cumulative deferred income tax benefit, which relates to our equity share in the $31.7 million cumulative deferred income tax benefit recorded by Quezon in the second quarter of 2006 related to unrealized foreign exchange losses that are expected to be tax deductible for Philippine tax purposes in future years, offset by a $2.1 million adjustment to this deferred tax asset as a result of strengthening of the Philippine peso versus the U.S. dollar in the last six months of 2006;
  •  a $2.3 million write-off of a deferred income tax asset due to a change in the deductibility of the amortization of deferred financing costs; and
  •  an increase in tax expense of approximately $4.1 million related to the conclusion of a six-year income tax holiday in May 2006.
 
Income tax expense increased by $3.8 million due to higher taxable income primarily from impacts of the businesses acquired as part of the ARC Holdings acquisition offset by a one-time tax benefit of $10 million recorded during 2006 associated with the adoption of the permanent reinvestment exception under APB 23 as discussed in Note 9. Income Taxes of the Notes.
 
Consolidated Results of Operations — Comparison of Reported Results for the Year Ended December 31, 2006 vs. Pro Forma Results for the Year Ended December 31, 2005
 
Our operating revenues increased by $59.5 million primarily from increases in waste and service revenues of $28.5 million and increases in electricity and steam sales of $31.4 million due to contract fee escalations and higher energy and ferrous and non-ferrous metal prices. Our operating income increased by $34.1 million primarily due to higher operating revenues, cost reduction initiatives and reduced operating expenses due to the absence of $10.3 million of expenses in 2005 related to the California Grantor Trust Settlement. For additional information, see Note 9. Income Taxes of the Notes.
 
Our total investment income increased by $4.4 million primarily due to higher invested cash balances. Interest expense decreased by $9.7 million primarily due lower outstanding debt balances and lower interest rates relating to amendments to our financing arrangements in May 2006. As a result of these 2006 amendments, a loss on extinguishment of debt of $6.8 million was recognized for the year ended December 31, 2006. For the year ended December 31, 2005, we realized a pre-tax gain on derivative instruments of $15.2 million related to an investment in ACL warrants which was liquidated in October 2005 as discussed in Note 19. Financial Instruments of the Notes.
 
Equity in net income from unconsolidated investments increased by $3.0 million primarily due to $1.5 million related to earnings from domestic investments combined with $1.5 million related to the effects of the following factors relating to the Quezon facility:
 
  •  the absence during 2006 of a major scheduled turbine-generator maintenance project that occurred during 2005 that is generally scheduled twice in a seven-year cycle combined with lower project debt interest expense;
  •  a $7.0 million cumulative deferred income tax benefit, which relates to our equity share in the $31.7 million cumulative deferred income tax benefit recorded by Quezon in the second quarter of 2006 related to unrealized foreign exchange losses that are expected to be tax deductible for Philippine tax purposes in future years, offset by a $2.1 million adjustment to this deferred tax asset as a result of strengthening of the Philippine peso versus the U.S. dollar in the last six months of 2006;
  •  a $2.3 million write-off of a deferred income tax asset due to a change in the deductibility of the amortization of deferred financing costs; and
  •  an increase in tax expense of approximately $4.1 million related to the conclusion of a six-year income tax holiday in May 2006.


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Income tax expense decreased by $4.7 million primarily due to a one-time tax benefit of $10 million recorded during the three months ended June 30, 2006 associated with the adoption of the permanent reinvestment exception under APB 23 offset by higher taxable income. For additional detail, see Note 9. Income Taxes of the Notes.
 
Domestic Business Results of Operations — Comparison of Reported Results for the Year Ended December 31, 2006 vs. Pro Forma Results for the Year Ended December 31, 2005
 
The domestic business results of operations are presented on both a reported and pro forma basis in the table below (in thousands of dollars):
 
                                 
    For the Years Ended December 31,  
    Reported     Pro Forma  
    2006     2005     2006     2005  
                (Unaudited)  
 
Waste and service revenues
  $ 813,260     $  634,268     $ 813,260     $ 784,920  
Electricity and steam sales
    301,339       194,057       301,339       273,717  
Other operating revenues
    3,328       2,693       3,328       2,693  
                                 
Total operating revenues
     1,117,927       831,018        1,117,927        1,061,330  
                                 
Plant operating expenses
    612,202       471,641       612,202       578,394  
Depreciation and amortization expense
    184,921       116,083       184,921       174,610  
Net interest expense on project debt
    53,270       44,762       53,270       59,828  
General and administrative expenses
    66,439       59,249       66,439       68,983  
California Grantor Trust Settlement
          10,342             10,342  
Acquisition-related charges
          3,950              
Other operating income
    (5,388 )     (3,651 )     (5,388 )     (3,132 )
                                 
Total operating expenses
    911,444       702,376       911,444       889,025  
                                 
Operating income
  $ 206,483     $ 128,642     $ 206,483     $ 172,305  
                                 
 
Total domestic revenues increased by $56.6 million primarily due to contract fee escalations and higher energy and ferrous and non-ferrous metal prices as described below.
 
Waste and service revenues increased by $28.3 million or 3.6% resulting from the impacts of the following factors:
 
  •  Revenue from energy-from-waste projects structured with Service Fee arrangements increased by $9.1 million. Such revenues increased by $13.5 million primarily due to contractual escalations and higher additional waste service fees offset by a reduction of $4.4 million related to lower revenues earned explicitly to service debt;
  •  Revenue from energy-from-waste projects structured with Tip Fee arrangements increased by $13.4 million. Such revenues increased by $5.2 million primarily driven by higher volumes of waste handled and favorable pricing and $8.2 million primarily due to the emergence of a subsidiary from bankruptcy in December 2005, and its subsequent inclusion in our consolidated results of operations; and
  •  Other waste and service fee revenues increased by $5.8 million primarily due to higher pricing for ferrous and non-ferrous metal.
 
Electricity and steam revenue increased by $27.6 million or 10.1%, comprised of an increase of $18.3 million due to higher energy rates and increased production, and an increase of $5.2 million due to the emergence of a subsidiary from bankruptcy in December 2005, and its subsequent inclusion in our consolidated results of operations. Also contributing to the favorable variance was a $4.8 million gain relating to the settlement of a dispute regarding the 2005 power rate at one of our facilities. These gains were partially offset by $0.7 million due to the termination of activities at two landfill gas facilities.
 
Plant operating expenses increased by $33.8 million primarily due to the scope of scheduled plant maintenance, normal cost escalations such as wages, and the emergence of a subsidiary from bankruptcy in December 2005, and its subsequent inclusion in our consolidated results of operations, partially offset by cost reduction initiatives.
 
Depreciation and amortization expense increased by $10.3 million primarily due to additions to property, plant and equipment and the emergence of a subsidiary from bankruptcy in December 2005, and its subsequent inclusion in our consolidated results of operations.


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Net interest expense on project debt decreased by $6.6 million primarily as a result of lower project debt balances.
 
General and administrative expenses decreased by $2.5 million primarily due to synergies from the ARC Holdings acquisition partially offset by wage escalations and increased development spending.
 
During the fourth quarter of 2005, we incurred $10.3 million of allocated expenses relating to the California Grantor Trust Settlement. For additional information, see Note 9. Income Taxes of the Notes.
 
Other operating income increased by $2.3 million primarily due to final distributions and settlements of disputed matters relating to Covanta Energy’s reorganization, and insurance recoveries.
 
