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As filed with the Securities and Exchange Commission on
December 19, 2005
Registration No. 333-120755
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No. 3
to
Form S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
Covanta Holding Corporation
(Exact name of registrant as specified in its charter)
| Delaware | 4991 | 95-6021257 | ||
|
(State or other jurisdiction of incorporation or organization) |
(Primary Standard Industrial Classification Code Number) |
(I.R.S. Employer Identification Number) |
40 Lane Road
Fairfield, New Jersey 07004
(973) 882-9000
(Address, including zip code and telephone number, including
area code, of registrant’s principal executive offices)
Anthony J. Orlando
President and Chief Executive Officer
Covanta Holding Corporation
40 Lane Road
Fairfield, New Jersey 07004
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
with copies to:
Timothy J. Simpson, Esq.
Senior Vice President, General Counsel and Secretary
Covanta Holding Corporation
40 Lane Road
Fairfield, New Jersey 07004
and
David S. Stone, Esq.
Neal, Gerber & Eisenberg LLP
Two North LaSalle Street
Suite 2200
Chicago, Illinois 60602
(312) 269-8000
Approximate date of commencement of proposed sale to the
public: From time to time after the registration statement
becomes effective.
If any of the securities being registered on this form are to be
offered on a delayed or continuous basis pursuant to
Rule 415 under the Securities Act of 1933 check the
following box: þ
If this form is filed to register additional securities for an
offering pursuant to Rule 462(b) under the Securities Act,
please check the following box and list the Securities Act
registration statement number of the earlier effective
registration statement for the same
offering. o
If this form is a post-effective amendment filed pursuant to
Rule 462(c) under the Securities Act, check the following
box and list the Securities Act registration statement number of
the earlier effective registration statement for the same
offering. o
If this form is a post-effective amendment filed pursuant to
Rule 462(d) under the Securities Act, check the following
box and list the Securities Act registration statement number of
the earlier effective registration statement for the same
offering. o
CALCULATION OF REGISTRATION FEE
| Proposed Maximum | Proposed Maximum | Amount of | ||||||||||
| Title of Each Class of | Amount | Offering | Aggregate | Registration | ||||||||
| Securities to be Registered | to be Registered | Price per Share(2) | Offering Price(2) | Fee(3) | ||||||||
|
Non-transferable warrants to purchase shares of common stock,
$0.10 par value per share, and common stock issuable upon
the exercise of non-transferable rights
|
3,000,000 | $1.53 | $4,590,000 | $582 | ||||||||
|
Non-transferable and contingently issuable warrants to purchase
shares of common stock and common stock issuable upon the
exercise of non-transferable warrants
|
2,700,000 | $6.00 | $16,200,000 | $1,734 | ||||||||
|
Total
|
5,700,000 shares(1) | N/A | $20,790,000 | $2,316 | ||||||||
| (1) | Represents: (a) 3,000,000 shares of the common stock, $0.10 par value, of Covanta Holding Corporation, that are issuable upon the exercise of warrants, referred to as the “Base Warrants,” to purchase common stock to be issued to holders of 9.25% debentures of Covanta Energy Corporation who voted in favor of Covanta Energy Corporation’s second plan of reorganization sponsored by Covanta Holding Corporation or who have been authorized to participate by the Bankruptcy Court having jurisdiction over that plan of reorganization; and (b) 2,700,000 shares of common stock that may be issued upon the exercise of the contingently issuable warrants, referred to as the “Contingent Warrants.” |
| (2) | The Base and Contingent Warrants are being offered at no charge to the eligible offerees as described in this Registration Statement; however, the purchase of common stock pursuant to the exercise of either Warrant requires the payment to Covanta Holding Corporation of the following per share purchase prices: $1.53 per share of common stock purchased pursuant to the exercise of a Base Warrant and $6.00 per share of common stock purchased pursuant to the exercise of a Contingent Warrant. The maximum offering price per share and the maximum aggregate offering price listed in the fee table above are estimated solely for the purpose of calculating the registration fee pursuant to Rule 457. |
| (3) | A registration fee of $582 was previously paid pursuant to Covanta Holding Corporation’s Registration Statement on Form S-3 filed on November 24, 2004 (File No. 333-120755) in connection with the offering of 3,000,000 shares of common stock for purchase to holders of the 9.25% debentures of Covanta Energy Corporation to which this Registration Statement is Amendment Number 3. The remaining filing fee of $1,734 is paid by Covanta Holding Corporation simultaneously with the filing of this Amendment No. 3 to the Registration Statement. |
The Registrant hereby amends this Registration Statement on
such date or dates as may be necessary to delay its effective
date until the Registrant shall file a further amendment which
specifically states that this Registration Statement shall
thereafter become effective in accordance with Section 8(a)
of the Securities Act of 1933 or until the Registration
Statement shall become effective on such date as the Commission,
acting pursuant to said Section 8(a), may determine.
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|
The information in
this prospectus is not complete and may be changed. We may not
sell these securities until the registration statement filed
with the Securities and Exchange Commission is effective. This
prospectus is not an offer to sell these securities and it is
not soliciting an offer to buy these securities in any states
where the offer or sale is not
permitted. |
PROSPECTUS (SUBJECT TO
COMPLETION)
PROSPECTUS
DATED ,
2005
Covanta Holding Corporation
Up to 3,000,000 Shares of Common Stock Issuable upon
Exercise of Non-Transferable
Warrants to Purchase Common Stock and
Up to 2,700,000 Shares of Common Stock Issuable upon
Exercise of Contingently
Issuable, Non-Transferable Warrants to Purchase Common
Stock
We are conducting an offering in which we are offering at no
charge 3,000,000 non-transferable warrants to
purchase 3,000,000 shares of our common stock at a
purchase price of $1.53 per share. This base offering is
being made solely to holders as of January 12, 2004 of the
$100,000,000 of principal amount of 9.25% debentures issued
by Covanta Energy Corporation who voted in favor of its second
plan of reorganization sponsored by us or who have been
authorized to participate by the Bankruptcy Court.
The number of warrants to be issued to each eligible offeree in
the base offering is determined by multiplying by 3,000,000 the
ratio of the principal amount of 9.25% debentures held by
each eligible offeree over $93,593,000.
We are also offering at no charge non-transferable and
contingently issuable warrants to purchase up to
2,700,000 shares of our common stock to eligible offerees
who exercise warrants in the base offering. For each share of
our common stock purchased by an eligible offeree through the
exercise of its warrants in the base offering, we will issue one
non-transferable warrant to purchase 0.9 shares of our
common stock at $6.00 per share. No contingently issuable
warrants will be issued with respect to base offering warrants
that are not exercised.
All warrants offered in this offering are non-transferable.
Warrants will not be certificated. There are no oversubscription
rights with respect to any warrants. All warrants are
immediately exercisable. Any warrants not exercised prior to the
expiration or termination of this offering will expire, be
cancelled and have no value. There is no minimum subscription
requirement.
If all of the warrants in the base offering are exercised, and
all contingently issuable warrants are issued and exercised, we
will receive gross proceeds of $4,590,000 and $16,200,000,
respectively, and total gross proceeds will be $20,790,000.
This offering begins on the date of this prospectus and ends
on ,
2005.
Our common stock is listed on the New York Stock Exchange under
the symbol “CVA.” On November 30, 2005, the last
reported sale price for the common stock was $13.04 per
share.
You should carefully consider the risk factors beginning on
page 8 of this prospectus before exercising your rights to
purchase any of the shares offered by this prospectus.
In order to avoid an “ownership change” for federal
tax purposes, our certificate of incorporation prohibits any
person from becoming a beneficial owner of 5% or more of our
outstanding common stock, except under limited circumstances.
Consequently, there are limitations on the exercise of the
warrants as described in this prospectus.
Neither the Securities and Exchange Commission nor any state
securities commission has approved or disapproved of these
securities or determined if this prospectus is truthful or
complete. Any representation to the contrary is a criminal
offense.
The date of this prospectus
is ,
2005.
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Unless the context otherwise requires, references in this
prospectus to “we,” “our,” “us”
and similar terms refer to Covanta Holding Corporation and its
subsidiaries; references to “Covanta” refer to Covanta
Energy Corporation and its subsidiaries; references to
“Ref-Fuel” refer to Covanta ARC Holdings, Inc. and its
subsidiaries; references to “Ref-Fuel Holdings” refer
to Covanta Ref-Fuel Holdings LLC; references to “ARC”
refer to Covanta ARC LLC; references to “TransRiver”
refer to TransRiver Marketing Company, L.P.; references to
“NAICC” refer to National American Insurance Company
of California and its subsidiaries; and references to
“ACL” refer to American Commercial Lines, LLC and its
subsidiaries.
SUMMARY
About Covanta Holding Corporation
We are a holding company incorporated in Delaware on
April 16, 1992. We changed our name as of
September 20, 2005 from Danielson Holding Corporation to
Covanta Holding Corporation. Prior to entering the waste and
energy services business through our acquisition of Covanta in
March 2004 and Ref-Fuel in June 2005, substantially all of our
operations were conducted in the insurance services industry. We
engage in insurance operations through our indirect
subsidiaries, National American Insurance Company of California
and related entities.
As a result of the consummation of the Covanta acquisition on
March 10, 2004, and the acquisition of Ref-Fuel on
June 24, 2005, our business strategy and future performance
will predominantly reflect the performance of our waste and
energy operations, often referred to as our “Waste and
Energy Services” in this prospectus. As a result, the
nature of our business, the risks attendant to such business and
the trends that we face have been and will be significantly
altered by these acquisitions. Accordingly, our financial
results prior to 2004 will not be comparable to our current and
future results.
As of the end of 2004, we had estimated aggregate consolidated
net operating loss tax carryforwards, which we refer to as
“NOLs” in this prospectus, for federal income tax
purposes of approximately $516 million. These NOLs will
expire over the course of the next 18 years unless utilized
prior thereto. Our NOLs are primarily from the taxable results
of certain grantor trusts established in 1990 as part of a
reorganization in which Mission Insurance Group, Inc., referred
to as “Mission Insurance” in this prospectus, emerged
from bankruptcy as Danielson Holding Corporation. Since 1990,
these grantor trusts have remained in existence as part of the
administration of the insolvency estates of the former Mission
Insurance entities. A significant portion of our operating
losses in the past three years stem from lines of insurance
business, such as commercial, automobile and workers’
compensation insurance, which our subsidiaries have ceased
actively underwriting.
As described in “Risk Factors — Covanta
Holding Corporation-Specific Risks — We cannot be
certain that our NOLs will continue to be available to offset
our tax liability,” possible changes in the status of
certain liabilities and the manner of distributions to holders
of certain claims in the Mission Insurance insolvency
proceedings may require us to recognize significant taxable
income, which may substantially reduce our available NOLs. While
we cannot predict with certainty what amounts, if any, may be
includable in our taxable income, we have received preliminary
information which raises the possibility that we may recognize
taxable income in connection with the conclusion of the
administration of the insolvency estates. However, after
reviewing the preliminary information, we determined that it was
insufficient to warrant inclusion of taxable income in our 2004
tax filing based on such preliminary information. We are in the
process of obtaining additional information regarding the
potential amount of includible taxable income and are also
considering a number of permissible actions and approaches,
including arrangements to clarify the treatment of certain
liabilities and the manner of distributions to claimsholders in
insolvency proceedings.
We acquired a 100% ownership interest in ACL in May 2002. As a
result of adverse developments in the marine transportation
business, ACL was no longer able to meet its obligations under
applicable financing arrangements. On January 31, 2003, ACL
and many of its subsidiaries and its immediate direct parent
entity, American Commercial Lines Holdings, LLC, referred to in
this prospectus as “ACL Holdings,” filed a petition
with the U.S. Bankruptcy Court for the Southern District of
Indiana to reorganize under Chapter 11
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of the U.S. Bankruptcy Code, referred to as
“Chapter 11” in this prospectus. We wrote off our
investment in ACL as an other than temporarily impaired asset at
the end of the first quarter of 2003. ACL Holdings and ACL
confirmed a plan of reorganization on December 30, 2004. As
a result, under the ACL plan of reorganization, our equity
interest in ACL was cancelled and we received warrants to
purchase 672,920 shares of ACL’s new common stock
at a price of $3.00 per share from certain creditors of
ACL. We subsequently exercised the warrants and sold the shares
of ACL stock.
As of November 25, 2005, our executive officers and
directors as a group owned approximately 23.88% of our common
stock that is outstanding and entitled to vote. This percentage
reflects shares beneficially owned by affiliates of executive
officers and directors, as well as shares underlying currently
exercisable options to purchase shares of common stock that our
executive officers and directors have the right to acquire
within 60 days of the date hereof, excluding any shares
which they might be entitled to receive upon exercise of
warrants in the offering.
Our principal executive offices are located at 40 Lane Road,
Fairfield, New Jersey 07004, and our telephone number is
(973) 882-9000.
About Covanta Energy Corporation
Our principal subsidiary is Covanta, which we acquired in March
2004 in connection with Covanta’s emergence from
bankruptcy. We acted as sponsor of Covanta’s second plan of
reorganization in purchasing 100% of its equity.
Covanta develops, constructs, owns and operates for itself and
others infrastructure for the conversion of waste to energy and
independent power production in the United States and abroad.
Following its acquisition of Ref-Fuel, an owner and operator of
six waste-to-energy projects, Covanta has ownership interests in
or operates 56 power generation facilities, 44 of which are in
the United States and twelve of which are located outside of the
United States. Covanta’s power generation facilities use a
variety of fuels, including municipal solid waste,
hydroelectric, natural gas, coal, wood waste, landfill gas and
heavy fuel oil. Covanta also has several businesses that are
associated with its waste-to-energy business, including a waste
procurement business, two landfills, and several waste transfer
stations. Covanta also operates one water treatment facility
which is located in the United States.
Prior to March 10, 2004, when we acquired Covanta upon its
emergence from bankruptcy proceedings, it and most of its
domestic subsidiaries had been operating as debtors in
possession under Chapter 11. When Covanta emerged from
bankruptcy proceedings, Covanta and certain of its subsidiaries
entered into both secured and unsecured financing arrangements,
which were repaid and replaced with new financing arrangements
in connection with the acquisition of Ref-Fuel. In addition,
many of Covanta’s operating subsidiaries are parties to
financing arrangements for individual operating projects which
are secured by the assets of the project. We have guaranteed
Covanta’s obligations with respect to the new financing
arrangements in connection with the acquisition of Ref-Fuel.
Covanta ARC Holdings, Inc. Acquisition
We acquired Ref-Fuel as of June 24, 2005, pursuant to the
terms of a stock purchase agreement with Ref-Fuel and
Ref-Fuel’s stockholders to purchase 100% of the issued
and outstanding shares of Ref-Fuel capital stock. Under the
terms of the agreement, we paid $740 million in cash for
the stock of Ref-Fuel and assumed the consolidated net debt of
Ref-Fuel, which was approximately $1.3 billion
($1.5 billion of consolidated indebtedness and
$0.2 billion of cash and restricted cash). See Note 11
to the Notes to the Condensed Consolidated Financial Statements
(Unaudited) for the period ended September 30, 2005 that
are included in Appendix B attached to this prospectus,
such Notes referred to as “Notes to the Unaudited Interim
Financial Statements” in this prospectus, for a more
detailed description of the indebtedness that we assumed in
connection with the transaction. Also, additional information
regarding this indebtedness is set forth in this prospectus
under “Management’s Discussion and Analysis of
Financial Condition and Results of Operations —
Management’s Discussion and Analysis of Liquidity and
Capital Resources — Waste and
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Energy Services Segment — Financing
Arrangements — Covanta Debt.” Upon completion
of the transaction, Ref-Fuel became a wholly-owned subsidiary of
Covanta.
We financed this transaction through a combination of debt and
equity financing. The equity component of the financing was
obtained through a pro rata rights offering to our stockholders
that was completed as of June 21, 2005, referred to as the
“Ref-Fuel rights offering” in this prospectus. In that
rights offering, we issued all 66,673,004 shares of common
stock offered at $6.00 per share for total gross proceeds
of approximately $400 million. Stockholders exercised
subscriptions for over 95% of their base subscription rights and
the Ref-Fuel rights offering had significant oversubscriptions.
In the Ref-Fuel rights offering, three of our largest
stockholders, SZ Investments, L.L.C., together with its
affiliate EGI-Fund (05-07) Investors, L.L.C., referred to in
this prospectus as “Fund 05-07” and collectively
with SZ Investments, L.L.C. “SZ Investments,” Third
Avenue Trust, on behalf of Third Avenue Value Fund, referred to
in this prospectus as “Third Avenue,” and D. E. Shaw
Laminar Portfolios, L.L.C., referred to in this prospectus as
“Laminar,” collectively then representing ownership of
approximately 40.4% of our outstanding common stock, pursuant to
prior commitments, each separately acquired at least their
respective pro rata portion of the shares offered in the rights
offering. In addition, they acquired an additional
1,315,921 shares through their individual exercise of their
respective oversubscription rights. As consideration for their
commitments, we paid each of these stockholders an amount equal
to 1.75% of their respective equity commitments. 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 Ref-Fuel in order to provide such stockholders
with liquidity.
The debt financing for the Ref-Fuel acquisition was arranged by
Goldman Sachs Credit Partners, L.P. and Credit Suisse First
Boston. The debt financing package not only financed the
acquisition, but also refinanced the existing recourse debt of
Covanta and provided additional liquidity for us. This financing
consisted of two tranches, each of which is secured by pledges
of the stock of Covanta’s subsidiaries that had not
otherwise been pledged, guarantees from us and certain of
Covanta’s subsidiaries and all other available assets of
Covanta’s subsidiaries. The first tranche, a first priority
senior secured bank facility, is made up of a $275 million
term loan facility due 2012, a $100 million revolving
credit facility due 2011 and a $340 million letter of
credit facility due 2012. The second tranche is a
$400 million second priority senior secured term loan
facility due 2013. See “Management’s Discussion and
Analysis of Financial Condition and Results of
Operations — Management’s Discussion and Analysis
of Liquidity and Capital Resources — Waste and Energy
Services Segment” and Note 11 to the Notes to the
Unaudited Interim Financial Statements for a more detailed
description of this debt financing.
Ref-Fuel is now a wholly-owned subsidiary of Covanta, and
Covanta controls the management and operations of the Ref-Fuel
facilities. The current project and other debt of Ref-Fuel
subsidiaries were not refinanced in connection with the
acquisition, except that two of the Ref-Fuel subsidiaries which
had outstanding secured notes were required to offer to purchase
their respective notes from existing note holders as a result of
the change in control of Ref-Fuel. Approximately $5 million
of such notes were repurchased as a result of such offers. In
addition, an existing revolving credit and letter of credit
facility of ARC (the parent of each Ref-Fuel project company)
has been cancelled and replaced with Covanta’s new
facilities, described above.
Shortly after the acquisition, we changed the names of Ref-Fuel
and many of its subsidiaries such that they are now operating
under the Covanta name.
About the Contingent Offering
As part of our obligations as the sponsor of a second plan of
reorganization for Covanta, we agreed to offer the right to
purchase 3,000,000 shares of our common stock, which
we refer to in this prospectus as the “Base Offering.”
In connection with the financing of our acquisition of Ref-Fuel
and prior to the commencement of the Base Offering, we agreed
with Laminar that because the Base Offering did not close prior
to the record date for the Ref-Fuel rights offering, we would
revise the terms of this offering so that eligible offerees,
including Laminar, would be offered the opportunity to purchase
additional shares as if the Ref-Fuel rights
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offering had occurred after this offering. Therefore, we are
offering to eligible offerees who participate in the Base
Offering contingently issuable warrants to purchase
0.9 shares of our common stock at $6.00 per share for
each share of common stock purchased in the Base Offering. We
refer to this additional offering as the “Contingent
Offering” in this prospectus. If all warrants under the
Base Offering and the Contingent Offering are exercised, we will
issue 3,000,000 shares of our common stock under the Base
Offering and 2,700,000 additional shares of our common
stock under the Contingent Offering. We sometimes refer to the
Base Offering and the Contingent Offering collectively in this
prospectus as the “offering.”
The Offering
| Reason for Offering | We agreed in January 2004 to make an offering of the right to purchase our common stock at $1.53 per share to provide additional benefits to those holders of 9.25% debentures of Covanta, referred to in this prospectus as the “9.25% Debentures,” who voted in favor of the second plan of reorganization for Covanta sponsored by us, referred to as the “Covanta Plan of Reorganization” in this prospectus, or who were authorized to participate by the Bankruptcy Court having jurisdiction over the Covanta Plan of Reorganization, as an inducement to facilitate the approval of our proposed plan of reorganization. | |
| We also agreed pursuant to a letter agreement dated January 31, 2005 with Laminar, one of our stockholders and a holder of Covanta’s 9.25% Debentures, that if this offering had not commenced prior to the record date for the Ref-Fuel rights offering, we would restructure the offering covered by this prospectus to offer additional shares of our common stock at the same purchase price and in an equivalent amount to the number of shares of common stock that eligible offerees would have been entitled to purchase in the Ref-Fuel rights offering if this offering had been consummated on or prior to the record date of the Ref-Fuel rights offering. | ||
| Eligible Offerees | Holders of the 9.25% Debentures on January 12, 2004 who voted in favor of the Covanta Plan of Reorganization and holders who were authorized to participate by the Bankruptcy Court having jurisdiction over the Covanta Plan of Reorganization are the only persons eligible to participate in this offering. These holders are referred to as “eligible offerees” in this prospectus. No other person is eligible to participate in either the Base Offering or the Contingent Offering covered by this prospectus. Only those eligible offerees who purchase common stock in the Base Offering will receive the contingently issuable warrants to purchase additional shares of our common stock under the Contingent Offering. The warrants offered under this prospectus in both the Base and Contingent Offering may not be transferred to any other person. Warrants in both the Base and Contingent Offering which are not exercised will be cancelled upon termination of this offering. | |
| Warrants Being Offered | In the Base Offering, we are offering the right to purchase shares of our common stock in the form of an offering, at no charge, of warrants to purchase shares of our common stock at $1.53 per share, which we sometimes refer to as “Base Warrants” in this prospectus. The number of shares of our common stock that each eligible offeree is entitled to purchase in the Base Offering is determined by multiplying by 3,000,000 the ratio of the principal | |
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| amount of 9.25% Debentures held by each eligible offeree over $93,593,000, the principal amount of all outstanding 9.25% Debentures voted in favor of the Covanta Plan of Reorganization or which have been authorized to participate by the Bankruptcy Court having jurisdiction over the Covanta Plan of Reorganization. | ||
| For each share of common stock purchased by an eligible offeree under the Base Offering, we are offering the additional right, in the form of a contingently issuable, non-transferable warrant, to purchase 0.9 shares of our common stock at $6.00 per share, which we sometimes refer to as the “Contingent Warrants” in this prospectus. | ||
| Wells Fargo, the warrant agent in this offering, will verify and confirm the eligibility of and the number of shares of our common stock that each eligible offeree is entitled to purchase in each of the Base Offering and the Contingent Offering. | ||
| Size of Offering | We are offering to sell a total of 5,700,000 shares of our common stock. 3,000,000 shares of our common stock are being offered in the form of Base Warrants under the Base Offering for purchase by eligible offerees at $1.53 per share and up to 2,700,000 shares of our common stock are being offered in the form of Contingent Warrants to purchase 0.9 shares of our common stock at a price of $6.00 per share under the Contingent Offering to eligible offerees who purchase shares in the Base Offering. If all of the shares of common stock offered under this prospectus are purchased in the Base Offering and Contingent Offering, then the total purchase price of our common stock will be $20,790,000. | |
| Offering Period | This offering, consisting of the Base Offering and the Contingent Offering, will commence on the date of this prospectus and remain open until 5:00 p.m., Eastern Time, on , 2005. | |
| Oversubscription Rights | There are no oversubscription rights in the offering. Any warrants to purchase our common stock in the Base Offering or the Contingent Offering which are not exercised by any eligible offeree will not be reallocated to any other eligible offeree and will be cancelled upon expiration or termination of this offering. | |
| Transferability of Warrants | The warrants to purchase our common stock under the Base Offering and the Contingent Offering are not transferable. Warrants may only be exercised by eligible offerees in the amount offered to an eligible offeree or in the amount an eligible offeree is entitled to purchase. | |
| Conditions to the Offering | There is no minimum subscription requirement. Your subscription rights are subject to, among other things, ownership restrictions imposed by our certificate of incorporation and the escrow protection mechanics described in this prospectus. See “The Offering” for more details. | |
| Certificate of Incorporation Restrictions; Escrow Protection Mechanics | Our ability to utilize our NOLs would be substantially reduced if we were to undergo an ownership change within the meaning of Section 382 of the Internal Revenue Code. In order to reduce the | |
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| risk of an ownership change, our certificate of incorporation restricts the ability of any holder of 5% or more of our common stock to sell or otherwise transfer any shares owned by such holder or to purchase or otherwise acquire shares of our common stock. Our certificate of incorporation also restricts the ability of any other holder to make an acquisition of our common stock which will result in total ownership by such stockholder of 5% or more of our common stock. These restrictions will apply unless and until we determine that such acquisition will not result in an unreasonable risk of an ownership change. We have the right, in our sole and absolute discretion, to limit the exercise of the warrants to purchase our common stock, including instructing the warrant agent to refuse to honor any exercise of warrants, by 5% stockholders or stockholders who would become 5% holders upon exercise of their warrants. |
| The total number of shares of our common stock to be outstanding upon completion of the offering, assuming the offering is fully subscribed, would be 146,876,122. 5% of 146,876,122 is 7,343,806. | ||
| In order to avoid an “ownership change” for federal income tax purposes, we have also implemented the following escrow protection mechanics: (1) by exercising its warrants under this offering, each eligible offeree will represent to us that such eligible offeree will not be, after giving effect to the exercise of the warrants, an owner, directly or indirectly (as described in this prospectus), of more than 6,600,000 shares; (2) if such exercise would result in such holder owning more than approximately 6,600,000 shares of our common stock, such holder must notify the warrant agent at the telephone number set forth under “The Offering — The Warrant Agent”; (3) if requested, each eligible offeree will provide us with additional information regarding the amount of common stock that the eligible offeree owns; and (4) we shall have the right to instruct the warrant agent to refuse to honor such eligible offeree’s exercise of its warrants to the extent such exercise of warrants might, in our sole and absolute discretion, result in such holder owning 5% or more of our common stock. By exercising your warrants in this offering, you agree that the escrow protection mechanics are valid, binding and enforceable against you. See “The Offering — Certificate of Incorporation Restrictions; Escrow Protection Mechanics.” | ||
| Procedure for Purchasing Common Stock under the Automated Subscription Offer Program | The offering is eligible for the Automated Subscription Offer Program, referred to in this prospectus as “ASOP,” of The Depository Trust Company, referred to in this prospectus as “DTC.” Since all record holders of the 9.25% Debentures are DTC participants, we are requiring that all rights under the Base Offering and the Contingent Offering be exercised through ASOP. | |
| If you are an eligible offeree and wish to exercise the rights that are issued to you in the Base Offering or which may be available to you in the Contingent Offering, you must transmit your notice of exercise by electronic message through ASOP prior to 5:00 p.m., | ||
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| Eastern Time, on the expiration date. DTC will then send an agent’s message to the warrant agent for the offering, Wells Fargo Bank, National Association, for its acceptance. Delivery of the warrant agent’s message by DTC indicates that you agree to be bound to the terms and conditions of the offering (including the authorization that the exercise price(s) be debited from your DTC account). | ||
| Once you have exercised your warrants, your exercise may not be revoked in whole or in part. | ||
| Warrants to purchase our common stock under both the Base Offering and the Contingent Offering that are not exercised prior to the expiration date will be cancelled and will lose their value. | ||
| United States Federal Income Tax Consequences to Eligible Offerees | For United States federal income tax purposes, it is likely that the Internal Revenue Service would take the position that each eligible offeree will recognize ordinary income for federal income tax purposes in an amount equal to the value of the warrants received upon receipt. | |
| Issuance of Our Common Stock | We will make the necessary book-entry transfers or, upon your request, issue certificates representing shares purchased in this offering, as soon as reasonably practicable after the closing of this offering. All exercises of warrants under the Base Offering and the Contingent Offering will be effective on the closing of the offering. | |
| No Recommendation to Eligible Offerees | Our board of directors is not making any recommendation to you as to whether you should purchase common stock in the offering. You should decide whether to purchase shares of our common stock in the offering based upon your own assessment of your best interests. | |
| New York Stock Exchange Listing of our Common Stock | Our common stock is traded on the New York Stock Exchange, which we sometimes refer to as the “NYSE,” under the symbol “CVA.” On November 30, 2005, the closing price of our common stock on the NYSE was $13.04 per share. Shares of our common stock issued upon the exercise of the warrants will also be listed on the NYSE under the same symbol. | |
Risk Factors
An investment in our common stock is very risky. You should
consider carefully the risk factors beginning on page 8 of
this prospectus.
Use of Proceeds
The proceeds from the offering, estimated to be approximately
$20 million, after deduction of expenses of the offering
estimated to be $750,000, will be used by us for general
corporate purposes.
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RISK FACTORS
An investment in our common stock is very risky. You should
carefully consider the following factors and all the information
in this prospectus and in the other documentation that is
referenced in this prospectus.
Risks Related to the Offering
| We have the right to limit the purchase of our common stock. |
Article Fifth of our certificate of incorporation generally
restricts the ability of any 5% holder of our common stock from
disposing of or acquiring shares of our common stock without our
consent. Our certificate of incorporation also restricts the
ability of other holders from becoming 5% stockholders without
our consent. In order to comply with these restrictions, we may
limit the number of shares purchased by a holder. If your
purchase of our common stock might result in a risk of you
becoming a 5% stockholder, your exercise may be reduced in order
to eliminate that risk. We may also limit the exercise of
warrants being offered in the offering by holders who possess 5%
of our outstanding common stock. In addition, you may be
required to provide certain information concerning your share
ownership in order to help us enforce these restrictions.
| The irrevocable exercise of warrants may adversely affect investors. |
Once you have exercised your warrants to purchase our common
stock, your exercise may not be revoked in whole or in part for
any reason, including a decline in our common stock price.
Warrants not exercised prior to the expiration date will lose
their value.
| The market price of our common stock may decline prior to the expiration date of the offering. |
The exercise of warrants pursuant to the offering is
irrevocable. During the past twelve months, the market price per
share of our common stock on the American Stock Exchange (on
which our common stock was listed until the close of trading on
October 4, 2005) and the NYSE (on which our common stock
has been listed from October 5, 2005 through the present)
has ranged from $5.40 to $17.70. Although the exercise prices of
both Base Warrants and Contingent Warrants to purchase our
common stock are at a significant discount to the market price
per share of our common stock as of the commencement of the
offering, the market price of our common stock may decline prior
to the expiration date due to many factors, including business
exigencies, acts of terrorism, general market declines,
interruptions to our business, accidents or other catastrophic
events, changes in investor perception, unanticipated financial
results, defaults on indebtedness or other factors that could
affect our stock price. In such event, you may be forced to
purchase the common stock at a price higher than the market
price.
Covanta Holding Corporation-Specific Risks
| We cannot be certain that our NOLs will continue to be available to offset our tax liability. |
As of December 31, 2004, we estimated that we had
approximately $516 million of NOLs. In order to utilize the
NOLs, we must generate consolidated taxable income which can
offset such carryforwards. The NOLs are also utilized by income
from certain grantor trusts that were established as part of the
Mission Insurance reorganization. The NOLs will expire if not
used. The availability of NOLs to offset taxable income would be
substantially reduced if we were to undergo an “ownership
change” within the meaning of Section 382(g)(1) of the
Internal Revenue Code. We will be treated as having had an
“ownership change” if there is more than a 50%
increase in stock ownership during a three-year “testing
period” by “5% stockholders.”
In order to help us preserve the NOLs, our certificate of
incorporation contains stock transfer restrictions designed to
reduce the risk of an ownership change for purposes of
Section 382 of the Internal Revenue Code. The transfer
restrictions were implemented in 1990, and we expect that the
restrictions will remain in force as long as the NOLs are
available. We cannot assure you, however, that these
restrictions will prevent an ownership change.
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The NOLs will expire in various amounts, if not used, between
2005 and 2023. The Internal Revenue Service, referred to in this
prospectus as the “IRS,” has not audited any of our
tax returns for any of the years during the carryforward period
including those returns for the years in which the losses giving
rise to the NOLs were reported. We cannot assure you that we
would prevail if the IRS were to challenge the availability of
the NOLs. If the IRS were successful in challenging our NOLs,
all or some portion of the NOLs would not be available to offset
our future consolidated taxable income and we may not be able to
satisfy our obligations to Covanta under a tax sharing agreement
described below or to pay taxes that may be due from our
consolidated tax group.
Reductions in our NOLs could occur in connection with the
administration of the grantor trusts associated with the Mission
Insurance entities which are in state insolvency proceedings.
During or at the conclusion of the administration of these
grantor trusts, material taxable income could result which could
utilize a substantial portion of our NOLs, which in turn could
materially reduce our cash flow and ability to service our
current debt. The impact of a material reduction in our NOLs
could also cause an event of default under our current debt and
a possible substantial reduction of our deferred tax asset, as
reflected in our financial statements. For a more detailed
discussion of the Mission Insurance entities and the grantor
trusts, please see Note 25 to Notes to our Consolidated
Financial Statements for the years ended December 31, 2004
and 2003 and December 27, 2002 included in Appendix A
attached to this prospectus, such Notes referred to as the
“Notes to the Audited Annual Financial Statements” in
this prospectus, Note 12 to the Notes to the Unaudited
Interim Financial Statements, “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations — Executive Summary — NOLs”
and “The Business — General Overview”
in this prospectus below.
In addition, if our existing insurance business were to require
capital infusions from us in order to meet certain regulatory
capital requirements and were we 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 and we may not
be able to recognize significant taxable income.
| The market for our common stock has been historically illiquid which may affect your ability to sell your shares. |
The volume of trading in our stock has historically been low. In
the last six months, the daily trading volume for our stock has
been approximately 401,023 shares. Having a market for
shares without substantial liquidity can adversely affect the
price of the stock at a time when you might want to sell your
shares.
| Reduced liquidity and price volatility could result in a loss to investors. |
Although our common stock is listed on the NYSE, there can be no
assurance as to the liquidity of an investment in our common
stock or as to the price an investor may realize upon the sale
of our common stock. These prices are determined in the
marketplace and may be influenced by many factors, including the
liquidity of the market for our common stock, the market price
of our common stock, investor perception and general economic
and market conditions.
| Concentrated stock ownership and a restrictive certificate of incorporation provision may discourage unsolicited acquisition proposals. |
Assuming the issuance of 5,700,000 shares of our common
stock in the offering described in this prospectus, SZ
Investments, Third Avenue and Laminar, separately own as of
November 25, 2005, approximately 15.8%, 6.0% and 18.0%,
respectively, or when aggregated, 39.8% of our outstanding
common stock. In addition, Laminar is an eligible offeree in the
offering. Although there are no agreements among
SZ Investments, Third Avenue and Laminar regarding their
voting or disposition of shares of our common stock, the level
of their combined ownership of shares of common stock could have
the effect of discouraging or impeding an unsolicited
acquisition proposal. In addition, the change in ownership
limitations contained in
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Article Fifth of our certificate of incorporation could
have the effect of discouraging or impeding an unsolicited
takeover proposal.
| Future sales of our common stock may depress our stock price. |
No prediction can be made as to the effect, if any, that future
sales of our common stock, or the availability of our common
stock for future sales, will have on the market price of our
common stock. Sales in the public market of substantial amounts
of our common stock, or the perception that such sales could
occur, could adversely affect prevailing market prices for our
common stock. In addition, in connection with the Covanta
acquisition financing, we filed a registration statement on
Form S-3 to register the resale of 17,711,491 shares
of our common stock held by Laminar, Third Avenue and SZ
Investments, which was declared effective on August 24,
2004. In connection with our acquisition of Ref-Fuel, we have
agreed to register, within twelve months of the June 24,
2005 closing of the Ref-Fuel acquisition, the resale of certain
shares held or acquired by Laminar, Third Avenue and SZ
Investments in an underwritten public offering. The potential
effect of these shares being sold may be to depress the price at
which our common stock trades.
| Our disclosure controls and procedures may not prevent or detect all acts of fraud. |
Our disclosure controls and procedures are designed to
reasonably assure that information required to be disclosed by
us in reports we file or submit under the Securities Exchange
Act is accumulated and communicated to management, recorded,
processed, summarized and reported within the time periods
specified in the rules and forms of the Securities and Exchange
Commission commonly referred to as the “SEC.”
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 reflect
the fact that there are resource constraints, and the benefits
of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, they cannot
provide absolute assurance that all control issues and instances
of fraud, if any, within our companies have been prevented or
detected. These inherent limitations include the realities that
judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally,
controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by an
unauthorized override of the controls. The design of any systems
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 not be
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 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, and in the future may discover, areas of
our internal control over financial reporting which may require
improvement. For example, during the course of its audit of our
2004 financial statements, our independent auditors,
Ernst & Young LLP, referred to as
“Ernst & Young” in this prospectus,
identified errors, principally related to complex manual
“fresh-start” accounting calculations, predominately
affecting Covanta’s investments in its international
businesses. Although the net effect of these errors was
immaterial
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(less than $2.0 million, pretax), and such errors were
corrected before our 2004 consolidated financial statements were
issued, management determined that errors in complex fresh-start
and other technical accounting areas originally went undetected
due to insufficient technical in-house expertise necessary to
provide sufficiently rigorous review. As a result, management
has concluded that our internal control over financial reporting
was not effective as of December 31, 2004. Although we have
identified and undertaken steps necessary in order to remediate
this material weakness, as of our quarterly report on
Form 10-Q for the period ended September 30, 2005, we
were unable to conclude that we had remediated this material
weakness. The effectiveness of our internal control over
financial reporting in the future will depend on our ability to
fulfill these steps to remediate this material weakness. 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.
Waste and Energy Services Business-Specific Risks
| In connection with the Ref-Fuel acquisition, Covanta has incurred a large amount of debt, and we cannot assure you that our cash flow from operations will be sufficient to pay this debt. |
Following the acquisition of Ref-Fuel, Covanta had corporate
debt of $675 million, which we have guaranteed. Our ability
to service this debt will depend upon:
| • | the continued operation and maintenance of our facilities, consistent with historical performance levels; | |
| • | compliance with our debt covenants under our, and our subsidiaries, various credit arrangements; | |
| • | compliance by our subsidiaries with their respective debt covenants in order to permit distributions of cash to Covanta; | |
| • | maintenance or enhancement of revenue from renewals or replacement of existing contracts, which begin to expire in 2007, 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 Covanta’s existing contracts expire; and | |
| • | the continued availability to Covanta of the benefit of our NOLs under a tax sharing agreement. | |
For a more detailed discussion of Covanta’s domestic debt
covenants, please see “Management’s Discussion and
Analysis of Financial Condition and Results of
Operations — Management’s Discussion and Analysis
of Liquidity and Capital Resources — Waste and Energy
Services Segment” and Note 11 to the Notes to the
Unaudited Interim Financial Statements.
Covanta’s ability to make payments on its indebtedness and
to fund planned capital expenditures and other necessary
expenses will depend on its ability to generate cash and receive
dividends and distributions from its subsidiaries in the future.
This, to a certain extent, is subject to general economic,
financial, competitive, legislative, regulatory and other
factors that are beyond our control. We cannot assure you that
Covanta’s business will generate sufficient cash flow from
operations to pay this debt.
| We may be unable to integrate the operations of Ref-Fuel and Covanta successfully and may not realize the full anticipated benefits of the acquisition. |
Achieving the anticipated benefits of the recent acquisition of
Ref-Fuel will depend in part upon our ability to integrate the
two companies’ businesses in an efficient and effective
manner. Our attempt to integrate two companies that have
previously operated independently may result in significant
challenges, and we may be unable to accomplish the integration
smoothly or successfully. In particular, the necessity of
coordinating organizations in additional locations and
addressing possible differences in corporate cultures and
management philosophies may increase the difficulties of
integration. The integration will require the
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dedication of significant management resources, which may
temporarily distract management’s attention from the
day-to-day operations of the businesses of the combined company.
The process of integrating operations after the transaction
could cause an interruption of, or loss of momentum in, the
activities of one or more of the combined company’s
businesses and the loss of key personnel. Employee uncertainty
and lack of focus during the integration process may also
disrupt the businesses of the combined company. Any inability of
management to successfully integrate Ref-Fuel’s operations
with the operations of Covanta could have a material adverse
effect on our business and financial condition.
The anticipated benefits of the transaction include the
elimination of duplicative costs, the strategic expansion of
Covanta’s core waste-to-energy business in the northeast
region of the United States and the strengthening of
Covanta’s credit profile and lowering of our costs of
capital. We may not be able to realize, in whole or in part, or
within the anticipated time frames, any of these expected costs
of savings or improvements. The realization of the anticipated
benefits of the transaction are subject to significant business,
economic and competitive uncertainties and contingencies, many
of which are beyond our control. As a result, we may not be able
to achieve our expected results of operations and our actual
income, cash flow or earnings available to satisfy debt
obligations may be materially lower than the pro forma results
we have previously filed with the SEC and that are included in
this prospectus.
| We may not have access to the cash flow and other assets of our subsidiaries that may be needed to make payment on Covanta’s debt. |
Much of our business is conducted through our subsidiaries. Our
ability to make payments on the debt incurred by Covanta is
dependent on the earnings and the distribution of funds from our
subsidiaries.
Certain of our subsidiaries and affiliates are already subject
to project and other financing and will not guarantee our
obligations on Covanta’s debts. The debt agreements of
these subsidiaries and affiliates generally restrict their
ability to pay dividends, make distributions or otherwise
transfer funds to us. In addition, a substantial amount of the
assets of our non-guarantor subsidiaries and affiliates has been
pledged as collateral under their respective project financing
agreements, or financings at intermediate subsidiary levels, and
will be excluded entirely from the liens in favor of
Covanta’s new financing. See “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations — Management’s Discussion and Analysis
of Liquidity and Capital Resources — Waste and Energy
Services Segment” and Note 11 to the Notes to the
Unaudited Interim Financial Statements for a more complete
description of the terms of such indebtedness. We cannot assure
you that certain of the agreements governing the current and
future indebtedness of our subsidiaries will permit our
subsidiaries to provide us with sufficient dividends,
distributions or loans to fund payments on the Covanta
indebtedness when due.
| Our ability to grow our Waste and Energy Services business may be limited. |
Our ability to grow our Waste and Energy Services business by
investing in new projects may be limited by debt covenants in
Covanta’s principal financing agreements, and by
potentially fewer market opportunities for new waste-to-energy
facilities. Our Waste and Energy Services business is based upon
building and operating municipal solid waste disposal and energy
generating projects, which are capital intensive businesses that
require financing through direct investment and the incurrence
of debt. The covenants in Covanta’s financing agreements
limit investments in new projects or acquisitions of new
businesses and place restrictions on Covanta’s ability to
expand existing projects. The covenants limit borrowings to
finance new construction, except in limited circumstances
related to expansions of existing facilities.
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| Operation of our Waste and Energy Services facilities and the expansion of facilities involve significant risks. |
The operation of our Waste and Energy Services facilities and
the construction of new or expanded facilities involve 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; | |
| • | the unavailability of sufficient quantities of waste; | |
| • | decreases in the fees for solid waste disposal; | |
| • | 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 Waste and
Energy Services business or operations. These risks, if they
were to occur, could prevent Covanta and its subsidiaries from
meeting their obligations under their operating contracts.
| Development, construction and operation of new projects may not commence as scheduled, or at all. |
The development and construction of new facilities involves many
risks including siting, permitting, financing and construction
delays and expenses, start-up problems, the breakdown of
equipment and performance below expected levels of output and
efficiency. New facilities have no operating history and may
employ recently developed technology and equipment. Our Waste
and Energy Services 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.
| Our insurance and contractual protections may not always cover lost revenues, increased expenses or liquidated damages payments. |
Although our Waste and Energy Services 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.
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| Performance reductions could materially and adversely affect us and our projects may operate at lower levels than expected. |
Most service agreements for our waste-to-energy 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 contract. In most
cases, such contractual provisions excuse our Waste and Energy
Services businesses from performance obligations to the extent
affected by uncontrollable circumstances and provide for service
fee adjustments if uncontrollable circumstances increase its
costs. We cannot assure you that these provisions will prevent
our Waste and Energy Services businesses from incurring losses
upon the occurrence of uncontrollable circumstances or that if
our Waste and Energy Services businesses were to incur such
losses they would continue to be able to service their debt.
Covanta and certain of its subsidiaries have issued or are party
to performance guarantees and related contractual obligations
associated with its waste-to-energy, independent power and water
facilities. With respect to its domestic businesses, Covanta and
certain of its subsidiaries have issued guarantees to their
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. The
obligations guaranteed will depend upon the contract involved.
Many of our subsidiaries have contracts to operate and maintain
waste-to-energy 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 Covanta and
certain of its subsidiaries 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 waste-to-energy
facilities could expose us to recourse liability on project
debt. Covanta and certain of its subsidiaries may not have
sufficient sources of cash to pay such damages or other
obligations. We cannot assure you that Covanta and such
subsidiaries will be able to continue to avoid incurring
material payment obligations under such guarantees or that if it
did incur such obligations that they would have the cash
resources to pay them.
| Our Waste and Energy Services businesses generate their revenue primarily under long-term contracts and must avoid defaults under their contracts in order to service their debt and avoid material liability to contract counterparties. |
Covanta’s subsidiaries must satisfy performance and other
obligations under contracts governing waste-to-energy
facilities. These contracts typically require Covanta’s
subsidiaries to meet certain performance criteria relating to
amounts of waste processed, energy generation rates per ton of
waste processed, residue quantity and environmental standards.
The failure of Covanta subsidiaries to satisfy these criteria
may subject them to termination of their respective operating
contracts. If such a termination were to occur, Covanta’s
subsidiaries would lose the cash flow related to the projects
and incur material termination damage liability, which may be
guaranteed by Covanta or certain of its subsidiaries. In
circumstances where the contract of one or more subsidiaries has
been terminated due to the default of the Covanta subsidiary
they may not have sufficient sources of cash to pay such
damages. We cannot assure you that Covanta’s subsidiaries
will be able to continue to perform their respective obligations
under such contracts in order to avoid such contract
terminations, or damages related to any such contract
termination, or that if they could not avoid such terminations
that they would have the cash resources to pay amounts that may
then become due.
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| Covanta and certain of its subsidiaries have provided guarantees and support in connection with its subsidiaries’ projects. |
Covanta and certain of its subsidiaries are obligated to
guarantee or provide financial support for its
subsidiaries’ projects in one or more of the following
forms:
| • | support agreements in connection with service or operating agreement-related obligations; | |
| • | direct guarantees of certain debt relating to three of its facilities; | |
| • | contingent obligation to pay lease payment installments in connection with two of its facilities; | |
| • | 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.
| Covanta may face increased risk of market influences on its domestic revenues after its contracts expire. |
Covanta’s contracts to operate waste-to-energy projects
expire on various dates between 2007 and 2023, and its contracts
to sell energy output generally expire when the project’s
operating contract expires. One of Covanta’s contracts will
expire in 2007. During the twelve-month period from January 1 to
December 31, 2004, this contract contributed
$12.5 million in revenues. Expiration of these contracts
will subject Covanta to greater market risk in maintaining and
enhancing its revenues. As its operating contracts at
municipally-owned projects approach expiration, Covanta will
seek to enter into renewal or replacement contracts to continue
operating such projects. However, we cannot assure you that
Covanta will be able to enter into renewal or replacement
contracts on terms favorable to it, or at all. Covanta 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 Covanta to sell project energy output either into
the electricity grid or pursuant to new contracts.
At some of our facilities, market conditions may allow Covanta
to effect extensions of existing operating contracts along with
facility expansions. Such extensions and expansions are
currently being considered at a limited number of Covanta’s
facilities in conjunction with its municipal clients. If Covanta
were unable to reach agreement with its municipal clients on the
terms under which it 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 Covanta’s
cash flow and profitability. We cannot assure you that Covanta
will be able to enter into such contracts or that the terms
available in the market at the time will be favorable to it.
| Our Waste and Energy Services businesses depend on performance by third parties under contractual arrangements. |
Our Waste and Energy Services businesses depend on a limited
number of third parties to, among other things, purchase the
electric and steam energy produced by its 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 Services businesses or
other parties to the contracts, or due to force majeure events
or changes in laws or regulations, our Waste and Energy Services
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
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bankruptcy or insolvency of a participant or third party in our
Waste and Energy Services 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.
Our Waste and Energy Services 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 Waste and Energy
Services 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
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 Waste and Energy Services business.
In addition, for their waste-to-energy facilities, our
subsidiaries rely on their municipal clients as a source not
only of waste for fuel but also of revenue from fees for
disposal services our subsidiaries provide. Because contracts of
our subsidiaries with their municipal clients are generally
long-term, our subsidiaries may be adversely affected if the
credit quality of one or more of their municipal clients were to
decline materially.
| Our Waste and Energy Services business is subject to pricing fluctuations caused by the waste disposal and energy market. |
While our Waste and Energy Services businesses both sell the
majority of their waste disposal capacity and energy output
pursuant to long-term contracts, a portion of this capacity and
output representing less than 30% of our revenue is subject to
market price fluctuation. With the acquisition of Ref-Fuel, a
larger percentage of our revenue is subject to market risk from
fluctuations in waste market prices than has historically been
the case. Consequently, short-term fluctuations in the waste and
energy markets may have a greater impact on our revenues than we
have previously experienced.
| Covanta’s waste operations are concentrated in one region, and expose us to regional economic or market declines. |
The majority of Covanta’s waste disposal facilities are
located in the northeastern United States, primarily along the
Washington, D.C. to Boston corridor. Adverse economic
developments in this region could affect regional waste
generation rates and demand for waste disposal services provided
by Covanta. 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 Covanta’s revenues and cash
generation.
| Some of Covanta’s energy contracts involve greater risk of exposure to performance levels which could result in materially lower revenues. |
While our historic energy business typically is contractually
entitled to only a small share (generally 10%) of the energy
revenues generated by a waste-to-energy project, subsequent to
the Ref-Fuel acquisition, seven of our 31 waste-to-energy
facilities receive 100% of the energy revenues they generate.