International Business Results of Operations — Comparison of Reported Results for the Year Ended December 31, 2006 vs. Pro Forma Results for the Year Ended December 31, 2005
 
The international business results of operations are presented on both a reported and pro forma basis in the table below (in thousands of dollars):
 
                                 
    For the Years Ended December 31,  
    Reported     Pro Forma  
    2006     2005     2006     2005  
                (Unaudited)  
 
Waste and service revenues
  $ 4,373     $ 4,235     $ 4,373     $ 4,235  
Electricity and steam sales
     132,495        128,713        132,495        128,713  
                                 
Total revenues
    136,868       132,948       136,868       132,948  
                                 
Plant operating expenses
    99,954       87,997       99,954       87,997  
Depreciation and amortization expense
    8,193       8,731       8,193       8,731  
Net interest expense on project debt
    6,940       7,669       6,940       7,669  
General and administrative expenses
    4,394       4,967       4,394       4,967  
Restructuring charges
          2,765              
Other operating (income) expenses
    (2,452 )     2,764       (2,452 )     2,764  
                                 
Total operating expenses
    117,029       114,893       117,029       112,128  
                                 
Operating income
  $ 19,839     $ 18,055     $ 19,839     $ 20,820  
                                 
 
Variances in revenues and plant operating expenses for the international segment are as follows (in millions of dollars):
 
                 
    International Segment  
    Operating Revenue
    Plant Operating Expense
 
    Variances     Variances  
 
Indian facilities energy sales
  $  16.6     $  18.9  
Yanjiang and Linan steam sales
    (1.3 )     (0.7 )
Debt service component of revenue
    (1.1 )      
Provision related to dispute with off-taker
    (1.4 )      
Sale of Huantai facility
    (9.0 )     (7.4 )
Other
    0.1       1.2  
                 
Total
  $ 3.9     $ 12.0  
                 
 
The increases in revenues and plant operating expenses under energy contracts at both Indian facilities resulted primarily from higher fuel costs passed through to the electricity offtaker. The decreases in revenues and plant operating expenses from the Yanjiang and Linan coal facilities in China resulted from lower steam sales. Additional decreases in revenues and plant operating expenses resulted from the sale of the Huantai coal facility in China during the second quarter of 2006.
 
Depreciation and amortization expense decreased by $0.5 million primarily due to the sale of the Huantai facility in China during the second quarter of 2006.


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Net interest expense on project debt decreased by $0.7 million primarily due to the scheduled quarterly payment of project debt at both Indian facilities, partially offset by an increase in the amortization of deferred financing costs at both projects.
 
Other operating income increased by $5.2 million primarily due to the effects of the following factors:
 
  •  a $1.7 million write-off of the remaining assets of the Bataan facility in the Philippines during the year ended December 31, 2005;
  •  a $1.2 million gain on the sale of the Huantai facility in China during the second quarter of 2006; and
  •  a $0.4 million gain on the sale of inventory at the Bataan facility in the Philippines during the second quarter of 2006.
 
General and administrative expenses decreased by $0.6 million primarily due to lower personnel costs.


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Pro Forma Reconciliations
 
The following tables provide reconciliations from the as reported results to the pro forma results presented above for the consolidated and Domestic and International segments where applicable (in thousands of dollars, except per share amounts). Notes to the pro forma reconciliations begin directly after the tables.
 
CONSOLIDATED PRO FORMA RECONCILIATIONS
 
                                         
    Year Ended December 31, 2005  
          Acquisition
    Pro forma
             
    As Reported     Activity     Adjust.     Pro Forma        
          (Unaudited)              
 
Operating revenues
                                       
Waste and service revenues
  $  638,503     $  148,792     $ 1,860     $ 789,155          
Electricity and steam sales
    322,770       79,660             402,430          
Other operating revenues
    17,490                   17,490          
                                         
Total operating revenues
    978,763       228,452       1,860        1,209,075          
                                         
Operating expenses
                                       
Plant operating expenses
    559,638       103,617       3,136       666,391          
Depreciation and amortization expense
    124,925       57,032       1,495       183,452          
Net interest expense on project debt
    52,431       13,964       1,102       67,497          
General and administrative expenses
    67,481       52,133        (42,399 )     77,215          
California Grantor Trust Settlement
    10,342                   10,342          
Restructuring charges
    2,765             (2,765 )              
Acquisition-related charges
    3,950             (3,950 )              
Other operating expenses
    11,015       519             11,534          
                                         
Total operating expenses
    832,547       227,265       (43,381 )     1,016,431          
                                         
Operating income
    146,216       1,187       45,241       192,644          
                                         
Other income (expenses)
                                       
Investment income
    6,129       1,225             7,354          
Interest expense
    (89,973 )     (26,368 )     (2,903 )     (119,244 )        
Gain on derivative instruments, ACL warrants
    15,193                   15,193          
                                         
Total other expenses
    (68,651 )     (25,143 )     (2,903 )     (96,697 )        
                                         
Income before income tax (expense) benefit, minority interest and equity in net income from unconsolidated investments
    77,565       (23,956 )     42,338       95,947          
Income tax expense
    (34,651 )     6,033       (14,558 )     (43,176 )        
Minority interest
    (9,197 )     (56 )           (9,253 )        
Equity in net income of unconsolidated investments
    25,609                   25,609          
                                         
Net income
  $ 59,326     $ (17,979 )   $ 27,780     $ 69,127          
                                         
Weighted Average Common Shares Outstanding:
                                       
Basic
    122,209             17,787       139,996          
                                         
Diluted
    127,910             17,788       145,698          
                                         
Earnings Per Share:
                                       
Basic
  $ 0.49                     $ 0.49          
                                         
Diluted
  $ 0.46                     $ 0.47          
                                         


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DOMESTIC AND INTERNATIONAL BUSINESS PRO FORMA RECONCILIATIONS
 
                                                                 
    Year Ended December 31, 2005  
    Domestic     International  
          Acquisition
    Pro Forma
                Acquisition
    Pro Forma
       
    As Reported     Activity     Adjust.     Pro Forma     As Reported     Activity     Adjust.     Pro Forma  
                      (Unaudited)                    
 
Operating revenues
                                                               
Waste and service revenues
  $  634,268     $  148,792     $ 1,860     $ 784,920     $ 4,235     $   —     $     $ 4,235  
Electricity and steam sales
    194,057       79,660             273,717       128,713                    128,713  
Other operating revenues
    2,693                   2,693                          
                                                                 
Total operating revenues
    831,018       228,452       1,860        1,061,330        132,948                   132,948  
                                                                 
Operating expenses
                                                               
Plant operating expenses
    471,641       103,617       3,136       578,394       87,997                   87,997  
Depreciation and amortization expense
    116,083       57,032       1,495       174,610       8,731                   8,731  
Net interest expense on project debt
    44,762       13,964       1,102       59,828       7,669                   7,669  
General and administrative expenses
    59,249       52,133       (42,399 )     68,983       4,967                   4,967  
California Grantor Trust Settlement
    10,342                   10,342                          
Acquisition-related charges
    3,950             (3,950 )                              
Restructuring charges
                            2,765             (2,765 )      
Other operating (income) expenses
    (3,651 )     519             (3,132 )     2,764                   2,764  
                                                                 
Total operating expenses
    702,376       227,265        (40,616 )     889,025       114,893              (2,765 )     112,128  
                                                                 
Operating income
  $ 128,642     $ 1,187     $ 42,476     $ 172,305     $ 18,055     $     $ 2,765     $ 20,820  
                                                                 
 
Notes To Pro Forma Reconciliations
 
Pro Forma Assumptions
 
The unaudited pro forma combined consolidated financial statements reflect the following assumptions:
 
ARC Holdings’ Transactions — Acquisition Activity:
 
  •  Represents ARC Holdings’ results of operations prior to June 25, 2005 for the pro forma year ended December 31, 2005.
  •  We acquired 100% of the issued and outstanding shares of ARC Holdings’ capital stock on January 1, 2005 on the same terms described in Note 3. Acquisitions, Business Development and Dispositions of the Notes.
  •  The debt structure that was in place as of January 1, 2005 was assumed to be refinanced (prior to the amendment to the credit facilities on May 26, 2006) on the same terms described in Note 3. Acquisitions, Business Development and Dispositions of the Notes in connection with the acquisition of ARC Holdings.
 
Pro Forma Adjustments
 
The following are a summary of the pro forma adjustments made:
 
  •  Waste and service revenues:  To record additional revenues prior to June 25, 2005, as a result of conforming debt service revenue recognition at ARC Holdings subsidiaries to our debt service revenue recognition policy, which policy has been implemented by ARC Holdings since its acquisition.
  •  Plant operating expenses:  To record as rent expense the net impact of the change in the fair value of a lease owned by an operating subsidiary of ARC Holdings as of January 1, 2005.


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  •  Depreciation and amortization expense:  To reverse historical depreciation and amortization expense and to record pro forma depreciation and amortization expense based on fair values assigned to ARC Holdings’ property, plant and equipment and amortizable intangible assets prior to its acquisition date of June 24, 2005.
  •  Net interest expense on project debt:  To reverse ARC Holdings’ project debt prior bond issuance cost amortization and to record the impact of fair value adjustments to ARC Holdings’ project debt prior to its acquisition date of June 24, 2005.
  •  General and administrative expenses:  To reverse ARC Holdings’ executive compensation of approximately $30 million and related expenses of approximately $12 million in the periods prior to its acquisition date of June 24, 2005.
  •  Restructuring charges:  To reverse severance and incentive payments to certain of our international business executives as a result of overhead reductions made possible by the elimination of international’s separate capital structure and debt repayments in connection with the refinancing of debt.
  •  Acquisition-related charges:  To reverse employee bonuses and integration expenses as a result of the acquisition of ARC Holdings.
  •  Interest expense:  To reverse ARC Holdings’ pre-acquisition period amortization of deferred financing costs; to record the impact of the fair value adjustment to the intermediate debt of ARC Holdings; to record the effect of the fair value adjustment associated with terminating an obligation to one of ARC Holdings’ prior owners; and to record the net adjustment to interest expense as a result of the new capital structure, prior to the amendment to the credit facilities on May 26, 2006, described in Liquidity and Capital Resources below. Additionally, to adjust for changes in valuation estimates of ARC Holdings debt premiums in the quarter ended December 31, 2005.
  •  Income tax (expense) benefit:  To record the adjustment for the estimated income tax effects associated with the pro forma adjustments to pre-tax income and arrive at a blended assumed effective tax rate 45% for the year ended December 31, 2005. We used an effective tax rate rather than the combined federal and statutory rate based upon the nature of the permanent difference related to the pro forma adjustments.
  •  Earnings per share and weighted average shares outstanding:  Basic and diluted earnings per share and the average shares outstanding used in the calculation of basic and diluted earnings per share of common stock and shares of common stock outstanding for the pro forma year ended December 31, 2005 have been adjusted, as necessary, to reflect the issuance of 66.7 million shares pursuant to a pro rata rights offering to all of our stockholders on June 24, 2005 in connection with the ARC Holdings acquisition as if they occurred on January 1, 2005. In addition, diluted earnings per share and the weighted average shares used in the calculation of diluted earnings per share of common stock and shares of common stock outstanding for the pro forma year ended December 31, 2005 has been adjusted, as necessary, to reflect the offering of 5.7 million shares of our common stock in a rights offering as if it occurred on January 1, 2005.
 
LIQUIDITY AND CAPITAL RESOURCES
 
Generating sufficient cash to invest in our business, meet our liquidity needs, pay down project debt, and pursue strategic opportunities remain important objectives of management. We derive our cash flows principally from our operations at our domestic and international projects, where our historical levels of production allow us to satisfy project debt covenants and payments, and distribute cash. We typically receive cash distributions from our domestic projects on either a monthly or quarterly basis, whereas a material portion of cash from our international projects is received semi-annually, during the second and fourth quarters.
 
During the first quarter of 2007, we completed a comprehensive recapitalization utilizing a series of equity and debt financings. Under the new credit facilities, we have substantially greater, but not unrestricted, ability to make investments in our business and to take advantage of opportunities to grow our business through investments and acquisitions, both domestically and internationally. Additional information, including material terms related to our recapitalization, is contained below under 2007 Recapitalization and in Note 6. Long-Term Debt of the Notes.
 
Our primary future cash requirements will be to fund capital expenditures to maintain our existing businesses, make debt service payments and grow our business through acquisitions and business development. We will also seek to enhance our cash flow from renewals or replacement of existing contracts, from new contracts to expand existing facilities or operate additional facilities and by investing in new projects.


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The frequency and predictability of our receipt of cash from projects differs, depending upon various factors, including whether restrictions on distributions exist in applicable project debt arrangements, whether a project is domestic or international, and whether a project has been able to operate at historical levels of production.
 
Additionally, as of December 31, 2007, we had available credit for liquidity of $268.8 million under the Revolving Loan Facility (as defined below) and unrestricted cash of $149.4 million.
 
As of December 31, 2007, we were in compliance with the covenants under the Credit Facilities (as defined below). We believe that when combined with our other sources of liquidity, including our existing cash on hand and the Revolving Loan Facility, we will generate sufficient cash over at least the next twelve months to meet operational needs, make capital expenditures, invest in the business and service debt due.
 
2007 Recapitalization
 
During the first quarter of 2007, we completed a comprehensive recapitalization utilizing a series of equity and debt financings including the following transactions:
 
  •  the refinancing of our previously existing credit facilities with the new credit facilities, comprised of a $300 million revolving credit facility (the “Revolving Loan Facility”), a $320 million funded letter of credit facility (the “Funded L/C Facility”) and a $650 million term loan (collectively referred to as the “Credit Facilities”);
  •  an underwritten public offering of 6.118 million shares of our common stock, from which we received proceeds of approximately $136.6 million, net of underwriting discounts and commissions;
  •  an underwritten public offering of approximately $373.8 million aggregate principal amount of 1.00% Senior Convertible Debentures due 2027 (the “Debentures”), from which we received proceeds of approximately $364.4 million, net of underwriting discounts and commissions; and
  •  the repayment, by means of a tender offer and redemptions, of approximately $611.9 million in aggregate principal amount of outstanding notes previously issued by our intermediate subsidiaries.
 
We completed our public offerings of common stock and Debentures, including over-allotment options exercised by underwriters, on January 31, 2007 and February 6, 2007, respectively, and we closed on the Credit Facilities on February 9, 2007. We completed our tender offer for approximately $604.4 million in aggregate principal amount of outstanding notes on February 22, 2007. On April 16, 2007 and September 6, 2007, all remaining outstanding ARC Notes and the remaining outstanding MSW I Notes and MSW II Notes were redeemed, respectively. Additional information, including material terms related to our recapitalization, are described in Note 6. Long-Term Debt of the Notes.
 
As a result of the recapitalization, we recognized a loss on extinguishment of debt of approximately $32.1 million, pre-tax, which is comprised of the write-down of deferred financing costs, tender premiums paid for the intermediate subsidiary debt, and a call premium paid in connection with previously existing financing arrangements. These amounts were partially offset by the write-down of unamortized premiums relating to the intermediate subsidiary debt and a gain associated with the settlement of our interest rate swap agreements.
 
Credit Agreement Financial Covenants
 
The loan documentation under the Credit Facilities contains customary affirmative and negative covenants and financial covenants as discussed in Note 6. Long-Term Debt of the Notes. We expect that the negative covenants will place limitations on us, but be materially less restrictive than the restrictions in effect prior to February 9, 2007. We were in compliance with all required covenants as of December 31, 2007.
 
The financial covenants of the Credit Facilities, which are measured on a trailing four quarter period basis, include the following:
 
  •  maximum Covanta Energy leverage ratio of 4.25 to 1.00 for the four quarter period ended December 31, 2007, which measures Covanta Energy’s principal amount of consolidated debt less certain restricted funds dedicated to repayment of project debt principal and construction costs (“Consolidated Adjusted Debt”) to its adjusted earnings before interest, taxes, depreciation and amortization, as calculated under the Credit


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Facilities (“Adjusted EBITDA”). The definition of Adjusted EBITDA in the Credit Facilities excludes certain non-cash charges. The maximum Covanta Energy leverage ratio allowed under the Credit Facilities adjusts in future periods as follows:
 
  •  4.25 to 1.00 for each of the four quarter periods ended March 31, June 30 and September 30, 2008;
  •  4.00 to 1.00 for each of the four quarter periods ended December 31, 2008, March 31, June 30 and September 30, 2009;
  •  3.75 to 1.00 for each of the four quarter periods ended December 31, 2009, March 31, June 30 and September 30, 2010;
  •  3.50 to 1.00 for each four quarter period thereafter;
 
  •  maximum Covanta Energy capital expenditures incurred to maintain existing operating businesses of $100 million per fiscal year, subject to adjustment due to an acquisition by Covanta Energy; and
  •  minimum Covanta Energy interest coverage ratio of 3.00 to 1.00, which measures Covanta Energy’s Adjusted EBITDA to its consolidated interest expense plus certain interest expense of ours, to the extent paid by Covanta Energy.
 
Sources and Uses of Cash Flow
 
                                         
    For the Years Ended December 31,     Increase (Decrease)  
    2007     2006     2005     2007 vs 2006     2006 vs 2005  
          (In thousands of dollars)        
 
Net cash provided by operating activities
  $ 358,098     $ 311,199     $ 208,259     $ 46,899     $ 102,940  
Net cash used in investing activities(1)
     (179,910 )     (66,904 )      (676,879 )     113,006        (609,975 )
Net cash (used in) provided by financing activities
    (262,842 )      (139,630 )     501,249       123,212       (640,879 )
Effect of exchange rate changes on cash and cash equivalents
    618       221       (221 )     397       442  
                                         
Net (decrease) increase in cash and cash equivalents
  $ (84,036 )   $ 104,886     $ 32,408        (188,922 )     72,478  
                                         
 
 
(1) For the years ended December 31, 2007 and 2006, net cash used in investing activities is net of proceeds of $2.3 million and $3.6 million, respectively, from the sale of facilities in China. For the year ended December 31, 2005, net cash used in investing activities is net of cash acquired from ARC Holdings of $62.4 million.
 