As a result, if we are unable to operate these seven facilities
at their historical performance levels for any reason, our
revenues from energy sales could materially decrease.
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| Exposure to international economic and political factors may materially and adversely affect our Waste and Energy Services businesses. |
Covanta Power International Holdings, Inc., which we refer to as
“CPIH” in this prospectus, is a wholly-owned
subsidiary of Covanta. CPIH’s operations are entirely
outside the United States and expose it to 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 CPIH
of a foreign project.
CPIH’s projected cash distributions from existing
facilities comes from facilities located in countries with
sovereign ratings below investment grade, including Bangladesh,
the Philippines and India. 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 tariffs; | |
| • | 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; and | |
| • | expropriation and confiscation of assets and facilities. |
The legal and financial environment in foreign countries in
which CPIH currently owns assets or projects also could make it
more difficult for it to enforce its rights under agreements
relating to such projects.
Any or all of the risks identified above with respect to the
CPIH projects could adversely affect our revenue and cash
generation. As a result, these risks may have a material adverse
effect on our Waste and Energy Services business, consolidated
financial condition and results of operations.
| Exposure to foreign currency fluctuations may affect CPIH’s costs of operations. |
CPIH participates in projects in jurisdictions where limitations
on the convertibility and expatriation of currency have been
lifted by the host country and where such local currency is
freely exchangeable on the international markets. In most 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 CPIH’s costs and results of operations. |
Changes in the market prices and availability of fuel supplies
to generate electricity may increase CPIH’s cost of
producing power, which could adversely impact our energy
businesses’ profitability and financial performance.
The market prices and availability of fuel supplies of some of
CPIH’s facilities fluctuate. Any price increase, delivery
disruption or reduction in the availability of such supplies
could affect CPIH’s ability to operate its facilities and
impair its cash flow and profitability. CPIH may be subject to
further exposure if any
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of its future 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 waste-to-energy facilities depend on solid waste for fuel,
which provides a source of revenue. For most of our facilities,
the prices they 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
waste-to-energy facilities, the availability of solid waste to
us, as well as the tipping fee that we must charge to attract
solid waste to its facilities, depends upon competition from a
number of sources such as other waste-to-energy 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
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 waste-to-energy facilities and market
pricing.
| Compliance with environmental laws could adversely affect our results of operations. |
Costs of compliance with federal, state and local existing and
future environmental regulations could adversely affect our cash
flow and profitability. Our Waste and Energy Services 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 Waste and Energy Services
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 Waste and Energy Services 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. In addition, lawsuits or
enforcement actions by federal and/or state 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.
Our Waste and Energy Services 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.
| Federal energy regulation could adversely affect our revenues and costs of operations. |
Our Waste and Energy Services businesses are subject to
extensive energy regulations by federal and state authorities.
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, commonly referred to as the
“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 the Public Utility Regulatory Policies Act of
1978, commonly referred to as “PURPA,” our domestic
facilities are exempt from most provisions of the FPA and state
rate regulation. In addition, PURPA requires utility
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companies to purchase electricity produced by exempt non-utility
generators, such as Covanta. Our foreign projects are also
exempt from regulation under the FPA.
The Energy Policy Act of 2005, referred to as the “Policy
Act” in this prospectus, enacted comprehensive changes to
the domestic energy industry which may affect our businesses.
The 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 Policy
Act includes provisions that may remove some of the benefits
provided to non-utility electricity generators, like Covanta,
after its existing energy sale contracts expire. As a result, we
may face increased competition after such expirations occur.
If our Waste and Energy Services businesses become subject to
either the FPA or lose the ability under PURPA to require
utilities to purchase our electricity, 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, referred to as the “FERC” in
this prospectus, 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 Services businesses are continually in the
process of obtaining or renewing federal, state and local
approvals required to operate our facilities. While our Waste
and Energy Services 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 Waste and Energy Services 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 U.S. competitive pressures increase
and the pricing and sale of electricity assumes more
characteristics of a commodity business, the economics of our
business may come under increasing pressure. Regulatory
initiatives in foreign countries where our Waste and Energy
Services businesses have or will have operations involve the
same types of risks.
| Changes in laws and regulations affecting the solid waste and the energy industries could adversely affect our Waste and Energy Services business. |
Our Waste and Energy Services business is highly regulated. We
cannot predict whether the federal or state governments or
foreign governments will adopt legislation or regulations
relating to the solid waste or energy industries. These laws and
regulations can result in increased capital, operating and other
costs to our Waste and Energy Services business, particularly
with regard to enforcement efforts. The introduction of new laws
or other future regulatory developments that increase the costs
of operation or capital to us may have a material adverse effect
on our business, financial condition or results of operations.
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| 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
or produce power, including fuel cells, microturbines and solar
cells. It is possible that advances in these or other
technologies will reduce the cost of waste disposal or power
production from these technologies to a level below our costs.
Furthermore, increased conservation efforts could reduce the
demand for power or reduce the value of our facilities. Any of
these changes could have a material adverse effect on our
revenues and profitability.
| We have incurred and will continue to incur significant transaction and combination-related costs in connection with the acquisition of Ref-Fuel. |
We expect to incur significant costs, which we currently
estimate to be approximately $20 million through 2007,
associated with combining the operations of Covanta and
Ref-Fuel. However, we cannot predict with certainty the specific
size of those charges at this preliminary stage of the
integration process. Although we expect the elimination of
duplicative costs, as well as the realization of other
efficiencies related to the integration of the businesses, we
cannot give any assurance that this net benefit will be achieved
as planned in the near future or at all.
Insurance Business-Specific Risks
| Insurance regulations may affect NAICC’s operations. |
The insurance industry is highly regulated. NAICC is subject to
regulation by state and federal regulators, and a significant
portion of NAICC’s operations are subject to regulation by
the state of California. Changes in existing insurance
regulations or adoption of new regulations or laws which could
affect NAICC’s results of operations and financial
condition may include, without limitation, proposed changes to
California regulations regarding a broker’s fiduciary duty
to select the best carrier for an insured, extension of
California’s Low Cost Automobile Program beyond Los Angeles
and San Francisco counties and changes to California’s
workers’ compensation laws. We cannot predict the impact of
changes in existing insurance regulations or adoption of new
regulations or laws on NAICC’s results of operations and
financial condition.
| The insurance products sold by NAICC are subject to intense competition. |
The insurance products sold by NAICC are subject to intense
competition from many competitors, many of whom have
substantially greater resources than NAICC. The California
non-standard personal automobile marketplace consists of over
100 carriers.
In order to decrease rates, insurers in California must obtain
prior permission for rate reductions from the California
Department of Insurance. In lieu of requesting rate decreases,
competitors may soften underwriting standards as an alternative
means of attracting new business. Such tactics, should they
occur, would introduce new levels of risk for NAICC and could
limit NAICC’s ability to write new policies or renew
existing profitable policies. We cannot assure you that NAICC
will be able to successfully compete in these markets and
generate sufficient premium volume at attractive prices to be
profitable. This risk is enhanced by the reduction in lines of
business NAICC writes as a result of its decision to reduce
underwriting operations.
| If NAICC’s loss experience exceeds its estimates, additional capital may be required. |
Unpaid losses and loss adjustment expenses are based on
estimates of reported losses, historical company experience of
losses reported for reinsurance assumed and historical company
experience for unreported claims. Such liability is, by
necessity, based on estimates that may change in the near term.
NAICC cannot assure you that the ultimate liabilities will not
exceed, or even materially exceed, the amounts estimated. If the
ultimate liability materially exceeds estimates, then additional
capital may be required to be contributed to some of our
insurance subsidiaries. NAICC and the other insurance
subsidiaries received additional capital contributions from us
in 2003 and 2002, and NAICC cannot provide any assurance that it
and its subsidiaries will be able to obtain additional capital
on commercially reasonable terms or at all.
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In addition, due to the fact that NAICC and its other insurance
subsidiaries are in the process of running off several
significant lines of business, the risk of adverse development
and the subsequent requirement to obtain additional capital is
heightened.
| Failure to satisfy capital adequacy and risk-based capital requirements would require NAICC to obtain additional capital. |
NAICC is subject to regulatory risk-based capital requirements.
Depending on its risk-based capital, NAICC could be subject to
various levels of increasing regulatory intervention ranging
from company action to mandatory control by insurance regulatory
authorities. NAICC’s capital and surplus is also one factor
used to determine its ability to distribute or loan funds to us.
If NAICC has insufficient capital and surplus, as determined
under the risk-based capital test, it will need to obtain
additional capital to establish additional reserves. NAICC
cannot provide any assurance that it will be able to obtain such
additional capital on commercially reasonable terms or at all.
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UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma condensed consolidated
financial statements for the nine-month period ended
September 30, 2005 and the year ended December 31,
2004, are based on our historical financial statements and the
historical financial statements of Covanta, Ref-Fuel and
Ref-Fuel Holdings. The unaudited pro forma condensed statements
of combined operations are presented as if the acquisitions of
Covanta and Ref-Fuel both occurred on January 1, 2004
adjusted for events that are (1) directly attributable to
the transactions, (2) expected to have continuing impact,
and (3) factually supportable.
The unaudited pro forma condensed consolidated financial
information should be read in conjunction with:
| • | The accompanying notes to the unaudited pro forma condensed consolidated financial statements; | |
| • | Our separate historical financial statements (1) as of and for the year ended December 31, 2004 attached to this prospectus as Appendix A, and (2) as of and for the nine months ended September 30, 2005 attached to this prospectus as Appendix B; | |
| • | Ref-Fuel’s separate historical financial statements (1) as of and for the year ended December 31, 2004 attached to this prospectus as Appendix C, and (2) as of and for the nine months ended September 30, 2005 attached to this prospectus as Appendix D; and | |
| • | Covanta’s separate historical financial statements as of and for the year ended December 31, 2004 attached to this prospectus as Appendix E. | |
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Covanta Holding Corporation
Pro Forma Nine Months Ended September 30, 2005
Unaudited Pro Forma Consolidated Statement of Operations
| Covanta Holding | Ref-Fuel | |||||||||||||||||||||
| Jan. 1 — Sep. 30, | Jan. 1 — June 24, | Pro Forma | Pro Forma | |||||||||||||||||||
| 2005 | 2005 | Adjustments | ADJ | Combined | ||||||||||||||||||
| (In thousands of dollars) | ||||||||||||||||||||||
|
OPERATING REVENUES
|
||||||||||||||||||||||
|
Waste and service revenues
|
$ | 436,624 | $ | 148,792 | $ | — | $ | 585,416 | ||||||||||||||
|
Energy and steam sales
|
225,541 | 79,660 | — | 305,201 | ||||||||||||||||||
|
Other operating revenues
|
13,236 | — | — | 13,236 | ||||||||||||||||||
|
Total operating revenues
|
675,401 | 228,452 | — | 903,853 | ||||||||||||||||||
|
OPERATING EXPENSES
|
||||||||||||||||||||||
|
Plant operating expenses
|
393,343 | 103,617 | 3,136 | J | 500,096 | |||||||||||||||||
|
Depreciation and amortization expense
|
78,027 | 57,032 | (5,380 | ) | J | 129,679 | ||||||||||||||||
|
Net interest expense on project debt
|
36,700 | 13,964 | 1,474 | J | 52,138 | |||||||||||||||||
|
Other operating expenses
|
7,736 | 519 | — | 8,255 | ||||||||||||||||||
|
General and administrative expenses
|
46,313 | 52,133 | (41,675 | ) | M | 56,047 | ||||||||||||||||
| (724 | ) | J | ||||||||||||||||||||
|
Restructuring charges
|
2,655 | — | (2,655 | ) | M | — | ||||||||||||||||
|
Acquisition-related charges
|
2,963 | — | (2,963 | ) | M | — | ||||||||||||||||
|
Total operating expenses
|
567,737 | 227,265 | (48,787 | ) | 746,215 | |||||||||||||||||
|
Operating income
|
107,664 | 1,187 | 48,787 | 157,638 | ||||||||||||||||||
|
Investment income
|
3,530 | 1,225 | — | 4,755 | ||||||||||||||||||
|
Interest expense
|
(59,053 | ) | (26,368 | ) | — | (90,859 | ) | |||||||||||||||
| 28,944 | H | |||||||||||||||||||||
| (37,362 | ) | I | ||||||||||||||||||||
| 2,980 | J | |||||||||||||||||||||
|
Gain on derivative instrument, unexercised ACL warrants
|
14,796 | — | — | 14,796 | ||||||||||||||||||
|
Total other expenses
|
(40,727 | ) | (25,143 | ) | (5,438 | ) | (71,308 | ) | ||||||||||||||
|
Income before income taxes, minority interests and equity in net
income from unconsolidated investments
|
66,937 | (23,956 | ) | 43,349 | 86,330 | |||||||||||||||||
|
Income tax benefit (expense)
|
(24,008 | ) | 6,033 | (20,874 | ) | K | (38,849 | ) | ||||||||||||||
|
Minority interest expense
|
(9,311 | ) | (56 | ) | — | (9,367 | ) | |||||||||||||||
|
Equity in net income from unconsolidated investments
|
20,003 | — | — | 20,003 | ||||||||||||||||||
|
NET INCOME (LOSS)
|
$ | 53,621 | $ | (17,979 | ) | $ | 22,475 | $ | 58,117 | |||||||||||||
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Covanta Holding Corporation
Pro Forma Year Ended December 31, 2004
Unaudited Pro Forma Consolidated Statement of Operations
| Jan. 1 to | |||||||||||||||||||||||||||||||||
| Mar. 10, 2004 | Jan. 1 to | ||||||||||||||||||||||||||||||||
| Jan. 1 to | Deconsolidation | Apr. 30, 2004 | |||||||||||||||||||||||||||||||
| Dec. 31, 2004 | Jan. 1 to | of Covanta | Jan. 1 to | Ref-Fuel | |||||||||||||||||||||||||||||
| Covanta | Mar. 10, 2004 | Energy | Dec. 31, 2004 | Ownership | Pro Forma | Pro Forma | |||||||||||||||||||||||||||
| Holding | Covanta Energy | Entities(A) | Ref-Fuel | Changes(G) | Adjustments | ADJ | Combined | ||||||||||||||||||||||||||
| (In thousands of dollars) | |||||||||||||||||||||||||||||||||
|
OPERATING REVENUES
|
|||||||||||||||||||||||||||||||||
|
Waste and service revenues
|
$ | 372,748 | $ | 89,867 | $ | (5,282 | ) | $ | 194,950 | $ | 89,496 | $ | (7,219 | ) | L | $ | 778,729 | ||||||||||||||||
| 44,169 | L | ||||||||||||||||||||||||||||||||
|
Energy and steam sales
|
181,074 | 53,307 | (535 | ) | 93,188 | 41,566 | 59,770 | L | 398,797 | ||||||||||||||||||||||||
| (29,573 | ) | L | |||||||||||||||||||||||||||||||
|
Other operating revenues
|
22,374 | 58 | — | 10,506 | 6,475 | (16,981 | ) | L | 22,432 | ||||||||||||||||||||||||
|
Total operating revenues
|
576,196 | 143,232 | (5,817 | ) | 298,644 | 137,537 | 50,166 | 1,199,598 | |||||||||||||||||||||||||
|
OPERATING EXPENSES
|
|||||||||||||||||||||||||||||||||
|
Plant operating expenses
|
348,867 | 100,774 | (3,632 | ) | 116,089 | 73,322 | 15,840 | L | 657,619 | ||||||||||||||||||||||||
| 6,359 | J | ||||||||||||||||||||||||||||||||
|
Depreciation and amortization expense
|
53,131 | 13,426 | (786 | ) | 45,154 | 22,842 | (12,640 | ) | B | 173,315 | |||||||||||||||||||||||
| 8,598 | C | ||||||||||||||||||||||||||||||||
| 3,375 | D | ||||||||||||||||||||||||||||||||
| 59,770 | L | ||||||||||||||||||||||||||||||||
| (7,219 | ) | L | |||||||||||||||||||||||||||||||
| (12,336 | ) | J | |||||||||||||||||||||||||||||||
|
Net interest expense on project debt
|
32,586 | 13,407 | (1,045 | ) | — | — | (2,400 | ) | L | 76,960 | |||||||||||||||||||||||
| 30,779 | L | ||||||||||||||||||||||||||||||||
| (3,419 | ) | E | |||||||||||||||||||||||||||||||
| 7,052 | J | ||||||||||||||||||||||||||||||||
|
Other operating expenses
|
16,560 | (2,234 | ) | 116 | 1,462 | 220 | (425 | ) | L | 15,699 | |||||||||||||||||||||||
|
General and administrative expenses
|
48,182 | 7,597 | (322 | ) | 30,216 | 15,031 | (18,634 | ) | L | 76,037 | |||||||||||||||||||||||
| (4,949 | ) | M | |||||||||||||||||||||||||||||||
| (1,084 | ) | J | |||||||||||||||||||||||||||||||
|
Total operating expenses
|
499,326 | 132,970 | (5,669 | ) | 192,921 | 111,415 | 68,667 | 999,630 | |||||||||||||||||||||||||
|
Operating income
|
76,870 | 10,262 | (148 | ) | 105,723 | 26,122 | (18,501 | ) | 200,328 | ||||||||||||||||||||||||
|
Investment income
|
2,343 | 935 | — | 2,967 | 1,022 | (2,400 | ) | L | 4,867 | ||||||||||||||||||||||||
|
Interest expense
|
(43,739 | ) | (6,142 | ) | 6 | (69,219 | ) | (21,626 | ) | 30,779 | L | (123,339 | ) | ||||||||||||||||||||
| 55,400 | H | ||||||||||||||||||||||||||||||||
| (74,724 | ) | I | |||||||||||||||||||||||||||||||
| 5,926 | J | ||||||||||||||||||||||||||||||||
|
Reorganization items
|
— | (58,282 | ) | — | — | — | 58,282 | F | — | ||||||||||||||||||||||||
|
Fresh-start adjustments
|
— | (399,063 | ) | — | — | — | 399,063 | F | — | ||||||||||||||||||||||||
|
Gain on extinguishment of debt
|
— | 510,680 | — | — | — | (510,680 | ) | F | — | ||||||||||||||||||||||||
|
Income (loss) before income taxes, minority interests and equity
in net income from unconsolidated investments
|
35,474 | 58,390 | (142 | ) | 39,471 | 5,518 | (56,855 | ) | 81,856 | ||||||||||||||||||||||||
|
Income tax benefit (expense)
|
(11,535 | ) | (30,240 | ) | — | (17,818 | ) | — | 21,939 | K | (37,654 | ) | |||||||||||||||||||||
|
Minority interest expense
|
(6,869 | ) | (2,511 | ) | — | (12,283 | ) | 11,372 | — | (10,291 | ) | ||||||||||||||||||||||
|
Equity in net income (loss) from unconsolidated investments
|
17,024 | 3,924 | 142 | 6,148 | (6,148 | ) | — | 21,090 | |||||||||||||||||||||||||
|
NET INCOME
|
$ | 34,094 | $ | 29,563 | $ | — | $ | 15,518 | $ | 10,742 | $ | (34,916 | ) | $ | 55,001 | ||||||||||||||||||
24
Table of Contents
| NOTE 1: | BASIS OF PRESENTATION |
| Covanta |
On December 2, 2003, we executed a definitive investment
and purchase agreement to acquire Covanta in connection with
Covanta’s emergence from Chapter 11 proceedings after
the non-core and geothermal assets of Covanta were divested. The
primary components of the transaction were: (1) our
purchase of 100% of the equity of Covanta in consideration for a
cash purchase price of approximately $30 million, and
(2) agreement as to new letter of credit and revolving
credit facilities for Covanta’s domestic and international
operations, provided by some of the existing Covanta lenders and
a group of additional lenders we organized. Our acquisition of
Covanta was consummated on March 10, 2004.
The aggregate purchase price was $47.5 million which
included the cash purchase price of $30 million,
$6.4 million for professional fees and other estimated
costs incurred in connection with the acquisition, and an
estimated fair value of $11.3 million for our commitment to
sell up to 3.0 million shares of our common stock at
$1.53 per share to certain creditors of Covanta, subject to
certain limitations.
In addition to the purchase price allocation adjustments,
Covanta’s emergence from Chapter 11 proceedings on
March 10, 2004 resulted in Covanta becoming a new reporting
entity and adoption of fresh-start accounting as of that date,
in accordance with AICPA Statement of Position 90-7,
“Financial Reporting by Entities in Reorganization Under
the Bankruptcy Code,” referred to as
“SOP 90-7” in this prospectus. The following
table summarizes the final allocation of values to the assets
acquired and liabilities assumed at March 10, 2004 in
conformity with Statement of Financial Accounting Standards,
referred to in this prospectus as “SFAS,”
No. 141, “Business Combinations,” referred to as
“SFAS No. 141” in this prospectus, and
SFAS No. 109, “Accounting for Income Taxes,”
referred to as “SFAS No. 109” in this
prospectus (in thousands of dollars):
|
Current assets
|
$ | 522,659 | |||
|
Property, plant and equipment
|
814,369 | ||||
|
Intangible assets
|
191,943 | ||||
|
Other assets
|
327,065 | ||||
|
Total assets acquired
|
$ | 1,856,036 | |||
|
Current liabilities
|
$ | 364,480 | |||
|
Long-term debt
|
328,053 | ||||
|
Project debt
|
850,591 | ||||
|
Deferred income taxes
|
88,405 | ||||
|
Other liabilities
|
176,982 | ||||
|
Total liabilities assumed
|
$ | 1,808,511 | |||
|
Net assets acquired
|
$ | 47,525 | |||
The acquired intangible assets of $191.9 million primarily
relate to service and energy agreements on publicly-owned
waste-to-energy projects with an approximate 17-year weighted
average useful life. However, many such contracts have remaining
lives that are significantly shorter.
25
Table of Contents
| Ref-Fuel |
The following table summarizes the preliminary allocation of
values to the assets acquired and liabilities assumed as of
June 24, 2005, the acquisition date of Ref-Fuel, in
conformity with SFAS No. 141 and
SFAS No. 109. The allocation of purchase price to
Ref-Fuel is preliminary and subject to change as additional
information and analysis is obtained. We are in the process of
performing the valuation studies necessary to finalize the fair
values of the assets and liabilities of Ref-Fuel and the related
allocation of purchase price. We expect that adjustments to the
preliminary fair values may include those related to:
| • | property, plant and equipment, intangibles, goodwill and debt, all of which may change based on consideration of additional analysis by us and our valuation consultants; | |
| • | accrued expenses for transaction costs and restructuring efforts which may change based on identification of final fees and costs; and | |
| • | tax liabilities and deferred taxes, which may be adjusted based upon additional information to be received from taxing authorities and which result from changes in the allocated book basis of items for which deferred taxes are provided. | |
| Purchase Price Allocation as of | |||||||||
| June 24, | September 30, | ||||||||
| 2005 | 2005 | ||||||||
| (In thousands of dollars) | |||||||||
|
Current assets
|
$ | 233,885 | $ | 233,885 | |||||
|
Property, plant and equipment
|
1,901,786 | 1,901,786 | |||||||
|
Intangible assets (excluding goodwill)
|
269,436 | 269,436 | |||||||
|
Goodwill
|
298,089 | 292,810 | |||||||
|
Other assets
|
111,458 | 108,869 | |||||||
|
Total assets acquired
|
$ | 2,814,654 | $ | 2,806,786 | |||||
|
Current liabilities
|
$ | 156,610 | $ | 156,610 | |||||
|
Long-term debt
|
655,270 | 655,270 | |||||||
|
Project debt
|
718,805 | 706,732 | |||||||
|
Deferred income taxes
|
368,907 | 372,684 | |||||||
|
Other liabilities
|
164,787 | 165,215 | |||||||
|
Total liabilities assumed
|
2,064,379 | 2,056,511 | |||||||
|
Minority interest acquired
|
3,058 | 3,058 | |||||||
|
Net assets acquired
|
$ | 747,217 | $ | 747,217 | |||||
The acquired intangible assets of $269.4 million relate to
favorable energy and waste contracts and a favorable leasehold
interest with an approximate ten-year average useful life. In
its initial purchase price allocation as of June 24, 2005,
goodwill of $298.1 million was recorded to reflect the
excess of cost over the preliminary fair value of acquired net
assets. As of September 30, 2005, goodwill was
$292.8 million which reflected adjustments to the carrying
value of project debt by $12.1 million, a fair value
adjustment related to a service agreement of $2.5 million,
a deferred tax adjustment of $3.8 million and various other
liability adjustments of $0.5 million as part of
Covanta’s ongoing purchase accounting review.
| NOTE 2: | PRO FORMA ADJUSTMENTS |
| Adjustments for the Covanta Transactions |
A. The “Deconsolidation of Covanta Energy
Entities” column of the unaudited pro forma condensed
consolidated statements of operations pertains to six of
Covanta’s subsidiaries which had not reorganized or filed a
liquidation plan under Chapter 11 as of March 10,
2004. For the 2004 pro forma period presented, these
26
Table of Contents
entities were not consolidated because we did not control these
debtors or the ultimate outcome of their respective
Chapter 11 cases. The subsidiaries related to the Tampa Bay
desalination and Lake County waste-to-energy projects emerged
from Chapter 11 on August 6, 2004 and
December 14, 2004, respectively, when they were
reconsolidated.
B. To reverse Covanta’s historical depreciation and
amortization expense, for the period January 1, 2004 to
March 10, 2004.
C. To include pro forma depreciation expense based on fair
values assigned to Covanta’s property, plant and equipment
for the period January 1, 2004 to March 10, 2004. The
weighted average remaining useful life of property, plant and
equipment acquired in the Covanta acquisition was approximately
19 years, consisting principally of energy facilities and
buildings with a weighted average remaining useful life of
approximately 21 years and machinery and equipment with a
weighted average remaining useful life of approximately
13 years.
D. To include pro forma amortization expense based on fair
values assigned to Covanta’s acquired intangible assets for
the period January 1, 2004 to March 10, 2004,
primarily service agreements on publicly owned waste-to-energy
projects.
E. To reverse Covanta’s historical amortization of
bond issuance costs ($0.8 million) on outstanding project
debt and include pro forma amortization of the premium on
project debt ($2.6 million) based on fair values assigned
to Covanta’s project debt, for the period January 1,
2004 to March 10, 2004.
F. To remove historical reorganization items, fresh-start
adjustments and the gain on extinguishment of debt resulting
from Covanta’s bankruptcy proceedings. Since the pro forma
condensed statement of combined operations has been prepared on
the basis that Covanta’s emergence from bankruptcy and the
business combination with us both occurred on January 1,
2004, these items have been removed, as these transactions to
effect Covanta’s reorganization would have been completed
and these items would have been recorded prior to
January 1, 2004.
| Adjustments for the Ref-Fuel Transactions |
G. On April 30, 2004, Ref-Fuel entered into a series
of transactions, referred to as “Equalization
Transactions” in this prospectus, that changed its
ownership structure. As a result of the Equalization
Transactions, Ref-Fuel gained control of MSW Energy Holdings
LLC, referred to as “MSW I” in this prospectus, and
MSW Energy Holdings II LLC, referred to as
“MSW II” in this prospectus (each being
subsidiaries of Ref-Fuel), which on a combined basis, owned
substantially all interests in Ref-Fuel Holdings. Ref-Fuel
Holdings is a holding company with a 100% membership interest in
ARC, which through subsidiaries, owns and operates six
waste-to-energy facilities in the United States. As a result of
the Equalization Transactions, Ref-Fuel had effective control of
Ref-Fuel Holdings, and therefore began consolidating its results
of operations from May 1, 2004.
The “Ref-Fuel Ownership Changes” column of the
unaudited pro forma condensed consolidated statement of
operations for the year-ended December 31, 2004 pertains to
entities that were not consolidated by Ref-Fuel until ownership
interests changed effective April 30, 2004 (the
Equalization Transactions described above). Ref-Fuel reported
its 50% share of earnings from its investment in Ref-Fuel
Holdings under the equity method from January 1, 2004 to
April 30, 2004 (four-month period) and consolidated such
operations from May 1, 2004 to December 31, 2004
(eight-month period). In addition, as a result of the
Equalization Transactions, Ref-Fuel obtained a 0.01% interest
and was named managing member of MSW I and began consolidating
its operations as of April 30, 2004. On August 31,
2004, in another transaction, Ref-Fuel acquired the 99.99%
non-managing interests in MSW I. As a result, Ref-Fuel owned
100% of the interests in MSW I after that date.
This column reverses the impact of accounting under the equity
method for the investment in Ref-Fuel Holdings for the
four-month period ended April 30, 2004 and reflects the
results of operations as if they had been consolidated as of
January 1, 2004. In addition, this column reflects the
results of operations for MSW I
27
Table of Contents
as if Ref-Fuel had owned a 100% interest in MSW I as of
January 1, 2004, which includes reversing the minority
interest relating to MSW I for the period of May 1,
2004 through August 31, 2004.
H. Covanta entered into new credit arrangements, referred
to as the “the Debt Financing Package” in this
prospectus, as part of the Ref-Fuel acquisition which were
assumed to have occurred as of January 1, 2004 on a pro
forma basis.
To reverse historical interest expense (including letter of
credit fees) associated with recourse debt and unfunded credit
facilities refinanced with the Debt Financing Package, the net
proceeds from a rights offering undertaken by us during the
second quarter of 2005 as part of the financing of the Ref-Fuel
acquisition, the interest expense related to Ref-Fuel’s
$40 million, 9% interest senior notes contributed by
Ref-Fuel’s members as a result of the August 31, 2004
transactions, and the interest expense for a related bridge loan
(in thousands of dollars).
| Nine Months | |||||||||
| Ended | Full Year | ||||||||
| Sept. 2005 | 2004 | ||||||||
|
Covanta Energy recourse debt (January 1 to March 10, 2004)
|
$ | — | $ | 6,142 | |||||
|
Covanta recourse debt (January 1 to December 31, 2004)
|
— | 9,033 | |||||||
|
Covanta Energy recourse debt and credit facilities
|
28,352 | 34,706 | |||||||
|
Ref-Fuel credit facilities
|
592 | 432 | |||||||
|
Ref-Fuel senior notes & bridge
|
— | 5,087 | |||||||
|
Total
|
$ | 28,944 | $ | 55,400 | |||||
I. To include pro forma interest expense based on the Debt
Financing Package (in thousands of dollars).
| Nine Months | |||||||||||||||||
| Ended | Full Year | ||||||||||||||||
| Principal | Rate | Sept. 2005 | 2004 | ||||||||||||||
|
Borrowings:
|
|||||||||||||||||
|
First Lien Facility
|
$ | 275,000 | 7.07 | % | $ | 9,721 | $ | 19,443 | |||||||||
|
Second Lien Facility
|
100,000 | 9.57 | % | 4,785 | 9,570 | ||||||||||||
|
Second Lien Facility
|
60,000 | 9.77 | % | 2,932 | 5,863 | ||||||||||||
|
Second Lien Facility
|
240,000 | 9.78 | % | 11,736 | 23,472 | ||||||||||||
|
Total Borrowings
|
$ | 675,000 | $ | 29,174 | $ | 58,348 | |||||||||||
|
Available for letters of credit and revolving credit
|
$ | 340,000 | 3 | % | $ | 5,100 | $ | 10,200 | |||||||||
|
Letter of credit availability under First Lien Facility
|
|||||||||||||||||
|
Revolving credit facility*
|
100,000 | 0.5 | % | 250 | 500 | ||||||||||||
|
Total unfunded
|
$ | 440,000 | $ | 5,350 | $ | 10,700 | |||||||||||
|
Amortization of Debt Financing
|
2,838 | 5,676 | |||||||||||||||
|
Package financing costs
|
|||||||||||||||||
|
Total
|
$ | 37,362 | $ | 74,724 | |||||||||||||
| (*) | Available for up to $75 million of letters of credit as an alternative to borrowings. This facility remains unused. |
Interest rates under the Debt Financing Package are based on the
three-month London InterBank Offering Rate, referred to as
“LIBOR,” plus a margin of 3.00% for the First Lien
Facility and 5.50% for the Second Lien Facility. The rates used
to determine the pro forma adjustments above were selected with
regard to our current credit ratings and the three-month LIBOR
rate of 4.07% used for the October through December 2005 payment
period.
28
Table of Contents
J. To record the difference between the preliminary
estimates of the fair values and the historical amounts of
Ref-Fuel’s assets and debt assumed by Covanta on
June 24, 2005, the date we acquired Ref-Fuel, and the
related impacts on depreciation, amortization and interest
expense as if the acquisition had occurred on January 1,
2004. The fair value of contract related assets (classified as
intangible assets, net) were attributable to revenue
arrangements for which the contractual rates were greater than
the market rates. The fair value of contract-related liabilities
(classified as other liabilities) were attributable to revenue
arrangements for which contractual rates were less than the
market rates.
| Other adjustments |
K. To record the estimated income tax effects associated
with the pro forma adjustments to pre-tax income other than item
(g) to arrive at a blended assumed effective tax rate of
47% for the combined company for the nine months ended
September 30, 2005.
L. Represents the reclassification of certain amounts among
revenue and expense categories to conform Ref-Fuel’s
historical presentation to our policies. These reclassifications
consisted of the following:
| • | Reclassification of the amortization of waste and energy contracts from revenue and expense to depreciation and amortization; | |
| • | Other revenues, which primarily consisted of sales of scrap metals, were reclassified from other revenues into waste and service revenues; | |
| • | Certain costs associated with operating facilities and TransRiver were reclassified from general and administrative expenses into plant operating expenses; | |
| • | Reimbursements from certain municipal clients for operating expenses were reclassified from revenues to reductions of operating expenses; | |
| • | Reductions of revenues shared with certain municipal customers for energy produced were reclassified from waste and service revenues to energy revenues; and | |
| • | Other minor miscellaneous reclassifications were also made. | |
M. Represents costs related to Ref-Fuel’s officers
that were terminated in connection with the transaction as well
as transaction related costs incurred by Ref-Fuel as follows (in
thousands of dollars):
| Nine Months | ||||||||
| Ended | Full Year | |||||||
| Sept. 2005 | 2004 | |||||||
|
Transaction costs
|
$ | 12,150 | $ | — | ||||
|
Executive severance
|
25,730 | — | ||||||
|
Executive compensation
|
3,795 | 4,949 | ||||||
| $ | 41,675 | $ | 4,949 | |||||
Additionally, our September 30, 2005 financial statements
reflect charges of $2.7 million and $3.0 million
related to restructuring and integration expenses, respectively.
29
Table of Contents
SELECTED FINANCIAL DATA
The following table sets forth selected components of our
consolidated financial data as of and for the fiscal years ended
December 31, 2004 and 2003, December 27, 2002, and
December 31, 2001 and 2000 and as of and for the nine
months ended September 30, 2005 and 2004.
The selected consolidated financial data at September 30,
2005 and for the nine months ended September 30, 2005 and
2004 have been derived from our unaudited financial statements
which are included elsewhere in this prospectus. The selected
consolidated financial data at and for the fiscal years ended
December 31, 2004 and 2003 and December 27, 2002 have
been derived from each of our audited financial statements which
are included elsewhere in this prospectus. The selected
consolidated financial data at and for the years ended
December 31, 2001 and 2000 have been derived from our
audited financial statements which are not included in this
prospectus but that can be obtained from our Annual Reports that
we have filed with the SEC on Form 10-K for each of the
years ended December 31, 2001 and 2000.
Results for past periods are not necessarily indicative of
results that may be expected for any future period.
The selected consolidated financial and other data presented
below have been derived from financial statements that have been
prepared in accordance with U.S. generally accepted
accounting principles. You should read the selected consolidated
financial data presented below together with
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and our
consolidated financial statements and the notes to those
consolidated financial statements appearing elsewhere in this
prospectus. Certain prior period amounts presented below,
including various revenues and expenses, have been reclassified
to conform to the current period presentation. (In thousands of
dollars, except per share amounts.)
| Nine Months | Nine Months | |||||||||||||||||||||||||||
| Ended | Ended | Years Ended | ||||||||||||||||||||||||||
| September 30, | September 30, | |||||||||||||||||||||||||||
| 2005(1) | 2004 | 2004(2)(3) | 2003(3) | 2002(4) | 2001 | 2000 | ||||||||||||||||||||||
| (Unaudited) | (Audited) | |||||||||||||||||||||||||||
|
Statement of Operations Data
|
||||||||||||||||||||||||||||
|
Operating revenue
|
$ | 675,401 | $ | 402,375 | $ | 576,196 | $ | 41,123 | $ | 531,501 | $ | 92,104 | $ | 84,331 | ||||||||||||||
|
Operating expense
|
567,737 | 346,111 | 499,326 | 54,029 | 528,168 | 106,365 | 85,073 | |||||||||||||||||||||
|
Operating income (loss)
|
107,664 | 56,264 | 76,870 | (12,906 | ) | 3,333 | (14,261 | ) | (742 | ) | ||||||||||||||||||
|
Other income (loss)
|
14,796 | — | — | — | 2,793 | — | (1,906 | ) | ||||||||||||||||||||
|
Interest expense, net
|
55,523 | 31,265 | 41,396 | 1,424 | 38,735 | — | — | |||||||||||||||||||||
|
Income (loss) before taxes, minority interest and equity income
|
66,937 | 24,999 | 35,474 | (14,330 | ) | (32,609 | ) | (14,261 | ) | 1,164 | ||||||||||||||||||
|
Minority interest expense
|
9,311 | 3,922 | 6,869 | — | — | — | — | |||||||||||||||||||||
|
Income taxes
|
24,008 | 8,436 | 11,535 | 18 | 346 | 73 | 134 | |||||||||||||||||||||
|
Equity in net income (loss) from unconsolidated investments
|
20,003 | 13,196 | 17,024 | (54,877 | ) | — | — | — | ||||||||||||||||||||
|
Net income (loss)
|
$ | 53,621 | $ | 25,837 | $ | 34,094 | $ | (69,225 | ) | $ | (32,955 | ) | $ | (14,334 | ) | $ | 1,030 | |||||||||||
|
Income (loss) per share(6)
|
||||||||||||||||||||||||||||
|
Basic
|
$ | 0.46 | $ | 0.31 | $ | 0.39 | $ | (1.05 | ) | $ | (0.58 | ) | $ | (0.34 | ) | $ | 0.03 | |||||||||||
|
Diluted
|
$ | 0.44 | $ | 0.30 | $ | 0.37 | $ | (1.05 | ) | $ | (0.58 | ) | $ | (0.34 | ) | $ | 0.03 | |||||||||||
30
Table of Contents
| Nine Months | Nine Months | |||||||||||||||||||||||||||
| Ended | Ended | Years Ended | ||||||||||||||||||||||||||
| September 30, | September 30, | |||||||||||||||||||||||||||
| 2005(1) | 2004 | 2004(2)(3) | 2003(3) | 2002(4) | 2001 | 2000 | ||||||||||||||||||||||
| (Unaudited) | (Audited) | |||||||||||||||||||||||||||
|
Balance Sheet Data
|
||||||||||||||||||||||||||||
|
Cash and cash equivalents
|
$ | 165,732 | $ | 112,661 | $ | 96,148 | $ | 17,952 | $ | 25,183 | $ | 17,866 | $ | 12,545 | ||||||||||||||
|
Restricted funds held in trust
|
428,738 | 255,693 | 239,918 | — | — | — | — | |||||||||||||||||||||
|
Investments
|
70,580 | 61,920 | 65,042 | 71,057 | 93,746 | 148,512 | 147,667 | |||||||||||||||||||||
|
Properties — net
|
2,675,799 | 862,609 | 819,400 | 254 | 654,575 | 131 | 56 | |||||||||||||||||||||
|
Service and energy contracts
|
426,197 | 192,389 | 177,290 | — | — | — | — | |||||||||||||||||||||
|
Goodwill
|
292,810 | — | — | — | — | — | — | |||||||||||||||||||||
|
Deferred tax asset
|
39,583 | 83,213 | 26,910 | |||||||||||||||||||||||||
|
Total assets
|
4,706,294 | 2,059,212 | 1,939,081 | 162,648 | 1,032,945 | 208,871 | 210,829 | |||||||||||||||||||||
|
Deferred income taxes
|
488,118 | 225,767 | 109,465 | — | — | — | — | |||||||||||||||||||||
|
Unpaid losses and LAE
|
51,557 | 66,741 | 64,270 | 83,380 | 101,249 | 105,745 | 100,030 | |||||||||||||||||||||
|
Recourse debt
|
1,343,015 | 318,438 | 312,896 | 40,000 | 597,246 | — | — | |||||||||||||||||||||
|
Project debt(7)
|
1,632,681 | 932,098 | 944,737 | — | — | — | — | |||||||||||||||||||||
|
Project debt premium
|
66,091 | 40,927 | 37,910 | — | — | — | — | |||||||||||||||||||||
|
Minority interest
|
83,410 | 83,174 | 83,350 | — | — | — | — | |||||||||||||||||||||
|
Shareholders’ equity
|
$ | 591,497 | $ | 121,992 | $ | 134,815 | $ | 27,791 | $ | 77,360 | $ | 74,463 | $ | 81,330 | ||||||||||||||
|
Book value per share of common stock(6)
|
$ | 4.19 | $ | 1.68 | $ | 1.84 | $ | 0.50 | $ | 1.63 | $ | 2.48 | $ | 2.74 | ||||||||||||||
|
Shares of common stock outstanding(5),(6)
|
141,175 | 72,814 | 73,430 | 55,105 | 47,459 | 30,039 | 29,716 | |||||||||||||||||||||
| (1) | For the nine months ended September 30, 2005, Ref-Fuel’s results of operations are included in our consolidated results subsequent to June 24, 2005. As a result of the consummation of the Ref-Fuel acquisition on June 24, 2005, our future performance will be significantly driven by the combined performance of Covanta and Ref-Fuel’s operations. As a result, the nature of our business, the risks attendant to such business and the trends that it will face have been significantly altered by the acquisitions of Covanta and Ref-Fuel. Accordingly, our historic financial performance and results of operations will not be indicative of our future performance. |
| (2) | For the year ended December 31, 2004, Covanta’s results of operations are included in our consolidated results subsequent to March 10, 2004. As a result of the consummation of the Covanta acquisition on March 10, 2004, our future performance will predominantly reflect the performance of Covanta’s operations which are significantly larger than our insurance operations. As a result, the nature of our business, the risks attendant to such business and the trends that it will face have been significantly altered by the acquisition of Covanta. Accordingly, our historic financial performance and results of operations will not be indicative of our future performance. |
| (3) | ACL, which was acquired on May 29, 2002, and certain of its subsidiaries, filed a petition on January 31, 2003 with the U.S. Bankruptcy Court for the Southern District of Indiana, New Albany Division to reorganize under Chapter 11. As a result of this filing, we no longer maintained control of the activities of ACL. Our equity interest in ACL was cancelled when ACL’s plan of reorganization was confirmed on |
31
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| December 30, 2004 and it emerged from bankruptcy on January 11, 2005. Accordingly, as of December 31, 2004 we did not include ACL and its subsidiaries as consolidated subsidiaries in our financial statements. Our investments in these entities were presented using the equity method effective as of the beginning of the year ending December 31, 2003. Other (loss) income above consists of our equity in the net loss of ACL, GMS and Vessel Leasing in 2003. |
| (4) | In 2002, we purchased 100% of ACL, 5.4% of GMS and 50% of Vessel Leasing. |
| (5) | Does not give effect to currently exercisable options, and, in 2001 and 2000, warrants to purchase shares of our common stock. |
| (6) | Basic and diluted earnings per share and the average shares used in the calculation of basic and diluted earnings per share and book value per share of common stock and shares of common stock outstanding for all periods have been adjusted retroactively to reflect the bonus element contained in the rights offering issued on May 18, 2004 and for the Ref-Fuel rights offering issued on May 31, 2005. |
| (7) | Includes $66 million, $41 million and $38 million of unamortized debt premium as of September 30, 2005 and 2004 and as of December 31, 2004. |
SUPPLEMENTAL QUARTERLY FINANCIAL DATA
The following tables present quarterly unaudited financial data
for the periods presented on the consolidated statements of
operations (in thousands of dollars, except per share amounts):
| 2005 | |||||||||||||
| Fiscal Quarter | First | Second | Third | ||||||||||
|
Operating revenue
|
$ | 174,819 | $ | 199,092 | $ | 301,490 | |||||||
|
Operating income
|
13,859 | 28,814 | 64,991 | ||||||||||
|
Net income
|
10,303 | 5,917 | 37,401 | ||||||||||
|
Net income per share:
|
|||||||||||||
|
Basic
|
0.10 | 0.06 | 0.27 | ||||||||||
|
Diluted
|
0.10 | 0.05 | 0.26 | ||||||||||
| 2004 | |||||||||||||||||||||
| Fiscal Quarter | First | Second | Third | Fourth | Total | ||||||||||||||||
|
Operating revenue
|
$ | 45,875 | $ | 184,878 | $ | 171,622 | $ | 174,553 | $ | 576,196 | |||||||||||
|
Operating income
|
3,799 | 30,757 | 21,708 | 20,606 | 76,870 | ||||||||||||||||
|
Net (Loss) income
|
(2,173 | ) | 15,195 | 12,815 | 8,257 | 34,094 | |||||||||||||||
|
Net (Loss) income per share:
|
|||||||||||||||||||||
|
Basic
|
(0.03 | ) | 0.19 | 0.13 | 0.08 | 0.39 | |||||||||||||||
|
Diluted
|
(0.03 | ) | 0.18 | 0.12 | 0.08 | 0.37 | |||||||||||||||
| 2003 | ||||||||||||||||||||
| Fiscal Quarter | First | Second | Third | Fourth | Total | |||||||||||||||
|
Operating revenue
|
$ | 11,076 | $ | 11,837 | $ | 8,909 | $ | 9,301 | $ | 41,123 | ||||||||||
|
Operating income
|
(2,650 | ) | (4,578 | ) | (3,546 | ) | (2,132 | ) | (12,906 | ) | ||||||||||
|
Net (Loss) income
|
(57,836 | ) | (4,501 | ) | (3,442 | ) | (3,446 | ) | (69,225 | ) | ||||||||||
|
Net (Loss) income per basic and diluted share
|
(0.87 | ) | (0.07 | ) | (0.05 | ) | (0.05 | ) | (1.05 | ) | ||||||||||
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FORWARD-LOOKING STATEMENTS
Cautionary Note Regarding Forward-Looking Statements
This prospectus and registration statement contain statements
that may constitute “forward-looking” statements as
defined in Section 27A of the Securities Act of 1933,
Section 21E of the Securities Exchange Act of 1934, the
Private Securities Litigation Reform Act of 1995, referred to as
the “PSLRA” in this prospectus, or in releases made by
the 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 us and our
subsidiaries, 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 of 1933, the Exchange Act of 1934 and the PSLRA
with the intention of obtaining the benefits of the “safe
harbor” provisions of such laws. We caution investors that
any forward-looking statements made by us 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 us include, but are not limited to, the risks and
uncertainties affecting their businesses described in
Item 1 of our Annual Report on Form 10-K, as amended,
for the year ended December 31, 2004 and in registration
statements and other securities filings by us and our
subsidiaries, including MSW I and MSW II.
Although we believe that our 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. Our 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 prospectus and
registration statement are made only as of the date hereof and
we do 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.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion addresses our financial condition,
including the following: our parent-level liquidity and capital
resources and cash flow as of and for the years ended
December 31, 2004 and 2003 and for the nine-month periods
ended as of September 30, 2005 and 2004; our parent-level
investment income and expenses as of and for the years ended
December 31, 2004 and 2003 and the year ended
December 27, 2002; the operating results of our Waste and
Energy Services business as of and for the years ended
December 31, 2004 and 2003 and for the nine-month periods
ended as of September 30, 2005 and 2004; and, the operating
results and cash flows of our insurance business for the years
ended December 31, 2004 and 2003 and December 27, 2002
and for the nine-month periods ended September 30, 2005 and
2004.
This discussion should be read in conjunction with our Audited
Consolidated Financial Statements and related notes for the
periods ended December 31, 2004 and 2003 and
December 27, 2002, attached to this prospectus as
Appendix A, and our Interim Financial Statements as of
September 30, 2005 (unaudited) and December 31,
2004 and for the nine-month periods ended September 30,
2005 and 2004 (unaudited), attached to this prospectus as
Appendix B.
The preparation of interim financial statements necessarily
relies heavily on estimates. This and certain other factors,
such as the seasonal nature of portions of our business, as well
as competitive and other market conditions, call for caution in
estimating full year results based on interim results of
operations. The preparation of financial statements requires
management to make estimates and assumptions that affect the
reported amounts and classification of assets and liabilities
and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could
differ materially from those estimates. As described in
Note 3 to the Notes to the Unaudited Interim Financial
Statements, our purchase accounting of our acquisition of
Covanta reflected the final allocation of value to the assets
acquired and liabilities assumed and our preliminary allocation
of value to the assets acquired and liabilities assumed for the
acquisition of Ref-Fuel.
EXECUTIVE SUMMARY
We are organized as a holding company and substantially all of
our operations were conducted in the insurance services industry
prior to the acquisition of Covanta’s business in 2004 and
of Ref-Fuel’s business in 2005. As a result of the
consummation of the Covanta and Ref-Fuel acquisitions, our
future performance will predominantly reflect the performance of
the Waste and Energy Services operations which are significantly
larger than our insurance operations.
| Covanta Acquisition |
On March 10, 2004, Covanta and most of its subsidiaries
engaged in waste-to-energy, water and independent power
production in the United States consummated reorganization and
emerged from proceedings under Chapter 11. As a result of
the consummation of the Covanta Plan of Reorganization, Covanta
is a wholly-owned subsidiary of ours. The results of operations
and financial condition of Covanta are consolidated for
financial reporting purposes from March 11, 2004.
After the consummation of the Covanta Plan of Reorganization,
the subsidiaries of Covanta that own and operate the Warren
County, New Jersey, and Lake County, Florida, waste-to-energy
facilities and the Covanta subsidiaries which were involved in
the Tampa Bay desalination facility, which are collectively
referred to as the “Remaining Debtors” in this
prospectus, remained in Chapter 11 proceedings. At
March 10, 2004, we did not include these entities as
consolidated subsidiaries in our financial statements. Our
investment in these entities was recorded in the financial
statements using the cost method as of March 10, 2004.
Subsequently, the subsidiaries of Covanta that were involved in
the Tampa Bay desalination project emerged from bankruptcy on
August 6, 2004. In connection with the settlement of
litigation associated with the Tampa Bay project, these
subsidiaries emerged from bankruptcy without material assets or
liabilities and without contractual rights to operate the Tampa
Bay facility. In addition, the subsidiaries of Covanta involved
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in the Lake County, Florida waste-to-energy facility reached
agreements with their counterparties and emerged from bankruptcy
on December 14, 2004. The Lake County subsidiaries are
consolidated in our financial statements as of December 14,
2004. In September 2005, Covanta’s subsidiaries involved
with the Warren County, New Jersey project filed a
reorganization plan after they reached agreement with various
contract counterparties, which was confirmed by the bankruptcy
court on December 1, 2005. Covanta expects such
subsidiaries will emerge from bankruptcy prior to
December 31, 2005 and that after such emergence they will
be consolidated in our financial statements.
| ACL Bankruptcy and Warrants |
Throughout 2004, we also had subsidiaries engaged in the marine
services industry which, beginning in 2003, were accounted for
under the equity method. Most of these subsidiaries were
involved in the bankruptcy proceedings of ACL, pursuant to which
these subsidiaries were sold or reorganized. On
December 30, 2004, a plan of reorganization was confirmed,
without any material conditions, and on January 10, 2005,
these subsidiaries emerged from bankruptcy and our ownership
interests in ACL were cancelled.
As discussed in Note 16 to the Notes to the Unaudited
Interim Financial Statements, on January 12, 2005, a
subsidiary of ours received 168,230 warrants to purchase the
common stock of ACL at $12.00 per share. The warrants were
given by certain of the former creditors of ACL. The number of
shares and exercise price subject to the warrants were
subsequently adjusted to 672,920 shares at an exercise
price of $3.00 per share, as a result of a four for one
stock split effective as of August 2005. We wrote our investment
in ACL down to zero in 2003. We determined that the aggregate
fair value of the warrant on the grant date was
$0.8 million.
Covanta recorded the warrants as a derivative security in
accordance with of SFAS No. 133 “Accounting for
Derivative Instruments and Hedging Activities.” On
October 7, 2005, ACL issued 7.5 million shares in an
initial public offering. Covanta proceeded to exercise the
warrants it owned and received shares of ACL common stock
in order to begin monetizing these shares. Based on market
quotes as of September 30, 2005, Covanta recorded a
mark-to-market adjustment for the period ended
September 30, 2005 which increased the investment in ACL
warrants to $15.6 million in the condensed consolidated
balance sheet and recorded a corresponding pre-tax gain on
derivative instruments of $10.6 million in the condensed
consolidated statements of operations for the three months ended
September 30, 2005. During October 2005, Covanta monetized
its investment in all ACL shares it owned. The average gross
selling price was $26.79 per share and resulted in net cash
proceeds of $18 million and a realized gain of
$16 million. As of September 30, 2005, Covanta had
recognized approximately $14.8 million in unrealized gains
related to these shares. As a result, Covanta will recognize an
additional $0.4 million realized gain in the fourth quarter
of 2005.
During 2004, our investment in marine services business included
a direct 5.4% interest in Global Material Services, LLC,
referred to as “GMS” in this prospectus, and a direct
50% interest in Vessel Leasing, LLC, referred to as
“Vessel Leasing” in this prospectus. Neither of these
two companies filed for Chapter 11 protection. GMS was a
joint venture among ACL, us and a third party, which owned and
operated marine terminals and warehouse operations. Vessel
Leasing was a joint venture between ACL and us which leased
barges to ACL’s barge transportation operations. Neither
GMS, Vessel Leasing nor us were guarantors of ACL’s debt
nor were we liable for any of ACL’s liabilities. On
October 6, 2004, we and ACL sold our interests in GMS to
the third party joint venture member, and on January 13,
2005 we sold our interest in Vessel Leasing to ACL. As a result,
we no longer are engaged in the marine services business.
As a result of ACL’s bankruptcy filing, while we continued
to exercise influence over the operating and financial policies
of ACL throughout 2004, we no longer maintained control of ACL.
Accordingly, for the years ended December 31, 2004 and
2003, we accounted for our investments in ACL, GMS and Vessel
Leasing using the equity method of accounting. Under the equity
method of accounting, we report our share of the equity
investees’ income or loss based on our ownership interest.
As a result of ACL’s continued losses and our
management’s belief that we would recover little, if any,
of our investment in ACL, we wrote off our remaining investment
in ACL during the first quarter of 2003. The equity in net loss
of unconsolidated marine services subsidiaries included a loss
from ACL of $47 million, an
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other than temporary impairment of the remaining investment in
ACL of $8.2 million and income from GMS and Vessel Leasing
of $0.3 million. The GMS and Vessel Leasing investments
were not considered to be impaired. The marine services
subsidiaries’ operating results in 2002 were consolidated
in our operating results from the date of acquisition,
May 29, 2002, through December 27, 2002, but were
deconsolidated in 2003 as a result of ACL’s bankruptcy.
| Ref-Fuel Acquisition |
On June 24, 2005, we acquired, through Covanta, 100% of the
issued and outstanding shares of Ref-Fuel in accordance with a
stock purchase agreement dated January 31, 2005 with
Ref-Fuel. Ref-Fuel and its subsidiaries operate six
waste-to-energy facilities located in the northeastern United
States and TransRiver Marketing Company, L.P., referred to as
“TransRiver” in this prospectus, a waste procurement
company. The Ref-Fuel subsidiaries that operate the
waste-to-energy facilities derive revenues principally from
disposal or tipping fees received for accepting waste, and from
the sale of electricity and steam produced by those facilities.
Immediately upon the closing of the acquisition, Ref-Fuel became
a wholly-owned subsidiary of Covanta, and Covanta assumed
control of the management and operations of the Ref-Fuel
facilities. Covanta has changed the names of many of the
Ref-Fuel subsidiaries so that they now conduct business under
the Covanta Energy name. Ref-Fuel’s results of operations
were consolidated into ours beginning June 25, 2005. Our
condensed consolidated balance sheet included the accounts of
Ref-Fuel as of September 30, 2005 and reflected preliminary
purchase accounting allocations.
We paid $740 million in cash for all of the outstanding
stock of Ref-Fuel and assumed Ref-Fuel’s consolidated net
debt of $1.3 billion ($1.5 billion of consolidated
indebtedness and $0.2 billion of cash and restricted cash).
We financed the Ref-Fuel acquisition through a combination of
debt and equity financing. The debt component of the financing
consisted of various senior secured credit facilities entered
into by Covanta and guaranteed by us and certain of
Covanta’s domestic subsidiaries. These credit facilities
are described below under “Management’s Discussion
and Analysis of Financial Condition and Results of
Operations — Management’s Discussion and Analysis
of Liquidity and Capital Resources — Waste and Energy
Services Segment.” The equity component of the
financing consisted of the Ref-Fuel rights offering, a
$400 million offering of warrants or other rights to
purchase our common stock to all of our existing stockholders.
Under the Ref-Fuel rights offering each holder was entitled to
purchase 0.9 shares of our common stock at an exercise
price of $6.00 for each share of our common stock held as of
May 27, 2005, the record date.
| NOLs |
In addition to the risks attendant to the operation of the Waste
and Energy Services business in the future and the integration
of Ref-Fuel and its employees into Covanta, our ability to
utilize our NOLs to offset taxable income generated by the Waste
and Energy Services’ operations will have a material effect
on our financial condition and results of operations. NOLs
predominantly arose from predecessor insurance entities of ours
(formerly named Mission Insurance Group Inc.).
We had NOLs estimated to be approximately $516 million for
federal income tax purposes as of December 31, 2004. The
NOLs will expire in various amounts from December 31, 2005
through December 31, 2023, if not used. The amount of NOLs
available to Covanta will be reduced by any taxable income
generated by current members of our consolidated tax group. The
IRS has not audited any of our tax returns relating to the years
during which the NOLs were generated.
A portion of our NOLs were utilized in 2004 as a result of
income we recognized in connection with ACL’s emergence
from bankruptcy, Covanta’s operations and from income from
certain grantor trusts relating to our historic insurance
business conducted by the Mission Insurance entities.
In addition, reductions in our NOLs could occur in connection
with the administration of the grantor trusts associated with
the Mission Insurance entities which are in state insolvency
proceedings. During or at the conclusion of the administration
of these grantor trusts, material taxable income could result
which could utilize a substantial portion of our NOLs, which in
turn could materially reduce cash flow and the ability to
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service current debt. The impact of a material reduction in our
NOLs could also cause an event of default under current secured
credit facilities and/or a reduction of a substantial portion of
our deferred tax asset relating to such NOLs. For a more
detailed discussion of the Mission Insurance entities and the
grantor trusts, please see Note 25 to the Notes to the
Audited Annual Financial Statements and Note 12 of the
Unaudited Interim Financial Statements.
While we cannot predict with certainty what amounts, if any, may
be includable in our taxable income, we have received
preliminary information which raises the possibility that we may
recognize taxable income in connection with the conclusion of
the administration of the insolvency estates. However, after
reviewing the preliminary information, we determined that it was
insufficient to warrant inclusion of taxable income in our 2004
tax filing based on such preliminary information. We are in the
process of obtaining additional information regarding the
potential amount of includible taxable income. We are also
considering a number of potential permissible actions and
approaches intended to reduce the amount of taxable income we
may be required to recognize. These include arrangements with
representatives of the grantor trusts and the state insurance
regulatory agencies to clarify the treatment of certain
liabilities and the manner of distributions to claimholders in
such insolvency proceedings, as well as the application of the
tax rules consistent with the original Mission Insurance
restructuring, and the terms of our agreement with the grantor
trusts established in connection with the restructuring. Given
the lack of definitive or complete information available as of
the date of this prospectus, we cannot assure you of the amount,
if any, of additional income that could possibly be recognized.
Further in response to court filings to set a final hearing date
for the closing of the insolvency proceedings, we have filed an
objection in order to preserve our right with respect to the
agreements entered into in connection with the formation of the
grantor trusts.
For additional detail relating to our NOLs and risks attendant
thereto, see Note 12 to the Notes to the Unaudited Interim
Financial Statements, and “Risk Factors —
Covanta Holding Corporation-Specific Risks — We cannot
be certain that our NOLs will continue to be available to offset
our tax liability.”
If we were to undergo, an “ownership change” as such
term is used in Section 382 of the Internal Revenue Code,
the use of our NOLs would be limited. We will be treated as
having had an “ownership change” if there is a more
than 50% increase in stock ownership during a three-year
“testing period” by “5% stockholders.”
Our certificate of incorporation contains stock transfer
restrictions that were designed to help preserve our NOLs by
avoiding an ownership change. The transfer restrictions were
implemented in 1990, and we expect that they will remain
in-force as long as we have NOLs. We cannot be certain, however,
that these restrictions will prevent an ownership change.
Business Segments
Given the significance of the Covanta and Ref-Fuel acquisitions
to our business results of operations and financial condition,
we decided, during the third quarter of 2005, to combine the
previously separate business segments of our insurance business
and our parent-level operations into one reportable segment
referred to as “Other Services.” Therefore, we
currently have two reportable business segments —
Waste and Energy Services and Other Services.
Waste and Energy Services develops, constructs, owns and
operates for others key infrastructure for the disposal of waste
(primarily waste-to-energy) and independent power production
facilities in the United States and abroad. The Other
Services segment is comprised of our insurance business, which
writes property and casualty insurance in the western United
States, primarily in California, and our operations as the
parent company which involves primarily the receipt of income
from our investments and incurrence of general and
administrative expenses prior to the acquisition of Covanta.
We, on a parent-only basis, have continuing expenditures for
administrative expenses and derive income primarily from
investment returns on portfolio securities. Therefore, the
analysis of our results of operations and financial condition is
generally done on a business segment basis. Our long-term
strategic and business objective is to enhance the value of our
investment in Covanta and acquire businesses that will allow us
to earn an attractive return on our investments.
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The following discussion and analysis should be read in
conjunction with our consolidated financial statements and
related notes attached as Appendixes A and B to this prospectus.
This discussion and analysis of results of operations and
financial condition has been prepared on a business segment
basis.
The results of operations from Covanta are included in our
consolidated results of operations beginning March 11,
2004. However, given the significance of the Covanta acquisition
to our future results of operations and financial condition, the
Waste and Energy Services business segment discussion includes
combined information for the year ended December 31, 2004
as compared to predecessor information for the year ended
December 31, 2003 in order to provide a more informative
comparison of results. Predecessor information refers to
financial information of Covanta and its subsidiaries pertaining
to periods prior to our acquisition of Covanta on March 10,
2004. Subsequent to our acquisition of Ref-Fuel on June 24,
2005, we have included the results of operations from Ref-Fuel
in our consolidated results of operations. We also present in
this discussion as reported, and where applicable, pro forma
results of operations, as we believe that an understanding of
our reported results, trends and ongoing performance is enhanced
by presenting results on a pro forma basis at both the
consolidated and Waste and Energy Services segment level.
| Waste and Energy Services — Overview |
The Waste and Energy Services segment includes Covanta’s
domestic and international businesses. Its domestic businesses
include those of Ref-Fuel as of June 24, 2005. Covanta has
changed the names of many of the Ref-Fuel subsidiaries such that
they will conduct business under the Covanta name.
Covanta’s subsidiary CPIH and CPIH’s subsidiaries
engage in the independent power production business outside the
United States.
With respect to its domestic business, Covanta designs,
constructs and operates key infrastructure for municipalities
and others in waste-to-energy, waste disposal and independent
power production. Covanta’s principal business, from which
it earns most of its revenue, is the ownership and/or operation
of waste-to-energy facilities. Waste-to-energy facilities
combust municipal solid waste as a means of environmentally
sound waste disposal and produce energy that is sold as
electricity or steam to utilities and other purchasers. Covanta
generally operates waste-to-energy facilities under long-term
contracts with municipal clients. Some of these facilities are
owned by subsidiaries of Covanta, while others are owned by the
municipal client or other third parties. For those facilities
owned by it, Covanta retains the ability to operate such
projects after current contracts expire. For those facilities
not owned by Covanta, municipal clients generally have the
contractual right, but not the obligation, to extend the
contract and continue to retain Covanta’s service after the
initial contract expiration date. For all waste-to-energy
projects, Covanta receives revenue from two primary sources:
fees it charges for processing waste received and payments for
electricity and steam sales. Covanta also has ownership
interests in and/or operates waste transfer stations and
landfills, for which it receives revenue in the form of fees per
ton of waste accepted for disposal.
Covanta operates, and in some cases has ownership interests in,
other renewable energy projects in the United States which
generate electricity from wood waste, landfill gas and
hydroelectric resources. The electricity from these projects is
sold to utilities. For these projects, Covanta receives revenue
from electricity sales and, in some cases, cash from equity
distributions.
Covanta also operates one domestic water project which produces
potable water that is distributed by a municipal entity. For
this project, Covanta receives revenue from service fees it
charges the municipal entity. Covanta does not expect to grow
its water business and may consider further divestitures.
In its international business, as of September 30, 2005,
Covanta’s subsidiaries have ownership interests in, and/or
operated, independent power production facilities in the
Philippines, China, Bangladesh, India and Costa Rica and one
waste-to-energy facility in Italy. The Costa Rica facilities
generate electricity from hydroelectric resources, while the
other independent power production facilities generate
electricity and steam by combusting coal, natural gas or heavy
fuel oil. For these projects, Covanta receives revenue from
operating fees, electricity and steam sales and, in some cases,
cash from equity distributions.
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Covanta (including Ref-Fuel) has historically performed its
operating obligations without experiencing material unexpected
service interruptions or incurring material increases in costs.
In addition, with respect to many of its contracts at domestic
projects, Covanta generally has limited its exposure for risks
not within its control. With respect to projects comprising of
Ref-Fuel subsidiaries, Covanta has 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 Covanta may owe for its unexcused
operating performance failures, see “Risk
Factors — Waste and Energy Services Business-Specific
Risks — Some of Covanta’s energy contracts
involve greater risk of exposure to performance levels which
could result in materially lower revenues.” In
monitoring and assessing the ongoing operating and financial
performance of Covanta’s businesses, management focuses on
certain key factors:
| • | tons of waste processed; | |
| • | electricity and steam sold; and | |
| • | boiler availability. | |
A material portion of Covanta’s domestic service revenues
and energy revenues is relatively predictable because it is
derived from long-term contracts relating to waste-to-energy
projects. At seven of its thirty-one waste-to-energy projects,
Covanta receives such revenue primarily based on the amount of
waste processed and energy generated. Projects where these
contractual structures exist are sometimes referred to in this
prospectus as having a “Tip Fee Structure.” At other
waste-to-energy projects, Covanta receives such revenue
primarily through a fixed operating fee (which does not vary
based on the amount of waste processed or energy generated) that
escalates over time. Projects where these contractual structures
exist are sometimes referred to in this prospectus as having a
“Service Fee Structure.” Covanta receives these
revenues for performing to base contractual standards, which
vary among contracts, including standards for waste processing
and energy generation efficiency. Its ability to meet or exceed
such standards at projects, and its general financial
performance, is affected by the following:
| • | Seasonal or long-term changes in market prices for waste, energy or scrap metals, for projects where Covanta sells into those markets; | |
| • | Seasonal, geographic and other variations in the heat content of waste processed, and thereby the amount of waste that can be processed by a waste-to-energy facility; | |
| • | Its 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 Covanta’s 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 Covanta’s 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 CPIH’s international
projects is affected by the following:
| • | Changes in fuel price for projects in which such costs are not completely passed through to the electricity purchaser through tariff adjustments, or delays in the effectiveness of tariff adjustments; | |
| • | The amounts of electricity actually requested by purchasers of electricity, and whether or when such requests are made, CPIH’s facilities are then available to deliver such electricity; | |
| • | CPIH’s 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; | |
| • | The financial condition and creditworthiness of purchasers of power and services provided by CPIH; | |
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| • | Fluctuations in the value of the domestic currency against the value of the U.S. dollar for projects in which CPIH is 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. | |
Covanta’s quarterly operating income from domestic and
international operations within the same fiscal year typically
differs substantially due to seasonal factors, primarily as a
result of the timing of scheduled plant maintenance.
Covanta typically conducts scheduled maintenance periodically
each year, which requires that individual boiler units
temporarily cease operations. During these scheduled maintenance
periods, Covanta incurs material repair and maintenance expenses
and receives less revenue, until the boiler units resume
operations. This scheduled maintenance typically occurs during
periods of off-peak electric demand and lower waste volume in
the spring and fall. The spring scheduled maintenance period is
typically more extensive than scheduled maintenance conducted
during the fall. As a result, Covanta has typically incurred its
highest maintenance expense in the first half of the year.
Given the seasonal factors discussed above, Covanta has
typically experienced lower operating income from its projects
during the first six months of each year and higher operating
income during the second six months of each year.
Covanta’s cash available for corporate debt service also
varies seasonally. Generally, cash provided by operating
activities follows income with a one to two month timing delay
for maintenance expense payables. Further, certain substantial
operating expenses (including annual insurance payments
typically due in the fourth quarter) are accrued each month
throughout the year while the corresponding cash payments are
made only a few times each year.
The acquired Ref-Fuel businesses have several layers of debt,
each of which restricts when cash may be distributed. Several of
the projects have debt that restricts distributions to one or
two times a year. Also, due to the timing of debt payments on
intermediate layers of debt, most of the cash available for
corporate debt service from the acquired Ref-Fuel business is
distributed in the first and fourth quarters.
Cash distributions from international operating subsidiaries and
partnerships also vary seasonally but are generally unrelated to
income seasonality. Covanta receives on a monthly basis modest
distributions of operating fees. In addition, Covanta receives
partnership distributions, which are typically prescribed by
project debt documents and occur no more than several times per
year for each project. Scheduled cash distributions from the
Quezon, Haripur and Indian facilities, which typically represent
the largest distributions from CPIH projects, generally occur
during the second and fourth quarters.
Covanta expects the factors discussed above will cause its cash
available for corporate debt (including those of the Ref-Fuel
businesses and international projects) to be the lowest during
the second quarter and the highest during the fourth quarter.
Covanta’s annual and quarterly financial performance can be
affected by many factors, several of which are outside
Covanta’s control as noted above. These factors can
overshadow the seasonal dynamics described in this prospectus;
particularly, with regard to quarterly cash from operations,
which can be materially affected by changes in working capital.
| Other Services — Overview |
Our Other Services segment is comprised of the holding company
and insurance subsidiaries. The operations of the holding
company prior to the acquisition of Covanta on March 10,
2004, primarily included general and administrative expense
related to officer salaries, legal and other professional fees
and insurance. Subsequent to the acquisition of Covanta, these
expenses are reimbursed to us by Covanta under an administrative
services agreement. The parent company operations also include
income earned on its investments.
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The operations of our insurance subsidiary, NAICC, and its
subsidiary Valor Insurance Company, Incorporated, referred to as
“Valor” in this prospectus, are primarily property and
casualty insurance. Effective July 2003, the decision was made
to focus exclusively on the California non-standard personal
automobile insurance market. Effective July 7, 2003, NAICC
ceased writing new policy applications for commercial automobile
insurance and began the process of providing the required
statutory notice of its intention not to renew existing
policies. From July 2003 to November 2004, our insurance
business had placed a moratorium on writing new non-standard
automobile policies. However, on November 15, 2004, our
insurance business commenced writing a new non-standard
automobile program under a new rate and class plan; and
subsequently on January 1, 2005, entered into a quota share
reinsurance agreements ceding 40% of new policy business and 28%
of the renewal policy business, including new non-owner vehicle
policies. As a result of declining net premium production, our
insurance business’ investment base has steadily declined,
its reserve adjustments on discontinued lines have
disproportionately impacted current operating ratios, and it
continues to lose operating leverage.
Our Business Strategy
With the acquisition of Covanta and Ref-Fuel, we are focused on
our Waste and Energy Services business. Our “mission
statement” is to be the world’s leading
Waste-to-Energy company, with a complementary network of waste
disposal and energy generation assets. We expect to build value
for our shareholder by satisfying our clients’ waste
disposal and energy generation needs with safe, reliable and
environmentally superior solutions. In order to accomplish this
mission, we intend to:
Leverage our core competencies by:
| • | providing outstanding client service, | |
| • | utilizing an experienced management team, | |
| • | developing and utilizing world-class technologies and operational expertise, and | |
| • | applying proven asset management and cost control; and | |
Maximize long-term value of our existing portfolio by:
| • | continuing to operate at historic production levels, | |
| • | continuing to execute effective maintenance programs, | |
| • | extending operating contracts, and | |
| • | enhancing the value of Covanta-owned facilities after expiration of existing contracts, and | |
Capitalize on growth opportunities by:
| • | expanding existing waste-to-energy facilities in attractive markets, | |
| • | developing TransRiver and its waste procurement and other expertise by leveraging that knowledge across a larger platform, | |
| • | seeking new ownership opportunities or operating contracts for waste-to-energy and other energy projects, and | |
| • | seeking additional opportunities in businesses ancillary to its existing business, including additional waste transfer, transportation, processing and landfill businesses. | |
In furtherance of this business strategy, in August 2005,
Covanta announced the execution of contracts with Hillsborough
County, Florida to construct, operate and maintain an expansion
to the Hillsborough County Solid Waste Energy Recovery Facility.
A subsidiary of Covanta constructed this facility and has been
operating it since 1987. Construction of the expansion is
expected to begin in mid to late 2006 once necessary federal,
state and local permits are obtained by Hillsborough County and
certain other conditions are satisfied.
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If these conditions are satisfied, Covanta’s original
20-year contract with Hillsborough County to operate and
maintain the facility, including the expansion, will be extended
to 2027.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS
Our Earnings
The nature of our business, the risks attendant to such business
and the trends that we will face have been significantly altered
by the acquisitions of Covanta and Ref-Fuel. Accordingly, our
prior financial performance will not be comparable with our
future performance and readers are directed to see the other
sections in “Management’s Discussion and Analysis
of Financial Condition and Results of Operations”
including “Executive Summary,”
“Management’s Discussion and Analysis of Results of
Operations — Optimizing Cash,”
“Management’s Discussion and Analysis of Results of
Operations — Interim Operating Results —
Factors in Operating Results” for a discussion of
management’s perspective on important factors of operations
and financial performance.
Covanta’s emergence from bankruptcy did not affect the
operating performance of its facilities or its ability to
generate cash. However, as a result of the application of
fresh-start and purchase accounting adjustments required upon
Covanta’s emergence from bankruptcy and acquisition by us,
the carrying value of Covanta’s assets was adjusted to
reflect its current estimated fair value based on discounted
anticipated cash flows and estimates of management in
consultation with valuation experts. These adjustments will
result in future changes in non-cash items such as depreciation
and amortization which will not be consistent with the amounts
of such items for prior periods. Such future changes for
post-emergence periods may affect earnings as compared to
pre-emergence periods.
In addition, Covanta’s consolidated financial statements
have been further adjusted to deconsolidate six subsidiaries
that remained in bankruptcy after March 10, 2004, when
Covanta and its other subsidiaries emerged. Of these six
subsidiaries, two subsequently emerged in the third quarter of
2004, and one emerged in the fourth quarter of 2004. The
remaining three subsidiaries are expected to emerge during the
fourth quarter of 2005. Each of these subsidiaries have been, or
will be, included in our consolidated financial statements after
their respective dates of emergence.
Our acquisition of Ref-Fuel markedly increased the size and
scale of the business comprising our Waste and Energy Services
segment, and thus our business. It also provided Covanta with
the opportunity to achieve cost savings by combining the
businesses of Covanta and Ref-Fuel. Furthermore, Covanta lowered
its cost of capital and obtained less restrictive covenants than
under its previous financing arrangements when it refinanced its
existing recourse debt concurrent with the acquisition of
Ref-Fuel.
The acquisition of Ref-Fuel is expected to enhance our earnings.
However, as a result of the application of purchase accounting
adjustments required in connection with the acquisition, the
historical carrying value of Ref-Fuel’s assets was adjusted
to reflect their current estimated fair value, using a
combination of replacement cost and discounted anticipated cash
flows, based on estimates of management in consultation with
valuation experts. The preliminary adjustments resulted in
changes in non-cash items such as depreciation and amortization
which will not be consistent with the amounts of such items for
prior periods, as previously reported on periodic reports filed
with the Commission for MSW I, MSW Energy Finance
Co., Inc, MSW II, and MSW Energy Finance Co. II,
Inc., each of which are subsidiaries of Ref-Fuel.
Although management has endeavored to use its best efforts to
make appropriate estimates of fair value of the assets and
liabilities of Ref-Fuel, the estimation process is subject to
inherent limitations and is based upon the preliminary work of
management and its valuation consultants. Moreover, under
applicable accounting principles to the extent that relevant
information remains to be developed, analyzed and fully
evaluated, such preliminary estimates may be adjusted during the
year following the June 24, 2005 acquisition date. The
adjusted values assigned to depreciable and amortizable assets
may affect our earnings. See Note 3 to the Notes to the
Unaudited Interim Financial Statements for additional
information on the impact of purchase accounting adjustments on
our financial statements.
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Generating sufficient cash to meet Covanta’s liquidity
needs, paying down its debt, and investing in its business
remain important objectives of management. Maintaining historic
facility production levels while effectively managing operating
and maintenance expense is important to optimize Covanta’s
long-term cash generation. Covanta does not expect to receive
any cash contributions from us, and is prohibited under its
principal financing arrangements from using its cash to issue
dividends to us except in limited circumstances. For expanded
discussions of liquidity, see “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations — Management’s Discussion and Analysis
of Liquidity and Capital Resources” below.
Covanta owns certain waste-to-energy facilities for which the
debt service (principal and interest) on project debt is
expressly included as a component of the service fee paid by the
municipal client. As of September 30, 2005, the principal
amount of project debt outstanding with respect to these
projects was approximately $781 million. In accordance with
GAAP, regardless of the actual amounts paid by the municipal
client with respect to this component, Covanta records revenues
with respect thereto based on levelized principal payments
during the contract term, which are then discounted to reflect
when the principal payments are actually paid by the municipal
client. Accordingly, the amount of revenues recorded does not
equal the actual payment of this component by the municipal
client in any given contract year and the difference between the
two methods gives rise to the unbilled service receivable
recorded on Covanta’s balance sheet. The interest expense
component of the debt service payment is recorded based upon the
actual amount of this component paid by the municipal client.
Covanta also owns seven waste-to-energy projects for which debt
service is not expressly included in the fee it is paid. Rather,
Covanta receives a fee for each ton of waste processed at these
projects. As of September 30, 2005, the principal amount of
project debt outstanding with respect to these projects was
approximately $694 million. Accordingly, Covanta does not
record revenue reflecting principal on this project debt. Its
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 when
due.
Optimizing Cash
Generating sufficient cash to meet Covanta’s liquidity
needs, pay down its recourse debt and invest in its business
remains an important objective of management. Maintaining
historic facility production levels while effectively managing
operating and maintenance expense is important to optimize
Covanta’s long-term cash generation. Covanta does not
expect to receive any cash contributions from us and is
prohibited under its principal financing arrangements from using
its cash to issue dividends to us except in limited
circumstances.
Covanta believes that when combined with its other sources of
liquidity, Covanta’s operations generate sufficient cash to
meet operational needs, capital expenditures and debt service
due prior to maturity on its recourse debt as well as the
recourse debt of its intermediate holding companies comprising
part of the Ref-Fuel acquisition. Management will also seek to
enhance Covanta’s cash flow from renewals or replacement of
existing contracts from new contracts to expand existing
facilities or operate additional facilities and by investing in
new projects. Covanta’s new financing arrangements place
certain restrictions on its ability to make investments in new
projects or to expand existing projects.
As part of the Ref-Fuel acquisition, Covanta entered into new
financing arrangements. These arrangements included a
$100 million revolving credit facility, which provides an
additional source of liquidity to Covanta.
Covanta derives its cash flow principally from its domestic and
international project operations and businesses. The frequency
and predictability of Covanta’s receipt of cash from
projects differs, depending upon various factors, including
whether restrictions on distributions exist in applicable
project debt arrangements or in debt arrangements at
intermediate holding companies, whether a project is domestic or
international and whether a project has been able to operate at
historical levels of production.
A material portion of Covanta’s domestic cash flows is
expected to be derived from projects acquired as part of the
Ref-Fuel acquisition. For these projects, financial tests and
other covenants contained in their respective debt arrangements
must be satisfied in order for project subsidiaries to make cash
distributions to
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intermediate holding companies and for intermediate holding
companies to make cash distributions to Covanta. Distributions
from these intermediate holding companies may only be made
quarterly, if such financial tests and other covenants are
satisfied. The Ref-Fuel business has historically satisfied all
such financial tests and covenants and has made quarterly
distributions, if funds were available. See
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations —
Management’s Discussion and Analysis of Liquidity and
Capital Resources — Waste and Energy Services
Segment” for a description of debt facilities at such
intermediate holding companies.
Covanta’s remaining domestic projects generally are not
restricted in making cash distributions, and no restrictions
exist at intermediate holding company levels. As a result,
Covanta generally receives cash from these projects on a monthly
basis.
Covanta’s receipt of cash from its international projects
is also subject to satisfaction of financial tests and other
covenants contained in applicable project debt arrangements. A
material portion of cash distributions from Covanta’s
international projects are received semi-annually, during the
second and fourth quarters. In addition, risks inherent in
international operations can affect the reliability of such cash
distributions.
Covanta’s ability to optimize its cash flow should be
enhanced under a tax sharing agreement with us entered into on
March 10, 2004. This agreement provides that we will file a
federal tax return for Covanta’s consolidated group of
companies, and that certain of our NOLs will be available to
offset the federal tax liability of Covanta. Consequently,
Covanta’s federal income tax obligations will be
substantially reduced. Covanta is not obligated to make any
payments to us with respect to the use of these NOLs. The NOLs
will expire in varying amounts from December 31, 2005
through December 31, 2023, if not used. The IRS has not
audited our tax returns. See Note 25 to the Notes to the
Audited Annual Financial Statements and Note 12 to the
Notes to the Unaudited Interim Financial Statements for
additional information regarding our NOLs and factors which may
affect its availability to offset taxable income of Covanta. If
the NOLs were not available to offset the federal income tax
liability of Covanta, Covanta may not have sufficient cash flow
available to pay debt service on its corporate credit
facilities. See “Covanta Holding Corporation-Specific
Risks — We cannot be certain that our NOLs will
continue to be available to affect our tax liability.”
Since March 10, 2004, CPIH has not been included as a
member of our consolidated taxpayer group, and as such CPIH has
not benefited from the tax sharing agreement. However, as of
July 31, 2005, Covanta has caused CPIH to be included in
our consolidated taxpayer group.
Interim Operating Results
As discussed above, given the significance of the Covanta and
Ref-Fuel acquisitions to Covanta’s business results of
operations and financial condition, we combined the previously
separate business segments of our insurance business and our
parent-level operations into one reportable segment referred to
as “Other Services” during the third quarter of 2005.
Therefore, we currently have two reportable business
segments — Waste and Energy Services and Other
Services. The information set forth below regarding our
operating results is compiled according to our consolidated
operations and these two business segments.
| Factors in Operating Results — Nine Months Ended September 30, 2005 vs. Nine Months Ended September 30, 2004 |
The results of operations for the nine months period ended
September 30, 2004 and for the nine months ended
September 30, 2005 are not representative of our ongoing
results since we only included Covanta’s and
Ref-Fuel’s results of operations in our consolidated
results of operations from March 11, 2004 and June 25,
2005 forward, respectively.
Therefore, given the significance of the Covanta and Ref-Fuel
acquisition to our current and future 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 at both the consolidated
and Waste and Energy Services segment level. Our consolidated
and segment results of operations, as reported and where
applicable, on a pro forma basis, are summarized in the tables
below. The pro forma basis presentation
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assumes that the acquisition of Covanta and Covanta’s
subsequent acquisition of Ref-Fuel occurred on January 1,
2004.
The pro forma financial information is presented for information
purposes only and is not indicative of the results of operations
that would have been achieved if the acquisitions had taken
place at the beginning of each period or that may result in the
future. In addition, the following pro forma information has not
been adjusted to reflect any operating efficiencies that may be
realized as a result of the Ref-Fuel acquisition.
In addition to the Ref-Fuel acquisition, the information
provided below with respect to Covanta’s revenue, expense
and certain other items for periods during 2004 was affected
materially by several factors which did not affect such items
for comparable periods during 2005. These factors principally
include:
| • | The exclusion of revenue and expense after May 2004 relating to the operations of the Philippines Magellan Project, referred to in this prospectus as the “MCI facility,” which commenced a reorganization proceeding under Philippine law on May 31, 2004, and is no longer included as a consolidated subsidiary after such date; | |
| • | The substantial reduction of revenue and expense after August 2004 relating to the Philippines Edison Bataan facility, which ceased operations due to the expiration and termination of energy contracts; and | |
| • | The Remaining Debtors involved in the Lake County, Florida waste-to-energy facility emerged from bankruptcy on December 14, 2004 and are included as consolidated subsidiaries from such date forward. | |
The factors noted above must be taken into account in developing
meaningful comparisons between the periods compared below.
Covanta’s predecessor and successor periods for 2004 have
been combined on a non-GAAP basis to facilitate the following
year to year comparison of Covanta’s operations. Ref-Fuel
results of operations are included in Covanta’s
consolidated results beginning June 25, 2005.
| Our Consolidated Results of Operations — Nine Months Ended September 30, 2005 vs. Nine Months Ended September 30, 2004 |
Our consolidated results of operations on both a reported and
pro forma basis are summarized below (in thousands of dollars,
except per share amounts):
| Nine Months Ended September 30, | ||||||||||||||||
| Reported | Pro Forma | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
| (Unaudited) | ||||||||||||||||
|
CONSOLIDATED RESULTS OF OPERATIONS
|
||||||||||||||||
|
Total operating revenues
|
$ | 675,401 | $ | 402,375 | $ | 903,853 | $ | 901,449 | ||||||||
|
Total operating expenses
|
567,737 | 346,111 | 746,215 | 758,442 | ||||||||||||
|
Consolidated operating income
|
107,664 | 56,264 | 157,638 | 143,007 | ||||||||||||
|
OTHER INCOME (EXPENSE)
|
||||||||||||||||
|
Investment income
|
3,530 | 2,002 | 4,755 | 3,895 | ||||||||||||
|
Interest expense
|
(59,053 | ) | (33,267 | ) | (90,859 | ) | (92,353 | ) | ||||||||
|
Gain on derivative instrument, unexercised ACL warrants
|
14,796 | — | 14,796 | — | ||||||||||||
|
Total other expense
|
(40,727 | ) | (31,265 | ) | (71,308 | ) | (88,458 | ) | ||||||||
|
Income before income taxes, minority interests and equity in net
income from unconsolidated investments
|
66,937 | 24,999 | 86,330 | 54,549 | ||||||||||||
|
Income tax expense
|
(24,008 | ) | (8,436 | ) | (38,849 | ) | (25,093 | ) | ||||||||
|
Minority interest expense
|
(9,311 | ) | (3,922 | ) | (9,367 | ) | (6,433 | ) | ||||||||
|
Equity in net income from unconsolidated investments
|
20,003 | 13,196 | 20,003 | 17,262 | ||||||||||||
|
NET INCOME
|
$ | 53,621 | $ | 25,837 | $ | 58,117 | $ | 40,285 | ||||||||
|
EARNINGS PER SHARE OF COMMON STOCK:
|
||||||||||||||||
|
Basic
|
$ | 0.46 | $ | 0.31 | $ | 0.41 | $ | 0.29 | ||||||||
|
Diluted
|
$ | 0.44 | $ | 0.30 | $ | 0.40 | $ | 0.28 | ||||||||
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The following general discussions should be read in conjunction
with the above table, the condensed consolidated financial
statements and the notes to those statements and other financial
information appearing and referred to elsewhere in this report.
Additional detail on comparable revenues, costs and expenses,
and operating income of Covanta is provided in the pro forma
Waste and Energy Services segment discussion and reported Other
Services segment discussion below.
| Our Reported Results |
Our net income increased by $27.8 million for the nine
months ended September 30, 2005, as compared to the same
period in 2004. Operating income for the Waste and Energy
Services segment increased by $48.7 million for the nine
months ended September 30, 2005, as compared to the same
period in 2004, primarily due to the Covanta and Ref-Fuel
acquisitions. The nine months ended September 30, 2005
included the write-off of deferred financing charges of
$7.0 million on Covanta’s prior domestic and
international debt, as well as $5.6 million of
restructuring and acquisition-related charges. Operating income
for the Other Services segment increased by $2.7 million
for the nine months ended September 30, 2005, as compared
to the same period in 2004, primarily due to decreased parent
company expenses primarily as a result of the corporate services
agreement as discussed below under Other Services.
Total investment income increased by $1.5 million for the
nine months ended September 30, 2005, as compared to the
same period in 2004, primarily due to higher invested cash
balances. Interest expense increased by $25.8 million for
the nine months ended September 30, 2005, as compared to
the same period in 2004, primarily due amortization of accrued
interest on the bridge financing for the acquisition of Covanta
and the new financing arrangements put into place in the second
quarter of 2005 as part of the Ref-Fuel acquisition. Equity in
net income from unconsolidated investments increased by
$6.8 million for the nine months ended September 30,
2005, as compared to the same period in 2004, primarily due to
Covanta’s emergence from bankruptcy on March 10, 2004,
a change in local tax law which occurred in the third quarter of
2005 at a project in Bangladesh, revenue adjustments which
occurred in 2004 at a project in the Philippines and lower
project debt interest expense at both projects in 2005 as a
result of project debt payments. As discussed in Note 16 to
the Notes to the Unaudited Interim Financial Statements, Covanta
recorded a mark-to-market adjustment for the period ended
September 30, 2005 which increased the investment in ACL
warrants to $15.6 million and resulted in a pre-tax gain on
derivative instruments of $14.8 million for the nine months
ended September 30, 2005.
| Our Pro Forma Results |
Our net income increased by $17.8 million for the nine
months ended September 30, 2005, as compared to the same
period in 2004. Operating income for the Waste and Energy
Services segment increased by $12.0 million for the nine
months ended September 30, 2005, as compared to the same
period in 2004, primarily due to lower operating expenses.
Operating income for the Other Services segment increased by
$2.7 million for the nine months ended September 30,
2005, as compared to the same period in 2004, primarily due to
decreased parent company expenses primarily as a result of the
corporate services agreement as discussed below under Other
Services.
Total investment income increased by $0.9 million for the
nine months ended September 30, 2005, as compared to the
same period in 2004, primarily due to higher invested cash
balances. Interest expense decreased $1.5 million for the
nine months ended September 30, 2005, as compared to the
same period in 2004. Equity in net income from unconsolidated
investments increased by $2.7 million for the nine months
ended September 30, 2005, as compared to the same period in
2004, primarily due to a change in local tax law which occurred
in the third quarter of 2005 at a project in Bangladesh, revenue
adjustments which occurred in 2004 at a project in the
Philippines and lower project debt interest expense at both
projects in 2005 as a result of project debt payments. As
discussed in Note 16 to the Notes to the Unaudited Interim
Financial Statements, we recorded a mark-to-market adjustment
for the period ended September 30, 2005 which increased the
investment in ACL warrants to $15.6 million and resulted in
a pre-tax gain on derivative instruments of $14.8 million
for the nine months ended September 30, 2005.
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| Waste and Energy Services — Nine Months Ended September 30, 2005 vs. Nine Months Ended September 30, 2004 |
Waste and Energy Services results of operations on both a
reported and pro forma basis are summarized below (in thousands
of dollars):
| Nine Months Ended September 30, | ||||||||||||||||
| Reported | Pro Forma | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
| (Unaudited) | ||||||||||||||||
|
Waste and service revenues
|
$ | 436,624 | $ | 260,563 | $ | 585,416 | $ | 583,722 | ||||||||
|
Electricity and steam sales
|
225,541 | 124,153 | 305,201 | 300,010 | ||||||||||||
|
Other operating revenues
|
1,779 | 1,109 | 1,779 | 1,167 | ||||||||||||
|
Total revenues
|
663,944 | 385,825 | 892,396 | 884,899 | ||||||||||||
|
Plant operating expenses
|
393,343 | 41,149 | 500,096 | 503,485 | ||||||||||||
|
Depreciation and amortization
|
78,027 | 36,784 | 129,679 | 129,565 | ||||||||||||
|
Net interest expense on project debt
|
36,700 | 23,194 | 52,138 | 59,082 | ||||||||||||
|
Other operating expense
|
(705 | ) | (529 | ) | (186 | ) | (1,687 | ) | ||||||||
|
General and administrative expenses
|
43,770 | 26,762 | 53,504 | 49,246 | ||||||||||||
|
Restructuring charges
|
2,655 | — | — | — | ||||||||||||
|
Acquisition-related charges
|
2,963 | — | — | — | ||||||||||||
|
Total operating expenses
|
556,753 | 327,360 | 735,231 | 739,691 | ||||||||||||
|
Operating income
|
$ | 107,191 | $ | 58,465 | $ | 157,165 | $ | 145,208 | ||||||||
The following business segment results of operations are
discussed on a pro forma basis only. Management believes that
due to the significance of the Covanta and Ref-Fuel acquisitions
to our current and future results of operations and financial
condition that an understanding of our reported results, trends
and ongoing performance is enhanced by a discussion of the Waste
and Energy Services Segment on a pro forma basis. The following
general discussions should be read in conjunction with the above
table, the condensed consolidated financial statements and the
notes to those statements and other financial information
appearing and referred to elsewhere in this prospectus.
Additional detail on comparable revenues, costs and expenses,
and operating income, within the Waste and Energy Services
segment is provided in the pro forma domestic and international
business discussions below.
| Waste and Energy Services Pro Forma Results |
Operating income for the nine months ended September 30,
2005 increased by $12.0 million, compared to the same
period in 2004. Revenues increased $7.5 million for the
nine-month period ended September 30, 2005 compared with
the same period in 2004, primarily from increases in electricity
and steam sales in domestic operations offset by declines in
these revenues in international operations. Total costs and
expenses for the nine months ended September 30, 2005
decreased by $4.5 million compared to the same period in
2004 as a result of lower plant operating expenses, lower
project debt interest expense in both the domestic and
international operations offset by increased domestic general
and administrative expense.
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Table of Contents
| Domestic Business |
The domestic business results of operations on both a reported
and pro forma basis are summarized below (in thousands of
dollars):
| Nine Months Ended September 30, | ||||||||||||||||
| Reported | Pro Forma | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
| (Unaudited) | ||||||||||||||||
|
Waste and service revenues
|
$ | 433,319 | $ | 258,705 | $ | 582,111 | $ | 580,694 | ||||||||
|
Electricity and steam sales
|
124,241 | 51,822 | 203,901 | 193,314 | ||||||||||||
|
Other operating revenues
|
1,779 | 1,109 | 1,779 | 1,167 | ||||||||||||
|
Total revenues
|
559,339 | 311,636 | 787,791 | 775,175 | ||||||||||||
|
Plant operating expenses
|
321,302 | 191,024 | 428,055 | 428,123 | ||||||||||||
|
Depreciation and amortization
|
71,435 | 32,305 | 123,087 | 121,719 | ||||||||||||
|
Net interest expense on project debt
|
30,778 | 16,223 | 46,216 | 49,022 | ||||||||||||
|
Other operating (income) expenses
|
(2,821 | ) | 128 | (2,302 | ) | (1,323 | ) | |||||||||
|
General and administrative expenses
|
40,195 | 23,707 | 49,929 | 45,772 | ||||||||||||
|
Acquisition-related charges
|
2,963 | — | — | — | ||||||||||||
|
Total operating expenses
|
463,852 | 263,387 | 644,985 | 643,313 | ||||||||||||
|
Operating income
|
$ | 95,487 | $ | 48,249 | $ | 142,806 | $ | 131,862 | ||||||||
| Total Revenues |
| Waste and Service Revenues |
Waste and service revenues for the nine months ended
September 30, 2005 increased by $1.4 million compared
to the same period in 2004.
| • | Revenue from projects structured as service fee agreements was unchanged. Primary drivers were increased revenue of $5.2 million due to contractual escalations, which was offset by a $1.2 million reduction in revenue earned explicitly to service debt, and a $4.0 million decrease in revenue at one facility due to a second quarter 2004 contract amendment in exchange for reduced letter of credit obligations; | |
| • | Revenue from projects structured as tipping fee agreements increased by $1.5 million primarily driven by pricing improvements; | |
| • | Revenue from scrap metal sales decreased $2.7 million primarily due to lower market pricing; and | |
| • | All other waste and service revenues increased $2.6 million primarily due to the impact of restructuring certain bio-gas operations and waste energy operations, and the termination or sale of certain non-core operations primarily in the fourth quarter of 2004. | |
| Electricity and Steam Sales |
Electricity and steam sales for the nine months ended
September 30, 2005 increased $10.6 million compared to
the same period in 2004.
| • | Higher energy rates drove a $5.0 million increase in revenue; and | |
| • | Other factors including the impact of restructuring certain bio-gas operations resulted in revenue increases of $5.6 million. | |
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Table of Contents
| Plant Operating Expenses |
Plant operating costs for the nine months ended
September 30, 2005 were flat compared to the first nine
months of 2004. During the first nine months of 2005 there was a
reduction in hauling services expense of $3.0 million due
primarily to lower waste volumes shipped to a third party
landfill, a $1.4 million decrease due to an ash marketing
arrangement that ended in the first quarter of 2004, and a
reduction in compensation expense of $1.7 million.
Maintenance and repair expense at two facilities increased
$6.9 million during 2005 and all other plant operating
expenses decreased $0.8 million, including the impact of
restructuring and the termination or sale of certain of our
non-core operations.
| Depreciation and Amortization |
Depreciation and amortization for the nine months ended
September 30, 2005 was comparable to the same period in
2004.
| Net Interest Expense on Project Debt |
Net interest expense on project debt for the nine months ended
September 30, 2005 decreased $2.8 million, compared to
the same period in 2004, primarily as a result of lower project
debt balances.
| Other Operating Expenses |
Other operating expenses were ($2.3) million, an increase
of $1.0 million in the first nine months of 2005, compared
to the same period in 2004, primarily due to a gain at a
facility related to a debt refinancing in April 2005 and to
third quarter insurance recoveries as noted above.
| General and administrative expenses |
General and administrative expenses increased $4.2 million
in the first nine months of 2005 compared to the first nine
months of 2004. This increase was primarily due to a
$4.0 million increase in professional fees, a
$1.7 million increase due to costs incurred for
Covanta’s parent operations, and a $1.6 million
increase in non-cash stock compensation expense primarily due to
the amortization of restricted stock granted in October 2004 and
July 2005. These increases were partially offset by a
$2.4 million decrease in wages and benefits and by other
reductions in various general and administrative expenses.
| Operating Income |
Operating income from the domestic Waste and Energy Services
segment for the first nine months of 2005 increased by
$10.9 million compared to the first nine months of 2004,
comprised of increases in total revenues ($12.6 million),
lower interest expense on project debt ($2.8 million), and
a gain in other income ($1.0 million), offset by higher
depreciation and amortization ($1.4 million) and general
and administrative expenses ($4.2 million).