Year Ended December 31, 2007 vs. Year Ended December 31, 2006
 
Net cash provided by operating activities for the year ended December 31, 2007 was $358.1 million, an increase of $46.9 million from the prior year. The increase was primarily due to lower interest paid of $59.1 million resulting from the 2007 recapitalization and from lower project debt balances.
 
Net cash used in investing activities for the year ended December 31, 2007 was $179.9 million, an increase of $113.0 million from the prior year. The increase was primarily due to the following:
 
  •  higher purchases of property, plant and equipment of $31.4 million, principally comprised of:
  •  $18.1 million relating to rebuilding at the SEMASS facility following the fire; and
  •  $12.1 million relating to our Central Valley biomass facilities and our Holliston transfer station businesses acquired during 2007;
  •  the acquisition of businesses, net of cash acquired, of $110.5 million;
  •  an equity investment in Sanfeng for $10.3 million;
  •  partially offset by property insurance proceeds of $9.4 million related to the fire at our SEMASS energy-from-waste facility and the acquisition of a non-controlling interest in a subsidiary during 2006 of $27.5 million.


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Net cash used in financing activities for the year ended December 31, 2007 was $262.8 million, an increase of $123.2 million from the prior year. This increase was primarily due to the 2007 recapitalization. The net proceeds from refinancing the previously existing credit facilities with the Credit Facilities was $5.6 million, net of transaction fees. Proceeds of approximately $364.4 million and $136.6 million, each net of underwriting discounts and commissions, were received during the year ended December 31, 2007 related to underwritten public offerings of Debentures and common stock, respectively. The combination of the proceeds from the public offerings of Debentures and common stock and approximately $130.0 million in cash and restricted cash (available for use as a result of the recapitalization) were utilized for the repayment, by means of a tender offer, of approximately $611.9 million in principal amount of outstanding notes previously issued by certain intermediate subsidiaries.
 
Year Ended December 31, 2006 vs. Year Ended December 31, 2005
 
Cash provided by operating activities was $311.2 million, an increase of $102.9 million from the prior year. The increase in cash flow from operating activities was primarily due to operations acquired in the ARC Holdings acquisition in June 2005 of approximately $64 million.
 
Net cash used in investing activities was $66.9 million in the year ended December 31, 2006 and was primarily due to $54.3 million in purchases of property, plant and equipment and the acquisition of the limited partnership interests Covanta Onondaga Limited Partnership for $27.5 million in December 2006.
 
Net cash used in financing activities was $139.6 million for the year ended December 31, 2006 and was primarily driven by the payment of project and long-term debt partially offset by the proceeds from borrowings of long-term debt and a decrease in restricted funds held in trust. On February 24, 2006, we completed a rights offering in which 5,696,911 shares were issued in consideration for $20.8 million in gross proceeds. During 2005, we received net proceeds from the ARC Holdings rights offering of $395.9 million to fund a portion of the $740.0 million cash purchase price for the outstanding shares in ARC Holdings.
 
Project Debt
 
Domestic Project Debt
 
Financing for the energy-from-waste projects is generally accomplished through tax-exempt and taxable municipal revenue bonds issued by or on behalf of the municipal client. For such facilities that are owned by a subsidiary of ours, the municipal issuers of the bond loans the bond proceeds to our subsidiary to pay for facility construction. For such facilities, project-related debt is included as “Project debt” (short- and long-term) in our consolidated financial statements. Generally, such project debt is secured by the revenues generated by the project and other project assets including the related facility. The only potential recourse to us with respect to project debt arises under the operating performance guarantees described below under Other Commitments and Contingencies.
 
Certain subsidiaries had recourse liability for project debt which is recourse to a certain ARC Holdings subsidiary, but is non-recourse to us and as of December 31, 2007 was as follows (in thousands of dollars):
 
         
Covanta Niagara, L.P. Series 2001 Bonds
  $  165,010  
Covanta Southeastern Connecticut Company Corporate Credit Bonds
    43,500  
Covanta Hempstead Company Corporate Credit Bonds
    42,670  
         
Total
  $ 251,180  
         
 
International Project Debt
 
Financing for projects in which we have an ownership or operating interest is generally accomplished through commercial loans from local lenders or financing arranged through international banks, bonds issued to institutional investors and from multilateral lending institutions based in the United States. Such debt is generally secured by the revenues generated by the project and other project assets and is without recourse to us. Project debt relating to two international projects in India is included as “Project debt (short- and long-term)” in our consolidated financial statements. In most projects, the instruments defining the rights of debt holders generally provide that the project subsidiary may not make distributions to its parent until periodic debt service obligations are satisfied and other financial covenants are complied with.


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Investments
 
Our insurance business requires both readily liquid assets and adequate capital to meet ongoing obligations to policyholders and claimants, as well as to pay ordinary operating expenses. Our insurance business meets both its short-term and long-term liquidity requirements through operating cash flows that include premium receipts, investment income and reinsurance recoveries. To the extent operating cash flows do not provide sufficient cash flow, the insurance business relies on the sale of invested assets. Its investment policy guidelines require that all loss and loss adjustment expense (“LAE”) liabilities be matched by a comparable amount of investment grade assets. We believe that the insurance business has both adequate capital resources and sufficient reinsurance to meet its current operating requirements.
 
The investment portfolio for our insurance business was as follows as of December 31, 2007 (in thousands of dollars):
 
                 
    Amortized Cost     Fair Value  
 
Investments by grade:
               
Fixed maturities:
               
U.S. Government/Agency
  $  14,750     $  14,813  
Mortgage-backed
    5,707       5,570  
Corporate (AAA to A)
    5,865       5,862  
Corporate (BBB)
    16       15  
                 
Total fixed maturities
    26,338       26,260  
Equity securities
    909       1,110  
                 
Total
  $ 27,247     $ 27,370  
                 
 
Capital Requirements
 
The following table summarizes our gross contractual obligations including project debt, leases and other obligations as of December 31, 2007 (in thousands of dollars, Note references are to the Notes):
 
                                         
          Payments Due by Period  
                2009 and
    2011 and
    2013 and
 
    Total     2008     2010     2012     Beyond  
 
Domestic project debt (Note 7)
  $ 1,178,408     $ 151,053     $ 325,960     $ 236,824     $ 464,571  
International project debt (Note 7)
    70,914       33,861       31,404       5,649        
                                         
Total project debt (Note 7)
    1,249,322       184,914       357,364       242,473       464,571  
Term Loan Facility (Note 6)
    645,125       6,500       13,000       13,000       612,625  
Debentures(1)
    373,750                         373,750  
Other long-term debt
    557       398       137       22        
                                         
Total debt obligations(2)
    2,268,754       191,812       370,501       255,495        1,450,946  
Less: Non-recourse debt(3)
     (1,249,879 )      (185,312 )      (357,501 )      (242,495 )     (464,571 )
                                         
Total recourse debt
  $ 1,018,875     $ 6,500     $ 13,000     $ 13,000     $ 986,375  
                                         
Operating leases
    392,729       36,786       96,890       73,700       185,353  
Less: Non-recourse rental payments
    (233,000 )     (19,278 )     (46,427 )     (47,182 )     (120,113 )
                                         
Total recourse rental payments
  $ 159,729     $ 17,508     $ 50,463     $ 26,518     $ 65,240  
                                         
Interest payments(4)
    648,659       107,871       153,394       111,444       275,950  
Less: Non-recourse interest payments
    (378,681 )     (73,644 )     (115,713 )     (74,071 )     (115,253 )
                                         
Total recourse interest payments
  $ 269,978     $ 34,227     $ 37,681     $ 37,373     $ 160,697  
                                         
Retirement plan obligations(5)
  $ 25,850     $ 4,870     $ 9,710     $ 6,110     $ 5,160  
FIN 48 tax obligations(6)
  $ 33,041     $     $ 21,846     $ 8,574     $ 2,621  
                                         
Total obligations
  $ 1,507,473     $ 63,105     $ 132,700     $ 91,575     $ 1,220,093  
                                         


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(1) The Debentures bear interest at a rate of 1.00% per year, payable semi-annually in arrears, on February 1 and August 1 of each year, commencing on August 1, 2007 and will mature on February 1, 2027. In addition, beginning with the six-month interest period commencing February 1, 2012, we will pay contingent interest on the Debentures, calculated with reference to the trading price of the Debentures. As of December 31, 2007, the closing price of our common stock did not exceed the specified conversion price, and therefore, for purposes of this Capital Requirements chart, we have assumed no conversions or redemptions of the Debentures and no contingent interest related to the Debentures. For information detailing the contingent interest, conversion or redemption features of the Debentures, see Note 6. Long-Term Debt of the Notes.
 