49
Table of Contents
| International Business |
The international business results of operations on both a
reported and pro forma basis are summarized below (in thousands
of dollars):
| Nine Months Ended September 30, | ||||||||||||||||
| Reported | Pro Forma | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
| (Unaudited) | ||||||||||||||||
|
Waste and service revenues
|
$ | 3,305 | $ | 1,858 | $ | 3,305 | $ | 3,028 | ||||||||
|
Electricity and steam sales
|
101,300 | 72,331 | 101,300 | 106,696 | ||||||||||||
|
Total revenues
|
104,605 | 74,189 | 104,605 | 109,724 | ||||||||||||
|
Plant operating expenses
|
72,041 | 50,125 | 72,041 | 75,362 | ||||||||||||
|
Depreciation and amortization
|
6,592 | 4,479 | 6,592 | 7,846 | ||||||||||||
|
Net interest expense on project debt
|
5,922 | 6,971 | 5,922 | 10,060 | ||||||||||||
|
Other operating expenses (income)
|
2,116 | (657 | ) | 2,116 | (364 | ) | ||||||||||
|
General and administrative expenses
|
3,575 | 3,055 | 3,575 | 3,474 | ||||||||||||
|
Restructuring charges
|
2,655 | — | — | — | ||||||||||||
|
Total operating expenses
|
92,901 | 63,973 | 90,246 | 96,378 | ||||||||||||
|
Operating income
|
$ | 11,704 | $ | 10,216 | $ | 14,359 | $ | 13,346 | ||||||||
| Total Revenues |
Total revenues for the international business for the first nine
months of 2005 decreased $5.1 million compared to the first
nine months of 2004. This decrease was primarily due to a
$7.5 million decrease from the expiration of an energy
contract in the Philippines and a $4.2 million decrease
from the deconsolidation of the MCI facility. These decreases
were partially offset by a $6.6 million increase primarily
due to improved demand and increased tariffs, which resulted
from higher fuel prices, at two facilities in India in 2005.
| Plant Operating Expenses |
Plant operating costs were lower by $3.3 million in the
first nine months of 2005. Plant operating costs decreased
primarily as a result of a $4.8 million decrease in costs
from the expiration of an energy contract in the Philippines and
a $4.6 million reduction in costs due to the
deconsolidation of the MCI facility in the Philippines. These
decreases were partially offset by a $6.2 million increase
in plant operating costs due primarily to improved demand and
higher fuel prices at two facilities in India.
| Depreciation and Amortization |
Depreciation and amortization for the first nine months of 2005
decreased $1.3 million compared to the same period in 2004
as a result of fresh-start accounting adjustments.
| Net Interest Expense on Project Debt |
Net interest expense on project debt for the first nine months
of 2005 decreased $4.1 million compared to the first nine
months of 2004. The decrease was primarily due to lower expenses
at two Indian facilities resulting from the October 2004
refinancing and scheduled quarterly pay down of project debt,
and the deconsolidation of the MCI facility in May 2004.
| Other Operating Expenses |
Other operating expense was $2.5 million higher for the
nine months of 2005 primarily due to the write-off of remaining
assets at the Edison Bataan facility ($1.8 million).
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Table of Contents
| Operating Income |
Operating income for the international businesses for the first
nine months of 2005 was $1.0 million higher than the first
nine months of 2004. The increase was attributable to lower
plant operating costs ($3.3 million), a reduction of
interest due to refinancing and scheduled quarterly pay down of
project debt at two Indian facilities ($4.1 million) and
lower depreciation expense due to fresh-start accounting
adjustments ($1.3 million). These increases in operating
income were partially offset by lower revenues
($5.1 million), and a write-off of remaining assets at the
Bataan facility ($1.8 million).
| Other Services — Nine Months Ended September 30, 2005 vs. Nine Months Ended September 30, 2004 |
Other Services reported results of operations are summarized
below (in thousands of dollars):
| Nine Months Ended | ||||||||
| September 30, | ||||||||
| 2005 | 2004 | |||||||
| (Unaudited) | ||||||||
|
OPERATING REVENUES:
|
||||||||
|
Net earned premiums
|
$ | 9,928 | $ | 14,317 | ||||
|
Net investment income
|
1,513 | 1,872 | ||||||
|
Net realized investment gains (losses)
|
(75 | ) | 223 | |||||
|
Other income
|
91 | 138 | ||||||
|
Total operating revenues
|
11,457 | 16,550 | ||||||
|
Other operating expenses
|
8,441 | 13,132 | ||||||
|
General and administrative expenses
|
2,543 | 5,619 | ||||||
|
Total Other Services operating expenses
|
10,984 | 18,751 | ||||||
|
Operating income (loss) from Other Services
|
$ | 473 | $ | (2,201 | ) | |||
| Premiums |
Net written premiums decreased by $1.8 million for the nine
months ended September 30, 2005 as compared to the same
period in 2004. The decrease in net written premiums for 2005
was attributable to our insurance business entering into quota
share arrangements as described in the
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Executive
Summary — Other Services-Overview” section
above.
Net earned premiums decreased by $4.4 million for the nine
months ended September 30, 2005 as compared to the same
period in 2004. The change in net earned premiums during those
periods was directly related to the change in net written
premiums and the run-off of the commercial automobile program.
| Other Operating Expenses |
Other operating expenses decreased by $4.7 million for the
nine months ended September 30, 2005 as compared to the
same period in 2004. Other operating expenses consists of net
loss and loss adjustment expenses, referred to as
“LAE” in this prospectus, and policy acquisition costs
as described below.
Net loss and LAE decreased by $3.2 million for the nine
months ended September 30, 2005 as compared to the same
period in 2004. The resulting loss and LAE ratios were 69.7% and
70.7% for the nine months ended September 30, 2005 and
2004, respectively. The loss and LAE ratio improved in the
nine-month period ended September 30, 2005 over the
comparable period in 2004 due to net favorable reserve
adjustments on discontinued lines.
Policy acquisition costs decreased by $1.5 million for the
nine months ended September 30, 2005 as compared to the
same periods in 2004. As a percentage of net earned premiums,
policy acquisition costs were 15.4% and 21.0% for the nine
months ended September 30, 2005 and 2004, respectively.
Policy acquisition costs decreased compared to the 2004 period
due to reduced profit commissions incurred related to non-
51
Table of Contents
standard personal automobile and from ceding commissions
received under reinsurance agreements during 2005.
| General and Administrative Expenses |
General and administrative expenses decreased by
$3.1 million for the nine months ended September 30,
2005 as compared to the same period in 2004. Reductions in
administrative personnel and rent in the insurance business
contributed to the decrease in general and administrative
expenses. Decreases in parent company expenses were primarily
the result of the corporate services agreement, entered into
between us and Covanta, pursuant to which we provided to
Covanta, at Covanta’s expense, certain administrative and
professional services and Covanta paid our expenses. Such
expenses totaled zero and $2.1 million for the nine months
ended September 30, 2005 and 2004, respectively.
Pro Forma Reconciliations
The following tables provides a reconciliation from the as
reported results to the pro forma results presented above for us
and our Waste and Energy Services segment where applicable (in
thousands of dollars, except per share amounts). Notes to the
pro forma reconciliations begin directly after the tables.
| Consolidated Pro Forma Reconciliations |
| Nine Months Ended September 30, 2005 | Nine Months Ended September 30, 2004 | ||||||||||||||||||||||||||||||||
| Acquisition | Pro Forma | Acquisition | Pro Forma | ||||||||||||||||||||||||||||||
| As Reported | Activity | Adjust. | Pro Forma | As Reported | Activity | Adjust. | Pro Forma | ||||||||||||||||||||||||||
| (Unaudited) | (Unaudited) | ||||||||||||||||||||||||||||||||
|
Operating revenues
|
|||||||||||||||||||||||||||||||||
|
Waste and service revenues
|
$ | 436,624 | $ | 148,792 | $ | — | $ | 585,416 | $ | 260,563 | $ | 328,441 | $ | (5,282 | ) | $ | 583,722 | ||||||||||||||||
|
Electricity and steam sales
|
225,541 | 79,660 | — | 305,201 | 124,153 | 176,392 | (535 | ) | 300,010 | ||||||||||||||||||||||||
|
Other operating revenues
|
13,236 | — | — | 13,236 | 17,659 | 58 | — | 17,717 | |||||||||||||||||||||||||
|
Total operating revenues
|
675,401 | 228,452 | — | 903,853 | 402,375 | 504,891 | (5,817 | ) | 901,449 | ||||||||||||||||||||||||
|
Operating expenses
|
|||||||||||||||||||||||||||||||||
|
Plant operating expenses
|
393,343 | 103,617 | 3,136 | 500,096 | 241,149 | 261,164 | 1,172 | 503,485 | |||||||||||||||||||||||||
|
Depreciation and amortization expense
|
78,027 | 57,032 | (5,380 | ) | 129,679 | 36,784 | 103,893 | (11,112 | ) | 129,565 | |||||||||||||||||||||||
|
Net interest expense on project debt
|
36,700 | 13,964 | 1,474 | 52,138 | 23,194 | 34,605 | 1,283 | 59,082 | |||||||||||||||||||||||||
|
Other operating expenses
|
7,736 | 519 | — | 8,255 | 12,603 | (1,515 | ) | 357 | 11,445 | ||||||||||||||||||||||||
|
General and administrative expenses
|
46,313 | 52,133 | (42,399 | ) | 56,047 | 32,381 | 27,278 | (4,794 | ) | 54,865 | |||||||||||||||||||||||
|
Restructuring charges
|
2,655 | — | (2,655 | ) | — | — | — | — | — | ||||||||||||||||||||||||
|
Acquisition-related charges
|
2,963 | — | (2,963 | ) | — | — | — | — | — | ||||||||||||||||||||||||
|
Reorganization items
|
— | — | — | — | — | 58,282 | (58,282 | ) | — | ||||||||||||||||||||||||
|
Fresh-start adjustments
|
— | — | — | — | — | 399,063 | (399,063 | ) | — | ||||||||||||||||||||||||
|
Gain on extinguishment of debt
|
— | — | — | — | — | (510,680 | ) | 510,680 | — | ||||||||||||||||||||||||
|
Total operating expenses
|
567,737 | 227,265 | (48,787 | ) | 746,215 | 346,111 | 372,090 | 40,241 | 758,442 | ||||||||||||||||||||||||
|
Operating income (loss)
|
107,664 | 1,187 | 48,787 | 157,638 | 56,264 | 132,801 | (46,058 | ) | 143,007 | ||||||||||||||||||||||||
|
Other income (expenses)
|
|||||||||||||||||||||||||||||||||
|
Investment income
|
3,530 | 1,225 | — | 4,755 | 2,002 | 1,893 | — | 3,895 | |||||||||||||||||||||||||
|
Interest expense
|
(59,053 | ) | (26,368 | ) | (5,438 | ) | (90,859 | ) | (33,267 | ) | (52,291 | ) | (6,795 | ) | (92,353 | ) | |||||||||||||||||
|
Gain on derivative instrument, unexercised ACL warrants
|
14,796 | — | — | 14,796 | — | — | — | — | |||||||||||||||||||||||||
|
Total other expenses
|
(40,727 | ) | (25,143 | ) | (5,438 | ) | (71,308 | ) | (31,265 | ) | (50,398 | ) | (6,795 | ) | (88,458 | ) | |||||||||||||||||
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Table of Contents
| Nine Months Ended September 30, 2005 | Nine Months Ended September 30, 2004 | ||||||||||||||||||||||||||||||||
| Acquisition | Pro Forma | Acquisition | Pro Forma | ||||||||||||||||||||||||||||||
| As Reported | Activity | Adjust. | Pro Forma | As Reported | Activity | Adjust. | Pro Forma | ||||||||||||||||||||||||||
| (Unaudited) | (Unaudited) | ||||||||||||||||||||||||||||||||
|
Income before income tax provision, minority interests and
equity in net income from unconsolidated investments
|
66,937 | (23,956 | ) | 43,349 | 86,330 | 24,999 | 82,403 | (52,853 | ) | 54,549 | |||||||||||||||||||||||
|
Income expense
|
(24,008 | ) | 6,033 | (20,874 | ) | (38,849 | ) | (8,436 | ) | (30,240 | ) | 13,583 | (25,093 | ) | |||||||||||||||||||
|
Minority interest expense
|
(9,311 | ) | (56 | ) | — | (9,367 | ) | (3,922 | ) | (2,511 | ) | — | (6,433 | ) | |||||||||||||||||||
|
Equity in net income from unconsolidated investments
|
20,003 | — | — | 20,003 | 13,196 | 3,924 | 142 | 17,262 | |||||||||||||||||||||||||
|
Net Income (Loss)
|
$ | 53,621 | $ | (17,979 | ) | $ | 22,475 | $ | 58,117 | $ | 25,837 | $ | 53,576 | $ | (39,128 | ) | $ | 40,285 | |||||||||||||||
|
Earnings Per Share:
|
|||||||||||||||||||||||||||||||||
|
Basic
|
$ | 0.46 | $ | 0.41 | $ | 0.31 | $ | 0.29 | |||||||||||||||||||||||||
|
Diluted
|
$ | 0.44 | $ | 0.40 | $ | 0.30 | $ | 0.28 | |||||||||||||||||||||||||
| Waste And Energy Services Pro Forma Reconciliations — Domestic |
| Nine Months Ended September 30, 2005 | Nine Months Ended September 30, 2004 | |||||||||||||||||||||||||||||||
| Acquisition | Pro Forma | Acquisition | Pro Forma | |||||||||||||||||||||||||||||
| As Reported | Activity | Adjust. | Pro Forma | As Reported | Activity | Adjust. | Pro Forma | |||||||||||||||||||||||||
| (Unaudited) | (Unaudited) | |||||||||||||||||||||||||||||||
|
Waste and service revenues
|
$ | 433,319 | $ | 148,792 | $ | — | $ | 582,111 | $ | 258,705 | $ | 327,271 | $ | (5,282 | ) | $ | 580,694 | |||||||||||||||
|
Electricity and steam sales
|
124,241 | 79,660 | — | 203,901 | 51,822 | 142,027 | (535 | ) | 193,314 | |||||||||||||||||||||||
|
Other operating revenues
|
1,779 | — | — | 1,779 | 1,109 | 58 | — | 1,167 | ||||||||||||||||||||||||
|
Total operating revenues
|
559,339 | 228,452 | — | 787,791 | 311,636 | 469,356 | (5,817 | ) | 775,175 | |||||||||||||||||||||||
|
Plant operating expenses
|
321,302 | 103,617 | 3,136 | 428,055 | 191,024 | 235,927 | 1,172 | 428,123 | ||||||||||||||||||||||||
|
Depreciation and amortization expense
|
71,435 | 57,032 | (5,380 | ) | 123,087 | 32,305 | 100,526 | (11,112 | ) | 121,719 | ||||||||||||||||||||||
|
Net interest expense on project debt
|
30,778 | 13,964 | 1,474 | 46,216 | 16,223 | 31,516 | 1,283 | 49,022 | ||||||||||||||||||||||||
|
Other operating (income) expenses
|
(2,821 | ) | 519 | — | (2,302 | ) | 128 | (1,808 | ) | 357 | (1,323 | ) | ||||||||||||||||||||
|
General and administrative expenses
|
40,195 | 52,133 | (42,399 | ) | 49,929 | 23,707 | 26,859 | (4,794 | ) | 45,772 | ||||||||||||||||||||||
|
Acquisition related charges
|
2,963 | — | (2,963 | ) | — | — | — | — | — | |||||||||||||||||||||||
|
Reorganization items
|
— | — | — | — | — | 58,282 | (58,282 | ) | — | |||||||||||||||||||||||
|
Fresh-start adjustments
|
— | — | — | — | — | 399,063 | (399,063 | ) | — | |||||||||||||||||||||||
|
Gain on extinguishment of debt
|
— | — | — | — | — | (510,680 | ) | 510,680 | — | |||||||||||||||||||||||
|
Total operating expenses
|
463,852 | 227,265 | (46,132 | ) | 644,985 | 263,387 | 339,685 | 40,241 | 643,313 | |||||||||||||||||||||||
|
Operating income (loss)
|
$ | 95,487 | $ | 1,187 | $ | 46,132 | $ | 142,806 | $ | 48,249 | $ | 129,671 | $ | (46,058 | ) | $ | 131,862 | |||||||||||||||
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Table of Contents
| Waste And Energy Services Pro Forma Reconciliations — International |
| Nine Months Ended September 30, 2005 | Nine Months Ended September 30, 2004 | |||||||||||||||||||||||||||||||
| Acquisition | Pro Forma | Acquisition | Pro Forma | |||||||||||||||||||||||||||||
| As Reported | Activity | Adjust. | Pro Forma | As Reported | Activity | Adjust. | Pro Forma | |||||||||||||||||||||||||
| (Unaudited) | (Unaudited) | |||||||||||||||||||||||||||||||
|
Waste and service revenues
|
$ | 3,305 | $ | — | $ | — | $ | 3,305 | $ | 1,858 | $ | 1,170 | $ | — | $ | 3,028 | ||||||||||||||||
|
Electricity and steam sales
|
101,300 | — | — | 101,300 | 72,331 | 34,365 | — | 106,696 | ||||||||||||||||||||||||
|
Other operating revenues
|
— | — | — | — | — | — | — | — | ||||||||||||||||||||||||
|
Total operating revenues
|
104,605 | — | — | 104,605 | 74,189 | 35,535 | — | 109,724 | ||||||||||||||||||||||||
|
Operating Expenses
|
||||||||||||||||||||||||||||||||
|
Plant operating expenses
|
72,041 | — | — | 72,041 | 50,125 | 25,237 | — | 75,362 | ||||||||||||||||||||||||
|
Depreciation and amortization expense
|
6,592 | — | — | 6,592 | 4,479 | 3,367 | — | 7,846 | ||||||||||||||||||||||||
|
Net interest expense on project debt
|
5,922 | — | — | 5,922 | 6,971 | 3,089 | — | 10,060 | ||||||||||||||||||||||||
|
Other operating (income) expenses
|
2,116 | — | — | 2,116 | (657 | ) | 293 | — | (364 | ) | ||||||||||||||||||||||
|
General and administrative expenses
|
3,575 | — | — | 3,575 | 3,055 | 419 | — | 3,474 | ||||||||||||||||||||||||
|
Restructuring charges
|
2,655 | — | (2,655 | ) | — | — | — | — | — | |||||||||||||||||||||||
|
Total operating expenses
|
92,901 | — | (2,655 | ) | 90,246 | 63,973 | 32,405 | — | 96,378 | |||||||||||||||||||||||
|
Operating income
|
$ | 11,704 | $ | — | $ | 2,655 | $ | 14,359 | $ | 10,216 | $ | 3,130 | $ | — | $ | 13,346 | ||||||||||||||||
| Notes To Pro Forma Reconciliations |
| Pro Forma Assumptions |
The unaudited pro forma condensed combined financial statements
reflect the following assumptions:
| Covanta Transactions: |
| • | We purchased Covanta on January 1, 2004, on the same terms described in “Acquisitions — Covanta Energy” in Note 3 to the Notes to the Unaudited Interim Financial Statements. | |
| • | The debt structure of Covanta and CPIH that was in place upon Covanta’s emergence from bankruptcy on March 10, 2004, was assumed to be refinanced in connection with the acquisition of Ref-Fuel as of January 1, 2004 as more fully described in Note 11 to the Notes to the Unaudited Interim Financial Statements. | |
| Ref-Fuel Transactions: |
| • | We, through Covanta, purchased 100% of the issued and outstanding shares of Ref-Fuel’s capital stock on January 1, 2004 on the same terms described in “Acquisitions — Ref-Fuel” in Note 3 to the Notes to the Unaudited Interim Financial Statements. | |
| • | The April 30, 2004 equalization transactions and the ownership changes that occurred on August 31, 2004 between and among Ref-Fuel and its owners are assumed to have taken place on January 1, 2004. | |
| Acquisition Activity: |
| • | Acquisition activity includes Covanta’s results of operations prior to March 11, 2004 for the pro forma nine months ended September 30, 2004 and Ref-Fuel’s results of operations prior to June 25, 2005 for the pro forma nine months ended September 30, 2005 and for the pro forma nine months ended September 30, 2004. |
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| Pro Forma Adjustments |
The following are a summary of the pro forma adjustments made:
| • | To reverse the operating results of the Waste and Energy Services domestic business comprising the Remaining Debtors for the period January 1 through March 10, 2004, referred to as the “predecessor period” in this prospectus. | |
| • | Plant operating costs: To record as rent expense the net impact of the change in the fair value of a lease owned by an operating subsidiary of Ref-Fuel as of January 1, 2004. | |
| • | Depreciation and amortization: To reverse historical depreciation and amortization expense and to record pro forma depreciation and amortization expense based on fair values assigned to Covanta’s and Ref-Fuel’s property, plant and equipment and amortizable intangible assets prior to their respective acquisition dates of March 1, 2004 and June 24, 2005. | |
| • | General and administrative: To reverse the buy out of Ref-Fuel’s stock option plan, at the acquisition date of Ref-Fuel and to reverse Ref-Fuel’s compensation and related expenses of its executives in the periods prior to the acquisition date. | |
| • | Net interest expense on project debt: To reverse prior bond issue costs and amortization of Covanta’s project debt and to reverse prior bond issue costs Ref-Fuel’s project debt and to record the impact of the fair value adjustment to their project debt prior to their respective acquisition dates. | |
| • | Restructuring charges: To reverse severance and incentive payments to CPIH executives as a result of overhead reductions made possible by the elimination of CPIH’s separate capital structure and debt repayments in connection with the refinancing of Covanta’s and CPIH’s debt and Covanta’s acquisition of Ref-Fuel. | |
| • | Acquisition related charges: To reverse employee bonuses and integration expenses as a result of the acquisition of Ref-Fuel. | |
| • | Reorganization items, fresh-start adjustments and gain on cancellation of pre-petition debt: To reverse the historical items resulting from Covanta’s bankruptcy proceedings. Since the pro forma condensed statement of combined operations has been prepared on the basis that Covanta’s emergence from bankruptcy and the business combination with Covanta both occurred on January 1, 2004, these items have been removed, as these transactions to effect Covanta’s reorganization would have been completed and these items would have been recorded prior to January 1, 2004. | |
| • | Interest expense: To reverse Covanta’s predecessor period and Ref-Fuel’s pre-acquisition period amortization of deferred financing costs; to record the impact of the fair value adjustment to the intermediate debt of Ref-Fuel; and to record the net adjustment to interest expense as a result of the new capital structure of Covanta described below. | |
| • | Income tax expense: To record the adjustment for the estimated income tax effects associated with the pro forma adjustments to pre-tax income and arrive at a blended assumed effective tax rate of 46% for the combined company for the nine months ended September 30, 2004 and 45% for the nine months ended September 30, 2005. | |
| • | 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 nine months ended September 30, 2004 and the nine months ended September 30, 2005 have been adjusted, as necessary, to reflect the following equity transactions, as if they occurred on January 1, 2004, the issuance of: (1) 5.1 million shares for the bridge lenders relating to the Covanta acquisition; (2) 27.4 million shares in connection with a pro rata rights offering to all of our stockholders on May 18, 2004; (3) 8.75 million shares pursuant to the conversion of approximately $13.4 million in principal amount of Covanta convertible notes; and (4) 66.7 million shares associated with the Ref-Fuel rights offering. In addition, diluted earnings per share and the average shares used in the calculation of diluted earnings per share of common stock and shares of common stock outstanding | |
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| for the pro forma nine months ended September 30, 2004 and the nine months ended September 30, 2005 have been adjusted, as necessary, to reflect the following additional equity transactions, as if they occurred on January 1, 2004: (1) our commitment to sell up to 3.0 million shares of our common stock at $1.53 per share to certain creditors of Covanta; and (2) an additional 2.7 million shares to such creditors in this offering at $6.00 per share. |
| Historic Operating Results |
As discussed above, while we combined the previously separate
business segments of our insurance business and our parent-level
operations into one reportable segment referred to as
“Other Services” during the third quarter of 2005,
prior to the third quarter of 2005 we reported our operations
based on Waste and Energy Services and Insurance Services
segments. Therefore, the following information is compiled
according to these two historic segments, instead of our current
segments of Waste and Energy Services and Other Services. Also
included is historic financial information with respect to
parent-level investment income.
| Waste and Energy Services — Operating Results |
| Waste and Energy Services — Operating Results — 2004 vs. 2003 |
The discussion below provides comparative information regarding
Covanta’s historical consolidated results of operations.
The information provided below with respect to revenue, expense
and certain other items for periods during 2004 was affected
materially by several factors which did not affect such items
for comparable periods during 2003. These factors principally
include:
| • | the application of fresh-start and purchase accounting following Covanta’s emergence from bankruptcy, which are described in Note 2 to the Notes to the Audited Annual Financial Statements; | |
| • | the exclusion of revenue and expense after March 10, 2004 relating to the operations of the Remaining Debtors (which prior to August 6, 2004 included subsidiaries involved with the Tampa Bay Project and prior to December 14, 2004 included the subsidiaries involved with the Lake County facility), which were no longer included as consolidated subsidiaries after such date; | |
| • | the exclusion of revenue and expense after May 2004 relating to the operations of the MCI facility, which commenced a reorganization proceeding under Philippine law on such date, and is no longer included as a consolidated subsidiary after such date; | |
| • | the reduction of revenue and expense during 2004 from one hydroelectric facility because of the scheduled expiration of an operating agreement relating to such facility; | |
| • | the reduction of revenue and expense as a result of project restructurings effected during 2003 and the first quarter of 2004 as part of Covanta’s overall restructuring and emergence from bankruptcy; and | |
| • | upon our acquisition of Covanta, we entered into a tax sharing agreement by which our existing NOLs generated before 2003 would be made available to Covanta. This agreement provides that we will file a federal tax return for our consolidated group of companies and that certain of our NOLs will be available to offset the federal tax liability of Covanta. These NOLs are maintained at the holding company level and are not reflected in the historical combined pro forma consolidated results of operations of Covanta for the years ended December 31, 2004 and 2003 for purposes of the following discussion of Covanta’s operating results. | |
The factors noted above must be taken into account in developing
meaningful comparisons between the periods compared below.
The periods for 2004 before and after our acquisition of Covanta
have been combined on a non-GAAP basis to facilitate the
following year-to-year comparison of Covanta’s operations.
Only the period after the Covanta acquisition is included in our
financial statements and the information prior to the
acquisition is presented only to facilitate the review of
Covanta’s operating results.
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The following table summarizes the historical consolidated
results of operations of Covanta for the years ended
December 31, 2004 and 2003 (in thousands of dollars):
| For the Period | ||||||||||||||||
| For the Period | March 11, through | Combined Results | Results for the | |||||||||||||
| January 1, through | December 31, | for the Year Ended | Year Ended | |||||||||||||
| March 10, 2004 | 2004 | December 31, 2004 | December 31, 2003 | |||||||||||||
|
Service revenues
|
$ | 89,867 | $ | 374,622 | $ | 464,489 | $ | 499,245 | ||||||||
|
Electricity and steam sales
|
53,307 | 181,074 | 234,381 | 277,766 | ||||||||||||
|
Construction revenues
|
58 | 1,506 | 1,564 | 13,448 | ||||||||||||
|
Other revenues
|
— | — | — | 9 | ||||||||||||
|
Total revenues
|
143,232 | 557,202 | 700,434 | 790,468 | ||||||||||||
|
Plant operating expenses
|
100,774 | 352,617 | 453,391 | 500,627 | ||||||||||||
|
Construction costs
|
73 | 1,925 | 1,998 | 20,479 | ||||||||||||
|
Depreciation and amortization
|
13,426 | 55,821 | 69,247 | 71,932 | ||||||||||||
|
Net interest on project debt
|
13,407 | 32,586 | 45,993 | 76,770 | ||||||||||||
|
Other operating costs and expenses
|
(209 | ) | 1,366 | 1,157 | 2,209 | |||||||||||
|
Net (gain) loss on sale of businesses and equity investments
|
(175 | ) | (245 | ) | (420 | ) | 7,246 | |||||||||
|
Selling, general and administrative expenses
|
7,597 | 38,076 | 45,673 | 35,639 | ||||||||||||
|
Other income — net
|
(1,923 | ) | (1,952 | ) | (3,875 | ) | (1,119 | ) | ||||||||
|
Write-down of and obligations related to assets held for use
|
— | — | — | 16,704 | ||||||||||||
|
Total costs and expenses
|
132,970 | 480,194 | 613,164 | 730,487 | ||||||||||||
|
Operating income
|
10,262 | 77,008 | 87,270 | 59,981 | ||||||||||||
|
Interest income
|
935 | 1,858 | 2,793 | 2,948 | ||||||||||||
|
Interest expense
|
(6,142 | ) | (34,706 | ) | (40,848 | ) | (39,938 | ) | ||||||||
|
Reorganization items-expense
|
(58,282 | ) | — | (58,282 | ) | (83,346 | ) | |||||||||
|
Gain on cancellation of pre-petition debt
|
510,680 | — | 510,680 | — | ||||||||||||
|
Fresh-start adjustments
|
(399,063 | ) | — | (399,063 | ) | — | ||||||||||
|
Income (loss) from continuing operations before income taxes,
minority interests and equity in net income from unconsolidated
investments
|
58,390 | 44,160 | 102,550 | (60,355 | ) | |||||||||||
|
Income tax (expense) benefit
|
(30,240 | ) | (23,637 | ) | (53,877 | ) | 18,096 | |||||||||
|
Minority interests
|
(2,511 | ) | (6,919 | ) | (9,430 | ) | (8,905 | ) | ||||||||
|
Equity in net income from unconsolidated investments
|
3,924 | 17,535 | 21,459 | 24,400 | ||||||||||||
|
Gain from discontinued operations
|
— | — | — | 78,814 | ||||||||||||
|
Cumulative effect of change in accounting principle
|
— | — | — | (8,538 | ) | |||||||||||
|
Net income (loss)
|
$ | 29,563 | $ | 31,139 | $ | 60,702 | $ | 43,512 | ||||||||
The following general discussion should be read in conjunction
with the above table, the consolidated financial statements and
the notes to those statements and other financial information
appearing in Appendixes A and B to this prospectus. Additional
detail on comparable revenues, costs and expenses and operating
income of Covanta is provided in the “Domestic
Business” and “International Business”
discussions below.
Revenues for 2004 decreased $90 million compared to 2003,
which resulted from a reduction in energy sales in both the
domestic and the international segments primarily due to the
factors described above.
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Additional reductions in revenue are attributable to decreases
in service fees and construction revenues in the domestic
segment. See separate segment discussion below for details
relating to these variances.
Total costs and expenses before operating income for 2004
decreased $117.3 million compared to 2003, primarily due to
the factors described above. Included in the reduction of total
costs and expenses in 2004 was lower depreciation and
amortization expense of $2.7 million. This decrease in
depreciation and amortization was primarily due to the factors
described above offset by service and energy contract
amortization of $16.1 million in 2004 resulting from
recording the estimated fair value of such contract assets and
amortizing them over their remaining estimated useful lives.
Additionally, on March 10, 2004, property, plant and
equipment were recorded at their fair value, and subsequently,
the estimated useful lives of property plant and equipment were
adjusted resulting in revised depreciation expense.
Operating income for the combined period ended December 31,
2004 increased $27.3 million compared to 2003. The
improvement in operating income was due to the operating factors
described above.
Equity in net income of unconsolidated investments decreased
$2.9 million in 2004 from a $3 million decrease in the
domestic segment primarily due to the sale of the geothermal
business in December of 2003.
Interest expense for 2004 increased $0.9 million compared
to 2003. The increase was primarily attributable to a
$6.2 million increase in the international segment
primarily due to the CPIH term loan which debt was incurred upon
emergence from Chapter 11. These increases were offset by a
$5.3 million decrease in the domestic segment primarily
attributable to the restructuring of contracts at the Onondaga
County, New York and Hennepin County, Minnesota facilities
in 2003.
Reorganization items for 2004 decreased $25.1 million
compared to 2003. The decrease was primarily the result of a
decrease in bankruptcy exit costs of $8.9 million and a
$20.7 million reduction in legal and professional fees,
offset by an increase in severance costs of $4.6 million in
the period ended March 10, 2004.
Gain on cancellation of pre-petition debt was
$510.7 million for 2004. Gain on cancellation of
pre-petition debt resulted from the cancellation on
March 10, 2004 of Covanta’s pre-petition debt and
other liabilities subject to compromise net of the fair value of
cash and securities distributed to petition creditors.
Fresh-start adjustments were $399.1 million for 2004.
Fresh-start adjustments represent adjustments to the carrying
amount of Covanta’s assets and liabilities to fair value in
accordance with the provisions of SOP 90-7, as more fully
described in Note 2 to the Notes to the Audited Annual
Financial Statements.
The gain from discontinued operations in 2003 was
$78.8 million due to the rejection of a waste-to-energy
lease, sale of the geothermal business, and the final
disposition of the Arrowhead Pond interests.
The cumulative effect of change in accounting principle of
$8.5 million in 2003 related to the January 1, 2003
adoption of SFAS No. 143, “Accounting for Asset
Retirement Obligations,” referred to as
“SFAS No. 143” in this prospectus.
| Domestic Business — Waste and Energy Services — Operating Results — 2004 vs. 2003 |
The following table summarizes the historical results of
operations of the domestic segment for the years ended
December 31, 2004 and 2003 (in thousands of dollars):
| For the Period | For the Period | Combined Results | Results for the | ||||||||||||||
| January 1, through | March 11, through | for the Year Ended | Year Ended | ||||||||||||||
| March 10, 2004 | December 31, 2004 | December 31, 2004 | December 31, 2003 | ||||||||||||||
|
Service revenues
|
$ | 88,697 | $ | 369,531 | $ | 458,228 | $ | 492,065 | |||||||||
|
Electric & steam sales
|
18,942 | 81,894 | 100,836 | 113,584 | |||||||||||||
|
Construction revenues
|
58 | 1,506 | 1,564 | 13,448 | |||||||||||||
|
Other revenues
|
— | — | — | 4 | |||||||||||||
|
Total revenues
|
$ | 107,697 | $ | 452,931 | $ | 560,628 | $ | 619,101 | |||||||||
|
Operating income
|
$ | 7,132 | $ | 62,232 | $ | 69,364 | $ | 35,846 | |||||||||
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Total revenues for the domestic segment for 2004 decreased
$58.5 million compared to 2003. Service revenues declined
$33.8 million, which was comprised of a $12.5 million
decrease resulting from contracts which were restructured at the
Hennepin and Onondaga facilities (including the elimination of
project debt at the Hennepin facility) during the second half of
2003 as part of Covanta’s overall restructuring. It also
reflected a $22.5 million reduction of service revenues due
to deconsolidation of the Remaining Debtors after March 10,
2004, and a $6.5 million decrease due to the elimination of
2004 revenues on two bio-gas facilities, which resulted from the
consolidation of the partnership. These decreases were offset by
a $9.3 million increase resulting primarily from higher
scrap metal prices, escalation increases under fixed service
agreements, and increased supplemental waste processed.
Electricity and steam sales for 2004 decreased
$12.7 million compared to 2003. The decrease was primarily
due to a $16.2 million decrease resulting from the
expiration of a lease at one domestic hydroelectric facility,
$1.5 million from the deconsolidation of the Remaining
Debtors, and a $7.2 million decrease due to fresh-start
adjustments related to the elimination of amortization on the
deferred gain relating to the Haverhill energy contract. The
foregoing decreases were offset by revenue increases of
$3.7 million primarily related to increased energy pricing
at the Union and Alexandria facilities, and a $7 million
increase due to the consolidation of a bio-gas facility in 2004
previously recorded on the partnership in 2003.
Construction revenues for 2004 decreased $11.9 million
compared to 2003. A decrease of $13.1 million was due to
Covanta’s completion of the Tampa Bay desalination
facility, offset by a $1.1 million increase relating to
initial work paid by clients in connection with planned
waste-to-energy plant expansions.
Plant operating costs for 2004 decreased $28.1 million
compared to 2003. $18.9 million of this decrease was due to
the deconsolidation of the Remaining Debtors noted in the
revenue discussion above, and $13.5 million of this
decrease was due to the expiration of a lease contract at a
domestic hydroelectric facility in October 2003. These
reductions were offset by an increase in domestic operating
expense of $4.3 million primarily attributable to facility
operation and maintenance cost.
Construction costs for 2004 decreased $18.5 million
compared to 2003 primarily attributable to Covanta’s
completion of the Tampa Bay desalination facility, offset in
part by increased plant expansions at three waste-to-energy
facilities.
Depreciation and amortization for 2004 increased
$3.3 million compared to 2003. This increase in
depreciation and amortization was due to service and energy
contract amortization of $16.1 million in 2004 resulting
from recording the estimated fair value of such contract assets
at March 10, 2004 and amortizing them over their remaining
estimated useful lives. Additionally on March 10, 2004,
property, plant and equipment were recorded at their fair value,
and subsequently, the estimated useful lives of property plant
and equipment were adjusted resulting in revised depreciation
expense. These increases were offset by decreases in
depreciation and amortization expense resulting from the
deconsolidation of the remaining debtors and the sale and
restructuring of businesses in 2003.
Net interest on project debt for 2004 decreased $27 million
compared to 2003. The decrease was primarily the result of a
reduction in project debt due to exclusion of debt service
related to the deconsolidation of the Remaining Debtors noted
above, the restructuring of debt at two domestic facilities in
the last six months of 2003, and the reduction of project debt
on another facility.
Write-off of assets held for use for 2004 decreased
$16.7 million compared to 2003 due to the provision for
arena commitments recorded in the second half of 2003.
Selling, general and administrative expenses had a net increase
totaling $4.7 million in 2004 compared to 2003 primarily
due to a $8.1 million increase in professional and
management fees offset by a $3.7 million decrease in wages
and benefits.
Income from operations for the domestic segment for 2004
increased by $34 million compared to 2003. This increase
was comprised of net increases due to cessation of construction
activities ($6.6 million), higher energy and scrap metal
revenues as well as increased supplemental waste processed
($13 million), lower interest expense on project debt
($27 million), a decrease in write-off of assets held for
use ($16.7 million)
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and a ($5.8 million) decrease in operating costs and
expenses related to the wind down of non-energy businesses.
These increases were offset by net decreases due to higher
operating and maintenance expenses ($4.3 million), the
expiration of a hydroelectric lease ($2.7 million),
restructuring of existing projects ($12.5 million), the
deconsolidation of Remaining Debtors ($5.1 million), the
elimination of amortization of deferred gains due to fresh-start
adjustments ($7.2 million), increases in selling, general
and administrative expense ($4.7 million) and the increase
in depreciation expense due to fresh-start accounting
adjustments ($3.3 million).
| International Business — Waste and Energy Services — Operating Results — 2004 vs. 2003 |
The following table summarizes the historical results of
operations of Covanta’s international business for the
years ended December 31, 2004 and 2003 (in thousands of
dollars):
| For the Period | |||||||||||||||||
| For the Period | March 11, through | Combined Results | Results for the | ||||||||||||||
| January 1, through | December 31, | for the Year Ended | Year Ended | ||||||||||||||
| March 10, 2004 | 2004 | December 31, 2004 | December 31, 2003 | ||||||||||||||
|
Service revenues
|
$ | 1,170 | $ | 5,091 | $ | 6,261 | $ | 7,180 | |||||||||
|
Electric & steam sales
|
34,365 | 99,180 | 133,545 | 164,182 | |||||||||||||
|
Construction revenues
|
— | — | — | — | |||||||||||||
|
Other revenues
|
— | — | — | 5 | |||||||||||||
|
Total revenues
|
$ | 35,535 | $ | 104,271 | $ | 139,806 | $ | 171,367 | |||||||||
|
Operating income
|
$ | 3,130 | $ | 14,776 | $ | 17,906 | $ | 24,135 | |||||||||
Total revenues for the international segment for 2004 compared
to 2003 decreased by $31.5 million. This decrease primarily
resulted from the deconsolidation of the MCI facility totaling
$17.2 million, a $12 million energy sales reduction
due to lower demand in 2004 at the CPIH facilities in India and
a $4.6 million decrease due to the expiration and
termination of contracts at one of the CPIH facilities in the
Philippines. These decreases were offset by a $3 million
increase due to higher steam tariffs at CPIH’s facilities
in China.
International plant operating costs were lower by
$19.1 million, of which $18.1 million was due to
deconsolidation of the MCI facility and $8 million was due
to lower demand at CPIH’s facilities in India, offset by a
$8.2 million increase in fuel costs at CPIH’s
facilities in China.
Depreciation and amortization for 2004 decreased $6 million
as a result of fresh-start accounting adjustments.
Net interest on project debt for 2004 decreased
$3.7 million compared to 2003. The decrease resulted from a
$1.6 million decrease due to the deconsolidation of the MCI
facility and a $2.9 million decrease due to lower interest
rates at two facilities in India.
Income from operations for the international segment for 2004
decreased $6.7 million compared to 2003 due to a decrease
in revenues discussed above, an increase in fuel costs at the
CPIH facilities in China and increased overhead costs at CPIH
post emergence offset by a combination of lower plant operating
costs in India, reductions in depreciation expense as a result
of fresh-start accounting adjustments, the deconsolidation of
the MCI facility and a reduction of interest on project debt.
| Insurance Services — Operating Results |
| Insurance Services — Operating Results — 2004 vs. 2003 |
Net earned premiums were $18 million and $35.9 million
for the years ended 2004 and 2003. The change in earned premiums
was a direct result of our insurance business exiting the
commercial automobile market in 2003. Net written premiums were
$15.2 million for 2004 consisting entirely of non-standard
personal automobile policies.
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Net investment income was $2.4 million and $4 million
for 2004 and 2003, respectively. The decrease was primarily due
to a decrease in the fixed income portfolio basis as well as a
reduction in the portfolio yield. Fixed income invested assets
portfolio decreased by only $12.1 million in 2004 despite
net loss and LAE, reserves declining by $18.9 million. The
differential was a result of management reducing its cash and
short-term investment positions. Due to the decrease in written
premiums on business placed in run-off noted above, NAICC also
experienced negative underwriting cash flows. For the years
ended 2004 and 2003, the weighted average yield on the bond
portfolio was 3.8% and 4.9%, respectively. Of the
$1.6 million change in investment income, $0.2 million
was the result of amortization recognized on a single bond that
was called prior to its maturity date. The effective duration of
the portfolio at December 31, 2004 was 2.3 years which
management believed was appropriate given the relative
short-tail nature of the auto programs and projected run-off of
all other lines of business.
Net realized investment gains of $0.2 million were
recognized in 2004 compared to $1.0 million in 2003. The
difference in activity was attributed to management engaging new
investment advisors in June 2003 to rebalance the portfolio to
address extension, credit and reinvestment risk exposures.
Concurrently, interest rates were at 40-year lows and the stock
market rebounded significantly in 2003 providing for improved
gains. For 2004, interest rates remained relatively low
providing for some gain activity, but the portfolio provided
better matching of principal pay-down to claim settlements thus
not requiring the same level of disposition activity.
The net loss and LAE ratios were 71.5% in 2004 and 102.3% in
2003. The decrease in the loss and LAE ratio during 2004
was attributable to much more stable development activity on
prior accident years. Although commercial automobile, assumed
property and casualty, and Valor workers’ compensation
reserves continued to generate unfavorable claim development,
the non-standard personal automobile and California
workers’ compensation performed better than anticipated.
The non-standard personal automobile loss and allocated LAE,
referred to as “ALAE” in this prospectus, ratio was
49.3% for accident year 2004 versus 60.4% for accident year 2003
recorded in 2003. The accident year 2003 loss and ALAE ratio
reduced to 53.7% by 2004 year-end. Non-standard personal
automobile claim frequency was 7.7 and 7.9 per 1000 vehicle
months for accident years 2004 and 2003, respectively. Claim
severity trended favorably for non-standard decreasing by 5.6%
from the prior year. Meanwhile average premium per vehicle on
the non-standard personal automobile remained constant, despite
the mix of business moving towards non-owner policies 37% in
2004 versus 28% in 2003. Historically non-owner policies yield
loss and ALAE ratios 10% to 30% lower than owner policies.
Workers’ compensation reforms were enacted in California in
late 2003 and again in April 2004. The reforms were designed to
curb medical cost spending and appear to have resulted in more
favorable settlement activity. Although the reforms did not
eliminate systemic abuse, they do appear to have modified the
behavior of claimants, providers and applicant attorneys.
Although the impact of the reforms can not be measured,
management was able to recognize favorable development in the
amount of $1.6 million.
Policy acquisition costs as a percentage of net earned premiums
were 24.6% in 2004 and 22.2% in 2003. Policy acquisition costs
include expenses which are directly related to premium volume
(i.e., commissions, premium taxes and state assessments), as
well as certain underwriting expenses which vary with and are
directly related to policy issuance. The increase was a result
of profit commissions earned by the agent responsible for the
marketing, underwriting and policy administration of the
non-standard personal automobile program. The recognition of the
profit commission was a direct result of favorable reserve
development recognized on accident year 2003 and slightly
improved results for accident year 2004.
General and administrative expenses were $4.4 million in
2004 compared to $6.7 million in 2003. In 2004, management
recognized additional pension expense of $0.8 million
related to participants electing to receive lump sum
distributions of the pension plan and severance costs of
$0.1 million related to the outsourcing of its
workers’ compensation claims. In 2003, additional allowance
for uncollectible reinsurance recoverable of $1.3 million
and $0.2 million in employee severance expenses related to
business contraction inflated normal expenses. Normalizing both
years for items noted, general and administrative costs expenses
reduced by $1.6 million. Management continues to examine
its expense structure; however, given the decreases in
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premium production and its obligation to run-off several lines
of business, a core amount of fixed governance costs is required
and consequently its expense ratio will run higher than industry
averages until it can increase premium production.
| Insurance Services — Operating Results — 2003 vs. 2002 |
Net earned premiums were $35.9 million and
$62.2 million for the years ended 2003 and 2002,
respectively. The change in net earned premiums during 2003 was
directly related to the change in net written premiums. Net
written premiums were $30.4 million and $52.7 million
in 2003 and 2002, respectively. Net earned premiums exceeded net
written premiums in 2002 due to a significant reduction in
NAICC’s commercial automobile line and the decision made in
2001 to exit both the workers’ compensation line of
business in all states and private passenger automobile outside
of California. Workers’ compensation net written premiums
decreased $7.3 million during 2003 over the comparable
period in 2002. The commercial automobile net written premiums
decreased from $19.5 million in 2002 to $11.9 million
in 2003 due to the decision to exit the line in July 2003. Net
written premiums for personal automobile lines decreased by
$7.4 million during 2003 primarily due to underwriting
restrictions placed on the non-standard California private
passenger automobile program and the decline in net written
premiums outside of California.
Net investment income decreased primarily due to a decrease in
the fixed income portfolio basis as well as a reduction in the
portfolio yield. Fixed income invested asset portfolio decreased
by $5.6 million in 2003, despite net loss and LAE reserves
declining by $8.6 million. The differential was a result of
NAICC disposing of substantially all of its equity security
holdings in the fourth quarter of 2003 and reinvesting those
proceeds, approximately $4.1 million, in fixed income
securities. Additionally, NAICC received $2 million in
additional paid-in capital from us at year-end. Due to the
decrease in written premiums on business placed in run-off noted
above, NAICC also experienced negative underwriting cash flows.
As of December 31, 2003 and 2002, the weighted average
yield on NAICC’s portfolio was 4.9% and 5.9%, respectively.
The effective duration of the portfolio at December 31,
2003 was 2.3 years which management believed was
appropriate given the relative short-tail nature of the auto
programs and projected run-off of all lines of business.
In 2003, NAICC recognized $1.0 million in gains from fixed
income securities that were maturing in 2004 as a consequence of
a dynamic interest rate environment throughout the year. In
2002, a realized investment gain of $5.2 million was
recognized upon conversion of the ACL notes into equity. This
gain was offset by a $5.1 million loss on non-affiliated
equity securities and a $0.9 million gain on fixed
maturities. Of the $5.1 million loss on equity securities,
$1.0 million was recorded for other than temporary declines
in fair value. NAICC had a net unrealized loss of
$1.4 million on its equity portfolio at the end of December
2002 and a modest net unrealized gain at December 31, 2003.
Net losses and LAE ratios were 102.3% in 2003 and 96.3% in 2002.
The increase in the loss and LAE ratio during 2003 was
attributable to further recognition of prior accident year
reserve development on workers’ compensation and commercial
automobile insurance. NAICC has historically priced its
non-standard private passenger and commercial auto premium at
68% to 69% of its expected loss and ALAE costs in order to
balance its expense structure and market conditions. In 2003,
NAICC believed it had a far more successful underwriting year,
posting loss and ALAE ratios of 60.4% and 59.5% for its
California non-standard auto and entire commercial auto program.
These results were commensurate with industry results for 2003
driven primarily by the hard insurance market. Non-standard
private passenger and commercial auto claim frequency was 7.9
and 10.6 per 1,000 vehicle months in accident year 2003
compared to 9.5 and 10.8 per 1,000 vehicle months in 2002,
respectively. Severity was favorable for both lines as well in
2003 compared to 2002 by reduction of average cost per claim of
3% and 6% for the personal and commercial auto lines,
respectively. Although both these indicators were favorable in
2003, the average premium per vehicle on commercial lines had
the most significant effect on the loss and ALAE ratio. The
average premium per vehicle on commercial lines increased 17.8%
for the 2003 accident year. With respect to the personal
automobile insurance, the mix of business moving towards
non-owner policies 28% in 2003 versus 10% in 2002 had the most
significant impact for this program’s improved loss and LAE
ratio.
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Policy acquisition costs as a percentage of net earned premiums
were 22.2% in 2003 and 22.7% in 2002. The modest decrease was a
result of change in the mix of business and a favorable
renegotiation by management of its commission structure with its
general agent in the fourth quarter of 2003.
General and administrative expenses increased in 2003 over 2002
levels by $0.8 million primarily due to recording an
additional allowance for uncollectible reinsurance recoverable
of $1.3 million and $0.2 million in employee severance
expenses related to business contraction. Exclusive of the two
items noted above, expenses decreased $0.7 million compared
to 2002 due to decreased production and previously implemented
cost containment efforts.
| Parent Investment Income and Expenses |
| Parent Investment Income and Expenses — 2004 vs. 2003 |
Our total investment income decreased to $0.5 million for
the year ended December 31, 2004 as compared to
$1.4 million for the year ended December 31, 2003
primarily due to lower realized investment gains. Our realized
investment gains were $0.3 million in 2004 compared to
$1.1 million in 2003.
Our interest expense of $43.7 million for the year ended
December 31, 2004 relates to parent company and Waste and
Energy Services recourse debt of $318.4 million for the
year ended December 31, 2004. See Note 21 to the Notes
to the Audited Annual Financial Statements for details.
As noted above, we accounted for our investments in marine
services subsidiaries under the equity method. For the year
ended December 31, 2004, the equity in net loss of
unconsolidated marine services subsidiaries included our share
of GMS and Vessel Leasing’s reported net income of
$0.5 million.
Our expenses were primarily the result of the corporate services
agreement between us and Covanta, pursuant to which we provide
to Covanta, at Covanta’s expense, certain administrative
and professional services and Covanta pays most of our expenses.
Such expenses totaled $3.5 million for the period
March 11, 2004 through December 31, 2004. In addition,
we entered with Covanta into an agreement pursuant to which
Covanta provides, at our expense, payroll and benefit services
for Covanta Holding Corporation employees, which totaled
$0.5 million for the period March 11, 2004 through
December 31, 2004.
| Parent Investment Income and Expenses — 2003 vs. 2002 |
Our total parent company investment income decreased to
$1.4 million for the year ended December 31, 2003 as
compared to $9.5 million for the year ended
December 27, 2002 primarily due to recognition of
$8.4 million in gain on ACL bonds owned by us that were
contributed as part of the purchase price of ACL Holdings
recognized during 2002.
Our administrative expense decreased $0.7 million to
$4.2 million for the year ended December 2003 as compared
to $4.9 million for the year ended December 2002. The
decrease was primarily due to a reduction of facility and
payroll related costs. In 2003, we entered into a corporate
services agreement with Equity Group Investments, L.L.C.,
referred to as “EGI” in this prospectus. Samuel Zell,
our Chairman of the Board and former Chief Executive Officer and
President, is also the Chairman of EGI. EGI provided financial
and administrative services to us. Subsequent to the ACL
acquisition in 2002, ACL provided similar support services to us.
Interest expense decreased to $1.4 million for the year
ended December 31, 2003 compared to $38.7 million
during the year ended December 27, 2002. Interest expense
in 2003 was due to the accrual of one month of interest on the
bridge financing required for the Covanta acquisition. Interest
expense in 2002 was primarily due to ACL’s and GMS’
interest expense after their acquisition.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF LIQUIDITY AND
CAPITAL RESOURCES
The information set forth below regarding our liquidity and
capital resources is compiled according to our consolidated
operations and our current business segments of Waste and Energy
Services and Other Services (which includes both our
parent-level operations and those of our insurance business).
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| Capital Resources and Commitments |
As part of the Ref-Fuel acquisition, Covanta entered into new
credit arrangements which totaled approximately
$1.1 billion and are guaranteed by us and certain domestic
subsidiaries of Covanta. The proceeds of the new financing
arrangements were used to fund the acquisition of Ref-Fuel, to
refinance approximately $479 million of Covanta’s and
CPIH’s recourse debt and letter of credit facilities, and
to pay the related fees and expenses. The new credit facilities
are further available for ongoing permitted expenditures and for
general corporate purposes. The following chart summarizes the
various components and amounts of Covanta’s project and
intermediate debt and Credit Facilities as of September 30,
2005 (in millions of dollars):
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| Cash Flow and Liquidity |
| Summary |
Our sources of funds are our investments as well as dividends,
if any, and other payments received from our waste and energy
and insurance subsidiaries. Various state insurance requirements
restrict the amounts that may be transferred to us in the form
of dividends or loans from our insurance subsidiaries without
prior regulatory approval. Currently, NAICC cannot pay dividends
or make loans to us. Under its new financing arrangements,
Covanta’s ability to pay dividends to us is limited, except
in certain circumstances.
The following summarizes the actual inflows and outflows
relating to the Ref-Fuel rights offering (in millions of
dollars):
|
Proceeds from Ref-Fuel rights offering
|
$ | 400.0 | ||
|
Transfers to Covanta (to fund a portion of Ref-Fuel purchase
price)
|
(385.0 | ) | ||
|
Warrant agent and other costs
|
(4.1 | ) | ||
|
Net cash inflow to parent
|
$ | 10.9 | ||
Summarized cash flow information for our current business
segments reconciled to the condensed consolidated statements of
cash flows is as follows (in thousands of dollars):
| Nine Months Ended September 30, 2005 | ||||||||||||||||
| Waste and | ||||||||||||||||
| Energy | Other | Eliminations | Total | |||||||||||||
|
Net cash provided by (used in) operating activities
|
$ | 158,715 | $ | (10,863 | ) | $ | — | $ | 147,852 | |||||||
|
Net cash provided by (used in) investing activities(1)
|
(700,687 | ) | (372,477 | ) | 384,954 | (688,210 | ) | |||||||||
|
Net cash provided by (used in) financing activities
|
602,512 | 392,384 | (384,954 | ) | 609,943 | |||||||||||
|
Net increase in cash and cash equivalents
|
$ | 60,540 | $ | 9,044 | $ | — | $ | 69,584 | ||||||||
| Nine Months Ended September 30, 2004 | ||||||||||||||||
| Waste and | ||||||||||||||||
| Energy | Other | Eliminations | Total | |||||||||||||
|
Net cash provided by (used in) operating activities
|
$ | 108,595 | $ | (19,312 | ) | $ | — | $ | 89,283 | |||||||
|
Net cash provided by (used in) investing activities(2)
|
(4,895 | ) | 66,922 | — | 63,027 | |||||||||||
|
Net cash provided by (used in) financing activities
|
(70,474 | ) | 15,402 | — | (55,072 | ) | ||||||||||
|
Net increase in cash and cash equivalents
|
$ | 33,226 | $ | 63,012 | $ | — | $ | 96,238 | ||||||||
| (1) | Waste and Energy Services is net of cash acquired of Ref-Fuel of $62,358. |
| (2) | Other is net of cash acquired at parent-level of $57,795. |
| Waste and Energy Services Segment |
| Cash Generation |
Cash provided by operating activities was $158.7 million
and $108.6 million for the nine months ended
September 30, 2005 and 2004, respectively. The increase in
cash flow from operating activities was primarily due to the
Ref-Fuel acquisition. Net cash used in investing activities was
$700.7 million in the nine months ended September 30,
2005 and was primarily due to the purchase of Ref-Fuel, net of
acquired cash. Net cash
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provided by financing activities was $602.5 million for the
nine months ended September 30, 2005 and was primarily
driven by the capital contribution from us, the net impact of
the refinancing of the prior debt and for the acquisition of
Ref-Fuel, offset partially by the payment and future funding of
project debt.
Cash from Ref-Fuel was $74.1 million as of
September 30, 2005. Restricted funds held in trust were
$428.7 million as of September 30, 2005. These
restricted funds largely reflect payments from municipal clients
under service agreements as part of the service fee due
reflecting debt service. These payments are made directly to the
trustee for the related project debt and are held by it until
paid to project debt holders. We do not have access to these
funds. In addition, as of September 30, 2005, we had
$24.2 million in cash held in restricted accounts to pay
for additional bankruptcy emergence expenses that are estimated
to be paid in the future. Cash held in such reserve accounts is
not available for general corporate purposes.
Generating sufficient cash to meet Covanta’s liquidity
needs, pay down its debt and invest in its business remains an
important objective of management. Maintaining historic facility
production levels while effectively managing operating and
maintenance expense is important to optimize Covanta’s
long-term cash generation. Covanta does not expect to receive
any cash contributions from us and is prohibited under its
principal financing arrangements from using its cash to issue
dividends to us except in limited circumstances.
We believe that when combined with its other sources of
liquidity, Covanta’s operations generate sufficient cash to
meet operational needs, capital expenditures, and service debt
due prior to maturity. Management will also seek to enhance
Covanta’s cash flow from renewals or replacement of
existing contracts, from new contracts to expand existing
facilities or operate additional facilities and by investing in
new projects. Covanta’s new financing arrangements place
certain restrictions on its ability to make investments in new
projects or expansions of existing projects.
Covanta derives its cash flow principally from its domestic and
international project operations and businesses. The frequency
and predictability of Covanta’s receipt of cash from
projects differs, depending upon various factors, including
whether restrictions on distributions exist in applicable
project debt arrangements or in debt arrangements at
Covanta’s intermediate-level subsidiaries, whether a
project is domestic or international, and whether a project has
been able to operate at historical levels of production.
A material portion of Covanta’s domestic cash flows are
expected to be derived from projects of Ref-Fuel subsidiaries.
For these projects, financial tests and other covenants
contained in their respective debt arrangements must be
satisfied in order for project subsidiaries to make cash
distributions to intermediate Covanta subsidiaries, and for
Covanta’s intermediate-level subsidiaries to make cash
distributions to Covanta. Distributions from these
intermediate-level subsidiaries may only be made quarterly, if
such financial tests and other covenants are satisfied. Ref-Fuel
has historically satisfied all such financial tests and
covenants and has made quarterly distributions, if funds were
available. Covanta’s remaining domestic projects generally
are not restricted in making cash distributions, and no
restrictions exist at intermediate Covanta subsidiary levels. As
a result, Covanta generally receives cash from these projects on
a monthly basis.
Covanta’s receipt of cash from its international projects
is also subject to satisfaction of financial tests and other
covenants contained in applicable project debt arrangements. A
material portion of cash distributions from Covanta’s
international projects are received semi-annually, during the
second and fourth quarters. In addition, risks inherent in
international operations can affect the reliability of such cash
distributions.
Covanta’s cash available for corporate debt service and
letter of credit fees also varies seasonally. Cash available for
corporate debt service and letter of credit fees is affected
most significantly by the following three factors:
| • | timing of income with a one to two month timing delay for seasonable payables/receivables such as scheduled maintenance expense and annual incentive revenue; | |
| • | certain substantial operating expenses such as annual insurance payments that are accrued each month throughout the year while the corresponding cash payments are made only a few times each year; and | |
| • | subsidiary debt restrictions on distributions described above. | |
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We expect the factors discussed above will cause its cash
available for corporate debt and letter of credit fees
(including those of Ref-Fuel and international projects) to be
the lowest during the second quarter and the highest during the
fourth quarter.
Covanta’s annual and quarterly financial performance can be
affected by many factors, several of which are outside
Covanta’s control as noted above. These factors can
overshadow the seasonal dynamics described herein. In
particular, quarterly cash from operations, can be materially
affected by changes in working capital.
| Financing Arrangements |
| Covanta Debt |
On June 24, 2005, Covanta entered into two credit and
guaranty agreements with syndicates of lenders led by Goldman
Sachs Credit Partners, L.P. and Credit Suisse, respectively. The
proceeds of the financing were used to pay for a portion of the
purchase price of Ref-Fuel and related fees, commissions,
premiums and expenses, and to refinance outstanding recourse
debt of Covanta and its international holding company, CPIH. The
financing also provided us with available credit for the working
capital and general corporate needs of Covanta and its
subsidiaries.
The two credit agreements consist of (1) the Credit and
Guaranty Agreement, dated as of June 24, 2005, among
Covanta, us, as a guarantor, certain subsidiaries of Covanta, as
guarantors, various lenders, Credit Suisse, Cayman Islands
Branch, as joint lead arranger and co-syndication agent, Goldman
Sachs Credit Partners, L.P., as joint lead arranger,
co-syndication agent, administrative agent and collateral agent,
JPMorgan Chase Bank, as co-documentation agent, revolving
issuing bank and a funded LC issuing bank, UBS Securities LLC,
as co-documentation agent, UBS AG, Stamford Branch, as a funded
LC issuing bank, and Calyon New York Branch, as co-documentation
agent, which we refer to as the “First Lien Credit
Agreement” in this prospectus; and (2) the Second Lien
Credit and Guaranty Agreement, dated as of June 24, 2005,
among Covanta, us, as a guarantor, certain subsidiaries of
Covanta, as guarantors, various lenders, Credit Suisse, Cayman
Islands Branch, as joint lead arranger, co-syndication agent,
administrative agent, collateral agent and paying agent, and
Goldman Sachs Credit Partners, L.P., as joint lead arranger and
co-syndication agent, which we refer to as the “Second Lien
Credit Agreement” in this prospectus. Under these credit
agreements, the lenders agreed to provide secured revolving
credit, letter of credit and term loan facilities in the amount
of up to $1.115 billion as described below. The following
is a description of the general terms of these senior secured
credit facilities.
The senior secured credit facilities are comprised of the
following:
| • | a first priority secured term loan facility in the initial amount of $275 million that matures in 2012, which we refer to as the “First Lien Term Loan Facility” in this prospectus; | |
| • | a first priority secured revolving credit facility in the amount of $100 million, up to $75 million of which may be utilized for letters of credit, that matures in 2011, which we refer to as the “Revolving Credit Facility” in this prospectus; | |
| • | a first priority secured funded letter of credit facility in the amount of $340 million that matures in 2012, which we refer to as the “Funded L/ C Facility,” and collectively with the First Lien Term Loan Facility and the Revolving Credit Facility, as the “First Lien Facilities” in this prospectus; and | |
| • | a second priority secured term loan facility in the amount of $400 million that matures in 2013, which we refer to as the “Second Lien Term Loan Facility,” and collectively with the First Lien Facilities, as the “Credit Facilities” in this prospectus. | |
Letters of credit that may in the future be issued under the
Revolving Credit Facility will accrue fees at the then effective
borrowing margins on eurodollar rate loans, plus a fee on each
issued letter of credit payable to the issuing bank. Letter of
credit availability under the Funded L/ C Facility accrues fees
(whether or not letters of credit are issued thereunder) at the
then-effective borrowing margin for eurodollar rate loans
described above times the total availability under letters of
credit (whether or not then utilized), plus a fee on each issued
letter of credit payable to the issuing bank. In addition,
Covanta has agreed to pay to the
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participants under the Funded L/ C Facility any shortfall
between the eurodollar rate applicable to the relevant Funded L/
C Facility interest period and the investment income earned on
the pre-agreed investments made by the relevant issuing banks
with the purchase price paid by such participants for their
participations under the Funded L/ C Facility.
As of September 30, 2005, Covanta had neither drawn on the
Revolving Credit Facility nor caused to be issued any letters of
credit under the Revolving Credit Facility. As of
September 30, 2005, Covanta had $304.3 million
outstanding letters of credit under the Funded L/ C Facility.
Covanta also entered into the intercreditor agreement with the
respective lenders under the Revolving Credit Facility, the
Funded L/ C Facility, the First Lien Term Loan Facility and
the Second Lien Term Loan Facility described above under
“Capital Resources and Commitments.”
This agreement includes certain provisions regarding the
application of payments made by Covanta among the respective
creditors and certain matters relating to priorities upon the
exercise of remedies with respect to the collateral.
Under these agreements Covanta is obligated to apply 50% of
excess cash from operations (calculated pursuant to the new
credit agreements), as well as specified other sources, to repay
borrowing under the First Lien Term Loan Facility and
reduce commitments under the financing arrangements, and in some
circumstances to collateralize its reimbursement obligations
with respect to outstanding letters of credit and/or repay
borrowings under the Second Lien Term Loan Facility.
The new debt issued in the refinancing transaction is outlined
in the following table:
| Designation | Principal Amount | Interest | Principal Payments | |||
|
First Lien Term Loan Facility
|
$274 million as of September 30, 2005 | Eurodollar or base rate as elected by Covanta plus a margin of 3.00% | Annual amortization paid quarterly beginning September 30, 2005 | |||
|
Second Lien Term Loan Facility
|
$400 million as of September 30, 2005 | Eurodollar or base rate as elected by Covanta plus a margin of 5.50% | Due at maturity in 2013 | |||
The First Lien Term Loan Facility has mandatory annual
amortization, paid in quarterly installments beginning
September 30, 2005, through the date of maturity in annual
amounts set forth in the following schedule (in thousands of
dollars):
| Remaining | ||||
| First Lien Term Loan Facility | Amortization | |||
|
2005
|
$ | 688 | ||
|
2006
|
2,750 | |||
|
2007
|
2,750 | |||
|
2008
|
2,750 | |||
|
2009
|
2,750 | |||
|
2010
|
2,750 | |||
|
2011
|
130,625 | |||
|
2012
|
129,250 | |||
The Second Lien Term Loan Facility has no mandatory
amortization requirements and is required to be repaid in full
on its maturity date.
Loans under the senior secured credit facilities are designated,
at Covanta’s election, as Eurodollar rate loans or base
rate loans. Eurodollar loans bear interest at a reserve adjusted
British Bankers Association Interest Settlement Rate for
deposits in dollars plus a borrowing margin as described below.
Interest on Eurodollar rate loans is payable at the end of the
applicable interest period of one, two, three or six months (and
at the end of every three months in the case of six month
eurodollar loans). Base rate loans bear interest at (a) a
rate per annum equal to the greater of (1) the “prime
rate” designated in the relevant facility or (2) the
federal funds rate plus 0.50% per annum, plus (b) a
borrowing margin as described below.
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The borrowing margins referred to above for the Revolving Credit
Facility are as follows:
| Borrowing Margin for | Borrowing Margin for | |||||||||||
| Company Leverage Ratio | Revolving Eurodollar Loans | Revolving Base Rate Loan | ||||||||||
|
³ 4.25:1.00
|
3.00% | 2.00 | % | |||||||||
|
< 4.25:1.00
|
2.75% | 1.75 | % | |||||||||
|
³ 3.50:1:00
|
||||||||||||
|
< 3.50:1:00
|
2.50% | 1.50 | % | |||||||||
The borrowing margins for First Lien Term Loan Facility and
the Funded Letter of Credit Facility are 3.00% for Eurodollar
rate loans and 2.00% for base rate loans. The borrowing margins
under the Second Lien Term Loan Facility are 5.50% for
Eurodollar rate loans and 4.50% for base rate loans.
The Credit Facilities provide that Covanta and its subsidiaries
must comply with certain affirmative and negative covenants. See
Note 11 to the Notes to the Unaudited Interim Financial
Statements for a description of such covenants, as well as other
material terms and conditions of such agreements.
As of September 30, 2005, Covanta was not in default under
the Credit Facilities.
The obligations of Covanta under the Credit Facilities are
guaranteed by us and by certain of Covanta’s subsidiaries,
which we refer to as the “subsidiary guarantors” in
this prospectus. We and our subsidiary guarantors are required
under the terms of the guarantee provisions in the credit
agreements, among other things, to pay the sum of any unpaid
principal amount of Covanta’s obligations, as well as
accrued and unpaid interest, and all other obligations then owed
by Covanta, upon Covanta’s failure to have paid any of its
obligations under the Credit Facilities when such obligations
became due and payable, whether by maturity, required
prepayment, acceleration or other demand under the terms of the
Credit Facilities.
Covanta’s obligations under the First Lien Facilities and
certain interest rate or other hedging arrangements entered into
with any of the lenders and their affiliates and our subsidiary
guarantors’ guaranty obligation are secured by a first
priority security interest in substantially all assets,
including substantially all of the personal, real and mixed
property of Covanta and the subsidiary guarantors pursuant to
the terms of the First Lien Facilities documentation including
the First Lien Pledge and Security Agreement between each of
Covanta and the other grantors party to the agreement and
Goldman Sachs Credit Partners, L.P., as collateral agent, dated
as of June 24, 2005, which we refer to as the “First
Lien Security Agreement” in this prospectus.
In addition, the First Lien Facilities are secured by a first
priority perfected lien or pledge on 100% of the capital stock
of Covanta and certain direct subsidiaries of Covanta and the
subsidiary guarantors, up to 65% of the capital stock of certain
first tier foreign subsidiaries of Covanta and the subsidiary
guarantors, and all intercompany debt owed to Covanta or the
subsidiary guarantors pursuant to the terms of the First Lien
Facilities documentation including the First Lien Security
Agreement and the First Lien Pledge Agreement between us and
Goldman Sachs Credit Partners, L.P., as collateral agent, dated
June 24, 2005, which we refer to as the “First Lien
Pledge Agreement” in this prospectus. Other subsidiaries of
ours are not subject to any guaranty.
The Second Lien Term Loan Facility is secured by a second
priority security interest in the same collateral as secures the
First Lien Facilities pursuant to the terms of the Second Lien
Term Loan Facility documentation including the Parity Lien
Pledge and Security Agreement between each of Covanta and the
other grantors party to the agreement and Credit Suisse, Cayman
Islands Branch, as collateral agent, dated as of June 24,
2005, which we refer to as the “Parity Lien Security
Agreement” in this prospectus.
In addition, the Second Lien Term Loan Facility is secured
by a second priority perfected lien or pledge on 100% of the
capital stock of Covanta and certain direct subsidiaries of
Covanta and the subsidiary guarantors, up to 65% of the capital
stock of certain first tier foreign subsidiaries of Covanta and
the subsidiary guarantors, and all intercompany debt owed to
Covanta or the subsidiary guarantors pursuant to the terms of
the Second Lien Term Loan Facility documentation including
the Parity Lien Security Agreement and the Parity Lien Pledge
Agreement between us and Credit Suisse, Cayman Islands Branch,
as collateral agent, dated June 24, 2005, which we refer to
as the “Parity Lien Pledge Agreement” in this
prospectus.
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The priority of the security interests and related creditor
rights between the First Lien Facilities, which we refer to as
the “First Lien Obligations” in this prospectus and
those of the Second Lien Term Loan Facility, which we refer
to as the “Second Lien Obligations” in this
prospectus, are set forth in the Intercreditor Agreement among
Covanta, Goldman Sachs Credit Partners, L.P., as collateral
agent for the First Lien Claimholders, Credit Suisse, Cayman
Islands Branch, as administrative agent for the Second Lien
Credit Claimholders and as collateral agent for the Parity Lien
Claimholders, dated as of June 24, 2005, which we refer to
as the “Intercreditor Agreement” in this prospectus.
Under the terms of the Intercreditor Agreement, for as long as
any of the First Lien Obligations are outstanding:
| • | liens securing the Second Lien Obligations will be junior and subordinated in all respects to liens securing the First Lien Obligations; | |
| • | the collateral agent for the Second Lien Obligations will not exercise any rights or remedies with respect to any collateral for 180 days from the date of delivery of notice in writing to the collateral agent for the First Lien Obligations; | |
| • | the collateral agent for the Second Lien Obligations will not take or receive any collateral or any proceeds of collateral in connection with the exercise of any right or remedy (including setoff) with respect to any collateral; | |
| • | any proceeds of collateral received in connection with the sale or disposition of such collateral by the collateral agent for the holders of the First Lien Obligations will be applied to the First Lien Obligations in the order specified by the Intercreditor Agreement and the applicable First Lien Obligation documents. Upon discharge of the First Lien Obligations, any proceeds of collateral held by the collateral agent for the First Lien Obligations will be delivered to the collateral agent for the Second Lien Obligations to be applied in the order specified by the Intercreditor Agreement and the applicable Second Lien Obligation documents; and | |
| • | except as permitted under the Intercreditor Agreement and the senior secured credit facilities, Covanta will not make prepayments of the Second Lien Obligations prior to any voluntary or mandatory prepayment of any amounts outstanding under the First Lien Obligations. | |
The loan documentation under the Credit Facilities contains
customary affirmative and negative covenants and financial
covenants. During the term of the Credit Facilities, we expect
that the negative covenants will restrict the ability of Covanta
and its subsidiaries to take specified actions, subject to
exceptions including, but not limited to:
| • | incurring additional indebtedness, including guarantees of indebtedness; | |
| • | creating, incurring, assuming or permitting to exist liens on property and assets; | |
| • | making loans and investments and entering into mergers, consolidations, acquisitions and joint ventures; | |
| • | engaging in sales, transfers and other dispositions of their property or assets; | |
| • | paying, redeeming or repurchasing debt, or amending or modifying the terms of certain material debt or certain other agreements; | |
| • | declaring or paying dividends to, making distributions to or making redemptions and repurchases from, equity holders; | |
| • | entering into certain affiliate transactions; and | |
| • | entering into agreements that would restrict the ability of Covanta’s subsidiaries to pay dividends and make distributions, making certain loans and advances to Covanta, and incurring liens or transferring property or assets to Covanta or certain of its subsidiaries. | |
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The financial covenants of the First Lien Facilities include the
following:
| • | maximum Covanta leverage ratio, which measures Covanta-level recourse debt to a specified Covanta-level cash flow; | |
| • | maximum capital expenditures; | |
| • | minimum Covanta interest coverage ratio, which measures Covanta-level recourse debt interest expense to a specified Covanta-level cash flow; and | |
| • | minimum consolidated adjusted earnings before interest, taxes, depreciation and amortization. | |
Covanta is required to make mandatory prepayments of the senior
secured credit facilities in the amounts set forth in the Credit
Facilities in the event it receives proceeds from the following
specified sources:
| • | excess cash flow, as defined in the loan documentation; | |
| • | net cash proceeds of any property or asset sale, subject to certain exceptions and reinvestment requirements; | |
| • | net insurance and condemnation proceeds, subject to certain exceptions and reinvestment provisions; | |
| • | net cash proceeds from the issuance of additional equity securities, subject to certain exceptions; and | |
| • | net cash proceeds of certain debt issuances, subject to certain exceptions. | |
Except as otherwise provided in the Intercreditor Agreement,
mandatory prepayments are applied to prepay the First Lien Term
Loan Facility prior to application with respect to the
remaining Credit Facilities.
The loan documentation for the Credit Facilities contains events
of default, including, but not limited to, failure to make
payments when due, cross defaults to certain other debt of
Covanta and its subsidiaries, certain change of control events
and specified material reductions in net operating losses
available to us, other than through utilization. Upon the
occurrence and during the continuance of events of default under
the Credit Facilities, and subject to the terms of the
Intercreditor Agreement, the administrative agents and/or the
lenders under the credit agreements may accelerate
Covanta’s payment obligations thereunder and the collateral
agents under the documents securing these obligations may
foreclose upon, and exercise other rights with respect to, our
assets and the assets of Covanta and/or the subsidiary
guarantors in which security interests have been granted.
| Domestic Project Debt |
Financing for Covanta’s waste-to-energy projects is
generally accomplished through tax-exempt and taxable municipal
revenue bonds issued by or on behalf of the municipal client.
For most facilities owned by a Covanta subsidiary, the issuer of
the bonds loans the bond proceeds to a Covanta subsidiary to pay
for facility construction. The municipality then pays to the
subsidiary as part of its service fee amounts necessary to pay
debt service on the project bonds. For such facilities,
project-related debt is included as “Project debt (short-
and long-term)” in Covanta’s consolidated financial
statements. Generally, such project debt is secured by the
revenues generated by the project and other project assets
including the related facility. Such project debt of Covanta
subsidiaries is described in the chart below under
“Capital Requirements” as non-recourse project
debt. The only potential recourse to Covanta with respect to
project debt arises under the operating performance guarantees
described below under “Other Commitments.”
With respect to certain of its waste-to-energy projects, debt
service on project debt is an explicit component of the fee paid
by the municipal client. Such fees are paid by the municipal
client to the trustee for the applicable project debt and held
by the trustee until applied as required by the project debt
documentation. While these funds are held by the trustee they
are reported as restricted funds held in trust on our
consolidated balance sheet. These funds are not generally
available to Covanta.
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Certain subsidiaries of Ref-Fuel have recourse liability for
project debt which is non-recourse to Covanta as of
September 30, 2005 as follows (in thousands of dollars):
|
Niagara Series 2001
|
$ | 165,010 | ||
|
Seconn Corporate Credit Bonds
|
43,500 | |||
|
Hempstead Corporate Credit Bonds
|
42,670 |
| International Project Debt |
Financing for projects in which Covanta has an ownership or
operating interest is generally accomplished through commercial
loans from local lenders or financing arranged through
international banks, bonds issued to institutional investors and
from multilateral lending institutions based in the United
States. Such debt is generally secured by the revenues generated
by the project and other project assets and is without recourse
to CPIH or us. Project debt relating to two CPIH 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 complied
with.
| Intermediate Subsidiary Debt |
Three Ref-Fuel subsidiaries have outstanding non-project debt
facilities. As of September 30, 2005, ARC has outstanding
$234 million aggregate principal amount of
6.26% senior notes due 2015, MSW I has outstanding
$196 million aggregate principal amount of 8.5% senior
secured notes due 2010 and MSW II has outstanding
$224 million aggregate principal amount of
7.375% senior secured notes due 2010. The indentures
defining the rights of note holders generally provide that these
subsidiaries may not make distributions to its parent (including
Covanta) until financial covenants are satisfied on a quarterly
basis.
| MSW I Financing |
MSW I has outstanding debt financing consisting of
$200 million of 8.50% senior secured notes due 2010
($196 million as of September 30, 2005), referred to
in this prospectus as the “MSW I notes.” Interest on
the MSW I notes is payable semi-annually in arrears on
March 1st and September 1st of each year.
The MSW I notes mature on September 1, 2010. Holders of MSW
I notes may require MSW I to repurchase the MSW I notes upon a
change in control or if MSW I or any of its restricted
subsidiaries receives any proceeds from certain financings or
asset sales by Ref-Fuel Holdings and its subsidiaries.
The MSW I notes are general obligations of MSW I and are secured
by a first priority lien on substantially all the assets of
MSW I, including a first priority pledge of the membership
interest in MSW I’s subsidiaries and of Ref-Fuel Holdings
indirectly owned by MSW I.
The indenture under which the MSW I notes were issued, referred
to in this prospectus as the “MSW I indenture,”
provides for certain restrictive covenants including, among
other things, restrictions on incurrence of indebtedness,
creation of liens, certain payments to related and unrelated
parties, acquisitions, asset sales and transactions with
affiliates.
The MSW I indenture provides that MSW I is not permitted to make
certain distributions or other restricted payments, subject to
certain exceptions, unless, and at the time of and after giving
effect to such restricted payment:
| • | no default or event of default shall have occurred and be continuing or would occur as a consequence of such restricted payment; | |
| • | MSW I is not required to make an offer, which they have not yet consummated, to repurchase or redeem MSW I notes with the net proceeds received from Ref-Fuel Holdings or its subsidiaries upon | |
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| the issuance of debt or equity securities, incurrence of indebtedness or consummation of an asset sale by Ref-Fuel Holdings or any of its subsidiaries; and | ||
| • | at the time of such restricted payment, the proportionate consolidated interest coverage ratio for MSW I’s most recently ended four full fiscal quarters would have been at least 2.0 to 1.0 on a pro forma basis as if the restricted payment had been made at the beginning of such four-quarter period, and the projected proportionate consolidated interest coverage ratio for MSW I’s four full fiscal quarters, commencing with the first full fiscal quarter after the date of the proposed restricted payment, would be at least 2.0 to 1.0. | |
Proportionate consolidated interest coverage ratio is defined in
the MSW I indenture to mean the ratio obtained by dividing an
amount equal to the applicable ownership percentage multiplied
by the consolidated cash flow of Ref-Fuel Holdings for such
period, by the sum of (1) an amount equal to the applicable
ownership percentage multiplied by the consolidated interest
expense of Ref-Fuel Holdings for the period, plus
(2) without duplication, the consolidated interest expense
of MSW I for such period. The consolidated interest coverage
ratio of MSW I was 3.3x for the twelve-month period ended
March 31, 2005.
Upon the occurrence of a change of control, as defined in the
MSW I indenture, MSW I shall be required to make an offer to
each holder of MSW I notes to repurchase all or any part of such
holder’s MSW I notes at a purchase price equal to 101% of
the aggregate principal amount plus accrued and unpaid interest
to the date of purchase. Within 30 days following a change
of control, MSW I shall mail a notice to each holder of MSW I
notes stating that a change of control offer is being made and
setting forth, among other things, the purchase price and the
purchase date, which shall be no earlier than 30 days and
no later than 60 days from the date such notice is mailed.
The MSW I indenture governing the MSW I notes includes
limitations on the ability of MSW I and its restricted
subsidiaries to incur additional indebtedness or issue preferred
equity. The MSW I indenture provides that MSW I and its
subsidiaries may only incur indebtedness or issue preferred
equity if the proportionate consolidated interest coverage ratio
tests set forth above are met. Other permitted indebtedness
under the MSW I indenture is generally limited to:
| • | the MSW I notes; | |
| • | indebtedness in respect of member loans; | |
| • | refinancing indebtedness; | |
| • | intercompany debt among MSW I and its restricted subsidiaries; | |
| • | indebtedness in respect of hedging obligations; | |
| • | guarantees of permitted indebtedness; | |
| • | if ARC becomes a subsidiary of MSW I, under specific circumstances indebtedness may be permitted to be incurred by ARC and its subsidiaries including: | |
| • | indebtedness under the ARC credit facility not to exceed $75 million; | |
| • | purchase money indebtedness; | |
| • | indebtedness incurred to finance capital expenditures required by law; | |
| • | indebtedness that is non-recourse to ARC; and | |
| • | other indebtedness not to exceed $30 million. | |
Ref-Fuel Holdings and its subsidiaries are not currently deemed
to be restricted subsidiaries under the MSW I indenture,
including for purposes of the restrictive covenants described
above.
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| MSW II Financing |
MSW II has outstanding debt financing consisting of
$225 million aggregate principal amount of
7.375% senior secured notes due 2010 ($224 million as
of September 30, 2005), referred to in this prospectus as
the “MSW II notes.” Interest on the MSW II
notes is payable semi-annually in arrears on
March 1st and September 1st of each year.
The MSW II notes mature on September 1, 2010. Holders
of MSW II notes may require MSW II to repurchase the
MSW II notes upon a change in control or if MSW II or
any of its restricted subsidiaries receives any proceeds from
certain financings or asset sales by Ref-Fuel Holdings and its
subsidiaries.
The MSW II notes are general obligations of MSW II and
are secured by a first priority lien on substantially all the
assets of MSW II, including a first priority pledge of the
membership interest in Ref-Fuel Holdings.
The indenture under which the MSW II notes were issued,
referred to in this prospectus as the “MSW II
indenture,” provides for certain restrictive covenants
including, among other things, restrictions on incurrence of
indebtedness, creation of liens, certain payments to related and
unrelated parties, acquisitions, asset sales and transactions
with affiliates.
The MSW II indenture provides that MSW II is not
permitted to make certain distributions or other restricted
payments, subject to certain exceptions, unless, and at the time
of and after giving effect to such restricted payment:
| • | no default or event of default shall have occurred and be continuing or would occur as a consequence of such restricted payment; | |
| • | MSW II is not required to make an offer, which it has not yet consummated, to repurchase or redeem MSW II notes with the net proceeds received from Ref-Fuel Holdings or its subsidiaries upon the issuance of debt or equity securities, incurrence of indebtedness or consummation of an asset sale by Ref-Fuel Holdings or any of its subsidiaries; and | |
| • | at the time of such restricted payment, the proportionate consolidated interest coverage ratio for MSW II’s most recently ended four full fiscal quarters would have been at least 2.0 to 1.0 on a pro forma basis as if the restricted payment had been made at the beginning of such four-quarter period, and the projected proportionate consolidated interest coverage ratio for MSW II’s four full fiscal quarters commencing with the first full fiscal quarter after the date of the proposed restricted payment would be at least 2.0 to 1.0. | |
Proportionate consolidated interest coverage ratio is defined in
the indenture to mean the ratio obtained by dividing an amount
equal to the applicable ownership percentage multiplied by the
consolidated cash flow of Ref-Fuel Holdings for such period, by
the sum of (1) an amount equal to the applicable ownership
percentage multiplied by the consolidated interest expense of
Ref-Fuel Holdings for the period, plus (2) without
duplication, the consolidated interest expense of MSW II
for such period. The consolidated interest coverage ratio of
MSW II was 3.3x for the twelve-month period ended
March 31, 2005.
Upon the occurrence of a change of control, as defined in the
MSW II indenture, MSW II shall be required to make an
offer to each holder of MSW II notes to repurchase all or
any part of such holder’s MSW II notes at a purchase
price equal to 101% of the aggregate principal amount plus
accrued and unpaid interest to the date of purchase. Within
30 days following a change of control, MSW II shall
mail a notice to each holder of MSW II notes stating that a
change of control offer is being made and setting forth, among
other things, the purchase price and the purchase date, which
shall be no earlier than 30 days and no later than
60 days from the date such notice is mailed.
The MSW II indenture governing the MSW II notes
includes limitations on the ability of MSW II and its
restricted subsidiaries to incur additional indebtedness or
issue preferred equity. The MSW II indenture provides that
MSW II and its subsidiaries may only incur indebtedness or issue
preferred equity if the
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proportionate consolidated interest coverage ratio tests set
forth above are met. Other permitted indebtedness under the
MSW II indenture is generally limited to:
| • | the MSW II notes; | |
| • | indebtedness in respect of member loans; | |
| • | refinancing indebtedness; | |
| • | intercompany debt among MSW II and its restricted subsidiaries; | |
| • | indebtedness in respect of hedging obligations; | |
| • | guarantees of permitted indebtedness; | |
| • | if ARC becomes a subsidiary of MSW II, under specific circumstances indebtedness may be permitted to be incurred by ARC and its subsidiaries including: | |
| • | indebtedness under the ARC credit facility not to exceed $75 million; | |
| • | purchase money indebtedness; | |
| • | indebtedness incurred to finance capital expenditures required by law; | |
| • | indebtedness that is non-recourse to ARC; and | |
| • | other indebtedness not to exceed $30 million. | |
Ref-Fuel Holdings and its subsidiaries are not currently deemed
to be restricted subsidiaries under the MSW II indenture,
including for purposes of the restrictive covenants described
above.
As described in “Management’s Discussion and
Analysis of Financial Condition and Results of
Operations — Management’s Discussion and Analysis
of Liquidity and Capital Resources — Waste and Energy
Services Segment” and Note 11 to the Notes to the
Unaudited Interim Financial Statements, MSW I and MSW II
outstanding notes were issued pursuant to indentures containing
covenants and other obligations of such subsidiaries. Under
applicable indentures, holders of these notes were entitled to
receive from the respective issuer an offer to repurchase such
notes upon a change of control, such as was caused by the
purchase of Ref-Fuel by Covanta. On June 24, 2005, change
of control offers were issued by both MSW I and MSW II.
Holders of approximately $4.2 million of MSW I notes
properly tendered their notes for repurchase, and holders of
approximately $0.9 million of MSW II notes properly
tendered their notes for repurchase. All such notes were
repurchased on July 26, 2005. MSW I and MSW II paid
the purchase price of such notes, which was $5.1 million in
the aggregate, with cash made available by Covanta.
| ARC Financing |
ARC has outstanding debt financing consisting of
$240 million aggregate principal amount of
6.26% senior notes due 2015 ($234 million as of
September 30, 2005), referred to in this prospectus as the
“ARC notes.” Interest on the ARC notes is payable
June 30 and December 31st of each year through
maturity.
The indenture under which the ARC notes were issued, referred to
in this prospectus as the “ARC indenture” provides for
certain restrictive covenants including, among other things,
restrictions on the incurrence of indebtedness, certain payments
to related and unrelated parties, acquisitions and asset sales.
In addition, the ARC indenture provides that distributions of
cash to parent entities (including Covanta) may occur quarterly
and only if certain financial covenants are satisfied.
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| Capital Requirements |
The following table summarizes our gross contractual obligations
including: project debt, recourse debt, estimated interest
payments, leases and other contractual obligations as of
September 30, 2005. (Amounts expressed in thousands of
dollars. Note references are to the Notes to the Unaudited
Interim Financial Statements.):
| Payments Due by Period | |||||||||||||||||||||
| Less Than | 1 to 3 | 4 to 5 | After | ||||||||||||||||||
| Total | One Year | Years | Years | 5 Years | |||||||||||||||||
|
Domestic Covanta project debt (Note 11)
|
$ | 765,751 | $ | 79,453 | $ | 169,336 | $ | 150,844 | $ | 366,118 | |||||||||||
|
CPIH project debt (Note 11)
|
91,282 | 27,653 | 29,537 | 28,828 | 5,264 | ||||||||||||||||
|
Ref-Fuel project debt (Note 11)
|
709,557 | 42,695 | 112,406 | 132,542 | 421,914 | ||||||||||||||||
|
Total project debt (Note 11)
|
1,566,590 | 149,801 | 311,279 | 312,214 | 793,296 | ||||||||||||||||
|
First lien term loan facility (Note 11)
|
274,313 | 3,438 | 5,500 | 5,500 | 259,875 | ||||||||||||||||
|
Second lien term loan facility (Note 11)
|
400,000 | — | — | — | 400,000 | ||||||||||||||||
|
6.26% senior notes (Note 11)
|
234,000 | 22,400 | 57,100 | 38,700 | 115,800 | ||||||||||||||||
|
8.5% senior secured notes (Note 11)
|
195,785 | — | — | 195,785 | — | ||||||||||||||||
|
7.375% senior secured notes (Note 11)
|
224,100 | — | — | 224,100 | — | ||||||||||||||||
|
Other Long-term debt (Note 11)
|
225 | 122 | 85 | 18 | — | ||||||||||||||||
|
Total debt obligations of Covanta(1)
|
2,895,013 | 175,761 | 373,964 | 776,317 | 1,568,971 | ||||||||||||||||
|
Less:
|
|||||||||||||||||||||
|
Non-recourse project debt(2)
|
(2,220,700 | ) | (172,323 | ) | (368,464 | ) | (770,817 | ) | (909,096 | ) | |||||||||||
|
Covanta recourse debt
|
$ | 674,313 | $ | 3,438 | $ | 5,500 | $ | 5,500 | $ | 659,875 | |||||||||||
|
Operating leases
|
466,432 | 33,104 | 63,742 | 78,891 | 290,695 | ||||||||||||||||
|
Less: Non-recourse rental payments
|
(434,085 | ) | (29,636 | ) | (59,342 | ) | (75,361 | ) | (269,746 | ) | |||||||||||
|
Covanta recourse rental payments
|
32,347 | 3,468 | 4,400 | 3,530 | 20,949 | ||||||||||||||||
|
Interest payments(3)
|
1,307,308 | 212,327 | 378,414 | 330,960 | 385,607 | ||||||||||||||||
|
Less: Non-recourse interest payments
|
(764,056 | ) | (132,874 | ) | (233,951 | ) | (190,068 | ) | (207,163 | ) | |||||||||||
|
Covanta recourse interest payments
|
543,252 | 79,453 | 144,463 | 140,892 | 178,444 | ||||||||||||||||
|
Retirement plan obligations(4)
|
21,159 | 4,844 | 5,283 | 3,670 | 7,362 | ||||||||||||||||
|
Duke long-term obligation
|
46,500 | 2,500 | 5,000 | 7,500 | 31,500 | ||||||||||||||||
|
Other long-term obligations
|
33,283 | 4,998 | 8,190 | — | 20,095 | ||||||||||||||||
|
Total Covanta contractual obligations
|
$ | 1,350,854 | $ | 98,701 | $ | 172,836 | $ | 161,092 | $ | 918,225 | |||||||||||
| (1) | Excludes $80.7 million of Covanta’s unamortized debt premium. |
| (2) | Payment obligations for the project debt associated with waste-to-energy facilities owned by Covanta are limited recourse to the operating subsidiary and non-recourse to Covanta, subject to operating performance guarantees and commitments. |
| (3) | Interest payments and letter of credit fees are estimated. |
| (4) | Retirement plan obligations are based on actuarial estimates for pension plan obligations and post-retirement plan obligations as of December 31, 2004. |
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| Other Commitments |
Covanta’s other commitments as of September 30, 2005
were as follows (in thousands of dollars):
| Commitments Expiring by Period | ||||||||||||
| Less Than | More Than | |||||||||||
| Total | One Year | One Year | ||||||||||
|
Letters of credit
|
$ | 306,329 | $ | 19,275 | $ | 287,054 | ||||||
|
Surety bonds
|
44,948 | — | 44,948 | |||||||||
|
Total other commitments — net
|
$ | 351,277 | $ | 19,275 | $ | 332,002 | ||||||
The letters of credit were issued pursuant to the Funded L/ C
Facility (and for one international project under a separate
unsecured, letter of credit facility) to secure Covanta’s
performance under various contractual undertakings related to
its domestic and international projects, or to secure
obligations under its insurance program. Each letter of credit
relating to a project is required to be maintained in effect for
the period specified in related project contracts, and generally
may be drawn if it is not renewed prior to expiration of that
period.
Some of these letters of credit reduce over time. As of
September 30, 2005, Covanta had approximately
$35.7 million in available capacity for additional letters
of credit under its Funded L/ C Facility and $75 million
under its Revolving Credit Facility.
Covanta believes that it will be able to fully perform its
contracts to which these existing letters of credit relate, and
that it is unlikely that letters of credit would be drawn
because of a default of its performance obligations. If any of
Covanta’s letters of credit were to be drawn under its
current debt facilities, the amount drawn would be immediately
repayable to the issuing bank. If Covanta were unable to
immediately repay such amounts drawn under letters of credit,
unreimbursed amounts would be treated under the Credit
Facilities as additional term loans issued under the First Lien
Facilities.
The surety bonds listed on the table above primarily relate to
assumed contracts from Ref-Fuel ($35.3 million) and
possible closure costs for various energy projects when such
projects cease operating ($9.6 million). Were these bonds
to be drawn upon, Covanta would have a contractual obligation to
indemnify the surety company.
Covanta and certain of its subsidiaries have issued or are party
to performance guarantees and related contractual support
obligations undertaken mainly pursuant to agreements to
construct and operate certain waste-to-energy and water
facilities. With respect to its domestic businesses, Covanta and
certain of its subsidiaries have issued guarantees to municipal
clients and other parties that Covanta’s subsidiaries will
perform in accordance with contractual terms, including, where
required, the payment of damages or other obligations. Such
contractual damages or other obligations could be material, and
in circumstances where one or more subsidiary’s contract
has been terminated for its default, such damages could include
amounts sufficient to repay project debt. For facilities owned
by municipal clients and operated by Covanta, Covanta’s
potential maximum liability as of September 30, 2005
associated with the repayment of the municipalities’
project debt on such facilities was in excess of
$1.0 billion. This amount was not recorded as a liability
in Covanta’s condensed consolidated balance sheet as of
September 30, 2005 as Covanta believes that it had not
incurred such liability at the date of the financial statements.
Additionally, damages payable under such guarantees on
Covanta-owned waste-to-energy facilities could expose Covanta to
recourse liability on project debt shown on the foregoing table.
Covanta also believes that it has not incurred such damages at
the date of the financial statements. If Covanta is asked to
perform under one or more of such guarantees, its liability for
damages upon contract termination would be reduced by funds held
in trust and proceeds from sales of the facilities securing the
project debt, which is presently not estimable.
With respect to its international businesses, Covanta has issued
guarantees of certain of CPIH’s operating subsidiaries
contractual obligations to operate power projects. The potential
damages owed under such arrangements for international projects
may be material. See “Risk Factors — Waste and
Energy Services
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Business-Specific Risks — Covanta and certain of
its subsidiaries have provided guarantees and support in
connection with its subsidiaries’ projects.”
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 greater than Covanta’s then-available
sources of funds. To date, Covanta has not incurred has not
incurred material liabilities under its guarantees, either on
domestic or international projects.
Manila Electric Company, referred to as “Meralco” in
this prospectus, the sole power purchaser for Covanta’s
Quezon Project, is engaged in discussions and legal proceedings
with instrumentalities of the government of the Philippines
relating to past billings to its customers, cancellations of
recent tariff increases, and potential tariff increases. The
outcome of these proceedings may affect Meralco’s financial
condition.
Quezon Project management continues to negotiate with Meralco
with respect to proposed amendments to the power purchase
agreement to modify certain commercial terms under the existing
contract, and to resolve issues relating to the Quezon
Project’s performance during its first year of operation.
Following the first year of the operation, in 2001, based on a
claim that the plant’s performance did not merit full
payment, Meralco withheld a portion of each of several monthly
payments to the Quezon Project that were due under the terms of
the power purchase agreement. The total withheld amount was
$10.8 million. Although the Quezon Project was able to pay
all of its debt service and operational costs, the withholding
by Meralco constituted a default by Meralco under the power
purchase agreement and a potential event of default under the
project financing agreements. To address this issue, Quezon
Project management agreed with the project lenders to hold back
cash from distributions in excess of the reserve requirements
under the financing agreements in the amount of approximately
$20.5 million. Based upon subsequent stable Meralco
payments and Quezon Project cash-flows, and consistent plant
operating performance, in May of 2005 the project lenders agreed
to release $10.1 million of the $20.5 million special
reserve. In November 2005, the Quezon Project Board elected to
make adjustments to the accounts receivable due from Meralco, as
follows: (1) apply $2.3 million to shortfall payments
due from the Quezon Project to Meralco, and (2) write off
$8.5 million in accordance with the project financing
agreements as an adjustment to receivables in the ordinary
course of business. As a result of these actions, the project
lenders agreed to release the $10.4 million remaining
balance of the special reserve.
In addition to the issues under the power purchase agreement,
issues under the financing agreements arose during late 2003 and
2004 regarding compliance with the Quezon Project operational
parameters and the Quezon Project’s inability to obtain
required insurance coverage. In October 2004, Covanta and other
Quezon project participants, with the consent of the Quezon
Project lenders, amended certain of the Quezon Project documents
to address such operational matters, resolving all related
contract issues. Subsequently, the project lenders granted a
waiver with respect to the insurance coverage issue because
contractual coverage levels were not then commercially available
on reasonable terms. This waiver remains in effect.
Adverse developments in Meralco’s financial condition or
delays in finalizing the power purchase agreement amendments and
potential consequent lender actions are not expected to
adversely affect Covanta’s liquidity. In late 2004, Meralco
successfully refinanced $228 million in expiring short-term
debt on a long-term seven year basis, improving Meralco’s
financial condition. Meralco is reportedly current on all debt
obligations.
| Insurance Coverage |
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.