(2) Excludes $31.0 million of unamortized debt premium.
 
(3) Payment obligations for the project debt associated with owned energy-from-waste facilities are limited recourse to the operating subsidiary and non-recourse to us, subject to operating performance guarantees and commitments.
 
(4) Interest payments on the Term Loan Facility and letter of credit fees are estimated based on current LIBOR rates and are estimated assuming contractual principal repayments.
 
(5) Retirement plan obligations are based on actuarial estimates for the pension plan obligations and post-retirement plan obligations as of December 31, 2007.
 
(6) FIN 48 obligations are based upon the expected date of settlement taking into account all of our administrative rights including possible litigation.
 
Other Commitments and Contingencies
 
Other commitments as of December 31, 2007 were as follows (in thousands of dollars):
 
                         
    Commitments Expiring by Period  
          Less Than
    More Than
 
    Total     One Year     One Year  
 
Letters of credit
  $  380,670     $  57,983     $  322,687  
Surety bonds
    61,981             61,981  
                         
Total other commitments — net
  $ 442,651     $ 57,983     $ 384,668  
                         
 
The letters of credit were issued under various credit facilities (primarily the Funded L/C Facility and the Revolving Credit 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 Loan Facility.
 
The surety bonds listed on the table above relate primarily to performance obligations ($53.0 million) and support for closure obligations of various energy projects when such projects cease operating ($9.0 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 Debentures. These are:
 
  •  holders may require us to repurchase their Debentures on February 1, 2012, February 1, 2017 and February 1, 2022;
  •  holders may require us to repurchase their Debentures, if a fundamental change occurs; and
  •  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.


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See Note 6. Long-Term Debt of the Notes for specific criteria related to contingent interest, conversion or redemption features of the Debentures.
 
We have issued or are party to performance guarantees and related contractual support obligations undertaken pursuant to agreements to construct and operate certain domestic and international energy and waste facilities, and one domestic water facility. 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 financing for a project. With respect to our domestic and international 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 on 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 domestic and international 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 material. To date, we have not incurred material liabilities under such performance guarantees. See Item 1A. Risk Factors — We have provided guarantees and financial support in connection with our projects.
 
Insurance Coverage
 
We periodically review our insurance programs to ensure that our coverage is appropriate for the risks attendant to our business. As part of this review, we assess whether we have adequate coverage for risk to our physical assets from extreme weather events. We have obtained insurance for our assets and operations that provides coverage for what we believe are probable maximum losses, subject to self-insured retentions, policy limits and premium costs which we believe to be appropriate. However, the insurance obtained does not cover us for all possible losses.
 
Off-Balance Sheet Arrangements
 
We are party to lease arrangements with our municipal clients at our Union County, New Jersey, Alexandria, Virginia and Delaware County, Pennsylvania energy-from-waste facilities. At our Union County facility, we lease the facility from the Union County Utilities Authority, referred to as the “UCUA,” under a lease that expires in 2023, which we may extend for an additional five years. We guarantee a portion of the rent due under the lease. Rent under the lease is sufficient to allow the UCUA to repay tax exempt bonds issued by it to finance the facility and which mature in 2023.
 
At our Alexandria facility, we are a party to a lease which expires in 2025 related to certain pollution control equipment that was required in connection with the Clean Air Act amendments of 1990, and which was financed by the City of Alexandria and by Arlington County, Virginia. We own this facility, and the rent under this lease is sufficient to pay debt service on tax exempt bonds issued to finance such equipment and which mature in 2013.
 
Our Covanta Delaware Valley, L.P. (“Delaware Valley”) facility is a party to a lease for the facility that expires in 2019. We are obligated to pay a portion of lease rent, designated as “Basic Rent B,” and could be liable to pay certain related contractually-specified amounts, referred to as “Stipulated Loss,” in the event of a default in the payment of rent under the Delaware Valley lease beyond the applicable grace period. The Stipulated Loss is similar to lease termination liability and is generally intended to provide the lessor with the economic value of the lease, for the remaining lease term, had the default in rent payment not occurred. The balance of rental and Stipulated Loss obligations are payable by a trust formed and collateralized by the project’s former operator in connection with the disposition of its interest in the Delaware Valley facility. Pursuant to the terms of various guarantee agreements, we have guaranteed the payments of Basic Rent B and Stipulated Loss to the extent such payments are not made by our subsidiary, referred to as the “Delaware Partnership”. We do not believe, however, that such payments constitute a material obligation of our subsidiary since our subsidiary expects to continue to operate the Delaware Valley facility in the ordinary course for the entire term of the lease and will continue to pay rent throughout the term of the lease. As of December 31, 2007, the estimated Stipulated Loss would have been $143.7 million.
 
We are also a party to lease arrangements pursuant to which we lease rolling stock in connection with our energy-from-waste and independent power facilities, as well as certain office equipment. Rent payable under these


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arrangements is not material to our financial condition. We generally use operating lease treatment for all of the foregoing arrangements. A summary of the operating lease obligations is contained in Note 15. Leases of the Notes.
 
As described above under Other Commitments, we have issued or are party to performance guarantees and related contractual obligations undertaken mainly pursuant to agreements to construct and operate certain energy and waste facilities. To date, we have not incurred material liabilities under our guarantees, either on domestic or international projects.
 
We have investments in several investees and joint ventures which are accounted for under the equity and cost methods and therefore we do not consolidate the financial information of those companies. See Note 8. Equity Method Investments of the Notes for additional information regarding these investments.
 
Discussion of Critical Accounting Policies
 
In preparing our consolidated financial statements in accordance with United States generally accepted accounting principles, we are required to use judgment in making estimates and assumptions that affect the amounts reported in our financial statements and related notes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. These estimates form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Many of our critical accounting policies are subject to significant judgments and uncertainties which could potentially result in materially different results under different conditions and assumptions. Future events rarely develop exactly as forecast, and the best estimates routinely require adjustment.
 
Stock-Based Compensation
 
We calculate the fair value of our share-based option awards using the Black-Scholes option pricing model which requires estimates of the expected life of the award and stock price volatility. For the option awards granted prior to 2007, we determined an expected life of eight years in accordance with SFAS 123 and SFAS 123R. In December 2007, the SEC issued Staff Accounting Bulletin (“SAB”) No. 110, which permits use of the simplified method, as discussed in SAB No. 107, to determine the expected life of “plain vanilla” options. The expected life for the options issued in 2007 was determined using this “simplified method” and as such, the expected lives of the options issued in 2007 range from 6.5 years to 6.04 years.
 
In addition, we also estimate expected forfeitures for our options and share-based awards and the probability of achieving specific performance factors affecting the vesting of our share-based awards. For our current share-based awards, our estimate of a forfeiture rate and determination of achieving stated performance vesting factors will have the most significant impact on the compensation cost we must recognize. We recognize compensation costs using the graded vesting attribution method over the requisite service period of the award, which is generally three to five years.
 
We review the forfeiture rate at least annually and revise compensation expense, if necessary. Prior to the second quarter of 2007, we recognized compensation expense based on an overall forfeiture rate of 8%. In order to better reflect compensation expense by type of award, i.e. options versus restricted stock, we reevaluated the forfeiture rate during the second quarter of 2007. The new forfeiture rates range from 8% to 15% depending on the type of award and the vesting period. The cumulative effect of the change in the forfeiture rate to compensation expense did not have a material effect on our financial results of operations.
 