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| Off Balance Sheet Arrangements |
Subsidiaries of Covanta are parties to lease arrangements with
Covanta’s municipal clients at its Union County, New
Jersey, its Alexandria, Virginia and its Delaware County,
Pennsylvania waste-to-energy facilities. At its Union County
facility, Covanta’s operating subsidiary leases the
facility from the Union County Utilities Authority, referred to
as the “UCUA,” under a lease that expires in 2023,
which Covanta may extend for an additional five years. Covanta
guarantees 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 its Alexandria facility, a Covanta subsidiary is a party to a
lease related to certain pollution control equipment that was
required in connection with the Clean Air Act amendments of
1990, and which were financed by the City of Alexandria and by
Arlington County, Virginia. Covanta’s subsidiary owns this
facility, and rent under this lease is sufficient to pay debt
service on tax exempt bonds issued to finance such equipment and
which mature in 2013.
At its Delaware Valley facility, a Covanta subsidiary is a party
to a lease with the Delaware County Solid Waste Authority, known
as “DCSWA,” for the facility that expires in 2019.
Covanta’s operating subsidiary, referred to as the
“Delaware Partnership,” is 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 this
prospectus, 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 Westinghouse in connection with the
disposition of its interest in the Delaware Valley facility.
Pursuant to the terms of various guarantee agreements, ARC has
guaranteed the payments of Basic Rent B and Stipulated Loss to
the extent such payments are not made by 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.
Covanta is also a party to lease arrangements pursuant to which
it leases rolling stock in connection with its waste-to-energy
and independent power facilities, as well as certain office
equipment. Rent payable under these arrangements is not material
to Covanta’s financial condition.
Covanta generally uses operating lease treatment for all of the
foregoing arrangements. A summary of Covanta’s operating
lease obligations is contained in Note 22 to the Notes to
the Audited Annual Financial Statements. See “Waste and
Energy Services Business — Domestic Waste and Energy
Services Business — Other Waste-to-Energy Project
Structures — Delaware County, Pennsylvania”
for more information on the operating lease of
Covanta’s Delaware County, Pennsylvania facility.
Covanta and certain of its subsidiaries 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. With respect to its
domestic businesses, Covanta has issued guarantees to municipal
clients and other parties that Covanta’s subsidiaries will
perform in accordance with contractual terms, including, where
required, the payment of damages or other obligations. Such
contractual damages or other obligations could be material, and
in circumstances where one or more subsidiary’s contract
has been terminated for its default, such damages could include
amounts sufficient to repay project debt. For facilities owned
by municipal clients and operated by Covanta, Covanta’s
potential maximum liability as of December 31, 2004
associated with the repayment of the municipalities’ debt
on such facilities was in excess of $1.0 billion. This
amount was not recorded as a liability in our Consolidated
Balance Sheet as of December 31, 2004 as Covanta believes
that it had not incurred such liability at the date of the
financial statements. Additionally, damages payable under such
guarantees on Covanta-owned waste-to-energy facilities could
expose Covanta to liability under the limited recourse
provisions on project debt related to its facilities. See
Note 20 to the Notes to the Audited Annual Financial
Statements for additional information relating to Covanta’s
project debt. Covanta also believes that it has not incurred
such damages at the date of the financial statements. If the
local
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subsidiaries contractual breach of pertinent sections of their
contract were to occur, its liability for damages upon contract
termination would be reduced by funds held in trust and proceeds
from sales of the facilities securing the project debt, which is
presently not estimable.
To date, Covanta has not incurred material liabilities under its
guarantees, either on domestic or international projects.
Covanta has investments in several investees and joint ventures
which are accounted for under the equity and cost methods and
therefore does not consolidate the financial information of
those companies. See Note 5 to the Notes to the Audited
Annual Financial Statements for additional information regarding
these leases.
| Contract Structures and Duration |
Covanta attempts to structure contracts related to its domestic
waste-to-energy projects as fixed price operating contracts
which escalate in accordance with indices Covanta believes
appropriate to reflect price inflation, so that its revenue is
relatively stable for the contract term. Covanta’s returns
will be similarly stable if it does not incur material
unexpected operation and maintenance or other expense. In
addition, most of Covanta’s waste-to-energy project
contracts are structured so that contract counterparties
generally bear the costs associated with events or circumstances
not within Covanta’s control, such as uninsured force
majeure events and changes in legal requirements. The stability
of Covanta’s domestic revenue and returns could be affected
by its ability to continue to enforce these obligations. Also,
at some of Covanta’s waste-to-energy facilities, commodity
price risk is further mitigated by passing through commodity
costs to contract counterparties. With respect to its domestic
and international independent power projects, such structural
features generally do not exist because either Covanta operates
and maintains such facilities for its own account or does so on
a cost-plus rather than a fixed fee basis.
Certain energy contracts related to domestic projects provide
for energy sales prices linked to the “avoided costs”
of producing such energy and, therefore, energy revenues
fluctuate with various economic factors. In many of
Covanta’s waste-to-energy projects, the operating
subsidiary retains only a fraction of the energy revenues
(generally 10%) with the balance used to provide a credit to the
client community against its disposal costs. Therefore, the
client community derives most of the benefit and risk of
changing energy prices. At seven of its waste-to-energy
projects, Covanta sells its energy output under contracts of
varying lengths or directly into the regional electricity grid,
retaining 100% of the energy revenues. At these projects Covanta
derives the benefit, and retains the risk, of changing energy
prices.
At some of Covanta’s domestic and international independent
power projects, Covanta’s operating subsidiary purchases
fuel in the open markets. Covanta is exposed to fuel price risk
at these projects. At other plants, fuel costs are contractually
included in Covanta’s electricity revenues, or fuel is
provided by Covanta’s customers. In some of Covanta’s
international projects, the project entity (which in some cases
is not a subsidiary of Covanta) 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.
Covanta’s service agreements for domestic waste-to-energy
projects begin to expire as early as 2007, and energy sales
contracts at Covanta-owned waste-to-energy projects generally
expire at or after the date on which that project’s service
agreement expires. Expiration of these contracts will subject
Covanta to greater market risk in maintaining and enhancing its
revenues. As its service agreements at municipally-owned
projects expire, Covanta will seek to enter into renewal or
replacement contracts to continue operating such projects. For
example, Covanta recently negotiated an extension of its service
agreement to operate the Hillsborough County, Florida facility
(which would have otherwise expired in 2007), which will become
effective when various conditions are satisfied. As its service
agreements at facilities it owns begin to expire, Covanta
intends to seek replacement or additional contracts for waste
supplies. Furthermore, because project debt on these facilities
will be paid off at such time, Covanta believes it will be able
to offer disposal services at rates that will attract sufficient
quantities of waste and provide acceptable revenues. Covanta
will seek to bid competitively in the market for additional
contracts to operate other facilities as similar contracts of
other vendors expire. At Covanta’s domestic facilities, the
expiration of existing energy sales contracts will require
Covanta to sell project energy output either into the
electricity grid or pursuant to new contracts. There can be
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no assurance that Covanta will be able to enter into such
renewals, replacement or additional contracts, or that the terms
available in the market at the time will be favorable to Covanta.
Because Covanta’s business is based upon building and
operating municipal solid waste processing and energy generating
projects, which are capital intensive businesses, in order to
provide meaningful growth Covanta must be able to invest its own
funds, obtain debt financing, and provide support to its
operating subsidiaries. Covanta intends to pursue opportunities
to expand the processing capacity of its existing projects where
market conditions are favorable, or where its municipal clients,
referred to in this prospectus as “client
communities,” have encountered significantly increased
waste volumes without correspondent competitively-priced
landfill availability. Covanta’s ability to make
investments in new projects or expansions of projects it owns,
and/or borrow additional funds for the construction of such new
or expanded projects, is limited by covenants in its new
financing arrangements.
Covanta’s new financing arrangements limit its ability to
engage in material development activity which will require
significant equity investment. There can be no assurance that
Covanta will be able to implement new projects or expansions at
existing facilities it owns. There can be no assurance that
Covanta will be able to implement expansions at existing
facilities.
| Waste-To-Energy Project Ownership Structures |
Covanta’s waste-to-energy business originally was developed
in response to competitive procurements conducted by
municipalities for waste disposal services. One of the threshold
decisions made by each municipality early in the procurement
process was whether it, or the winning vendor, would own the
facility to be constructed; there were advantages and
disadvantages to the municipality with both ownership
structures. As a result, Covanta today operates nine publicly
owned facilities and owns and operates 18 others. In addition,
as a result of acquisitions of additional projects originally
owned or operated by other vendors, Covanta operates four
projects under a lease structure where a third party lessor owns
the project. In all cases, Covanta operates each facility
pursuant to a long-term contract and provides the same service
in consideration of a monthly service fee or receipt of waste
disposal fees and payments for energy generated.
Under all of these ownership structures, the municipalities
typically borrowed funds to pay for the facility construction by
issuing bonds. In a private ownership structure, the municipal
entity loans the bond proceeds to Covanta’s 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
pay for construction without loaning the bond proceeds to
Covanta.
Regardless of whether a project was owned by Covanta or its
municipal client, in most projects the municipality is generally
responsible for repaying the project debt after construction is
complete. Where it owns the facility, the municipality pays
periodic debt service directly to a trustee under an indenture.
For twelve projects where Covanta owns the facility and a
Service Fee Structure exists, the municipal client pays debt
service as a component of its monthly service fee payment to
Covanta. As of September 30, 2005, the principal amount of
project debt outstanding with respect to these projects was
approximately $781 million. As with a public ownership
structure, this debt service payment is retained by a trustee
and is not held or available to Covanta for general use. In
these private ownership structures, we record on our
consolidated financial statements revenue with respect to debt
service (both principal and interest) on project debt, and
expense for depreciation and interest on project debt.
Covanta also owns seven waste-to-energy projects where a Tip Fee
Structure exists, and so debt service is not expressly included
in the fee it is paid. Rather, Covanta receives a fee for each
ton of waste processed at these projects. As of
September 30, 2005, the principal amount of project debt
outstanding with respect to these projects was approximately
$694 million. Accordingly, Covanta does not record revenue
reflecting principal on this project debt. Its 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 when due.
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For all Covanta-owned projects, all cash held by trustees is
recorded as restricted funds held in trust. For facilities not
owned by Covanta, Covanta does not incur, nor does it record
project debt service obligations, project debt service revenue
or project debt service expense.
Covanta generates electricity and/or steam for sale at all of
its waste-to-energy projects, regardless of ownership structure.
During the term of its operating contracts at projects owned by
its municipal clients, most of the revenue from electricity and
steam sales (typically 90%) benefits the municipal client as a
reduction to its monthly service fee obligation to Covanta.
Generally, the term of Covanta’s operating contracts with
its municipal clients coincides with the term of the bonds
issued to pay for the project construction. Therefore, another
important difference between public and private ownership of
Covanta’s waste-to-energy projects is project ownership
after these contracts expire. 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,
Covanta’s role, and its revenue, with respect to that
project would cease. If a contract is not extended on a
Covanta-owned project, it 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. Covanta 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 and
waste disposal revenue. Covanta would in such circumstances also
be responsible for paying all project-related expenses,
including those related to the transportation and disposal of
ash from its operations.
Other Services Segment
For the nine months ended September 30, 2005, we, on a
parent-only basis, held cash and investments of approximately
$47.4 million, of which $25.3 million was available to
pay general corporate expenses and general working capital
purposes. We are required to maintain a separate cash fund of
approximately $6.5 million to provide potential liquidity
to our insurance business. Cash deposited for this purpose is
restricted and is not available for general corporate expenses
or for working capital requirements. Covanta, through its
subsidiaries, had an investment in ACL warrants that were given
by certain of the former creditors of ACL. The fair market value
of the warrants as of September 30, 2005 was
$15.6 million. In October 2005, we converted the ACL
warrants into shares of ACL common stock and subsequently sold
the shares for net proceeds of approximately $18.0 million.
See Note 19 to the Notes to the Unaudited Interim Financial
Statements for further information.
We received net proceeds from the Ref-Fuel rights offering of
$395.9 million and contributed approximately
$385 million to Covanta to fund a portion of the
$740 million cash purchase price for the outstanding shares
in Ref-Fuel.
Cash used in operations from insurance business was
$10.0 million and $14.9 million for the nine months
ended September 30, 2005 and September 30, 2004,
respectively. The ongoing use of cash in operations was due to
the insurance business continuing to make payments related to
discontinued lines and territories in excess of premium receipts
from existing lines. This negative cash flow restricted the
insurance business from fully re-investing bond maturity
proceeds and in some circumstances required the sale of bonds in
order to meet obligations as they arose. Cash provided from
investing activities was $10.0 million for the nine months
ended September 30, 2005 compared with $9.4 million
for the comparable period in 2004. The $0.6 million
increase in cash provided by investing activities in 2005 was
due to a reduction in reinvestment activity in conjunction with
reduced premium production. There were no financing activities
in either nine-month period ended September 30, 2005 and
2004.
Our insurance business, which comprises a portion of our Other
Services segment, requires both readily liquid assets and
adequate capital to meet ongoing obligations to policyholders
and claimants, as well as to pay ordinary operating expenses.
The insurance business meets both its short-term and long-term
liquidity requirements through operating cash flows that include
premium receipts, investment income and reinsurance recoveries.
To the extent operating cash flows do not provide sufficient
cash flow, the insurance business relies on the sale of invested
assets. Its investment policy guidelines require that all loss
and LAE liabilities be
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matched by a comparable amount of investment grade assets.
Covanta believes that the insurance business has both adequate
capital resources and sufficient reinsurance to meet its current
operating requirements.
The National Association of Insurance Commissioners provides
minimum solvency standards in the form of risk based capital
requirements, referred to as “RBC” in this prospectus.
The RBC model for property and casualty insurance companies
requires that carriers report their RBC ratios based on their
statutory annual statements as filed with the regulatory
authorities. We believe our insurance business has projected its
RBC requirement as of September 30, 2005 under the RBC
model and believes that it is above the level which would
trigger increase oversight by regulators.
Two other common measures of capital adequacy for insurance
companies are premium-to-surplus ratios (which measure current
operating risk) and reserves-to-surplus ratios (which measure
financial risk related to possible changes in the level of loss
and LAE reserves). A commonly accepted standard for net written
premium-to-surplus ratio is 3.0 to 1, although this varies
with different lines of business. Our insurance business’s
annualized premium-to-year-end statutory surplus ratio of 0.7 to
1 remains well under current industry standards of 3.0 to 1. Its
ratio of loss and LAE reserves to statutory surplus of 2.0 to 1
as of September 30, 2005 is within industry guidelines.
Management continues to examine its insurance business expense
structure. However, a core amount of fixed governance costs are
required. Consequently, given the decreases in premium
production and its obligation to run-off several lines of
business, we expect that our expense ratio will run higher than
industry averages until it can increase premium production.
We estimate our insurance business’s reserves for unpaid
losses and LAE based on reported losses and historical
experience, including losses reported by other insurance
companies for reinsurance assumed, and estimates of expenses for
investigating and adjusting all incurred and unadjusted claims.
Key assumptions used in the estimation process could have
significant effects on the reserve balances. Our insurance
business regularly evaluates its estimates and assumptions based
on historical experience adjusted for current economic
conditions and trends. Changes in the unpaid losses and LAE can
materially effect the statement of operations. Different
estimates could have been used in the current period, and
changes in the accounting estimates are reasonably likely to
occur from period to period based on the economic conditions.
Since the loss reserving process is complex and subjective, the
ultimate liability may vary significantly from estimates.
| NAICC’S Investments |
California and Montana insurance laws and regulations regulate
the amount and type of NAICC’s investments. NAICC’s
investment portfolio is comprised primarily of fixed maturities
and is weighted heavily toward investment grade short and medium
term securities. See Note 4 to the Notes to the Audited
Annual Financial Statements for information regarding
significant accounting policies affecting these investments.
The following table sets forth a summary of NAICC’s
investment portfolio at September 30, 2005 (in thousands of
dollars):
| Amortized Cost | Fair Value | ||||||||||
|
Investments by investment by grade:
|
|||||||||||
|
Fixed maturities:
|
|||||||||||
|
U.S. Government/ Agency
|
$ | 20,755 | $ | 20,385 | |||||||
|
Mortgage-backed
|
10,994 | 10,662 | |||||||||
|
Corporate (AAA to A)
|
14,184 | 13,927 | |||||||||
|
Corporate (BBB)
|
1,071 | 1,060 | |||||||||
|
Total fixed maturities
|
47,004 | 46,084 | |||||||||
|
Equity securities
|
1,326 | 1,518 | |||||||||
|
Total
|
$ | 48,330 | $ | 47,602 | |||||||
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| Letters of Credit |
NAICC pledges assets and posts letters of credit for the benefit
of other insurance companies in connection with risks assumed by
predecessor companies or as ordered by courts and arbitration
panels, in the event that NAICC is not able to pay such
creditors. NAICC had pledged assets of $6.5 million and had
letters of credit outstanding of $2.7 million at
September 30, 2005.
| Contractual Obligations and Commitment Summary |
Our insurance business’ contractual commitments under
operating lease agreements total approximately $2.2 million
at September 30, 2005 and are due as follows:
$0.2 million in 2005, $0.8 million in 2006,
$0.3 million in each year 2007 through 2009 and
$0.1 million thereafter.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
In preparing our consolidated financial statements in accordance
with U.S. generally accepted accounting principles, we are
required to use our judgment in making estimates and assumptions
that affect the amounts reported in our financial statements and
related notes. Management bases its estimates on historical
experience and on various other assumptions that were believed
to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying value of
assets and liabilities that are not readily apparent from other
sources. Many of our critical accounting policies are those
subject to significant judgments and uncertainties which could
potentially result in materially different results under
different conditions and assumptions. Future events rarely
develop exactly as forecast, and the best estimates routinely
require adjustment.
| Recent Accounting Pronouncements |
In December 2004, the FASB issued SFAS No. 123
(revised 2004), “Share-Based Payment” referred to in
this prospectus as “SFAS 123R,” which replaces
SFAS No. 123, “Accounting for Stock-Based
Compensation.” The mandatory adoption period for
implementing this standard was revised in April 2005. For
further discussion see Note 2 to the Notes to the Unaudited
Interim Financial Statements.
In March 2005, the SEC issued Staff Accounting
Bulletin No. 107 referred to in this prospectus as
“SAB 107” regarding the SEC’s interpretation
of SFAS 123R and the valuation of share-based payments for
public companies. We are evaluating the requirements of
SFAS 123R and SAB 107 and expect that the adoption of
SFAS 123R on January 1, 2005 will have a material
impact on our consolidated results of operations and earnings
per share. We have not yet determined the method of adoption or
the effect of adopting SFAS 123R, and we have not
determined whether the adoption will result in amounts that are
similar to the current pro forma disclosures under SFAS 123.
In March 2005, the FASB issued FIN 47, “Accounting for
Conditional Asset Retirement Obligations, an interpretation of
FASB Statement No. 143” referred to in this prospectus
as “FIN 47,” which requires an entity to
recognize a liability for the fair value of a conditional asset
retirement obligation when incurred if the liability’s fair
value can be reasonably estimated. FIN 47 is effective for
fiscal years ending after December 15, 2005. We are
currently evaluating the effect that the adoption of FIN 47
will have on our consolidated results of operations and
financial condition but do not expect it to have a material
impact.
| Purchase Accounting |
We applied purchase accounting in accordance with
SFAS No. 141 “Business Combinations,” for
our acquisition of Covanta and Ref-Fuel. As described in
Note 3 to the Notes to the Unaudited Interim Financial
Statements, we valued the acquired assets and liabilities
assumed at fair value. The estimates of fair value used by us
reflect our best estimate based on our work and independent
valuation consultants and, where such work has not been
completed, such estimates have been based on our experience and
relevant information available to management. 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
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discounted cash flow method to estimate the value of many of our
assets. This entails developing projections about future cash
flows and adopting an appropriate discount rate. We cannot
predict with certainty actual cash flows and 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 therefore have
substantial effect on our balance sheet. In addition, because
the valuations impact depreciation and amortization, changes in
such assumptions and estimates may effect earnings in the future.
| Long-lived Assets |
We have estimated the useful lives over which we depreciate our
long-lived assets. Such estimates are based on our experience
and management’s expectations as to the useful lives of the
various categories of assets it owns, as well as practices in
industries we believe are comparable. Estimates of useful lives
determine the rate at which we depreciate such assets and
utilizing other estimates could impact both our balance sheet
and earnings statements.
We review our long-lived assets for impairment when events or
circumstances indicate that the carrying value of such assets
may not be recoverable over the estimated useful life.
Determining whether an impairment has occurred typically
requires various estimates and assumptions, including which cash
flows are directly attributable to the potentially impaired
asset, the useful life over which the cash flows will occur,
their amount and the assets residual value, if any. Also,
impairment losses require an estimate of fair value, which is
based on the best information available. We principally use
internal discounted cash flow estimates, but also use quoted
market prices when available and independent appraisals as
appropriate to determine fair value. Cash flow estimates are
derived from historical experience and internal business plans
with an appropriate discount rate applied.
Accordingly, inaccuracies in the assumptions used by management
in establishing these estimates, and in the assumptions used in
establishing the extent to which a particular asset may be
impaired, could potentially have a material effect on our
consolidated financial statements.
| NOLs — Deferred Tax Assets |
As described in Note 25 to the Notes to the Audited Annual
Financial Statements and Note 12 to the Notes to the
Unaudited Interim Financial Statements, 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 Covanta’s domestic business, to the extent it
is reasonably predictable.
We cannot be certain that the NOLs will be available to offset
our tax liability.
We estimated that we have NOLs of approximately
$516 million for federal income tax purposes as of the end
of 2004. The NOLs will expire in various amounts beginning on
December 31, 2005 through December 31, 2023, 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 trust relating to
the Mission Insurance entities.
The IRS has not audited any of our tax returns for the years in
which the losses giving rise to the NOLs were reported, and it
could challenge any past and future use of the NOLs.
Under applicable tax law, the use and availability of our NOLs
could be limited if there is a more than 50% increase in stock
ownership during a 3-year testing period by stockholders owning
5% or more of our stock. Our certificate of incorporation
contains stock transfer restrictions that were designed to help
preserve our NOLs by avoiding such an ownership change. We
expect that the restrictions will remain in-force as long as we
have NOLs. There can be no assurance, however, that these
restrictions will prevent such an ownership change. See
“Risk Factors — Covanta Holding
Corporation-Specific Risks — We cannot be certain that
our NOLs will continue to be available to offset our tax
liability,” for more information on our NOLs.
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| Loss Contingencies |
As described in Note 34 in the Notes to the Audited Annual
Financial Statements and Note 17 to the Notes to the
Unaudited Interim Financial Statements, 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 may experience regarding such
matters. Any inaccuracies could potentially have a material
effect on our Consolidated Financial Statements.
| Revenue Recognition |
Covanta’s revenues are generally earned under contractual
arrangements and fall into three categories: service revenues,
electricity and steam revenues, and construction revenues.
| Waste and Service Revenues |
Waste and service revenues consist of the following:
| (1) Fees earned under contracts to operate and maintain waste-to-energy, independent power and water facilities are recognized as revenue when earned, regardless of the period they are billed; | |
| (2) Fees earned 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 waste-to-energy service agreements. Regardless of the timing of amounts paid by client communities relating to project debt principal, Covanta records service revenue with respect to this principal component on a levelized basis over the term of the service agreement. Unbilled service receivables related to waste-to-energy operations are discounted in recognizing the present value for services performed currently in order to service the principal component of the project debt. Such unbilled receivables amounted to $146 million at September 30, 2005; | |
| (3) Fees earned for processing waste in excess of service agreement requirements are recognized as revenue beginning in the period Covanta processes waste in excess of the contractually stated requirements; | |
| (4) Tipping fees earned under waste disposal agreements are recognized as revenue in the period waste is received; and | |
| (5) Other miscellaneous fees such as revenue for scrap metal recovered and sold are generally recognized as revenue when scrap metal is sold. | |
| Electricity and Steam Sales |
Revenue from the sale of electricity and steam are earned at
energy facilities and are recorded based upon output delivered
and capacity provided at rates specified under contract terms or
prevailing market rates net of amounts due to client communities
under applicable service agreements.
| Construction Revenues |
Revenues under fixed-price construction contracts, including
construction, are recognized on the basis of the estimated
percentage of completion of services rendered. Construction
revenues also include design, engineering and construction
management fees. In 2004, Covanta incurred some preliminary
construction costs for which it has not billed the municipality
or received reimbursement. Covanta anticipates the contracts
will be finalized in 2005 at which time it expects to be fully
reimbursed for such costs.
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| Unpaid Losses and Loss Adjustment Expenses |
Our insurance business establishes loss and 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 reserves or
“IBNR” reserves in this prospectus, 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.
Ultimate loss and LAE are generally determined by extrapolation
of claim emergence and settlement patterns observed in the past
that can reasonably be expected to persist into the future. In
forecasting ultimate loss and LAE with respect to any line of
business, past experience with respect to that line of business
is the primary resource, but cannot be relied upon in isolation.
Insurance Service’s own experience, particularly claims
development experience, such as trends in case reserves,
payments on and closings of claims, as well as changes in
business mix and coverage limits, are the most important
information for estimating its reserves.
Uncertainties in estimating ultimate loss and LAE are magnified
by the time lag between when a claim actually occurs and when it
is reported and settled. This time lag is sometimes referred to
as the “claim-tail.” The claim-tail for most property
coverages is typically short (usually a few days up to a few
months). The claim-tail for automobile liability is relatively
short (usually one to two years) and liability/casualty
coverages, such as general liability, multiple peril coverage,
and workers compensation, can be especially long as claims are
often reported and ultimately paid or settled years, even
decades, after the related loss events occur. During the long
claims reporting and settlement period, additional facts
regarding coverages written in prior accident years, as well as
about actual claims and trends may become known and, as a
result, our insurance business may adjust its reserves. If
management determines that an adjustment is appropriate, the
adjustment is recorded in the accounting period in which such
determination is made in accordance with GAAP. Accordingly,
should reserves need to be increased or decreased in the future
from amounts currently established, future results of operations
would be negatively or positively impacted, respectively.
Our insurance business uses independent actuaries which it
significantly relies on to form a conclusion on reserve
estimates. Those independent actuaries use several generally
accepted actuarial methods to evaluate our 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 the management or our insurance
business.
Our insurance business’ reserves include provisions made
for claims that assert damages from asbestos and environmental,
referred to as “A&E” in this prospectus, related
exposures against policies issued prior to 1985. Asbestos claims
relate primarily to injuries asserted by those who came in
contact with asbestos or products containing asbestos.
Environmental claims relate primarily to pollution and related
clean-up cost obligations, particularly as mandated by federal
and state environmental protection agencies. In addition to the
factors described above regarding the reserving process, our
insurance business estimates its A&E reserves based upon,
among other factors, facts surrounding reported cases and
exposures to claims, such as policy limits, existence of other
underlying primary coverage and deductibles, current law, past
and projected claim activity and past settlement values for
similar claims, as well as analysis of industry studies and
events, such as recent settlements and asbestos-related
bankruptcies. The cost of administering A&E claims, which is
an important factor in estimating loss reserves, tends to be
higher than in the case of non-A&E claims due to the higher
legal costs typically associated with A&E claims. Due to the
inherent difficulties in estimating ultimate
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A& E exposures, our insurance business and its contracted
independent actuaries do not estimate a range for A&E
incurred losses.
Due to the factors discussed above and others, the process used
in estimating unpaid losses on LAE cannot provide an exact
result. Our results of operation for each of the past three
years have been adversely affected by insurance loss development
related to prior years of $2.5 million, $13.5 million
and $10.4 million for 2004, 2003 and 2002, respectively.
The prior year development recognized in 2004, 2003 and 2002,
expressed as a percentage of the previous years reported loss
and LAE reserves, net of reinsurance recoveries, was 3.9%, 17.0%
and 11.8%, respectively. The lines of business significantly
contributing to the adverse development include workers’
compensation, commercial automobile and property and casualty.
Workers’ compensation was most affected by changes in
California legislation that occurred in 1995 and took several
years to develop, with such development being different than the
experience prior to 1995. California legislative reforms in 2003
and 2004 have taken hold that appear to be reversing some of the
prior recognized adverse development. Commercial automobile was
most significantly impacted by case strengthening related to a
change in claims administration in 2002, coupled with the
recognition that development factors of prior years were not as
indicative of the business written for those respective years
due to changes in risk profile and limits. Due to the
stabilization of claims staff and recognition of the profile
change that occurred in 1999, the adjustments recorded to
commercial automobile in 2003 and 2004 are likely to hold. Given
the nature of the casualty line of business, most notably the
A&E liabilities, it is difficult to assess whether the
extent of adverse adjustments recognized in the past will be
required in future periods.
The table below shows our insurance business’ recorded loss
and LAE reserves, net of reinsurance recoveries, as of
December 31, 2004 by line of business compared to the high
and low ends of the reserve range that our contracted actuaries
have determined to be acceptable for issuing their opinions.
Given the nature and extent of long-tail liabilities versus
total net reserves and the fact that net reserves have
historically shown adverse development, our insurance business
cannot provide assurances that its estimate of loss and LAE
reserves will not adversely develop outside of the individual
line of business ranges and in such instances could materially
effect the statement of operations. However as our insurance
business is limited in its current policy writing to the
non-standard personal automobile program, the extent of adverse
development recognized in the past will likely not re-occur (in
thousands of dollars).
| Range of Reserves by Line of Business | Low | Reported | High | ||||||||||
|
On-going lines of business:
|
|||||||||||||
|
Private passenger automobile — SCJ programs
|
$ | 5,706 | $ | 6,006 | $ | 6,452 | |||||||
|
Discontinued lines of business:
|
|||||||||||||
|
Private passenger automobile — Non-SCJ programs
|
644 | 678 | 728 | ||||||||||
|
Commercial automobile
|
9,238 | 9,724 | 10,454 | ||||||||||
|
Workers’ compensation
|
18,021 | 18,970 | 20,867 | ||||||||||
|
Property and casualty — Non A&E
|
2,506 | 2,638 | 2,836 | ||||||||||
|
Property and casualty — A&E
|
$ | 8,212 | |||||||||||
|
Net unpaid losses and LAE at end of year
|
$ | 46,228 | |||||||||||
The probability that ultimate losses will fall outside of the
ranges of estimates by line of business is higher for each line
of business individually than it is for the sum of the estimates
for all lines taken together due to the effects of
diversification. Moreover, it would not be appropriate to add
the ranges for each line of business to obtain a range around
the total net reserves as each line of business is not
completely correlated. Although management believes the reserves
are reasonably stated, ultimate losses may deviate, perhaps
materially, from the recorded reserve amounts and could be above
the high end of the range of actuarial projections.
MATERIAL WEAKNESS IN INTERNAL CONTROLS AND
PROCEDURES
As of December 31, 2004, we reported that management had
identified a material weakness in our internal controls and
procedures over financial reporting. Specifically, during the
course of its audit of our
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2004 financial statements, Ernst & Young, our
independent auditors, identified errors, principally related to
complex manual “fresh-start” accounting calculations,
predominantly affecting Covanta’s investments in its
international businesses. Fresh-start accounting was required
following Covanta’s emergence from bankruptcy on
March 10, 2004, pursuant to SOP 90-7. These errors,
the net effect of which was immaterial (less than
$2.0 million in pretax income) were corrected in our 2004
Consolidated Financial Statements prior to their issuance.
However, management determined that errors in complex
fresh-start and other technical accounting areas originally went
undetected due to insufficient technical in-house expertise
necessary to provide sufficiently rigorous review.
Although the material weakness reported related primarily to
complicated “fresh-start” accounting calculations,
which are no longer applicable after March 10, 2005,
similarly complicated accounting calculations may be required in
connection with CPIH’s international operations and the
acquisition of Ref-Fuel. As a result, prior to and during the
first nine months of 2005 and subsequent thereto, our management
has identified and undertaken several actions to remediate the
reported material weakness in internal controls over financial
reporting.
In addition, management is evaluating the impact of the
acquisition of Ref-Fuel on our system of internal controls over
financial reporting. Prior to the acquisition, Ref-Fuel was not
required to comply with Section 404 of the Sarbanes Oxley
Act until December 31, 2006. As a result, its internal
controls over financial reporting had neither been tested as
extensively as had ours, nor had such controls been reviewed by
its independent auditors in the context of the required
attestation by such auditors. In addition, we operate different
software systems than Ref-Fuel which will require integration.
Also, changes in, and integration of, accounting and financial
staff resulting from the acquisition may create challenges in
implementing a combined and effective system of internal
controls. Management expects that it will take a period of time
to integrate the financial reporting systems and related
software of the combined businesses sufficiently to conclude
that our overall internal controls are working effectively, and
to appropriately apply purchase accounting adjustments with
respect to Re-Fuel.
Management believes that the actions taken to address the
control deficiency underlying the reported material weakness,
and to address the overall integration of controls with respect
to the combined businesses, will improve our internal controls
over financial reporting. Although we have devoted, and will
continue to devote, significant time and resources toward
remediating our reported material weakness, and to such overall
integration, and made progress in improving our internal
controls over financial reporting, our management is unable, as
of the date of this prospectus and registration statement, to
conclude that its actions have effectively corrected the
reported material weakness. Until we are able to assert that our
internal control over financial reporting is effective, our
management believes the existence of the reported material
weakness represents a known uncertainty with respect to the
accuracy of its financial statements. See also “Risk
Factors — Covanta Holding Corporation-Specific
Risks — Failure to maintain an effective system of
internal control over financial reporting may have an adverse
effect on our stock price” for continuing risks of the
failure to maintain an effective system of financial reporting
controls and procedures, including risks of exposing us to
regulatory sanctions and a loss of investor confidence.
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 in this
prospectus are based on pertinent
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information available to management as of December 31,
2004. Further information is included in Note 30 to the
Notes to the Audited Annual Financial Statements.
Covanta’s Business
| Interest Rate Risk |
Covanta and/or its subsidiaries have project debt outstanding
bearing interest at floating rates that could subject it 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 Covanta’s project
debt, approximately $218.9 million was floating rate at
December 31, 2004. However, of that floating rate project
debt, $126.7 million related to waste-to-energy projects
where, because of their contractual structure, interest rate
risk is borne by client communities because debt service is
passed through to those clients. Covanta had only one interest
rate swap outstanding at December 31, 2004 in the notional
amount of $80.2 million related to floating rate project
debt. Gains and losses on this swap are for the account of the
client community.
For floating rate debt, a 20% hypothetical increase in the
underlying December 31, 2004 market interest rates would
result in a potential loss to twelve month future earnings of
$5.5 million. For fixed rate debt, the potential reduction
in fair value from a 20% hypothetical increase in the underlying
December 31, 2004 market interest rates would be
approximately $32.5 million. The fair value of
Covanta’s fixed rate debt (including $677 million in
fixed rate debt related to revenue bonds in which debt service
is an explicit component of the service fees billed to the
client communities) was $750.2 million at December 31,
2004, and was determined using average market quotations of
price and yields provided by investment banks.
Covanta entered into interest rate swap derivative agreements to
hedge its interest rate exposure arising from $300 million
of variable interest rate borrowings under the senior secured
credit arrangements Covanta entered into on June 24, 2005.
As described in Notes 11 and 16 to the Notes to the
Unaudited Interim Financial Statements, Covanta is required to
enter into hedging arrangements with respect to a portion of its
exposure to interest rate changes with respect to its borrowing
under the Credit Facilities. On July 8, 2005, Covanta
entered into two pay fixed, receive floating interest rate swap
agreements with a total notional amount of $300 million.
Under the terms of our financing arrangements, we are also
obligated to enter into interest rate swap arrangements for up
to an additional notional amount of approximately
$37.5 million. Interest rate swaps allow Covanta to raise
long-term borrowings at floating rates and effectively swap them
into fixed rates that are lower than those available if it
entered into fixed rate borrowings directly. Interest rate swaps
are used for the purpose of controlling interest expense by
managing the mix of fixed and floating rate debt. Covanta does
not seek to make a profit from changes in interest rates.
Covanta manages interest rate sensitivity by measuring potential
increases in interest expense that would result from a probable
change in interest rates. When the potential increase in
interest expense exceeds an acceptable amount, Covanta reduces
risk by entering into interest rate swap agreements.
Under the interest rate swaps, Covanta agreed with other parties
to exchange, at specified intervals, the difference between an
agreed fixed rate and the variable floating rate interest
payments required under its recourse term loan obligations,
calculated by reference to an agreed notional principal amount.
Covanta will pay the fixed rate and will receive the floating
rate under the swap agreements. The impact of the swaps was to
increase interest expense for the three months ended
September 30, 2005 by $0.5 million. As of
September 30, 2005, the net after-tax deferred gain in
other comprehensive income was $1.0 million
($1.5 million before income taxes, which is recorded in
other assets).
| Market Risk of Acquired Business of Ref-Fuel |
All of Ref-Fuel’s operating facilities are located in the
northeastern United States. Thus, with the acquisition of
Ref-Fuel our operations are more concentrated in this region
than prior to the acquisition. The entrance of new competitors
into this region or the expansion of existing facilities
operations that compete with Covanta could have a material
adverse effect on cash distributions that can be made available
to us, and, ultimately, our financial condition.
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In addition, these Ref-Fuel operating facilities currently rely,
to a greater extent than Covanta’s other operating
facilities, on obtaining supplies of solid waste in the market
at prices and in quantities that are sufficient to operate such
facilities at their expected levels. Covanta’s inability to
obtain solid waste at such prices or in such amounts could have
a material adverse effect on the cash flow it is able to
generate from Ref-Fuel, and potentially on our financial
condition. For a discussion of factors that could impact the
price and supply of solid waste which Covanta may be able to
obtain, see the discussion in this prospectus under the heading
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Executive
Summary — Business Segments — Waste and
Energy Services-Overview.”
| Foreign Currency Exchange Rate Risk |
Covanta has investments in energy projects in various foreign
countries, including the Philippines, China, India and
Bangladesh, and to a much lesser degree, Italy and Costa Rica.
Neither we nor Covanta enter into currency transactions to hedge
Covanta’s exposure to fluctuations in currency exchange
rates. Instead, Covanta attempts to mitigate its currency risks
by structuring its project contracts so that its revenues and
fuel costs are denominated in the same currency. As a result,
the U.S. dollar is the functional currency at most of
Covanta’s international projects. Therefore, only local
operating expenses and project debt denominated in other than a
project entity’s functional currency are exposed to
currency risks.
At December 31, 2004, Covanta had $102 million of
project debt related to two diesel engine projects in India. For
$87.7 million of the debt (related to project entities
whose functional currency is the Indian rupee), exchange rate
fluctuations are recorded as translation adjustments to the
cumulative translation adjustment account within
stockholders’ deficit in our Consolidated Balance Sheets.
The remaining $14.3 million of debt is denominated in
U.S. dollars.
The potential loss in fair value for such financial instruments
from a 10% adverse change in December 31, 2004 quoted
foreign currency exchange rates would be approximately
$8.8 million.
At December 31, 2004, Covanta also had net investments in
foreign subsidiaries and projects. See Note 5 to the Notes
to the Audited Annual Financial Statements for further
discussion.
| Commodity Price Risk and Contract Revenue Risk |
Neither we nor Covanta have entered into futures, forward
contracts, swaps or options to hedge purchase and sale
commitments, fuel requirements, inventories or other
commodities. Alternatively, Covanta attempts to mitigate the
risk of energy and fuel market fluctuations by structuring
contracts related to its energy projects in the manner described
in this prospectus under the heading “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations — Management’s Discussion and Analysis
of Liquidity and Capital Resources — Cash Flow and
Liquidity — Waste and Energy Services
Segment — Contract Structures and Duration.”
Generally, Covanta is protected against fluctuations in the
waste disposal market, and thus its ability to charge acceptable
fees for its services, through service agreements and existing
long-term disposal contracts at its waste-to-energy facilities.
At eight of its waste-to-energy facilities, differing amounts of
waste disposal capacity are not subject to long-term contracts
and, therefore, Covanta is partially exposed to the risk of
market fluctuations in the waste disposal fees it may charge.
Assuming the extension of the agreement to operate the
Hillsborough County facility, Covanta’s service agreements
will begin to expire in 2008, and energy sales contracts at
Covanta-owned projects generally expire at or after the date on
which that project’s service agreement expires. Expiration
of these contracts will subject Covanta to greater market risk
in maintaining and enhancing its revenues. As its service
agreements at municipally-owned projects expire, Covanta will
seek to enter into renewal or replacement contracts to continue
operating such projects. As Covanta’s service agreements at
facilities it owns begin to expire, Covanta intends to seek
replacement or additional contracts for waste supplies, and
because project debt on these facilities will be paid off at
such time, Covanta expects to be able to offer disposal services
at rates that will attract sufficient quantities of waste and
provide acceptable revenues. Covanta will seek to bid
competitively in the market for additional contracts to operate
other facilities as similar contracts of other vendors expire.
At Covanta-owned facilities, the
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expiration of existing energy sales contracts will require
Covanta to sell its output either into the local electricity
grid or pursuant to new contracts. There can be no assurance
that Covanta will be able to enter into such renewals,
replacement or additional contracts, or that the terms available
in the market at the time will be favorable to Covanta. See
“Risk Factors — Waste and Energy Services
Business-Specific Risks — Covanta may face increased
risk of market influences on its domestic revenues after its
contracts expire” for more information regarding the
possible effects of the expiration of Covanta’s existing
contracts.
Because Covanta’s business is based upon building and
operating municipal solid waste processing and energy generating
projects, which are capital intensive businesses, in order to
provide meaningful growth Covanta must be able to invest its own
funds, obtain debt financing, and provide support to its
operating subsidiaries. Covanta intends to pursue opportunities
to expand the processing capacity of its existing projects where
market conditions are favorable, or where its municipal clients,
referred to in this prospectus as “client
communities,” have encountered significantly increased
waste volumes without correspondent competitively-priced
landfill availability. Covanta’s ability to make
investments in new or projects or expansions of projects it
owns, and/or borrow additional funds for the construction of
such new or expanded projects, is limited by covenants in its
new financing arrangements.
Insurance Business
| Risk Related to the Investment Portfolio |
NAICC’s objectives in managing its investment portfolio are
to 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 its
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 NAICC’s fixed maturity portfolio
are primarily credit risk, interest rate risk, reinvestment risk
and prepayment risk. The market risk related to NAICC’s
equity portfolio is price risk.
| Fixed Maturities |
Interest rate risk is the price sensitivity of fixed maturities
to changes in interest rate. Management views these potential
changes in price within the overall context of asset and
liability matching. Management estimates the payout patterns of
NAICC’s liabilities, primarily loss reserves, to determine
their duration. Management sets duration targets for the fixed
income portfolio after consideration of the duration of
NAICC’s liabilities that it believes mitigates the overall
interest rate risk. NAICC’s exposure to interest rate risk
is mitigated by the relative short-term nature of its insurance
and other liabilities. The effective duration of the portfolio
at December 31, 2004 and 2003 was 2.3 years and
2.3 years, respectively. Management believes its 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 2.7% decrease in the
fair value of the portfolio while a hypothetical 100 basis
point decrease would cause an approximate 2.1% increase in fair
value. Credit risk is the price sensitivity of fixed maturities
to changes in the credit quality of such investment.
NAICC’s exposure to credit risk is mitigated by its
investment in high quality fixed income alternatives.
Fixed maturities of NAICC include mortgage-backed securities and
collateralized mortgage obligations, referred to as
“MBS” in this prospectus, collectively representing
24.3% and 22.0% of total fixed maturities at December 31,
2004 and December 31, 2003, respectively. All MBS held by
NAICC are issued by the Federal National Mortgage Association,
referred to as “FNMA” in this prospectus, or the
Federal Home Loan Mortgage Corporation, referred to as
“FHLMC” in this prospectus, which are both rated AAA
by Moody’s Investors Services. Both FNMA and FHLMC are
corporations that were created by Acts of Congress. 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. The
principal an investor receives depends upon amortization
schedules and the termination pattern (resulting from
prepayments or defaults) of the individual mortgages included in
the underlying pool of mortgages. The principal is guaranteed
but the yield and cash flow can vary depending on the timing of
the repayment of the principal balance. The degree to which a
security is susceptible to changes in yield is influenced by the
difference between its amortized cost and par, the relative
sensitivity to repayment of the underlying mortgages backing the
securities in a changing interest rate environment, and the
repayment priority of the securities in its overall
securitization structure. NAICC attempts 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 and targeted amortization classes.
The structures of the attempts of planned amortization classes
and targeted amortization classes to increase the certainty of
the timing of prepayment and thereby minimize the prepayment and
interest rate risk. In 2004, NAICC recognized $0.2 million
in gain on sales of fixed maturities.
MBS, as well as callable bonds, have a greater sensitivity to
market value declines in a rising interest rate environment than
to market value increases in a declining interest rate
environment. This is primarily due to the ability and the
incentive of the payor to prepay the principal or the issuer to
call the bond in a declining interest rate scenario. NAICC
realized significant increases in its prepayments of principal
during 2004 and 2003. The prepayments mitigated the need to sell
securities to meet operating cash requirements as noted
previously. Generally, this trend will lower the portfolio yield
in future years in a declining interest environment.
As interest rates at December 31, 2004 were at relatively
historical lows, NAICC is subject to reinvestment risk as
approximately 24% of its fixed maturity portfolio will be
received in the following year. Absent changing its credit risk
and extension profile, it is unlikely that NAICC could reinvest
proceeds at yields similar to those recognized in 2004.
| Equity Securities |
In the fourth quarter of 2003, NAICC sold nearly all of its
equity investments capitalizing on the general stock market
recovery and specifically the technology sector. In 2003, NAICC
recognized $0.4 million as net realized gains from equity
investments. In the third and fourth quarter of 2004, NAICC
began reinvesting in equity securities, generally limited to
Fortune 500 companies with strong balance sheets, history
of dividend growth and price appreciation. As of
December 31, 2004 equity securities represented 2.6% of the
total NAICC investment portfolio.
| Economic Conditions |
The operating results of a property and casualty insurer are
influenced by a variety of factors including general economic
conditions, competition, regulation of insurance rates, weather,
frequency and severity of losses. The California non-standard
personal auto market in which NAICC operates has experienced a
recovery of rate adequacy coupled with stable competition.
Frequency of claims improved from 2002 to 2003 and remained
stable in 2004, while the average cost of settling claims has
steadily improved from 2002 to 2004.
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NO BOARD RECOMMENDATION
Our board of directors believes the offering is in our best
interests. The proceeds from the offering will be used for
general corporate purposes. See “Use of
Proceeds” for a discussion of how we intend to allocate
and use the proceeds from the offering.
Our board of directors is not making any recommendation to
you as to whether you should exercise your warrants. You must
make your own decision as to whether to exercise your
warrants.
No dealer, salesman or other person has been authorized by us to
provide you with any information other than the information
contained in this prospectus, the information included and
incorporated by reference in this prospectus and the other
documents delivered herewith. You should rely only on the
information provided in this document or other information that
we have referred you to. This prospectus and the other documents
referred to do not constitute an offer to sell or a solicitation
to buy securities in any jurisdiction in which an offer or a
solicitation would be unlawful.
The warrant agent for the offering, Wells Fargo, National
Association, has agreed to provide services to us in connection
with the offering. If you require assistance, please contact the
warrant agent at Wells Fargo Bank, Corporate
Trust Services, Sixth & Marquette, MAC N9303-120,
Minneapolis, MN 55479, Telephone (612) 667-1102.
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THE BUSINESS
General Overview
We are a holding company incorporated in Delaware on
April 16, 1992. We changed our name as of
September 20, 2005 from Danielson Holding Corporation to
Covanta Holding Corporation. Substantially all of our current
operations were conducted in the insurance services industry
prior to our acquisition of Covanta in March 2004. We engage in
insurance operations through our indirect subsidiaries, NAICC
and related entities. A significant portion of our operating
losses in the past three years stem from lines of insurance
business, such as commercial automobile and workers’
compensation insurance, which the company has ceased actively
underwriting. Our insurance operations under NAICC and related
subsidiaries reported segment losses of $0.8 million,
$10.2 million and $10.5 million, for the three fiscal
years ended December 31, 2004, 2003 and 2002, respectively.
Our strategy had been to grow by making strategic acquisitions.
As part of this corporate strategy, we have sought acquisition
opportunities, such as the March 2004 acquisition of Covanta and
the June 2005 acquisition of Ref-Fuel. Accordingly, with the
recent acquisitions, our corporate strategy has evolved to focus
on the waste and energy markets generally, and positioning
Covanta as a leader in these sectors, specifically. Also see
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Executive
Summary — Our Business Strategy” for a more
detailed discussion of our new corporate strategy.
As a result of the consummation of the Covanta acquisition on
March 10, 2004, our performance predominantly reflects the
performance of Covanta’s operations which are significantly
larger than our other operations. The nature of our business,
the risks attendant to such business and the trends that we face
have been significantly altered by the acquisitions of Covanta
and Ref-Fuel. Accordingly, our financial results prior to the
acquisition of Covanta in March 2004 and Ref-Fuel in June 2005
are not directly comparable to our current and future financial
results.
In May 2002, we acquired a 100% ownership interest in ACL,
thereby entering into the marine transportation, construction
and related service provider businesses. On January 31,
2003, ACL and many of its subsidiaries and its immediate direct
parent entity, ACL Holdings, filed a petition with the
U.S. Bankruptcy Court to reorganize under Chapter 11.
We wrote off our remaining investment in ACL at the end of the
first quarter of 2003 as an other than temporary asset
impairment.
As a result of ACL’s bankruptcy filing, beginning in the
year ended December 31, 2003, we accounted for our
investment in ACL under the equity method, reflecting our
significant influence, but not control, over ACL. On
December 30, 2004, a plan of reorganization for ACL was
confirmed by the U.S. Bankruptcy Court for the Southern
District of Indiana, referred to in this prospectus as the
“ACL Plan of Reorganization.” At the time of
confirmation, there were no material conditions that needed to
be fulfilled for emergence and, as a result of the confirmation
of the ACL Plan of Reorganization, for purposes of generally
accepted accounting principles, all of our equity interests in
ACL were cancelled. On January 10, 2005, ACL emerged from
Chapter 11 proceedings, and upon emergence, a warrant was
issued to us under the ACL Plan of Reorganization to purchase up
to 168,230 shares of common stock of ACL at a price of
$12.00 per share. The number of shares and exercise price
subject to the warrants were subsequently adjusted to
672,920 shares at an exercise price of $3.00 per
share, as a result of a four for one stock split effective as of
August 2005.