Purchase Accounting
 
As described in Note 3. Acquisitions, Business Development and Dispositions of the Notes, we allocate acquisition purchase prices to identified intangible assets and tangible assets acquired and liabilities assumed based on their estimated fair values at the dates of acquisition, with any residual amounts allocated to goodwill. The fair value estimates used reflect our best estimates based on our work and the work of independent valuation consultants based on relevant information available to us. These estimates, and the assumptions used by us and by our valuation consultants, are subject to inherent uncertainties and contingencies beyond our control. For example, we used the discounted cash flow method to estimate the value of many of our assets. This entailed developing projections about future cash flows and adopting an appropriate discount rate. We cannot predict with certainty actual cash flows and


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the selection of a discount rate is heavily dependent on judgment. If different cash flow projections or discount rates were used, the fair values of our assets and liabilities could be materially increased or decreased. Accordingly, there can be no assurance that such estimates and assumptions reflected in the valuations will be realized, or that further adjustments will not occur. The assumptions and estimates used by us substantially affect our balance sheet. In addition, the valuations impact depreciation and amortization expense and changes in such assumptions and estimates may affect earnings in the future. During the current year, some of our estimates have been refined which resulted in changes to assets and liabilities recognized on the balance sheet as of December 31, 2007.
 
Depreciation and Amortization
 
We have estimated the useful lives over which we depreciate our long-lived assets. Additionally, in accordance with SFAS No. 143, “Accounting for Asset Retirement Obligations,” we have capitalized the estimate of our legal liabilities which includes closure and post-closure costs for landfill cells and site restoration for certain energy-from-waste and power producing sites.
 
Goodwill and Intangible Assets
 
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” we evaluate our goodwill and indefinite lived intangible assets for impairment at least annually or when indications of impairment exist. Our judgments regarding the existence of impairment indicators are based on regulatory factors, market conditions, anticipated cash flows and operational performance of our acquired assets. There has been no impairment recognized in the current year, however an impact of impairment in the future could have a material impact on our financial position and results of operations.
 
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we evaluate our long-term assets and amortizable intangible assets for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. No events or change in circumstances occurred during the period to warrant this testing. However, had an event or change in circumstances occurred, the impact of recognizing an impairment could have a material impact on our financial position and results of operations.
 
Net Operating Loss Carryforwards — Deferred Tax Assets
 
As described in Note 9. Income Taxes of the Notes, we have recorded a deferred tax asset related to the NOLs. The amount recorded was calculated based upon future taxable income arising from (a) the reversal of temporary differences during the period the NOLs are available and (b) future operating income expected from our domestic and international businesses, to the extent it is reasonably predictable.
 
We estimated that we have NOLs of approximately $275 million for federal income tax purposes as of the end of 2007. The NOLs will expire in various amounts beginning on December 31, 2009 through December 31, 2026, if not used. The amount of NOLs available to us will be reduced by any taxable income generated by current members of our tax consolidated group including certain grantor trusts relating to the Mission Insurance Entities or increased to the extent of any new losses recorded.
 
The Internal Revenue Service (“IRS”) has not audited any of our tax returns for the years in which the losses giving rise to the NOLs were reported, and the IRS could challenge any past and future use of the NOLs.
 
Loss Contingencies
 
As described in Note 21. Commitments and Contingencies of the Notes, 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 with respect to these matters on an ongoing basis and when losses are considered probable and reasonably estimable, we record as a loss an estimate of the ultimate 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 and disclosure is made regarding the possibility of additional losses. We review such estimates on an ongoing basis as developments occur with respect to such matters and may in the future increase or decrease such estimates. There can be no assurance that our initial or adjusted estimates of losses will reflect the ultimate loss we


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may experience regarding such matters. Any inaccuracies could potentially have a material adverse effect on our consolidated financial condition.
 
Financial Instruments
 
As described in Note 19. Financial Instruments of the Notes, 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 are not necessarily indicative of the amounts that we would realize in a current market exchange.
 
For cash and cash equivalents, restricted cash, 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. The insurance subsidiaries’ fixed maturity debt and equity securities portfolio are classified as “available-for-sale” and are carried at fair value.
 
Fair values for debt were determined based on interest rates that are currently available to us for issuance of debt with similar terms and remaining maturities for debt issues that are not traded on quoted market prices. The fair value of project debt is estimated based on quoted market prices for the same or similar issues.
 
The fair value of our interest rate swap agreements is the estimated amount we would receive or pay to terminate the agreement based on the net present value of the future cash flows as defined in the agreement.
 
Revenue Recognition
 
We earn fees to service project debt (principal and interest) where such fees are expressly included as a component of the service fee paid by the client community pursuant to applicable energy-from-waste service agreements. Regardless of the timing of amounts paid by client communities relating to project debt principal, we record service revenue with respect to this principal component on a levelized basis over the term of the applicable service agreement. Unbilled service receivables related to energy-from-waste operations are discounted in recognizing the present value for services performed currently in order to service the principal component of the project debt. Fees for waste disposal are recognized in the period received. Revenue from electricity and steam sales are recorded when delivered at rates specified in the contracts. We also earn fees under fixed-price construction contracts, in which case revenue is accounted for using the percentage-of-completion of services rendered.
 
Pensions
 
Our pension and other postretirement benefit plans are accounted for in accordance with SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment to FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS 158”), which require costs and the related obligations and assets arising from the pension and other postretirement benefit plans to be accounted for based on actuarially-determined estimates. Upon the adoption of SFAS 158 in December 2006, we recognized a net gain of $2.5 million, $1.7 million net of deferred tax, in Accumulated Other Comprehensive Income (“AOCI”) to reflect the funded status of the pension and postretirement benefit obligations.
 
On an annual basis, management evaluates the assumed discount rate and expected return on assets used to determine pension benefit and other postretirement benefit obligations. The discount rate is determined based on the timing of future benefit payments and expected rates of return currently available on high quality fixed income securities whose cash flows match the timing and amount of future benefit payments of the plan. Based on this evaluation, we increased the discount rate assumption for benefit obligations from 5.75% as of December 31, 2006 to 6.50% as of December 31, 2007. We recorded a pension plan liability equal to the amount by which the present value of the projected benefit obligations (using a discount rate of 6.50%) exceeded the fair value of pension assets as of December 31, 2007. We recognized a net actuarial gain of $14.5 million, $9.4 million net of deferred tax, in AOCI during the year ended December 31, 2007.


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Unpaid Losses and Loss Adjustment Expenses
 
Our insurance subsidiaries establish loss and loss adjustment expense (“LAE”) reserves that are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The process of estimating reserves involves a considerable degree of judgment by management and, as of any given date, is inherently uncertain.
 
Reserves are typically comprised of (1) case reserves for claims reported and (2) reserves for losses that have occurred but for which claims have not yet been reported, referred to as incurred but not reported (“IBNR”) reserves, which include a provision for expected future development on case reserves. Case reserves are estimated based on the experience and knowledge of claims staff regarding the nature and potential cost of each claim and are adjusted as additional information becomes known or payments are made. IBNR reserves are derived by subtracting paid loss and LAE and case reserves from estimates of ultimate loss and LAE. Actuaries estimate ultimate loss and LAE using various generally accepted actuarial methods applied to known losses and other relevant information. Like case reserves, IBNR reserves are adjusted as additional information becomes known or payments are made.
 
Our insurance subsidiaries use independent actuaries which we significantly rely on to form a conclusion on reserve estimates. Those independent actuaries use several generally accepted actuarial methods to evaluate the insurance business loss reserves, each of which has its own strengths and weaknesses. The independent actuaries place more or less reliance on a particular method based on the facts and circumstances at the time the reserve estimates are made and through discussions with our insurance subsidiaries’ management.
 
Recent Accounting Pronouncements
 
See Note 1. Organization and Summary of Significant Accounting Policies and Note 2. Recent Accounting Pronouncements of the Notes for a summary of additional accounting policies and new accounting pronouncements.
 
Related-Party Transactions
 
Employment Arrangements
 
See the descriptions of our employment agreements with Anthony J. Orlando, Mark A. Pytosh, John M. Klett, Timothy J. Simpson and Seth Myones which are incorporated by reference into Item 11. Executive Compensation of this Annual Report on Form 10-K.
 
Affiliate Agreements
 
Clayton Yeutter, a current director, is senior advisor to the law firm of Hogan & Hartson LLP. Hogan & Hartson has provided Covanta Energy with certain legal services for many years including 2007. This relationship preceded our acquisition of Covanta Energy and Mr. Yeutter did not direct or have any direct or indirect involvement in the procurement, provision, oversight or billing of such legal services and does not directly or indirectly benefit from those fees. The Board has determined that such relationship does not interfere with Mr. Yeutter’s exercise of independent judgment as a director.
 
As described in Note 8. Equity Method Investments of the Notes, we hold a 26% investment in Quezon. We are party to an agreement with Quezon in which we assumed responsibility for the operation and maintenance of Quezon’s coal-fired electricity generation facility. Accordingly, 26% of the net income of Quezon is reflected in our statement of income and as such, 26% of the revenue earned under the terms of the operation and maintenance agreement is eliminated against Equity in Net Income from Unconsolidated Investments. For the fiscal years ended December 31, 2007, 2006 and 2005, we collected $35.4 million, $26.9 million, and $29.5 million, respectively, for the operation and maintenance of the facility. As of December 31, 2007 and December 31, 2006, the net amount due to Quezon was $1.1 million and $2.2 million, respectively, which represents advance payments received from Quezon for operation and maintenance costs.
 
SZ Investments, Third Avenue and D.E. Shaw Laminar Portfolios, L.L.C. (“Laminar”), then representing aggregate ownership of approximately 40% of our outstanding common stock, each agreed to and participated in the ARC Holdings Rights Offering and acquired at least their respective pro rata portion of the shares. As


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consideration for their commitments, we paid each of these stockholders an amount equal to 1.75% of their respective equity commitments, which in the aggregate was $2.8 million. We also agreed to amend an existing registration rights agreement to provide these stockholders with the right to demand that we undertake an underwritten offering within twelve months of the closing of the acquisition of ARC Holdings in order to provide such stockholders with liquidity or to register for resale common stock acquired in such offering. None of such stockholders exercised such right to request an underwritten offering prior to the expiration of such period.
 
As part of the Covanta Energy acquisition, we agreed to conduct the 9.25% Offering and because of the possibility that the 9.25% Offering could not be completed prior to the completion of the ARC Holdings Rights Offering, we restructured the 9.25% Offering to offer an additional 2.7 million shares of our common stock at the same purchase price as in the ARC Holdings Rights Offering. On February 24, 2006, we completed the 9.25% Offering in which 5,696,911 shares were issued in consideration for $20.8 million in gross proceeds, including 633,380 shares purchased by Laminar pursuant to the exercise of rights held by Laminar as a holder of 9.25% debentures.
 
Item 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
In the normal course of business, our subsidiaries are party to financial instruments that are subject to market risks arising from changes in interest rates, foreign currency exchange rates, and commodity prices. Our use of derivative instruments is very limited and we do not enter into derivative instruments for trading purposes. The following analysis provides quantitative information regarding our exposure to financial instruments with market risks. We use a sensitivity model to evaluate the fair value or cash flows of financial instruments with exposure to market risk that assumes instantaneous, parallel shifts in exchange rates and interest rate yield curves. There are certain limitations inherent in the sensitivity analysis presented, primarily due to the assumption that exchange rates change in a parallel manner and that interest rates change instantaneously. In addition, the fair value estimates presented herein are based on pertinent information available to us as of December 31, 2007. Further information is included in Note 19. Financial Instruments of the Notes.
 
Interest Rate Risk
 
We have project debt outstanding bearing interest at floating rates that could subject us to the risk of increased interest expense due to rising market interest rates, or an adverse change in fair value due to declining interest rates on fixed rate debt. Of our project debt, approximately $164.8 million was floating rate debt at December 31, 2007. However, interest rate risk relating to the floating rate project debt is borne by the client communities because debt service is passed through to those clients under the contractual structure of their agreements. We had only one interest rate swap relating to project debt outstanding as of December 31, 2007 in the notional amount of $72.4 million related to floating rate project debt. Gains and losses, however, on this swap are for the account of the client community and are not borne by us.
 
We were required, under financing arrangements in effect from June 24, 2005 to February 9, 2007, to enter into hedging arrangements with respect to a portion of our exposure to interest rate changes with respect to our borrowing under the previously existing credit facilities. The impact of the swaps decreased interest expense for the year ended December 31, 2006 by $2.4 million and increased interest expense for the year ended December 31, 2005 by $0.7 million. As of December 31, 2006, the net after-tax deferred gain in other comprehensive income was $2.1 million ($3.3 million before income taxes which was recorded in other assets). In connection with the refinancing of our credit facilities, the interest rate swap agreements were settled on February 9, 2007. We recognized a gain associated with the settlement of our interest rate swap agreements of $3.4 million, pre-tax. The Term Loan Facility, discussed below, does not require us to enter into interest rate swap agreements. For additional information, see Note 6. Long-Term Debt and Note 19. Financial Instruments of the Notes and Liquidity and Capital Resources — 2007 Recapitalization.
 
Outstanding loan balances under the Credit Facilities bear interest at floating rates, which are calculated as either interest at a reserve adjusted British Bankers Association Interest Settlement Rate, commonly referred to as “LIBOR,” the “prime rate” or the Federal Funds rate plus 0.5% per annum, plus a borrowing margin. For details as to the various election options under the Credit Facility, see Note 6. Long-Term Debt of the Notes. As of December 31, 2007, the outstanding balance of the Term Loan was $645.1 million. We have not entered into any interest rate hedging


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arrangements against this balance. A hypothetical increase of 1.00% in the underlying December 31, 2007 market interest rates would result in a potential loss to twelve month future earnings of $6.5 million.
 
Contingent Interest
 
On January 31, 2007, we completed an underwritten public offering of $373.8 million aggregate principal amount of 1.00% Senior Convertible Debentures due 2027 (the “Debentures”). The Debentures bear interest at a rate of 1.00% per year, payable semi-annually in arrears, on February 1 and August 1 of each year, commencing on August 1, 2007 and will mature on February 1, 2027. Beginning with the six-month interest period commencing February 1, 2012, we will pay contingent interest on the Debentures during any six-month interest period in which the trading price of the Debentures measured over a specified number of trading days is 120% or more of the principal amount of the Debentures. When applicable, the contingent interest payable per $1,000 principal amount of Debentures will equal 0.25% of the average trading price of $1,000 principal amount of Debentures during the five trading days ending on the second trading day immediately preceding the first day of the applicable six-month interest period. The contingent interest feature in the Debentures is an embedded derivative instrument. The first contingent cash interest payment period does not commence until February 1, 2012, and as such, the fair market value for the embedded derivative was zero as of December 31, 2007. For additional information related to the Credit Facilities, see Note 6. Long-Term Debt of the Notes and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — 2007 Recapitalization.
 
Foreign Currency Exchange Rate Risk
 
We have investments in energy projects in various foreign countries, including the Philippines, China, India and Bangladesh, and to a much lesser degree, England, Ireland, Italy and Costa Rica. We do not enter into currency transactions to hedge our exposure to fluctuations in currency exchange rates. At some projects, we have mitigated our currency risks by structuring our project contracts so that our revenues are adjusted in line with corresponding changes in currency rates. Therefore, only working capital and project debt denominated in other than a project entity’s functional currency are exposed to currency risks.
 
As of December 31, 2007, we had $70.9 million of project debt related to two heavy fuel-oil projects in India. For $63.0 million of the debt (related to project entities whose functional currency is the Indian rupee), exchange rate fluctuations were recorded as translation adjustments in other comprehensive income within stockholders’ equity in our consolidated balance sheets. The remaining $7.9 million of debt was denominated in U.S. dollars.
 
The potential loss in fair value for such financial instruments from a 10% adverse change in December 31, 2007 quoted foreign currency exchange rates would be approximately $6.3 million.
 
As of December 31, 2007, we also had net investments in foreign subsidiaries and projects. See Note 8. Equity Method Investments of the Notes for further discussion.
 
Commodity Price Risk and Contract Revenue Risk
 
We have not entered into futures, forward contracts, swaps or options to hedge purchase and sale commitments, fuel requirements, inventories or other commodities. Alternatively, we attempt to mitigate the risk of energy and fuel market fluctuations by structuring contracts related to our energy projects in the manner described above in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation — Overview — Contract Structures.
 
Generally, we are protected against fluctuations in the waste disposal market, and thus our ability to charge acceptable fees for our services, through long-term service agreements and disposal contracts at our energy-from-waste facilities. At ten of our energy-from-waste facilities, differing amounts of waste disposal capacity are not subject to long-term contracts and, therefore, we are partially exposed to the risk of market fluctuations in the waste disposal fees we may charge. Our long-term service agreements begin to expire in 2008, and energy sales contracts at owned projects generally expire at or after the date on which that project’s long-term agreement expires. Expiration of these contracts will subject us to greater market risk in maintaining and enhancing our revenues. As our agreements at municipally-owned projects expire, we will seek to enter into renewal or replacement contracts to


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continue operating such projects. As our agreements at facilities we own begin to expire, we intend to seek replacement or additional contracts for waste supplies, and because project debt on these facilities will be paid off at such time, we expect to be able to offer disposal services at rates that will attract sufficient quantities of waste and provide acceptable revenues. We will seek to bid competitively in the market for additional contracts to operate other facilities as similar contracts of other vendors expire. At facilities we own, the expiration of existing energy sales contracts will require us to sell our output either into the local electricity grid or pursuant to new contracts. There can be no assurance that we will be able to enter into such renewals, replacement or additional contracts, or that the price and other terms available in the market at the time will be favorable to us.
 