During 2004, we owned a direct 5.4% interest in GMS, and a
direct 50% interest in Vessel Leasing. GMS was a joint venture
among ACL, us and a third party, which owned and operated marine
terminals and warehouse operations. Vessel Leasing was a joint
venture between ACL and us which leases barges to ACL’s
barge transportation operations. Neither GMS nor Vessel Leasing
filed for Chapter 11 protection. Neither we, GMS nor Vessel
Leasing were guarantors of ACL’s debt or liable for any of
ACL’s liabilities. On October 6, 2004, we and ACL sold
our interests in GMS to the third party joint venture member and
on January 13, 2005, we sold our interest in Vessel Leasing
to ACL. Prior to the date of such sales, we accounted for our
interest in GMS and Vessel Leasing, beginning with the year
ended December 31, 2003, using the equity method of
accounting.
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On October 7, 2005, ACL issued 7.5 million shares in
an initial public offering. We proceeded to exercise the
warrants we owned and received shares of ACL common stock in
order to begin monetizing these shares. During October 2005, we
monetized our investment in all 672,920 ACL shares we owned. As
a result, we no longer hold any interest in ACL or in the marine
transportation business.
As of the end of 2004, we had estimated aggregate consolidated
NOLs for federal income tax purposes of approximately
$516 million. These losses will expire over the course of
the next 18 years unless utilized prior thereto. These NOLs
are primarily from the taxable results of certain grantor trusts
established in 1990 as part of a reorganization in which Mission
Insurance Group, Inc. emerged from bankruptcy as Danielson
Holding Corporation. These trusts were created for the purpose
of assuming various liabilities of their grantors, consisting of
certain present and former subsidiaries of ours, allowing state
regulators to administer the run-off of the Mission Insurance
Group business while releasing us and certain of its present and
former subsidiaries from the proceedings free of claims and
liabilities, including any obligation to provide for the funding
to the trusts.
As described in “Risk Factors — Covanta
Holding Corporation-Specific Risks — We cannot be
certain that our NOLs will continue to be available to offset
our tax liability,” and “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations — Executive Summary,” possible
changes in the status of certain liabilities and the manner of
distributions to holders of certain claims in the Mission
Insurance insolvency proceedings may require us to recognize
significant taxable income, which may substantially reduce our
available NOLs and cause us to adjust our deferred tax asset.
While we cannot predict with certainty what amounts, if any, may
be includable in our taxable income, we are in the process of
obtaining additional information regarding the potential amount
of includible taxable income.
We also are considering a number of potential permissible
actions and approaches intended to reduce the amount of taxable
income we may be required to recognize. These include
arrangements with representatives of the Mission Insurance
entities and the California Commissioner of Insurance to clarify
the treatment of certain liabilities and the manner of
distributions to claimholders in such insolvency proceedings, as
well as the application of the tax rules consistent with the
original Mission Insurance restructuring, and the terms of our
agreement with the grantor trusts established in connection with
that restructuring. Given the lack of definitive information
available as of the date of this prospectus, we cannot assure
you of the amount, if any, of additional income or losses that
could possibly be recognized.
See Note 25 to the Notes to the Audited Annual Financial
Statements and Note 12 in the Notes to the Unaudited
Interim Financial Statements for more detailed information on
our NOLs.
Our principal executive offices are located at 40 Lane Road,
Fairfield, New Jersey 07004 and our telephone number is
(973) 882-9000.
Acquisition of Covanta Energy Corporation
On December 2, 2003, we executed a definitive investment
and purchase agreement to acquire Covanta in connection with
Covanta’s emergence from Chapter 11 proceedings. The
primary components of the transaction were: (1) the
purchase by us of 100% of the equity of Covanta in consideration
for a cash purchase price of $30 million, and (2) an
agreement as to new letter of credit and revolving credit
facilities for Covanta’s domestic and international
operations, provided by some of the existing Covanta lenders and
three additional lenders arranged by us. We amended this
agreement with Covanta as of February 23, 2004 to reduce
the purchase price and release from an escrow account $175,000
so that a limited liability company formed by us and one of our
subsidiaries could acquire an equity interest in Covanta Lake,
Inc., a wholly-owned indirect subsidiary of Covanta, in a
transaction separate and distinct from the acquisition of
Covanta out of bankruptcy.
As required by the investment and purchase agreement, Covanta
filed a proposed plan of reorganization, a proposed plan of
liquidation for specified non-core businesses, and the related
draft disclosure statement, each reflecting the transactions
contemplated under the investment and purchase agreement, with
the Bankruptcy Court. On March 5, 2004, the Bankruptcy
Court confirmed the proposed plans. As part of the
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Covanta Plan of Reorganization, we agreed to offer to sell up to
3.0 million shares of our common stock, at a price of
$1.53 per share, to holders, as of January 12, 2004,
of the $100 million of principal amount of
9.25% Debentures issued by Covanta who voted in favor of
the Covanta Plan of Reorganization.
Under the terms of the investment and purchase agreement, on
March 10, 2004, we acquired 100% of Covanta’s equity
in consideration for $30 million (net of $175,000 discussed
above). As part of the investment and purchase agreement, we
arranged for a new $118 million replacement letter of
credit facility for Covanta, secured by a second lien on
Covanta’s domestic assets. This financing was provided by
each of SZ Investments, a stockholder of ours, Third
Avenue, a stockholder of ours, and Laminar, a creditor of
Covanta and a stockholder of ours. In addition, in connection
with a note purchase agreement, Laminar arranged for a
$10 million revolving loan facility for Covanta’s
international assets that we acquired, secured by these assets.
Based upon information provided to us by Laminar, Laminar was a
holder of $10.4 million in principal amount of the
9.25% debentures issued by Covanta as of January 12,
2004. As of the date of this prospectus, other than confirmation
of the restructuring of the offering to incorporate the
Contingent Offering, we have not had any discussions with
Laminar regarding Laminar’s participation in the offering.
On May 18, 2004, we commenced a pro rata rights offering to
our stockholders to purchase 0.75 shares of our common
stock, at a price of $1.53 per share, for each share of our
common stock held by our stockholders. The rights offering was
completed on June 11, 2004. We issued a total of 27,438,118
additional shares of our common stock in the rights offering,
constituting all of the shares offered for sale, with net
proceeds to us of approximately $42 million. We repaid
$40 million of bridge financing notes obtained in
connection with the Covanta acquisition with the proceeds from
the rights offering and through the conversion of a portion of
the notes held by Laminar.
As part of our negotiations with Laminar and its becoming a 5%
stockholder, pursuant to a letter agreement dated
December 2, 2003, Laminar agreed to additional restrictions
on the transferability of the shares of our common stock that
Laminar holds or will acquire. Further, in accordance with the
transfer restrictions contained in Article Fifth of our
certificate of incorporation restricting the resale of our
common stock by 5% stockholders, we have agreed with Laminar to
provide it with limited rights to resell the common stock that
it holds. Finally, pursuant to our agreement with the bridge
financing lenders on July 28, 2004, we have filed a
registration statement with the SEC to register the shares of
our common stock issued to or acquired by them under the note
purchase agreement. The registration statement was declared
effective on August 24, 2004. In addition, 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
Ref-Fuel acquisition in order to provide such stockholders with
liquidity.
Acquisition of Ref-Fuel
We acquired Ref-Fuel as of June 24, 2005, pursuant to the
terms of a stock purchase agreement with Ref-Fuel, an owner and
operator of waste-to-energy facilities in the northeast United
States, and Ref-Fuel’s stockholders to purchase 100%
of the issued and outstanding shares of Ref-Fuel capital stock.
Under the terms of the agreement, we paid $740 million in
cash for the stock of Ref-Fuel and assumed the consolidated net
debt of Ref-Fuel, which was net debt of approximately
$1.3 billion ($1.5 billion of consolidated
indebtedness and $0.2 billion of cash and restricted cash).
See “Management’s Discussion and Analysis of
Financial Condition and Results of Operations —
Management’s Discussion and Analysis of Liquidity and
Capital Resources — Waste and Energy Services
Segment” and Note 11 to the Notes to the Unaudited
Interim Financial Statements for a more detailed description of
the indebtedness that was assumed in connection with the
transaction.
We financed this transaction through a combination of debt and
equity financing. The equity component of the financing was the
Ref-Fuel rights offering that was completed as of June 21,
2005. SZ Investments, Third Avenue and Laminar, representing
ownership of approximately 40.4% of our outstanding common stock
prior to such offering, had each separately committed to acquire
their respective pro rata portion of the shares offered in the
Ref-Fuel rights offering. As consideration for their
commitments, we paid each of these stockholders an amount equal
to 1.75% of their respective equity commitments. We also agreed
to amend an
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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 Ref-Fuel in order to provide such stockholders
with liquidity.
Goldman Sachs Credit Partners, L.P. and Credit Suisse First
Boston arranged a debt financing package to finance the
acquisition, as well as to refinance the existing recourse debt
of Covanta and provide additional liquidity for us. This
financing consisted of two tranches, each of which is secured by
pledges of the stock of Covanta’s subsidiaries that has not
otherwise been pledged, guarantees from certain of
Covanta’s subsidiaries and all other available assets of
Covanta’s subsidiaries. The first tranche, a first priority
senior secured bank facility, is made up of a $275 million
term loan facility due 2012, a $100 million revolving
credit facility due 2011 and a $340 million letter of
credit facility due 2012. The second tranche is a
$400 million second priority senior secured term loan
facility due 2013. See “Management’s Discussion and
Analysis of Financial Condition and Results of
Operations — Management’s Discussion and Analysis
of Liquidity and Capital Resources — Waste and Energy
Services Segment” and Note 11 to the Notes to the
Unaudited Interim Financial Statements for a more detailed
description of this debt financing. See “Quantitative
and Qualitative Disclosures about Market Risk —
Covanta’s Business — Interest Rate Risk”
for information on Covanta’s interest rate swap
derivative agreements.
Ref-Fuel is now a wholly-owned subsidiary of Covanta, and
Covanta controls the management and operations of the Ref-Fuel
facilities. The current project and other debt of Ref-Fuel
subsidiaries were not refinanced in connection with the
acquisition, except to the extent certain subsidiaries of
Ref-Fuel were required to repurchase outstanding notes, at a
premium of 101% of par value, from existing holders. The
principal amount of notes repurchased was $5.1 million and
was financed through cash on hand.
Our Business Strategy
With the acquisition of Covanta and Ref-Fuel, we have a
materially different business profile. Accordingly, our previous
strategy has changed from seeking opportunistic acquisitions to
focusing on Covanta taking a leadership role in the waste and
energy services business. Our “mission statement” is
to be a world-class waste disposal and energy generation company
by providing our clients safe, reliable, environmentally sound
and cost-effective service. See “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations — Executive Summary — Our
Business Strategy” for our plans to accomplish this
mission.
Business Segments
Set forth below is a description of our business operations as
of September 30, 2005, as presented in the Consolidated
Financial Statements included in this prospectus. We are engaged
in two primary business segments: the Waste and Energy Services
business of Covanta and Other Services, which includes our
parent company operations and insurance business. Each of these
segments are described below.
Additional information about our business segments is contained
in this prospectus under the heading “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations — Executive Summary — Business
Segments” and in Note 32 to the Notes to the
Audited Annual Financial Statements and Note 14 to the
Notes to the Unaudited Interim Financial Statements.
WASTE AND ENERGY SERVICES BUSINESS
Covanta develops, constructs, owns and operates for itself and
others infrastructure for the conversion of waste-to-energy,
independent power production and the treatment of water and
wastewater in the United States and abroad. Covanta owns or
operates 56 power generation facilities, 44 of which are in the
United States and twelve of which are located outside of
the United States. Covanta’s facilities use a variety of
fuels, including municipal solid waste, water (hydroelectric),
natural gas, coal, wood waste, landfill gas and heavy fuel oil.
Covanta operates water or wastewater treatment facilities, all
of which are located in the United States.
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Waste-to-Energy Projects
The essential purpose of Covanta’s waste-to-energy projects
is to provide waste disposal services, typically to municipal
clients who sponsor the projects. Generally, Covanta provides
these services pursuant to long-term service contracts. The
electricity or steam generally is sold pursuant to long-term
power purchase agreements with local utilities or industrial
customers, and most of the resulting revenues reduce the overall
cost of waste disposal services to the municipal clients. The
original terms of the service contracts are each 20 or more
years, with the majority now in the second half of the
applicable term. Most of Covanta’s service contacts may be
renewed for varying periods of time, at the option of the
municipal client. Covanta receives its revenue in the form of
fees pursuant to the service or waste contracts, and in some
cases, energy purchase agreements, at facilities it owns. In the
case of Covanta’s indirect, wholly-owned subsidiary,
TransRiver Marketing Company, L.P., this subsidiary markets to
third parties the portion of the waste disposal capacity of its
projects which is not utilized by the clients under such
long-term service contracts.
Domestic Waste and Energy Services Business
Covanta currently operates the waste-to-energy projects
identified below under “Domestic Project
Summaries.” Most of Covanta’s operating
waste-to-energy projects were developed and structured
contractually as part of competitive procurement conducted by
municipal entities. As a result, these projects have many common
features, which are described in “Structurally Similar
Waste-to-Energy Projects” below. Certain projects which
do not follow this model, or have been restructured, are
described in “Other Waste-to-Energy Project
Structures” below.
Covanta receives its revenue in the form of fees pursuant to
service agreements, and in some cases energy contracts, at
facilities it owns. Assuming the effectiveness of the extension
of agreements relating to the Hillsborough County, Florida
facility, Covanta’s service agreements begin to expire in
2008, and energy contracts at Covanta-owned projects generally
expire at or after the date on which that project’s service
agreement expires. As Covanta’s contracts expire it will
become subject to greater market risk in maintaining and
enhancing its revenues. As its service agreements at
municipally-owned facilities expire, Covanta intends to seek to
enter into renewal or replacement contracts to operate several
such facilities. Covanta also will seek to bid competitively in
the market for additional contracts to operate other facilities
as similar contracts of other vendors expire. As Covanta’s
service agreements at facilities it owns begin to expire, it
intends to seek replacement or additional contracts, and because
project debt on these facilities will be paid off at such time
Covanta expects to be able to offer rates that will attract
sufficient quantities of waste while providing acceptable
revenues to Covanta. At Covanta-owned facilities, the expiration
of existing energy contracts will require Covanta to sell its
output either into the local electricity grid at prevailing
rates or pursuant to new contracts. There can be no assurance
that Covanta will be able to enter into such renewals,
replacement or additional contracts, or that the terms available
in the market at the time will be favorable to Covanta. See
“Risk Factors — Waste and Energy Services
Business-Specific Risks — Covanta may face increased
risk of market influences on its domestic revenues after its
contracts expire.”
Covanta’s opportunities for growth by investing in new
projects will be limited by existing non-project debt covenants,
as well as by competition from other companies in the waste
disposal business. (For a discussion of such debt covenants see
Note 19 to the Notes to the Audited Annual Financial
Statements and Note 11 to the Notes to the Unaudited
Interim Financial Statements.) See “Risk
Factors — Waste and Energy Services Business-Specific
Risks — Our ability to grow our Waste and Energy
Services business may be limited.”
Structurally Similar
Waste-to-Energy Projects
Each service agreement is different to reflect the specific
needs and concerns of a client community, applicable regulatory
requirements and other factors. However, the following
description sets forth terms that are generally common to these
agreements:
| • | Covanta designs the facility, helps to arrange for financing and then constructs and equips the facility on a fixed price and schedule basis. |
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| • | Covanta operates the facility and generally guarantees it will meet minimum waste processing capacity and efficiency standards, energy production levels and environmental standards. Covanta’s failure to meet these guarantees or to otherwise observe the material terms of the service agreement (unless caused by the client community or by events beyond its control, referred to in this prospectus as “Unforeseen Circumstances”) may result in liquidated damages charged to Covanta or, if the breach is substantial, continuing and unremedied, the termination of the service agreement. In the case of such service agreement termination, Covanta may be obligated to pay material damages, including payments to discharge project indebtedness. | |
| • | The client community is generally required to deliver minimum quantities of municipal solid waste to the facility on a put-or-pay basis and is obligated to pay a service 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. This payment is due even if the counterparty delivers less than the full amount of waste promised. Portions of the service fee escalate to reflect indices of inflation. In many cases the client community must also pay for other costs, such as insurance, taxes and transportation and disposal of the residue to the disposal site. If the facility is owned by Covanta, the client community also pays as part of the service fee an amount equal to the debt service due to be paid on the bonds issued to finance the facility. 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 that the client community pay increased expenses and capital costs resulting from Unforeseen Circumstances, subject to limits which may be specified in the service agreement. | |
| • | The client community usually retains a portion of the energy revenues (generally 90%) generated by the facility, and pays the balance to Covanta. | |
Financing for Covanta’s domestic waste-to-energy projects
is generally accomplished through tax-exempt and taxable revenue
bonds issued by or on behalf of the client community. If the
facility is owned by a Covanta subsidiary, the client community
loans the bond proceeds to the subsidiary to pay for facility
construction and pays to the subsidiary amounts necessary to pay
debt service. For such facilities, project-related debt is
included as “project debt (short-and long-term)” in
our consolidated financial statements. Generally, such debt is
secured by the revenues pledged under the respective indentures
and is collateralized by the assets of Covanta’s subsidiary
with the only recourse to Covanta being related to construction
and operating performance defaults.
Covanta and certain of its subsidiaries have issued instruments
to their client communities and other parties which guarantee
that Covanta’s operating subsidiaries will perform in
accordance with contractual terms including, where required, the
payment of damages. Such contractual damages 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. For facilities
owned by client communities and operated by Covanta
subsidiaries, Covanta’s potential maximum liability as of
December 31, 2004 associated with the repayment of project
debt on such facilities was in excess of $1.0 billion. If
Covanta is asked to perform under one or more of such
guarantees, its liability for damages upon contract termination
would be reduced by funds held in trust and proceeds from sales
of the facilities securing the project debt which is presently
not estimable. To date, Covanta has not incurred material
liabilities under such guarantees.
Other Waste-to-Energy Project
Structures
| Haverhill, Massachusetts |
Covanta’s Haverhill, Massachusetts waste-to-energy facility
is not operated pursuant to a service agreement with a client
community. In this project, Covanta assumed the project debt and
risks relating to waste availability and pricing, risks relating
to the continued performance of the electricity purchaser, as
well as risks associated with unforeseen circumstances. Covanta
retains all of the energy revenues from sales of power and
disposal fees for waste accepted at this facility. Accordingly,
Covanta believes that this project carries both greater risks
and greater potential rewards than projects in which there is a
client community. The Haverhill facility receives approximately
80% of its waste under long-term agreements with over
18 communi-
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ties in northeastern Massachusetts (generally through 2011) or
other multi-year agreements. The balance of its waste is
delivered pursuant to short-term arrangements.
| Union, New Jersey |
In Union County, New Jersey, a municipally-owned facility has
been leased to Covanta, and the client community has agreed to
deliver approximately 50% of the facility’s capacity on a
put-or-pay basis. The balance of facility capacity is marketed
by Covanta at its risk. Covanta guarantees its subsidiary’s
contractual obligations to operate and maintain the facility,
and on one series of subordinated bonds, its obligations to make
lease payments which are the sole source for payment of
principal and interest on that series of bonds. As of
December 31, 2004, the current outstanding principal amount
of the subordinated bonds, sold to refinance a portion of the
original bonds used to finance the facility, was
$17.7 million. As a part of restructuring of this project,
the client community assigned to Covanta the long-term power
contract with the local utility. As part of this assignment, the
power contract was amended to give Covanta the right to sell all
or a portion of the plant’s output to other purchasers.
Since April 2002, Covanta has sold the majority of its output
directly into the regional electricity grid at market pricing
with the remainder of the electricity sold under short-term
contract when Covanta believes doing so would enhance this
project’s revenues.
| Alexandria, Virginia |
Covanta’s Alexandria, Virginia waste-to-energy facility is
operated pursuant to a service agreement with the City of
Alexandria, Virginia and Arlington County, Virginia and
authorities established by those communities, referred to as the
“Virginia Communities” in this prospectus. The
Virginia Communities pay a fixed tip fee, subject to certain
adjustments, for each ton of waste they are required to deliver
on a put-or-pay basis (about 65% of the facility’s
capacity). The balance of the waste is obtained by Covanta from
private haulers pursuant to short-term contracts or on a spot
basis. Covanta’s operating subsidiary receives all of the
electricity revenues received under the facility’s power
sales agreement and pays the debt service on the bonds issued to
finance the facility. The service agreement provides that if
income available for debt service, as calculated in accordance
with the service agreement, does not cover debt service, the
Virginia Communities will loan Covanta’s operating
subsidiary the amount of the shortfall. Any such loan is
required to be repaid from the project’s positive cash flow
in succeeding years and would have an ultimate maturity in 2023.
The interest rate on any such loan is six percent. Since the
Alexandria facility began operating in 1988, the Virginia
Communities have been required to extend such loans on four
occasions, the last of which was with respect to the operating
year ending June 1, 2001. All such loans have been fully
repaid within six months, and, as of December 31, 2004,
there were no outstanding loans to Covanta’s operating
subsidiary.
| Rochester, Massachusetts (SEMASS Project) |
The SEMASS facility is not operated pursuant to a service
agreement with a client community. A subsidiary of Covanta owns
90% of the SEMASS Partnership, which owns the SEMASS facility. A
separate operating subsidiary, the Semass Operator, operates the
SEMASS facility. The SEMASS operator has also contracted with
the SEMASS Partnership to operate a landfill owned by a third
party (which is used primarily for disposal of residue from the
SEMASS facility), a transfer station and a citizen drop off
center, which together with the SEMASS facility constitute a
coordinated waste disposal system. This system is a principal
disposal location in southeastern Massachusetts and its transfer
station is located near Boston. The SEMASS facility receives
approximately one-third of its waste under long-term service
agreements with over 40 communities in southeastern
Massachusetts (generally through 2016) or other multi-year
agreements. The balance of its waste is delivered pursuant to
short term arrangements. Electricity from the SEMASS facility is
sold to Commonwealth Electric Company (ComElec) under two power
sales agreement, which we refer to as “PSA I” and
“PSA II.” The term of PSA I and the term of
PSA II both end on December 31, 2015. PSA I covers
output from the SEMASS facility up to 47.7 megawatts.
PSA II covers the remaining output of the SEMASS facility
above 47.7 megawatts.
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| Niagara, New York |
Covanta’s operating subsidiary that is referred to as the
“Niagara Partnership” acquired the rights and
responsibilities relating to the Niagara, New York facility from
Occidental Chemical Corporation, referred to as
“Occidental” in this prospectus. The Niagara facility
originally was comprised of refuse-derived fuel, referred to as
“RDF” in this prospectus, boilers, but now includes
both RDF and mass-burn boilers. In addition, the Niagara
Partnership leases coal and oil-fired boilers from Occidental in
order to maintain back-up steam capacity. The Niagara
facility’s permits allow it to burn wood waste and
municipal solid waste. The Niagara Partnership receives its
waste supply under contracts of varying lengths. Electricity
from the Niagara facility may be sold to a local utility under a
power sales agreement expiring in 2014, which permits the
Niagara Partnership to sell the electrical output to any third
party chosen by the Niagara Partnership. The Niagara Partnership
currently sells all the electricity produced by the Niagara
facility and not used for internal use to Constellation Power
Source at a fixed price, pursuant to contracts which expire in
2007. The Niagara Partnership also sells steam to Occidental
pursuant to a contract which expires in 2013, but which may be
terminated beginning in 2007 in the event Occidental decides to
shut down its facilities. Additional steam sale agreements have
been entered into with other third parties. The Niagara facility
was financed with tax-exempt bonds which have mandatory tender
dates ranging from 2012 through 2015. ARC provides a guaranty of
the due and punctual payment of debt service on the Niagara
bonds. ARC has also provided a guaranty to Occidental of certain
of the Niagara Partnership’s obligations under the
Occidental steam agreement.
| Delaware County, Pennsylvania |
The Delaware Valley facility was previously owned by
Westinghouse Electric Corporation, which sold the facility to
and leased back from an owner trustee indirectly controlled by
General Electric Capital Corporation pursuant to a leveraged
lease. Covanta’s operating subsidiary that is referred to
as the “Delaware Partnership” became a successor
lessee and acquired rights and contracts relating to the
Delaware Valley facility through an assignment from Westinghouse
entities. The Delaware Valley facility receives waste under a
service agreement with the Delaware County Solid Waste
Authority, known as “DCSWA.” The obligations of the
DCSWA under the Delaware Valley service agreement are guaranteed
by Delaware County, Pennsylvania. The Delaware Valley facility
also obtains waste from private companies under spot and short
term contracts. Under the service agreement, Delaware County is
obligated to deliver and pay for disposal of approximately
303,000 tons per year of municipal solid waste and provide a
landfill for the disposal of certain waste and residue delivered
to or resulting from waste processing at the facility. Under the
service agreement, service fee payable to the Delaware
Partnership for disposal of waste consists of:
| • | $0 per ton for the first 267,000 tons per year; | |
| • | $84 (subject to escalation) for the next 36,000 tons per year; | |
| • | certain costs of insurance and, other fees; and | |
| • | approximately 56% of any costs arising out of uncontrollable circumstances. | |
The Delaware Partnership leases the Delaware Valley facility
through 2019. The Delaware Partnership is 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 this prospectus, 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 Westinghouse in connection
with the disposition of its interest in the Delaware Valley
facility. Pursuant to the terms of various guarantee agreements,
ARC has guaranteed the payments of Basic Rent B and Stipulated
Loss to the extent such payments are not made by 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 period of the lease.
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| Warren County, New Jersey |
The Covanta subsidiaries, referred to as “Covanta
Warren” in this prospectus, which operate Covanta’s
waste-to-energy facility in Warren County, New Jersey, referred
to as the “Warren Facility” in this prospectus, and
the Pollution Control Financing Authority of Warren County,
referred to as “Warren Authority” in this prospectus,
have been engaged in negotiations for an extended time
concerning a potential restructuring of the parties’ rights
and obligations under various agreements related to Covanta
Warren’s operation of the Warren Facility. Those
negotiations were in part precipitated by a 1997 federal court
of appeals decision invalidating certain of the State of New
Jersey’s waste-flow laws, which resulted in significantly
reduced revenues for the Warren Facility. Since 1999, the State
of New Jersey has been voluntarily making all debt service
payments with respect to the project bonds issued to finance
construction of the Warren Facility, and Covanta Warren has been
operating the Warren Facility pursuant to an agreement with the
Warren Authority which modifies the existing Service Agreement
for the Warren Facility.
Covanta Warren, the Warren Authority, and certain third parties
have reached a settlement of the various disputed matters among
them, and in September 2005 Covanta Warren filed a plan of
reorganization with the bankruptcy court based upon that
settlement. The material features of the settlement include the
following:
| • | Covanta Warren and Warren Authority will execute a global mutual release of all their obligations under the previous agreements between the two entities. | |
| • | The parties will enter into an amended agreement which will provide that Covanta Warren will deliver ash residue from the Warren Facility to the Warren Authority’s landfill, which is adjacent to the Warren Facility. Covanta Warren will be solely responsible for contracting for waste deliveries to the Warren facility. The Warren Authority will have no waste delivery obligations. | |
| • | The parties will cooperate in seeking permit modifications to expand the processing capacity of the Warren Facility. | |
| • | Covanta Warren and the municipality will enter into an amended host community agreement. | |
| • | Covanta Warren will pay the remaining project debt plus transaction and emergence costs, totaling approximately $15 million. Covanta will not be required to provide credit support or performance guarantees relating to the operation and maintenance of the Warren Facility. | |
| • | Covanta Warren will own the waste-to-energy facility and will make annual lease payment to the Warren Authority for the Warren Facility site. This lease for the site will have a 20-year term and will include an option to purchase the site. The annual lease payments of $250,000, subject to increase based on changes in the consumer price index, are also subject to reduction based on any fees, assessments or taxes payable by Covanta Warren to the Warren Authority or Warren County. | |
On December 1, 2005, the bankruptcy court confirmed Covanta
Warren’s reorganization plan and Covanta Warren emerged
from bankruptcy on December 15, 2005.
| Projects under Development |
| Hillsborough County, Florida |
Covanta designed, constructed and now operates and maintains
this 1,200 ton per day mass-burn waste-to-energy facility
located in and owned by Hillsborough County. Due to the growth
in the amount of solid waste generated in Hillsborough County,
Hillsborough County informed Covanta of its desire to expand the
facility’s waste processing and electricity generation
capacities, a possibility contemplated by the existing contract
between Covanta and Hillsborough County. On August 24,
2005, Covanta and Hillsborough County entered into agreements to
implement this expansion, and to extend the agreement under
which Covanta operates the facility through 2027. Environmental
and other project related permits will need to be secured and
financing completed, and certain other conditions satisfied,
prior to commencement of construction. At this time, there can
be no assurance that such conditions will be satisfied.
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| Lee County, Florida |
Covanta designed, constructed and now operates and maintains
this 1,200 ton per day mass-burn waste-to-energy facility
located in and owned by Lee County. Due to the growth in the
amount of solid waste generated in Lee County, Lee County has
informed Covanta of its desire to enlist Covanta to manage the
expansion of the facility’s waste processing and
electricity generation capacities, a possibility contemplated by
the existing contract between Covanta and Lee County. As part of
the proposed agreement to implement this expansion Covanta would
receive a long-term operating contract extension. Negotiations
are ongoing and contracts for construction of the expansion and
operation and maintenance of the expanded facility are still to
be finalized and approved by the parties. In addition, financing
for the expansion project must be completed. Lee County has
received the principal environmental permit for the expansion.
At this time, there can be no assurance that any definitive
agreements will be finalized or approved by the parties or that
Lee County will, in fact, expand the facility.
| Honolulu, Hawaii |
This 2,160 ton per day refuse derived fuel facility was designed
and constructed by an entity not related to Covanta.
Subsequently, Covanta purchased the rights to operate and
maintain the facility on behalf of the City and County of
Honolulu. Previously, the City and County of Honolulu had
informed Covanta of their desire to expand the facility’s
waste processing capacity, a possibility contemplated by the
existing contract between Covanta and the City and the County of
Honolulu. However, more recently the City and County of Honolulu
may be reconsidering their desire to expand their facility and
are evaluating alternatives to accommodate their waste disposal
needs. At this time, there can be no assurance that any
definitive agreements will be finalized or approved by the
parties or that the City and the County of Honolulu will, in
fact, expand the facility.
| Independent Power Projects |
As mentioned in the overview of Covanta’s independent power
projects earlier in this prospectus, Covanta is also engaged
domestically in developing, owning and/or operating independent
power production facilities utilizing a variety of energy
sources including water (hydroelectric), waste wood
(biomass) and landfill gas. The electrical output from each
facility, with one exception, is sold to local utilities.
Covanta’s revenue from the independent power production
facilities is derived primarily from the sale of energy and
capacity under energy contracts.
The regulatory framework for selling power to utilities from
independent power facilities (including waste-to-energy
facilities) after current contracts expire is in flux, given the
energy crisis in California in 2000 and 2001, the over-capacity
of generation at the present time in many markets and the
uncertainty as to the adoption of new federal energy
legislation. Various states and Congress are considering a wide
variety of changes to regulatory frameworks, but none has been
established definitively at present.
| Hydroelectric |
Covanta owns a 50% equity interest in two run-of-river
hydroelectric facilities, Koma Kulshan and Weeks Falls, which
have a combined gross capacity of 17 MW. Both Koma Kulshan
and Weeks Falls are located in Washington State and both sell
energy and capacity to Puget Sound Power & Light
Company under long-term energy contracts. A subsidiary of
Covanta provides operation and maintenance services to the Koma
Kulshan partnership under a cost plus fixed fee agreement.
During the first quarter of 2004, Covanta operated the New
Martinsville facility in West Virginia, a 40 MW
run-of-river project pursuant to a short-term Interim Operations
and Maintenance Agreement which expired March 31, 2004.
Covanta chose not to renew the lease on the project, the term of
which expired in October 2003.
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| Waste Wood |
Covanta owns 100% interests in Burney Mountain Power, Mt. Lassen
Power, and Pacific Oroville Power, three wood-fired generation
facilities in northern California. A fourth facility, Pacific
Ultrapower Chinese Station, is owned by a partnership in which
Covanta holds a 50% interest. Fuel for the facilities is
procured from local sources primarily through short-term supply
agreements. The price of the fuel varies depending on time of
year, supply and price of energy. These projects have a gross
generating capacity of 67 MW and sell energy and capacity
to Pacific Gas & Electric under energy contracts. Until
July 2001 these facilities were receiving Pacific Gas &
Electric’s short run avoided cost for energy delivered.
However, beginning in July 2001 these facilities entered into
five-year fixed-price periods pursuant to energy contract
amendments.
| Landfill Gas |
Covanta has interests in and/or operates seven landfill gas
projects which produce electricity by burning methane gas
produced in landfills. The Otay, Oxnard, Salinas, Stockton,
Toyon and Santa Clara projects are located in California,
and the Gude project is located in Maryland. The seven projects
have a total gross capacity of 19.9 MW. The Gude facility
energy contract has expired and the facility is currently
selling its output into the regional utility grid. The remaining
six projects sell energy and contracted capacity to various
California utilities. The Salinas, Stockton and Santa Clara
energy contracts expire in 2007. The Otay and Oxnard energy
contracts expire in 2011. Upon the expiration of the energy
contracts, it is expected that these projects will enter into
new power off take arrangements or the projects will be shut
down. During the fourth quarter of 2004, Covanta sold its
interests in the Penrose and Toyon landfill gas projects,
located in California and a subsidiary of Covanta will continue
to operate the Toyon project under an agreement which expires in
2007.
| Water Operations |
Covanta designed, built and now continues to operate and
maintain a 24 million gallon per day, or as such
measurement system is used in this prospectus 24
“mgd,” potable water treatment facility and associated
transmission and pumping equipment that supplies water to
residents and businesses in Bessemer, Alabama, a suburb of
Birmingham. Under a long-term contract with the Governmental
Services Corporation of Bessemer, Covanta received a fixed price
for design and construction of the facility, and it is paid a
fixed fee plus pass-through costs for delivering processed water
to Bessemer’s water distribution system.
Between 2000 and 2002, Covanta was awarded contracts to supply
its patented
DualSandtm
microfiltration system to twelve municipalities in upstate New
York as the primary technological improvement necessary to
upgrade their existing water and wastewater treatment systems.
Five of these upgrades were made in connection with the United
States Environmental Protection Agency and New York City
Department of Environmental Protection, a $1.4 billion
program to protect and enhance the drinking water supply, or
watershed, for New York City. These
DualSandtm
microfiltration system contracts for upgrades have been
completed and non-material payment issues are currently being
discussed by, and may be litigated between, Covanta and the New
York City Department of Environmental Protection in order to
close out these contracts. Covanta does not expect to enter into
further contracts for such projects in the New York City
watershed.
| Domestic Project Dispositions in 2004 |
| Tampa Bay, Florida |
During 2003, Covanta Tampa Construction, Inc., referred to as
“CTC” in this prospectus, completed construction of a
25 mgd desalination-to-drinking water facility under a
contract with Tampa Bay Water, referred to as “TBW” in
this prospectus, near Tampa, Florida. Covanta Energy Group, Inc.
guaranteed CTC’s performance under its construction
contract with TBW. A separate subsidiary, Covanta Tampa Bay,
Inc., referred to as “CTB” in this prospectus, entered
into a contract with TBW to operate the Tampa Water Facility
after construction and testing is completed by CTC. As
construction of the Tampa Water Facility
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neared completion, the parties had material disputes between
them. These disputes led to TBW issuing a default notice to CTC
and shortly thereafter CTC filed a voluntary petition for relief
under Chapter 11.
In February 2004, Covanta and TBW reached a tentative compromise
of their disputes which was approved by the Bankruptcy Court. On
July 14, 2004, the Bankruptcy Court confirmed a plan of
reorganization for CTC and CTB, which incorporated the terms of
the settlement between Covanta and TBW. That plan became
effective on August 6, 2004 when CTC and CTB emerged from
bankruptcy. After payment of certain creditor claims under the
CTC and CTB plan, Covanta realized approximately $4 million
of the proceeds from the settlement with TBW. Under the terms of
the plan of reorganization CTB will not operate the Tampa Water
Facility, and Covanta will have no continuing obligations with
respect to this project.
| Transfers of Waste Water Project Contracts |
Covanta formerly operated and maintained wastewater treatment
facilities on behalf of seven small municipal and industrial
customers in upstate New York. During 2004, Covanta disposed of
these assets through assignment, transfer or contract
expiration. In addition, some of these contracts are short-term
agreements which were by their terms terminated by the
counterparty on notice that the counterparty no longer desired
to continue receiving service from Covanta.
| Sales of Landfill Gas Assets |
During the fourth quarter of 2004, Covanta sold its ownership
interests in two small landfill gas projects, the Penrose
project and the Toyon project, located in southern California.
These sales occurred following a determination by Covanta that
it would either cease operating these projects or sell them to
third parties who would upgrade them to meet new regulatory
requirements and run them to generate renewable energy. Covanta
received a total of approximately $0.5 million for the two
projects.
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| Domestic Project Summaries |
Summary information with respect to Covanta’s domestic
projects(1) that are currently operating, is provided in the
following table:
| Waste | Gross | Date of | ||||||||||||||||||||
| Processing | Electric | Acquisition/ | ||||||||||||||||||||
| Capacity | Output | Commencement | ||||||||||||||||||||
| Location | (Ton/Day) | (MW) | Nature of Interest(1) | of Operations | ||||||||||||||||||
|
A.
|
MUNICIPAL SOLID WASTE | |||||||||||||||||||||
|
1.
|
Marion County | Oregon | 550 | 13.1 | Owner/Operator | 1987 | ||||||||||||||||
|
2.
|
Hillsborough County | Florida | 1,200 | 29.0 | Operator | 1987 | ||||||||||||||||
|
3.
|
Hartford(5)(6) | Connecticut | 2,000 | 68.5 | Operator | 1987 | ||||||||||||||||
|
4.
|
Bristol | Connecticut | 650 | 16.3 | Owner/Operator | 1988 | ||||||||||||||||
|
5.
|
Alexandria/ Arlington | Virginia | 975 | 22.0 | Owner/Operator | 1988 | ||||||||||||||||
|
6.
|
Indianapolis(2) | Indiana | 2,362 | 6.5 | Owner/Operator | 1988 | ||||||||||||||||
|
7.
|
Warren County(5) | New Jersey | 400 | 11.8 | Owner/Operator | 1988 | ||||||||||||||||
|
8.
|
Hennepin County(5) | Minnesota | 1,212 | 38.7 | Operator | 1989 | ||||||||||||||||
|
9.
|
Stanislaus County | California | 800 | 22.4 | Owner/Operator | 1989 | ||||||||||||||||
|
10.
|
Babylon | New York | 750 | 16.8 | Owner/Operator | 1989 | ||||||||||||||||
|
11.
|
Haverhill | Massachusetts | 1,650 | 44.6 | Owner/Operator | 1989 | ||||||||||||||||
|
12.
|
Wallingford(5) | Connecticut | 420 | 11.0 | Owner/Operator | 1989 | ||||||||||||||||
|
13.
|
Kent County | Michigan | 625 | 16.8 | Operator | 1990 | ||||||||||||||||
|
14.
|
Honolulu(4)(5) | Hawaii | 1,851 | 57.0 | Lessee/Operator | 1990 | ||||||||||||||||
|
15.
|
Fairfax County | Virginia | 3,000 | 93.0 | Owner/Operator | 1990 | ||||||||||||||||
|
16.
|
Huntsville(2) | Alabama | 690 | — | Operator | 1990 | ||||||||||||||||
|
17.
|
Lake County | Florida | 528 | 14.5 | Owner/Operator | 1991 | ||||||||||||||||
|
18.
|
Lancaster County | Pennsylvania | 1,200 | 33.1 | Operator | 1991 | ||||||||||||||||
|
19.
|
Pasco County | Florida | 1,050 | 29.7 | Operator | 1991 | ||||||||||||||||
|
20.
|
Huntington(3) | New York | 750 | 24.3 | Owner/Operator | 1991 | ||||||||||||||||
|
21.
|
Detroit(2)(4)(5) | Michigan | 2,832 | 68.0 | Lessee/Operator | 1991 | ||||||||||||||||
|
22.
|
Union County(7) | New Jersey | 1,440 | 42.1 | Lessee/Operator | 1994 | ||||||||||||||||
|
23.
|
Lee County | Florida | 1,200 | 36.9 | Operator | 1994 | ||||||||||||||||
|
24.
|
Onondaga County(3) | New York | 990 | 36.8 | Owner/Operator | 1995 | ||||||||||||||||
|
25.
|
Montgomery County | Maryland | 1,800 | 63.4 | Operator | 1995 | ||||||||||||||||
|
26.
|
Delaware Valley(7) | Pennsylvania | 2,688 | 79 | Lessee/Operator | 2005 | ||||||||||||||||
|
27.
|
Essex County | New Jersey | 2,700 | 70 | Owner/Operator | 2005 | ||||||||||||||||
|
28.
|
Hempstead | New York | 2,671 | 72 | Owner/Operator | 2005 | ||||||||||||||||
|
29.
|
Niagara | New York | 2,250 | 50 | Owner/Operator | 2005 | ||||||||||||||||
|
30.
|
Southeast Connecticut | Connecticut | 689 | 18 | Owner/Operator | 2005 | ||||||||||||||||
|
31.
|
Southeast Massachusetts | Massachusetts | 2,700 | 79 | Owner/Operator | 2005 | ||||||||||||||||
| SUBTOTAL | 1184.3 | |||||||||||||||||||||
|
B.
|
HYDROELECTRIC | |||||||||||||||||||||
|
32.
|
Koma Kulshan(8) | Washington | 12.0 | Part Owner/Operator | 1997 | |||||||||||||||||
|
33.
|
Weeks Falls(8) | Washington | 5.0 | Part Owner | 1997 | |||||||||||||||||
| SUBTOTAL | 17.0 | |||||||||||||||||||||
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| Waste | Gross | Date of | ||||||||||||||||||||
| Processing | Electric | Acquisition/ | ||||||||||||||||||||
| Capacity | Output | Commencement | ||||||||||||||||||||
| Location | (Ton/Day) | (MW) | Nature of Interest(1) | of Operations | ||||||||||||||||||
|
C.
|
WOOD | |||||||||||||||||||||
|
34.
|
Burney Mountain | California | 11.4 | Owner/Operator | 1997 | |||||||||||||||||
|
35.
|
Pacific Ultrapower Chinese Station(8) | California | 25.6 | Part Owner | 1997 | |||||||||||||||||
|
36.
|
Mount Lassen | California | 11.4 | Owner/Operator | 1997 | |||||||||||||||||
|
37.
|
Pacific Oroville | California | 18.7 | Owner/Operator | 1997 | |||||||||||||||||
| SUBTOTAL | 67.1 | |||||||||||||||||||||
|
D.
|
LANDFILL GAS | |||||||||||||||||||||
|
38.
|
Gude | Maryland | 3.0 | Owner/Operator | 1997 | |||||||||||||||||
|
39.
|
Otay | California | 3.7 | Owner/Operator | 1997 | |||||||||||||||||
|
40.
|
Oxnard | California | 5.6 | Owner/Operator | 1997 | |||||||||||||||||
|
41.
|
Salinas | California | 1.5 | Owner/Operator | 1997 | |||||||||||||||||
|
42.
|
Santa Clara | California | 1.5 | Owner/Operator | 1997 | |||||||||||||||||
|
43.
|
Stockton | California | 0.8 | Owner/Operator | 1997 | |||||||||||||||||
|
44.
|
Toyon(9) | California | 3.8 | Operator | 1997 | |||||||||||||||||
| SUBTOTAL | 19.9 | |||||||||||||||||||||
| TOTAL DOMESTIC GROSS MW IN OPERATION | 1,288.3 | |||||||||||||||||||||
|
E.
|
WATER | |||||||||||||||||||||
|
45.
|
Bessemer | Alabama | 24mgd | Design/Build/Operate | 2000 | |||||||||||||||||
| (1) | Covanta’s ownership and/or operation interest in each facility listed in this table extends at least into calendar year 2007. |
| (2) | Facility has been designed to export steam for sale. |
| (3) | Owned by a limited partnership in which the limited partners are not affiliated with Covanta. |
| (4) | Operating contracts were acquired after completion. Facility uses a refuse-derived fuel technology and does not employ the Martin technology described below. |
| (5) | Covanta subsidiaries were purchased after construction completion. |
| (6) | Under contracts with the Connecticut Resource Recovery Authority, Covanta operates only the boilers and turbines for this facility. |
| (7) | The facility is leased to a Covanta subsidiary. |
| (8) | Covanta has a 50% ownership interest in the project. |
| (9) | Covanta owned this project from 1997 until its sale in the fourth quarter of 2004. Covanta continues to operate the project under a contract expiring in 2006. |
International Waste and Energy Services Business
Covanta conducts its international energy businesses through
CPIH and its subsidiaries. Internationally, the largest element
of Covanta’s energy business is its 26.2% ownership in and
operation of the 460 MW (net) pulverized coal-fired
electrical generating facility in Quezon Province, the
Philippines. Covanta has interests in other fossil-fuel
generating projects in Asia, a waste-to-energy project in Italy
and two small hydroelectric projects in Costa Rica. In general,
these projects provide returns primarily from equity
distributions and, to a lesser extent, operating fees. The
projects sell the electricity and steam they generate under
long-term contracts or market concessions to utilities,
governmental agencies providing power distribution, creditworthy
industrial users, or local governmental units. In select cases,
such sales of electricity and steam may be
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provided under short-term arrangements as well. Similarly,
Covanta seeks to obtain long-term contracts for fuel supply from
reliable sources.
Covanta presently has interests in international power projects
with an aggregate generating capacity of approximately
1061 MW (gross). Covanta’s ownership in these
facilities is approximately 461 MW. In addition to its
headquarters in Fairfield, New Jersey, Covanta’s business
is facilitated through field offices in Shanghai, China;
Chennai, India; Manila, the Philippines; and Bangkok, Thailand.
In August 2004, Covanta sold its 50% equity interest in a
15 MW natural gas-fired cogeneration project in the
province of Murcia, Spain and terminated its operations and
maintenance agreement for the facility.
| General Approach to International Projects |
In developing its international businesses, Covanta has employed
the same general approach to projects as is described above with
respect to domestic projects. While Covanta intends to focus its
business primarily in domestic markets, it may seek to develop
or participate in additional international projects,
particularly waste to energy projects. Covanta’s new
financing arrangements place limitations on investments and
borrowings Covanta may make in connection with such projects.
The ownership and operation of facilities in foreign countries
in connection with Covanta’s international business entails
significant political and financial uncertainties that typically
are not encountered in such activities in the United States. Key
international risk factors include governmentally-sponsored
efforts to renegotiate long-term contracts, non-payment of fees
and other monies owed to Covanta, unexpected changes in
electricity tariffs, conditions in financial markets, changes in
the markets for fuel, currency exchange rates, currency
repatriation restrictions, currency convertibility, changes in
laws and regulations and political, economic or military
instability, civil unrest and expropriation. Such risks have the
potential to cause material impairment to the value of
Covanta’s international businesses.
Many of the countries in which Covanta operates are lesser
developed countries or developing countries. The political,
social and economic conditions in some of these countries are
typically less stable than those in the United States. The
financial condition and creditworthiness of the potential
purchasers of power and services provided by Covanta (which may
be a governmental or private utility or industrial consumer) or
of the suppliers of fuel for projects in these countries may not
be as strong as those of similar entities in developed
countries. The obligations of the purchaser under the energy
contract, the service recipient under the related service
agreement and the supplier under the fuel supply agreement
generally are not guaranteed by any host country or other
creditworthy governmental agency. At the time it develops a
project, Covanta undertakes a credit analysis of the proposed
power purchaser or fuel supplier. It also has sought, to the
extent appropriate and achievable within the commercial
parameters of a project, to require such entities to provide
financial instruments such as letters of credit or arrangements
regarding the escrowing of the receivables of such parties in
the case of power purchasers.
Covanta’s power projects in particular depend on reliable
and predictable delivery of fuel meeting the quantity and
quality requirements of the project facilities. Covanta has
typically sought to negotiate long-term contracts for the supply
of fuel with creditworthy and reliable suppliers. However, the
reliability of fuel deliveries may be compromised by one or more
of several factors that may be more acute or may occur more
frequently in developing countries than in developed countries,
including a lack of sufficient infrastructure to support
deliveries under all circumstances; bureaucratic delays in the
import, transportation and storage of fuel in the host country;
customs and tariff disputes; and local or regional unrest or
political instability. In most of the foreign projects in which
Covanta participates, it has 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 its operating responsibilities under the
applicable agreements and an extension of its operating
concession under such agreements. In some instances, Covanta
requires the energy purchaser or service recipient to continue
to make payments in respect of fixed costs if such interruptions
occur. In order to mitigate the effect of short-term
interruptions in the supply of fuel, Covanta has also endeavored
to provide on-site storage of fuel in sufficient quantities to
address such interruptions.
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Payment for services that Covanta provides will often be made in
whole or part in the domestic currencies of the host countries.
Conversion of such currencies into U.S. dollars generally
is not assured by a governmental or other creditworthy country
agency and 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 Covanta’s
participation in such projects to yield less return than
expected. Transfer of earnings and profits in any form beyond
the borders of the host country may be subject to special taxes
or limitations imposed by host country laws. Covanta has sought
to participate in projects in jurisdictions where limitations on
the convertibility and expatriation of currency have been lifted
by the host country and where such local currency is freely
exchangeable on the international markets. In most cases,
components of project costs incurred or funded in the currency
of the United States 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.