We have similar protection against energy market fluctuations at most of our projects, which have long-term contracts for the sale of energy output. At a few of our projects, we enter into shorter term arrangements for energy sales, or have market-based pricing and therefore, we have some exposure to energy market fluctuations with respect to these projects. In addition, we sell recovered materials, principally ferrous metals, under short-term arrangements from most of our energy-from-waste projects, and have some exposure to market fluctuations with respect to such sales. While the ferrous metals markets fluctuate, given the amount of revenue we derive from such sales, we do not expect any such fluctuations to have a material affect on our financial results.
 
At some of our domestic renewable energy and international independent power projects, our operating subsidiaries purchase fuel in the open markets which exposes us to fuel price risk. At other plants, fuel costs are contractually included in our electricity revenues, or fuel is provided by our customers. In some of our international projects, the project entity (which in some cases is not our subsidiary) has entered into long-term fuel purchase contracts that protect the project from changes in fuel prices, provided counterparties to such contracts perform their commitments.
 
Risk Related to the Investment Portfolio
 
The objectives in managing the investment portfolio held by our insurance subsidiary are to maintain necessary liquidity and maximize investment income and investment returns while minimizing overall market risk. Investment strategies are developed based on many factors including duration of liabilities, underwriting results, overall tax position, regulatory requirements, and fluctuations in interest rates. Investment decisions are made by management, in consultation with an independent investment advisor, and approved by our insurance subsidiary’s board of directors. Market risk represents the potential for loss due to adverse changes in the fair value of securities. The market risks related to the fixed maturity portfolio are primarily credit risk, interest rate risk, reinvestment risk and prepayment risk. The market risk related to the equity portfolio is price risk.
 
Fixed Maturities
 
Interest rate risk is the price sensitivity of fixed maturities to changes in interest rate. We view these potential changes in price within the overall context of asset and liability matching. We estimate the payout patterns of the liabilities, primarily loss reserves, of our insurance subsidiary to determine their duration. Duration targets are set for the fixed income portfolio after consideration of the duration of the liabilities that we believe mitigate the overall interest rate risk. Our exposure to interest rate risk is mitigated by the relative short-term nature of our insurance and other liabilities. The effective duration of the portfolio as of December 31, 2007 and 2006 was 1.6 years. We believe that the portfolio duration is appropriate given the relative short-tail nature of the auto programs and projected run-off of all other lines of business. A hypothetical 100 basis point increase in market interest rates would cause an approximate 1.9% decrease in the fair value of the portfolio while a hypothetical 100 basis point decrease would cause an approximate 1.8% increase in fair value. Credit risk is the price sensitivity of fixed maturities to changes in the credit quality of such investment. Our exposure to credit risk is mitigated by our investment in high quality fixed income alternatives.
 
Fixed maturities held by our insurance subsidiary include mortgage-backed securities and collateralized mortgage obligations, collectively (“MBS”) representing 21.6% and 23.1% of total fixed maturities as of December 31, 2007 and 2006, respectively. All MBS held by our insurance subsidiary were issued by the Federal National Mortgage Association (“FNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”), which are both rated AAA by Moody’s Investors Services. FNMA and FHLMC guarantee the principal balance of their securities. FNMA guarantees timely payment of principal and interest.


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One of the risks associated with MBS is the timing of principal payments on the mortgages underlying the securities. We attempt to limit repayment risk by purchasing MBS whose cost is below or does not significantly exceed par, and by primarily purchasing structured securities with repayment protection which provides more certain cash flow to the investor such as MBS with sinking fund schedules known as Planned Amortization Classes (“PAC”) and Targeted Amortization Classes (“TAC”). The structures of PACs and TACs attempt to increase the certainty of the timing of prepayment and thereby minimize the prepayment and interest rate risk. In 2007, our insurance subsidiary recognized less than $0.1 million in loss on sales of fixed maturities.
 
Equity Securities
 
Our insurance subsidiary’s investments in equity securities are generally limited to Fortune 500 companies with strong balance sheets, along with a history of dividend growth and price appreciation. As of December 31, 2007, equity securities represented 4% of our insurance company’s total investment portfolio.


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Item 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
         
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Financial Statement Schedules:
       
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Report of Independent Registered Public Accounting Firm
 
The Board of Directors and Stockholders of Covanta Holding Corporation
 
We have audited the accompanying consolidated balance sheets of Covanta Holding Corporation (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedules listed in the Index at Item 8. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Covanta Holding Corporation at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
 
As discussed in Note 9 to the consolidated financial statements, effective January 1, 2007 the Company adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.”
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Covanta Holding Corporation’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2008 expressed an unqualified opinion thereon.
 
/s/  Ernst & Young LLP
 
MetroPark, New Jersey
February 24, 2008


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COVANTA HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
 
                         
    For the Years Ended December 31,  
    2007     2006     2005  
    (In thousands, except per share amounts)  
 
OPERATING REVENUES:
                       
Waste and service revenues
  $ 864,396     $ 817,633     $  638,503  
Electricity and steam sales
    498,877       433,834       322,770  
Other operating revenues
    69,814       17,069       17,490  
                         
Total operating revenues
     1,433,087        1,268,536       978,763  
                         
OPERATING EXPENSES:
                       
Plant operating expenses
    801,560       712,156       559,638  
Depreciation and amortization expense
    196,970       193,217       124,925  
Net interest expense on project debt
    54,579       60,210       52,431  
General and administrative expenses
    82,729       73,599       67,481  
Other operating expenses
    60,639       2,594       11,015  
California Grantor Trust Settlement
                10,342  
Restructuring charges
                2,765  
Acquisition-related charges
                3,950  
                         
Total operating expenses
    1,196,477       1,041,776       832,547  
                         
Operating income
    236,610       226,760       146,216  
                         
Other income (expense):
                       
Investment income
    10,578       11,770       6,129  
Interest expense
    (67,104 )     (109,507 )     (89,973 )
Loss on extinguishment of debt
    (32,071 )     (6,795 )      
Gain on derivative instruments, ACL warrants
                15,193  
                         
Total other expenses
    (88,597 )     (104,532 )     (68,651 )
                         
Income before income tax expense, minority interests and equity in net income from unconsolidated investments
    148,013       122,228       77,565  
Income tax expense
    (31,040 )     (38,465 )     (34,651 )
Minority interests
    (8,656 )     (6,610 )     (9,197 )
Equity in net income from unconsolidated investments
    22,196       28,636       25,609  
                         
NET INCOME
  $ 130,513     $ 105,789     $ 59,326  
                         
                         
Weighted Average Common Shares Outstanding:
                       
Basic
    152,653       145,663       122,209  
                         
Diluted
    153,997       147,030       127,910  
                         
Earnings Per Share:
                       
Basic
  $ 0.85     $ 0.73     $ 0.49  
                         
Diluted
  $ 0.85     $ 0.72     $ 0.46  
                         
 
The accompanying notes are an integral part of the consolidated financial statements.


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COVANTA HOLDING CORPORATION
CONSOLIDATED BALANCE SHEETS
 
                 
    As of December 31,  
    2007     2006  
    (In thousands, except per share amounts)  
 
ASSETS
Current:
               
Cash and cash equivalents
  $ 149,406     $ 233,442  
Marketable securities available for sale
    2,495       7,080  
Restricted funds held in trust
    187,951       178,054  
Receivables (less allowances of $4,353 and $4,469)
    252,114       209,306  
Unbilled service receivables
    59,232       56,868  
Deferred income taxes
    29,873       24,146  
Prepaid expenses and other current assets
    113,927       94,690  
                 
Total Current Assets
    794,998       803,586  
Property, plant and equipment, net
    2,620,507       2,637,923  
Investments in fixed maturities at market (cost: $26,338 and $35,833, respectively)
    26,260       35,007  
Restricted funds held in trust
    191,913       229,867  
Unbilled service receivables
    56,685       73,067