Covanta has sought to manage and mitigate these risks through
all means that it deems appropriate, including: 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; participation by United States and/or international
development finance institutions in the financing of projects in
which Covanta participates; and joint ventures with other
companies to pursue the development, financing and construction
of these projects. Covanta determines which mitigation measurers
to apply based on its balancing of the risk presented, the
availability of such measures and their cost.
In addition, Covanta has 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. There is therefore 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.
In certain cases, Covanta has issued guarantees of its operating
subsidiaries contractual obligations to operate certain
international power projects. The potential damages owed under
such arrangements for international projects may be material if
called. 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 greater than Covanta’s then-available
sources of funds. To date, Covanta has not incurred any material
liabilities under its guarantees on international projects.
The following is a description of Covanta’s international
power projects by fuel type:
| Waste-to-Energy |
During 2000, Covanta acquired a 13% equity interest in an
18 MW mass-burn waste-to-energy project at Trezzo
sull’Adda in the Lombardy Region of Italy which burns up to
500 metric tons per day of municipal solid waste. The remainder
of the equity in the project is held by Actelios S.p.A., a
subsidiary of Falck S.p.A. and the municipality of Trezzo
sull’Adda. The Trezzo project is operated by Ambiente 2000
S.r.l., referred to as “A2000,” an Italian special
purpose limited liability company of which Covanta owns 40%. The
solid waste supply for the project comes from municipalities and
privately owned waste management organizations 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 grid
operator, Gestore della Rete di Trasmissione Nazionale S.p.A.,
referred to as “GRTN.” The project started accepting
waste in September 2002, successfully passed its performance
tests in early 2003 and reached full commercial operation in
August 2003. The late completion of the plant by the
engineering, procurement and construction contractor, Protecma,
represents a non-compliance with the terms of the contract with
Protecma, and arbitration proceedings are currently underway
with regard to amounts withheld by the project company, Prima
Srl, in
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respect of penalties for late delivery of the plant. The project
debt facility was refinanced in September 2004 with a new
limited recourse project term loan and working capital facility
from a banking consortium led by Banca Nazionale del Lavoro
S.p.A.
In January 2001, A2000 also entered into a 15-year operations
and maintenance agreement with E.A.L.L (Energia Ambiente
Litorale Laziale S.r.l.), an Italian limited liability company
owned by Ener TAD, to operate and maintain a 10 MW
waste-to-energy facility capable of processing up to 300 metric
tons per day of refuse-derived fuel in the Municipality of
San Vittore del Lazio (Frosinone), Italy. The
San Vittore project has a 15-year waste supply agreement
with Reclas S.p.A. (mostly owned by regional municipalities) and
a long-term power off-take contract with GRTN. The project is
now in its third year of operation. There was a significant
delay in starting up the plant after construction was complete
due to a legal action by an environmental group that has
subsequently been overturned. Operation and maintenance of the
plant by A2000 was scheduled to commence in the third quarter of
2004 but has been delayed due to a dispute between the owner and
operator as to the validity of the operations and maintenance
agreement. Arbitration proceedings have commenced to settle the
dispute.
| Hydroelectric |
Covanta operates the Don Pedro and the Rio Volcan facilities in
Costa Rica through an operating subsidiary pursuant to long-term
contracts. Covanta also has 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 consortium, of which Covanta is a 26% member, owns a
510 MW (gross) coal-fired electric generating facility in
the Philippines, referred to as the “Quezon Project”
in this prospectus. The project first generated electricity in
October 1999 and full commercial operation occurred during the
second quarter of 2000. The other members of the consortium are
an affiliate of International Generating Company, an affiliate
of General Electric Capital Corporation, and PMR Limited Co., a
Philippines partnership. The consortium sells electricity to
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 produced by the facility at an all-in tariff which
consists of capacity, operating, energy, transmission and other
fees adjusted to inflation, fuel cost and foreign exchange
fluctuations. The consortium has entered into two coal supply
contracts expiring in 2015 and 2022. Under these supply
contracts, cost of coal is determined using a base energy price
adjusted to fluctuations of specified international benchmark
prices. Covanta is operating the project through a local
subsidiary under a long-term agreement with the consortium.
The financial condition of Meralco has been recently stressed by
the failure of regulators to grant tariff increases to allow
Meralco to achieve rates of return permitted by law. For further
discussion, see additional information in this prospectus under
the heading “Management’s Discussion and Analysis
of Financial Condition and Results of Operations —
Management’s Discussion and Analysis of Liquidity and
Capital Resources — Waste and Energy Services
Segment — Other Commitments” Covanta has
obtained political risk insurance for its equity investment in
this project.
Covanta has majority equity interests in three coal-fired
cogeneration facilities in three provinces in the People’s
Republic of China. Two of these projects are operated by the
project entity, in which Covanta has a majority interest. The
third project is operated by an affiliate of the minority equity
shareholder. Parties holding minority positions in the projects
include a private company, a local government enterprise and
affiliates of the local municipal government. In connection with
one of these projects, the local People’s Congress has
enacted a non-binding resolution calling for the relocation of
the cogeneration facility from the city center to an industrial
zone. The project company is currently reviewing its options in
this matter. While the steam produced at each of the three
projects is intended to be sold under long-term contracts to the
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industrial hosts, in practice, steam has been sold on either a
short-term basis to local industries or the industrial hosts, in
each case at varying rates and quantities. For two of these
projects, the electric power is sold at “average grid
rate” to a subsidiary of the Provincial Power Bureau. At
one project, the electric power is sold directly to an
industrial customer at a similar rate. In 2004, Covanta
discontinued political risk insurance for its equity investment
in these projects.
| Natural Gas |
In 1998, Covanta acquired an equity interest in a barge-mounted
126 MW (gross) diesel/natural gas-fired facility located
near Haripur, Republic of Bangladesh. This project began
commercial operation in June 1999 and is operated by a
subsidiary of Covanta. Covanta owns approximately 45% of the
project company equity. An affiliate of El Paso Energy
Corporation owns 50% of such equity, and the remaining interest
is held by Wartsila North America, Inc. The electrical output of
the project is sold to the Bangladesh Power Development Board,
referred to as “BPDB” in this prospectus, pursuant to
an energy contract with minimum energy off-take provisions at a
tariff 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 adjusted to actual load factor and foreign exchange
fluctuations. The energy contract also obligates the BPDB to
supply all the natural gas requirements of the project at a
pre-determined base cost adjusted to fluctuations on actual
landed cost of the fuel in Bangladesh. The BPDB’s
obligations under the agreement are guaranteed by the Government
of Bangladesh. In 1999, the project received $87 million in
financing and political risk insurance from the Overseas Private
Investment Corporation, referred to as “OPIC” in this
prospectus. Covanta obtained separate political risk coverage
for its equity interest in this project. In 2004, the project
obtained from OPIC the extension of an existing waiver
permitting it to continue to forego obtaining certain project
insurance coverage levels that are not presently commercially
available.
| Diesel/Heavy Fuel Oil |
In 1999, Covanta acquired an equity interest in a 106 MW
(gross) heavy fuel oil-fired generating facility located near
Samalpatti, Tamil Nadu, India. This project achieved commercial
operation during the first quarter of 2001. The project is
operated by a subsidiary of Covanta. Covanta owns a 60% interest
in the project company. Shapoorji Pallonji Infrastructure
Capital Co. Ltd. and its affiliates own 29% of such equity with
the remainder of 11% being held by Wartsila India Power
Investment, LLC. The electrical output of the project is sold to
the Tamil Nadu Electricity Board, referred to as the
“TNEB” in this prospectus, pursuant to a long-term
agreement with full pass-through tariff at a specified heat
rate, operation and maintenance cost, and return on equity. The
TNEB’s obligations are guaranteed by the government of the
State of Tamil Nadu. Bharat Petroleum Corporation, Ltd. supplies
the oil requirements of the project through a 15 year fuel
supply agreement based on market prices.
In 2000, Covanta acquired a controlling interest in a second
project in India, the 106 MW Madurai project located at
Samayanallur in the State of Tamil Nadu, India. The project
began commercial operation in the fourth quarter of 2001.
Covanta owns approximately 76.6% of the project equity and
operates the project through a subsidiary. The balance of the
project ownership interest is held by an Indian company
controlled by the original project developer. The electrical
output of the project is sold to the TNEB pursuant to a
long-term agreement with full pass-through tariff at a specified
heat rate, operation and maintenance cost, and return on equity.
The TNEB’s obligations are guaranteed by the government of
the state of Tamil Nadu. Indian Oil Corporation, Ltd. supplies
the oil requirements of the project through 15-year fuel supply
agreement based on market prices.
Disputing several tariff provisions, the TNEB has failed to pay
the full amount due under the energy contracts for both the
Samalpatti and Madurai projects. Similar to many Indian state
electricity boards, the TNEB has also failed to fund the escrow
account or post the letter of credit required under the project
energy contracts, which failure constitutes a default under the
project finance documents. The project lenders for both projects
have not declared an event of default due to this matter and
have permitted continued distributions of project dividends. To
date, the TNEB has paid the undisputed portion of its payment
obligations (approxi-
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mately 95%) representing each project’s operating costs,
fuel costs, debt service and some equity return. 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 Covanta’s recourse debt. Further, during 2004 CPIH
was able to refinance a significant portion of the original
project debt for both projects. While the tenor and the
covenants remain the same, each project has been able to lower
its interest costs substantially, resulting in reduced tariffs
to the TNEB. The TNEB has indicated a desire to renegotiate
tariffs for both project energy contracts, and it is possible
that the issue of the escrow account or letter of credit
requirement will be resolved as part of any such process.
Covanta owns a minority interest in the Island Power project, a
7 MW facility that has a long-term power contract.
International Project
Summaries
Summary information with respect to Covanta’s projects(1)
that are currently operating is provided in the following table:
| Gross | Date of | |||||||||||||||||
| Electric | Acquisition/ | |||||||||||||||||
| Output | Commencement | |||||||||||||||||
| Location | (MW) | Nature of Interest(1) | of Operations | |||||||||||||||
|
A
|
WASTE-TO-ENERGY | |||||||||||||||||
|
1.
|
Trezzo(2) | Italy | 18 | Part Owner/Operator | 2003 | |||||||||||||
|
2.
|
San Vittore(3) | Italy | 10 | Operator | 2006 | (est.) | ||||||||||||
| SUBTOTAL | 28 | |||||||||||||||||
|
B.
|
HYDROELECTRIC | |||||||||||||||||
|
3.
|
Rio Volcan(4) | Costa Rica | 17 | Part Owner/Operator | 1997 | |||||||||||||
|
4.
|
Don Pedro(4) | Costa Rica | 14 | Part Owner/Operator | 1996 | |||||||||||||
| SUBTOTAL | 31 | |||||||||||||||||
|
C.
|
COAL | |||||||||||||||||
|
5.
|
Quezon(5) | the Philippines | 510 | Part Owner/Operator | 2000 | |||||||||||||
|
6.
|
Lin’an(7) | China | 24 | Part Owner/Operator | 1997 | |||||||||||||
|
7.
|
Huantai(6) | China | 36 | Part Owner | 1997 | |||||||||||||
|
8.
|
Yanjiang(8) | China | 24 | Part Owner/Operator | 1997 | |||||||||||||
| SUBTOTAL | 594 | |||||||||||||||||
|
D.
|
NATURAL GAS | |||||||||||||||||
|
9.
|
Haripur(9) | Bangladesh | 126 | Part Owner/Operator | 1999 | |||||||||||||
|
E.
|
DIESEL/ HEAVY FUEL OIL | |||||||||||||||||
|
10.
|
Island Power Corporation(10) | the Philippines | 7 | Part Owner | 1996 | |||||||||||||
|
11.
|
Magellan Cogeneration(11) | the Philippines | 63 | Owner/Operator | 1999 | |||||||||||||
|
12.
|
Samalpatti(6) | India | 106 | Part Owner/Operator | 2001 | |||||||||||||
|
13.
|
Madurai(12) | India | 106 | Part Owner/Operator | 2001 | |||||||||||||
| SUBTOTAL | 282 | |||||||||||||||||
| TOTAL INTERNATIONAL MW IN OPERATION | 1,061 | |||||||||||||||||
| (1) | Covanta’s ownership and/or operation interest in each facility listed below extends at least into calendar year 2007. | |
| (2) | Covanta has a 13% interest in this project and a 40% interest in the operator Ambiente 2000 S.r.l. “A2000.” | |
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| (3) | Operation by A2000 begins one year after the project begins commercial operation provided certain criteria are satisfied. | |
| (4) | Covanta has a nominal ownership interest in this project. | |
| (5) | Covanta has an approximate 26% ownership interest in this project. | |
| (6) | Covanta has a 60% ownership interest in these projects. | |
| (7) | Covanta has an approximate 64% ownership interest in this project. | |
| (8) | Covanta has an approximate 96% ownership interest in this project. | |
| (9) | Covanta has an approximate 45% ownership interest in this project. This project is capable of operating through combustion of diesel oil in addition to natural gas. | |
| (10) | Covanta has an approximate 19.6% ownership interest in this project. |
| (11) | This project is in Corporate Rehabilitation proceedings. Under the Rehabilitation Plan approved by the Court, Covanta’s ownership interest will be reduced from 100% to approximately 30%. |
| (12) | Covanta has an approximate 77% ownership interest in this project. |
OTHER SERVICES BUSINESS
Discussion of Parent-Level Business
Given the significance of the Covanta and Ref-Fuel acquisitions
to our business results of operations and financial condition,
we decided, during the third quarter of 2005, to combine the
previously separate business segments of our insurance business
and our parent-level operations into one reportable segment
referred to as “Other Services.”
The Other Services segment is comprised of our insurance
business, which writes property and casualty insurance in
California, and the parent company operations. The operations of
the parent company prior to the acquisition of Covanta on
March 10, 2004, primarily included general and
administrative expense related to officer salaries, legal and
other professional fees and insurance. Subsequent to the
acquisition of Covanta, these expenses are reimbursed by Covanta
under an administrative services agreement. The parent company
operations also include income earned on its investments.
Prior to the Covanta acquisition, our strategy had been to grow
by developing business partnerships and making strategic
acquisitions. Following the Covanta acquisition, our strategy
has been to concentrate on increasing value in Covanta’s
core waste-to-energy business.
As of December 31, 2004, we had consolidated NOLs of
approximately $516 million. This estimate was based upon
federal consolidated income tax losses for the periods through
December 31, 2003 and an estimate of the 2004 taxable
results. Some or all of the carryforward may be available to
offset, for federal income tax purposes, the future taxable
income, if any, of us, our wholly-owned subsidiaries and the
Mission trusts described in more detail in Note 25 to the
Notes to the Audited Annual Financial Statements and
Note 12 to the Notes to the Unaudited Interim Financial
Statements. The 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 NOL
carryforward were reported.
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Our NOLs will expire, if not used, in the following approximate
amounts in the following years (in thousands of dollars):
| Amount of | ||||
| Year Expiring | Carryforward | |||
|
2005
|
$ | 12,405 | ||
|
2006
|
92,355 | |||
|
2007
|
89,790 | |||
|
2008
|
31,688 | |||
|
2009
|
39,689 | |||
|
2010
|
23,600 | |||
|
2011
|
19,755 | |||
|
2012
|
38,255 | |||
|
2019
|
33,635 | |||
|
2022
|
26,931 | |||
|
2023
|
108,331 | |||
| $ | 516,434 | |||
Our ability to utilize our NOLs would be substantially reduced
if we were to undergo an “ownership change” within the
meaning of Section 382(g)(1) of the Internal Revenue Code.
We will be treated as having had an “ownership change”
if there is more than a 50% increase in stock ownership during a
three year “testing period” by “5%
stockholders.” In an effort to reduce the risk of an
ownership change, we have imposed restrictions on the ability of
holders of 5% or more of our common stock, as well as the
ability of others to become 5% stockholders as a result of
transfers of our common stock. The transfer restrictions were
implemented in 1992, and we expect that they will remain in
force as long as the NOLs are available to us. Notwithstanding
such transfer restrictions, there could be circumstances under
which an issuance by us of a significant number of new shares of
our common stock or other new class of equity security having
certain characteristics (for example, the right to vote or
convert into our common stock) might result in an ownership
change under the Internal Revenue Code. See “Risk
Factors — Covanta Holding Corporation-Specific
Risks — We cannot be certain that our NOLs will
continue to be available to offset our tax liability.”
Discussion of Insurance Business
Following the acquisitions of Covanta and Ref-Fuel, the relative
contribution of our insurance business to our cash flow and its
relative percentage of our financial obligations were
significantly reduced. Consequently, unlike prior years, our
insurance business neither contributes materially to our cash
flow nor imposes material financial obligations on us.
Our insurance business continues to represent an important
element of our structure in that our NOLs were in part generated
through the operations of former subsidiaries of Danielson
Indemnity Company, referred to as “DIND” in this
prospectus. Our ability to utilize that portion of the NOLs will
depend upon the continued inclusion of our insurance business in
our consolidated federal tax return. See Note 25 in Notes
to the Audited Annual Financial Statements and Note 12 in
the Notes to the Unaudited Interim Financial Statements for more
information on our NOLs.
As discussed more fully below, our insurance businesses have
succeeded in reducing their loss ratio by tightening
underwriting criteria, exiting unprofitable lines of business
and focusing on writing more profitable lines of business
through its expanded arrangement with SCJ Insurance Services,
referred to as “SCJ” in this prospectus.
Our insurance operations are conducted through wholly-owned
subsidiaries. NAICC an indirect, wholly-owned subsidiary of ours
through DIND, is our principal operating insurance subsidiary.
NAICC, in turn, is the sole stockholder of Valor, a Montana
domiciled specialty insurance company, Danielson Insurance
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Company, referred to as “DICO” in this prospectus, and
Danielson National Insurance Company, referred to as
“DNIC” in this prospectus. References to
“NAICC” in this prospectus include NAICC and its
subsidiaries unless otherwise indicated.
NAICC has historically managed its business across four
principal lines of business:
| (1) non-standard private passenger automobile; | |
| (2) commercial automobile; | |
| (3) workers’ compensation; and | |
| (4) property and casualty. | |
However, as of December 31, 2004, NAICC was engaged in
writing exclusively non-standard private passenger automobile
primarily in California.
Insurers admitted in California are required to obtain approval
from the California Department of Insurance, of rates and/or
forms prior to being used. Many of the other states, in which
NAICC does business, have similar requirements. Rates and policy
forms are developed by NAICC and filed with the regulators in
each of the relevant states, depending upon each state’s
requirements. NAICC relies upon its own as well as industry
experience in establishing rates.
NAICC began writing non-standard private passenger automobile
insurance in California in July 1993 through SCJ and endeavored
to write additional personal automobile programs beginning in
1998 in other territories, but due to underwriting losses,
ceased writing such additional policies in March 2002.
Non-standard risks are those segments of the driving public
which generally are not considered “preferred”
business, such as drivers with a record of prior accidents or
driving violations, drivers involved in particular occupations
or driving certain types of vehicles, or those drivers whose
policies have not been renewed or declined by another insurance
company. Generally, in order to address the associated higher
risk or non-standard private automobile insurance, their premium
rates are higher than standard premium rates while policy limits
are lower than typical policy limits. Policyholder selection is
governed by underwriting guidelines established by NAICC.
Management believes that it is able to achieve underwriting
success through refinement of various risk profiles, thereby
dividing the non-standard market into more defined segments
which can be adequately priced. Additionally, traditional lower
policy limits lend themselves to quicker claims processing
allowing management to respond more quickly to changing loss
trends, by revising underlying underwriting guidelines and class
and rate filings accordingly.
Private passenger automobile policy limits vary by state. In
California non-standard policies primarily provide maximum
coverage up to the statutory minimum of $15,000 per person,
$30,000 per accident for liability and bodily injury and
$10,000 per accident for property damage.
Net written premiums were $15.2 million, $18.1 million
and $25.4 million in 2004, 2003 and 2002, respectively, and
$9.5 million for the nine months ended September 30,
2005 for the non-standard private passenger automobile program.
The primary reason for the continued decrease in private
passenger automobile premiums in 2003 and 2004 were
internally-imposed underwriting restrictions placed on the
California non-standard automobile program in February 2002.
However, in November 2004, NAICC lifted its moratorium on the
non-standard personal automobile program after receiving
approval from the California Department of Insurance for a new
rate and class plan filing that is offered by DNIC through SCJ.
As a result of the favorable underwriting results in the
non-standard personal automobile market, coupled with low
premium leverage on its surplus, NAICC has retained 100% of the
underlying risk of this program since 2001. Commencing in
January 2005, NAICC and DNIC began to reinsure, on a quota share
basis, 28% and 40%, respectively of its underlying risk with an
AM Best “A” rated reinsurer. The new reinsurance
program was sought to address premium growth ratio guidelines
established by the Insurance Regulation Information System,
referred to as “IRIS” in this prospectus, and the
relative uncertainty of the underwriting results of the new
program. Early in 2005 adverse trends were observed and in March
2005 certain underwriting measures were instituted on the DNIC
program that had a negative impact on premium volume.
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On November 15, 2005, the California Department of
Insurance approved and implemented a base rate increase of 11%
for DNIC. At the same time, DNIC loosened its underwriting
guidelines to attract additional production. Both the NAICC and
the DNIC reinsurance programs are being re-examined for 2006
given the production levels.
NAICC does not write any business through managing general
agents. SCJ is responsible for all of the marketing,
underwriting and policy administration for the non-standard
personal automobile policies in California. SCJ does not have
rate making authority nor can it bind reinsurance on behalf of
NAICC and DNIC. In return SCJ receives a flat commission on new
and renewal policies written and participates in an incentive
compensation arrangement dictated solely by underwriting results.
Commercial Automobile
NAICC began writing non-standard commercial automobile insurance
in 1995 through independent agents and ceased writing new
policies in July 2003. In September 2003, NAICC began providing
60-day statutory notification to non-renew all in-force
policies. As a result, as of September 2004, there was no
further loss exposure on this line. The majority of automobiles
owned or used by businesses are insured under policies that
provide other coverage for the business, such as commercial
multi-peril insurance. The policies issued by NAICC were
generally to businesses that were unable to insure a specific
driver and businesses having vehicles not qualifying for
commercial multi-peril insurance. The typical NAICC commercial
automobile policy covered fleets of four or fewer vehicles.
NAICC did not insure interstate trucking, trucks hauling logs,
gasoline or similar higher hazard operations.
The maximum non-standard commercial automobile policy limit
provided by NAICC was $1.0 million for bodily injury and
property damage combined as a single limit of liability for each
occurrence. NAICC retained the first $0.25 million of
bodily injury and property damage combined as a single limit of
liability for each occurrence.
Net written premiums for commercial automobile insurance were
$(0.1) million, $11.9 million and $19.5 million
in 2004, 2003 and 2002, respectively. The decrease in commercial
automobile premiums in 2003 and 2004 was attributable to
NAICC’s decision to exit this line of business. The
decision to exit the market was primarily driven by the
unprofitable historical underwriting results, lack of surplus
capacity and relatively high net retentions for this line of
business.
Workers’ Compensation
NAICC began writing workers’ compensation insurance in 1987
and ceased writing policies in January 2002 in response to
adverse market developments and loss experience. Through January
2002, NAICC and its subsidiary Valor wrote workers’
compensation insurance primarily in California and Montana.
NAICC previously wrote workers’ compensation insurance in
California and four other western states. Workers’
compensation insurance policies provide coverage for statutory
benefits which employers are required to pay to employees who
are injured in the course of employment including, among other
things, temporary or permanent disability benefits, death
benefits, medical and hospital expenses and expenses for
vocational rehabilitation. Policies were issued having a term of
no more than one year. The last California workers’
compensation policy was issued in July 2001 and the last policy
issued outside of California was issued in January 2002. Valor
began non-renewing all policies in December 2001 and was placed
into run-off effective January 2002.
Prior to April 2000, NAICC retained the first $0.5 million
of each workers’ compensation loss and purchased
reinsurance for up to $49.5 million in excess of its
retention, the first $9.5 million of which has been placed
with three major reinsurance companies with the remaining
$40 million provided by 16 other companies. In April 2000,
NAICC entered into a workers’ compensation excess of loss
reinsurance agreement with SCOR Re Insurance Company that
provided coverage commencing at losses of $0.2 million. In
May 2001, the $0.3 million excess of $0.2 million
layer was placed with PMA Re Insurance Company on a 50%
participation basis through run-off.
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Prior to January 1996, NAICC retained the first
$0.4 million of each workers’ compensation loss and
retained $0.5 million up through April 2000. In April 2000,
NAICC entered into a workers’ compensation excess of loss
reinsurance agreement with SCOR Re Insurance Company that
provided coverage commencing at losses of $0.2 million. In
May 2001, the $0.3 million excess of $0.2 million
layer was placed with PMA Re Insurance Company on a 50%
participation basis through run-off. NAICC has purchased
reinsurance up to a $50 million limit, net of its own
retention. The first $10 million limit was placed with
three major reinsurance companies with the remaining
$40 million limit provided by 16 other companies.
Net written premiums for workers’ compensation were nil,
$0.3 million and $7.6 million in 2004, 2003 and 2002,
respectively. These decreases reflected NAICC’s and
Valor’s exit from the market.
Property and Casualty
As of December 31, 1985, NAICC through a series of
assumption agreements assumed the assets and liabilities of the
Stuyvesant Insurance Company, referred to as
“Stuyvesant” in this prospectus, for policies issued
prior to 1978, along with then other affiliated H.F. Ahmanson
insurance subsidiaries, collectively referred as “H.F.
Ahmanson” in this prospectus. NAICC was subsequently
acquired by KCP Holding Company, referred to as “KCP”
in this prospectus, on September 19, 1986. On July 29,
1988, Mission American Insurance Company, referred to as
“MAIC” in this prospectus, pursuant to an assumption
agreement transferred all of its assets and liabilities
(accident years 1985 through 1988) to NAICC in exchange for
62.76% of KCP’s total common stock. MAIC was part of the
Mission Insurance Group, Inc., which subsequently emerged from
bankruptcy on August 16, 1990 as a predecessor of ours. On
December 31, 1991, our predecessor acquired the remaining
outstanding shares of KCP, not then indirectly owned by us,
through its ownership of MAIC. NAICC for the years 1987 to 1995
wrote a commercial multi peril program for artisan contractors,
and separately, a homeowners program from 1998 to 2001. NAICC
continues to discharge claims arising under its own insurance
policies and contracts and those issued by MAIC, Stuyvesant and
other H.F. Ahmanson former insurance affiliates.
The property and casualty claims are categorized as follows:
| (1) | direct excess and primary policies; | |
| (2) | workers’ compensation; | |
| (3) | reinsurance assumed on an excess of loss basis; and | |
| (4) | reinsurance assumed on pool business primarily from the London marketplace. | |
Substantially all remaining claims on policies, issued by
companies other than by NAICC, are of an A&E nature.
As of December 31, 2004, there remained 63 direct excess
and primary claims, of which 17 were related to policies issued
by Stuyvesant, 23 by H.F. Ahmanson entities, nine by MAIC and
twelve by NAICC. These claims generally had policy limits up to
$1.0 million with reinsurance generally above $50,000.
NAICC issued-policies are approaching the 10-year statute of
limitations baring future claims acceptance. As of
December 31, 2004, there were 51 open workers’
compensation claims, the majority of which were issued by MAIC
with no reinsurance coverage. The assumed reinsurance contracts
had relatively low participation, generally less than $25,000,
and estimates of unpaid losses have been based on information
provided by the primary insurance companies. At
December 31, 2004, there were 395 open claims related to
excess of loss assumed reinsurance. As of December 31, 2004
and 2003, NAICC’s net unpaid losses and loss adjustment
expenses relating to A&E claims were approximately
$8.2 million and $8.3 million, respectively. In the
most current three years of development there has been an influx
of newly reported A&E cases on an excess of loss basis
related to the Stuyvesant issued policies that are beginning to
pierce the limits in which NAICC participates. New cases
reported in 2004, 2003 and 2002 on the assumed excess of loss of
business increased 2%, 19% and 15%, respectively; however, the
incurred losses, related to assumed excess of loss of business,
were less than $0.4 million for the last three years.
Approximately 40% of the aggregate assumed pool business has
been reinsured, all with AM Best rated “A” or better
carriers. Management has been successful in
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commuting with several cedants and pools with respect to the
assumed liabilities and will continue to look for such
opportunities in the future.
Marketing
NAICC currently markets its non-standard private passenger
automobile insurance in California through SCJ who in turn uses
over 600 sub-agents or retail brokers to obtain applications for
policies. SCJ processed 16,641, 16,002 and 43,013 applications
in 2004, 2003 and 2002, binding 95.6%, 96.1% and 96.3% as
policies, respectively.
Claims
All automobile claims are handled by employees of NAICC at its
home office in Long Beach, California. Claims are reported by
agents, insureds and claimants directly to NAICC. Claims
involving suspected fraud are referred to an in-house special
investigation unit, which manages a detailed investigation of
these claims using outside investigative firms. When evidence of
fraudulent activity is identified, the special investigation
unit works with the various state departments of insurance, the
National Insurance Crime Bureau and local law enforcement
agencies in handling the claims.
Workers’ compensation claims have been consolidated and
outsourced to a regional third party administrator, TRISTAR Risk
Management, effective July 2004. NAICC transferred all of its
files, to leverage Tristar’s medical fee discounts,
including medical provider networks, operational size,
supervision, and the special investigation unit and quality
assurance program on the remaining outstanding claims liability.
Property and casualty claims are received, reviewed and
processed by NAICC employees located in Long Beach, California.
Additionally, NAICC uses external consultants and attorneys to
aid in determining the extent, obligation and accuracy of claims
originating from Stuyvesant policies issued prior to 1978.
Losses and Loss Adjustment
Expenses
NAICC’s net unpaid losses and LAE represent the estimated
indemnity cost and expense necessary to cover the ultimate net
cost of investigating and settling claims.
Such estimates are based upon estimates for reported losses,
historical company experience of losses reported by reinsured
companies for insurance assumed and actuarial estimates based
upon historical company and industry experience for development
of reported and unreported claims (incurred but not reported).
Any changes in estimates of ultimate liability are reflected in
current operating results. Inflation is assumed, along with
other factors, in estimating future claim costs and related
liabilities. NAICC does not discount any of its loss reserves.
The California legislature in response to rising workers’
compensation costs and a lack of available market, passed
Assembly Bill No. 227, Senate Bill No. 228 both signed
on September 12, 2003, and Senate Bill No. 899,
effective April 19, 2004, all of which were signed by the
Governor. These bills contain many reforms designed to reduce
the cost of workers’ compensation claims. Several of the
provisions apply to medical services provided after the
effective dates, including services on injuries that occurred
prior to the effective dates. As a result, the reforms are
expected to have a retroactive impact and therefore affect
pre-established reserve levels. The six major provisions that
could have a retroactive impact on NAICC’s reserves are:
| • | Changes to the Official Medical Fee Schedule Values for Physician Services | |
| • | Changes to the Official Medical Fee Schedule for Inpatient Services | |
| • | Pharmaceutical Fee Schedule | |
| • | Outpatient Surgery Center Fee Schedule | |
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| • | Repeal of the Primary Treating Physician Presumption for Pre-2003 Injuries | |
| • | Other Medical Treatment Utilization | |
Soon after the legislative changes became effective, NAICC
observed an increase in attempts to settle claims. The ultimate
loss and ALAE estimates for NAICC, not including Valor,
workers’ compensation was reduced by $2.6 million
between 2003 and 2004 or approximately 19% of the prior year
reserves. Although the actuarial estimates did not explicitly
factor the effect of the reforms, NAICC believes that the
favorable development was, in part, related to the new
legislation.
The ultimate cost of claims is difficult to predict for several
reasons. Claims may not be reported until many years after they
are incurred. Changes in the rate of inflation and uncertainty
in the legal environment may also create forecasting
complications. Court decisions may dramatically increase
liability in the time between the dates on which a claim is
reported and its resolution. For example, punitive damages
awards have grown in frequency and magnitude. Courts have
imposed increasing obligations on insurance companies to defend
policyholders. As a result, the frequency and severity of claims
have grown rapidly and unpredictably.
The unpaid losses and LAE, related to environmental cleanup,
were established considering facts then currently known and the
then current state of the law and coverage litigation.
Liabilities are estimated for known claims, including the cost
of related litigation, when sufficient information has been
developed to indicate the involvement of a specific contract of
insurance or reinsurance and management can reasonably estimate
its liability. Estimates for unknown claims and development on
reported claims are included in NAICC’s unpaid losses and
LAE. The liability for development of reported claims has been
based on the estimates of the range of potential losses for
reported claims in the aggregate. Estimates of liabilities are
reviewed and updated continually and there is the potential that
NAICC’s ultimate liabilities could be materially in excess
of amounts that are currently recorded.
Management believes, taking into account the opinions of
independent actuarial professionals, that the provisions for
unpaid losses and LAE are adequate to cover the net cost of
losses and loss expenses incurred to date; however, such
liability is necessarily based on estimates and there can be no
assurance that the ultimate liability will not exceed such
estimates.
The following table provides a reconciliation of NAICC’s
net unpaid losses and LAE (in thousands of dollars):
| Year Ended December 31, | |||||||||||||
| 2004 | 2003 | 2002 | |||||||||||
|
Net unpaid losses and LAE at beginning of year
|
$ | 65,142 | $ | 79,192 | $ | 88,012 | |||||||
|
Incurred losses, net, related to:
|
|||||||||||||
|
Current year
|
10,343 | 23,199 | 49,474 | ||||||||||
|
Prior years
|
2,518 | 13,485 | 10,407 | ||||||||||
|
Total net incurred
|
12,861 | 36,684 | 59,881 | ||||||||||
|
Paid losses, net, related to:
|
|||||||||||||
|
Current year
|
(5,427 | ) | (10,133 | ) | (22,871 | ) | |||||||
|
Prior years
|
(26,348 | ) | (40,601 | ) | (45,830 | ) | |||||||
|
Total net paid
|
(31,775 | ) | (50,734 | ) | (68,701 | ) | |||||||
|
Net unpaid losses and LAE at December 31
|
46,228 | 65,142 | 79,192 | ||||||||||
|
Plus: Reinsurance recoverable on unpaid losses, net
|
18,042 | 18,238 | 22,057 | ||||||||||
|
Gross unpaid losses and LAE at December 31
|
$ | 64,270 | $ | 83,380 | $ | 101,249 | |||||||
The net losses and LAE incurred during 2004 related to prior
years is attributable to recognition of unfavorable development
in commercial auto of $2.4 million primarily for accident
years 2001 through 2002, property and casualty of
$1.6 million and unallocated LAE for all lines of
$1.0 million. Favorable development
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on prior periods was recognized in workers’ compensation
and private passenger automobile of $0.7 million and
$1.8 million, respectively. The net losses and LAE incurred
during 2003 related to prior years and were attributable to
recognition of unfavorable development in the following:
commercial automobile of $5.5 million for accident years
2000 through 2002; workers’ compensation of
$5.5 million of which $3.9 million was attributable to
Valor; and property and casualty of $1.5 million, most of
which was attributable to unallocated LAE reserves. All of the
commercial automobile programs were placed in run-off during
2003. The net losses and LAE incurred during 2002 related to
prior years and were attributable to adverse development on both
the California workers’ compensation line totaling
$3.5 million, certain private passenger automobile programs
totaling $4.7 million, and commercial automobile totaling
$2.0 million.
The following table indicates the manner in which unpaid losses
and LAE at the end of a particular year change as time passes.
The first line reflects the liability as originally reported,
net of reinsurance, at the end of the stated year. Each calendar
year-end liability includes the estimated liability for that
accident year and all prior accident years comprising that
liability. The second section shows the original recorded net
liability as of the end of successive years adjusted to reflect
facts and circumstance that are later discovered. The next line,
cumulative (deficiency) or redundancy, compares the
adjusted net liability amount to the net liability amount as
originally established and reflects whether the net liability as
originally recorded was adequate to cover the estimated cost of
claims or redundant. The third section reflects the cumulative
amounts related to that liability that was paid, net of
reinsurance, as of the end of successive years.
Analysis of Net Losses and LAE
Development (in thousands of dollars):
| Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||
| 1994 | 1995 | 1996 | 1997 | 1998 | 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | |||||||||||||||||||||||||||||||||||
|
Originally reported gross
|
|||||||||||||||||||||||||||||||||||||||||||||
|
Unpaid Losses and LAE
|
$ | 146,330 | $ | 137,406 | $ | 120,651 | $ | 105,947 | $ | 95,653 | $ | 94,934 | $ | 100,030 | $ | 105,745 | $ | 101,249 | $ | 83,381 | $ | 64,270 | |||||||||||||||||||||||
|
Originally reported ceded recoverable
|
17,705 | 21,112 | 23,546 | 20,185 | 18,187 | 15,628 | 20,641 | 17,733 | 22,057 | 18,239 | 18,042 | ||||||||||||||||||||||||||||||||||
|
Originally reported net unpaid Losses and LAE
|
128,625 | 116,294 | 97,105 | 85,762 | 77,466 | 79,306 | 79,389 | 88,012 | 79,192 | 65,142 | 46,228 | ||||||||||||||||||||||||||||||||||
|
Net Unpaid Losses and LAE re-estimated as of:
|
|||||||||||||||||||||||||||||||||||||||||||||
|
One Year Later
|
131,748 | 126,413 | 98,045 | 85,762 | 79,957 | 84,560 | 87,035 | 98,419 | 92,677 | 67,660 | |||||||||||||||||||||||||||||||||||
|
Two Years Later
|
141,602 | 126,796 | 97,683 | 85,684 | 82,778 | 88,001 | 94,570 | 109,795 | 97,331 | ||||||||||||||||||||||||||||||||||||
|
Three Years Later
|
141,787 | 127,621 | 98,545 | 87,613 | 83,778 | 92,213 | 100,640 | 112,770 | |||||||||||||||||||||||||||||||||||||
|
Four Years Later
|
144,491 | 129,792 | 102,053 | 88,238 | 87,160 | 94,895 | 101,486 | ||||||||||||||||||||||||||||||||||||||
|
Five Years Later
|
146,827 | 133,985 | 102,949 | 89,802 | 89,476 | 95,803 | |||||||||||||||||||||||||||||||||||||||
|
Six Years Later
|
151,784 | 134,992 | 103,645 | 91,892 | 90,345 | ||||||||||||||||||||||||||||||||||||||||
|
Seven Years Later
|
152,764 | 135,629 | 105,767 | 92,301 | |||||||||||||||||||||||||||||||||||||||||
|
Eight Years Later
|
153,459 | 137,886 | 106,108 | ||||||||||||||||||||||||||||||||||||||||||
|
Nine Years Later
|
155,591 | 138,245 | |||||||||||||||||||||||||||||||||||||||||||
|
Ten Years Later
|
156,044 | ||||||||||||||||||||||||||||||||||||||||||||
|
Cumulative (deficiency) redundancy
|
(27,419 | ) | (21,951 | ) | (9,003 | ) | (6,539 | ) | (12,879 | ) | (16,497 | ) | (22,097 | ) | (24,758 | ) | (18,139 | ) | (2,518 | ) | |||||||||||||||||||||||||
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| Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||
| 1994 | 1995 | 1996 | 1997 | 1998 | 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | |||||||||||||||||||||||||||||||||||
|
Cumulative net paid Losses and LAE as of:
|
|||||||||||||||||||||||||||||||||||||||||||||
|
Inception Year
|
$ | 15,849 | $ | 14,464 | $ | 10,559 | $ | 13,801 | $ | 16,170 | $ | 16,527 | $ | 25,360 | $ | 28,631 | $ | 22,870 | $ | 10,263 | $ | 5,427 | |||||||||||||||||||||||
|
One Year Later
|
46,582 | 46,132 | 35,696 | 31,317 | 43,09 | 51,608 | 64,599 | 74,460 | 63,343 | 36,611 | |||||||||||||||||||||||||||||||||||
|
Two Years Later
|
80,515 | 74,543 | 54,815 | 43,855 | 62,577 | 71,151 | 86,722 | 98,827 | 83,710 | ||||||||||||||||||||||||||||||||||||
|
Three Years Later
|
101,726 | 90,818 | 63,290 | 56,968 | 74,267 | 83,225 | 97,694 | 111,535 | |||||||||||||||||||||||||||||||||||||
|
Four Years Later
|
114,424 | 97,900 | 74,306 | 66,015 | 82,524 | 88,524 | 103,944 | ||||||||||||||||||||||||||||||||||||||
|
Five Years Later
|
119,310 | 108,061 | 82,568 | 72,531 | 86,278 | 92,795 | |||||||||||||||||||||||||||||||||||||||
|
Six Years Later
|
128,117 | 115,721 | 88,424 | 75,231 | 89,696 | ||||||||||||||||||||||||||||||||||||||||
|
Seven Years Later
|
135,013 | 121,344 | 90,776 | 91,574 | |||||||||||||||||||||||||||||||||||||||||
|
Eight Years Later
|
140,146 | 123,477 | 103,563 | ||||||||||||||||||||||||||||||||||||||||||
|
Nine Years Later
|
141,899 | 125,575 | |||||||||||||||||||||||||||||||||||||||||||
|
Ten Years Later
|
143,828 | ||||||||||||||||||||||||||||||||||||||||||||
|
Reconciliation to gross re- estimated reserves:
|
|||||||||||||||||||||||||||||||||||||||||||||
|
Net reserves re-estimated
|
156,044 | 138,245 | 106,108 | 92,301 | 90,345 | 95,803 | 101,486 | 112,770 | 97,331 | 67,560 | 46,228 | ||||||||||||||||||||||||||||||||||
|
Re-estimated ceded recoverable
|
27,473 | 29,463 | 28,441 | 28,838 | 23,659 | 18,506 | 25,232 | 33,750 | 29,798 | 21,323 | 8,042 | ||||||||||||||||||||||||||||||||||
|
Total gross re-estimated reserves
|
$ | 183,517 | $ | 167,708 | $ | 134,549 | $ | 121,139 | $ | 114,004 | $ | 114,309 | $ | 126,718 | $ | 146,520 | $ | 127,129 | $ | 88,983 | $ | 64,270 | |||||||||||||||||||||||
A discussion regarding adverse development by line recorded in
2004, 2003 and 2002 is set forth above in the prior table and
narrative. The adverse development for the years ended 1996
through 2001 was related to both commercial auto and
workers’ compensation. The commercial auto was most
significantly impacted by case strengthening related to a change
in claims administration, coupled with the recognition that
development factors of prior years were not as indicative of the
business written for those respective years due to changes in
risk profile and limits. Workers’ compensation was most
affected by changes in legislation that occurred in 1995 that
took several years to develop, with such development being
different than the experience prior to 1995.
The development for the years ended 1994 and 1995 was due in
part to the strengthening of the unpaid losses and LAE of
property and casualty businesses assumed by NAICC in 1985 and
workers’ compensation written prior to 1991. NAICC has
continued to post additional IBNR despite negotiations on
several commutations of assumed excess of loss reinsurance
contracts that indicated previous estimates of IBNR.
Conditions and trends that have affected the development of
these liabilities in the past may not necessarily recur in the
future especially considering that those ongoing lines that have
experienced the greatest adverse development have been placed in
run-off in 2001 and 2003. Reliance on this cumulative history
may not be indicative of future performance.
Reinsurance
In its normal course of business, NAICC reinsures a portion of
its exposure with other insurance companies so as to effectively
limit its maximum loss arising out of any one occurrence.
Contracts of reinsurance do not legally discharge the original
insurer from its primary liability. Estimated reinsurance
receivables arising from these contracts of reinsurance are
reported separately as assets in accordance with generally
accepted accounting principles in the United States.
As of December 31, 2004, General Reinsurance Corporation
was the only reinsurer that comprised more than 10% of
NAICC’s reinsurance recoverable on paid and unpaid
balances. NAICC monitors all reinsurers, by reviewing A.M. Best
reports and ratings, information obtained from reinsurance
intermediaries and analyzing financial statements. At
December 31, 2004, NAICC had reinsurance recover-able on
paid and unpaid balances from General Reinsurance Corporation of
$12.4 million. General Reinsurance Corporation has an A.M.
Best rating of A++. See Note 10 to the Notes to the Audited
Annual Financial Statements for further information on
reinsurance.
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NAICC and two of its subsidiaries participate in an
inter-company pooling and reinsurance agreement. Under this
agreement DICO and DNIC cede 100% of their net liability,
defined to include premiums, losses and LAE, to NAICC to be
combined with the net liability for policies of NAICC in
formation of the “pool.” NAICC simultaneously cedes to
DICO and DNIC 10% of the net liability of the pool. DNIC
commenced participation in July 1993 and DICO commenced in
January 1994. Additionally, DICO, DNIC and Valor reimburse NAICC
for executive services, professional services, and
administrative expenses based primarily on designated
percentages of net written premiums and other cost determiners
for each line of business.
MARKETS, COMPETITION AND BUSINESS CONDITIONS
General Business Conditions
Covanta’s business can be adversely affected by general
economic conditions, war, inflation, adverse competitive
conditions, governmental restrictions and controls, change in
law, natural disasters, energy shortages, fuel cost and
availability, weather, the adverse financial condition of
customers and suppliers, various technological changes and other
factors over which Covanta has no control.
Covanta expects in the foreseeable future that competition for
new contracts and projects will be intense in all domestic
markets in which Covanta conducts or intends to conduct its
businesses, and its businesses will be subject to a variety of
competitive and market influences.
With respect to its waste-to-energy business, Covanta competes
in the waste disposal markets, which is highly competitive.
While Covanta currently processes for disposal over 5% of the
municipal solid waste 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, intermodal, trucking) to provide access to more distant disposal sites, thereby affecting the size of the waste shed itself. | |
In this market, Covanta competes on disposal price (usually on a
per-ton basis) with other disposal service providers seeking to
obtain waste supplies to their facilities. At most of its
facilities, Covanta is unable to compete in this market because
it does not have the contractual right to solicit waste; at
these facilities it is the client community which 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 Covanta’s facility. At all but eight of its
facilities, Covanta is unable to offer material levels of
disposal capacity to the market because of existing long-term
contractual commitments. At these projects plant capacity is
contractually committed and therefore unable to be offered to
the market. At eight of its facilities Covanta is responsible
for obtaining material amounts of waste supply and so is
actively competing in these markets to enter into spot medium-
and long-term contracts. All of these projects are in densely
populated areas, with high waste generation rates and numerous
large and small participants in the regional market.
Covanta’s waste operations are largely concentrated in the
northeastern United States. See “Risk
Factors — Waste and Energy Services Business-Specific
Risks — Covanta’s waste operations are
concentrated in one region, and expose us to regional economic
or market declines” for additional information
concerning this geographic concentration.
If a long-term contract expires and is not renewed or extended
by a client community, Covanta’s percentage of contracted
disposal capacity will decrease, and it will need to compete in
the regional market for waste disposal. At that point, it will
compete on price with landfills, transfer stations, other
waste-to-energy
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facilities and other waste disposal technologies that are then
offering disposal service in the region. See discussion under
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations —
Management’s Discussion and Analysis of Liquidity and
Capital Resources — Cash Flow and
Liquidity — Waste and Energy Services
Segment — Contract Structures and Duration”
for additional information concerning the expiration of existing
contracts.
Since before its bankruptcy filing in 2002, Covanta has not
engaged in material development activity with respect to its
independent power business. Covanta may consider developing
additional renewable energy projects in the future, and if it
were to do so would face competition from a large number of
independent energy companies.
With respect to its sales of electricity from its
waste-to-energy projects and independent power projects Covanta
primarily sells its output pursuant to long-term contracts.
Accordingly, it generally does not sell its output into markets
where it must compete on price. As these contracts expire,
Covanta will participate in such markets if it is unable to
enter into new or renewed long-term contracts. See discussion
under “Risk Factors — Waste and Energy
Services Business-Specific Risks — Covanta may face
increased risk of market influences on its domestic revenues
after its contracts expire” for additional information
concerning the expiration of existing contracts.
Once a contract is awarded or a project is financed and
constructed, Covanta’s 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 Covanta’s control, such as successful operation in
compliance with law and the presence or absence of labor
difficulties or disturbances. Other risk factors are largely out
of Covanta’s control and may have an adverse impact on a
project over a long-term operation. See “Risk
Factors — Waste and Energy Services Business-Specific
Risks” for more information on the these types of risks.
Technology
Covanta has the exclusive right to market in the United States
the proprietary mass-burn technology of Martin GmbH fur Umwelt
und Energietechnik, referred to in this prospectus as
“Martin.” All of the waste-to-energy projects that
Covanta has constructed use the Martin technology. 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
expired in 1989, and there are various other expired and
unexpired patents relating to the Martin technology. Covanta
believes that it is Martin’s know-how and worldwide
reputation in the waste-to-energy field, and Covanta’s
know-how in designing, constructing and operating
waste-to-energy facilities, rather than the use of patented
technology, that is important to Covanta’s competitive
position in the waste-to-energy industry in the United States.
Covanta does not believe that the expiration of the patent
covering the basic stoker grate technology or patents on other
portions of the Martin technology will have a material adverse
effect on Covanta’s financial condition or competitive
position.
Covanta believes that mass-burn technology is now the
predominant technology used for the combustion of solid waste.
Covanta believes that the Martin technology is a proven and
reliable mass-burn technology, and that its association with
Martin has created significant name recognition and value for
Covanta’s domestic waste-to-energy business.
Since 1984, Covanta’s rights to the Martin technology have
been provided pursuant to a cooperation agreement with Martin
which gives Covanta exclusive rights to market, and distribute
parts and equipment for the Martin technology in the United
States, Canada, Mexico, Bermuda and certain Caribbean countries.
Martin is obligated to assist Covanta 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 not affect the rights of Covanta to design,
construct, operate, maintain or repair waste-to-energy
facilities for which contracts have been entered into or
proposals made prior to the date of termination.
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Through facility acquisitions, Covanta owns and/or operates some
waste-to-energy 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.
Insurance Business
The property and casualty insurance industry is highly
competitive. The insurance industry consists of a large number
of companies, many of which operate in more than one state,
offering automobile, homeowners and commercial property
insurance, as well as insurance coverage in other lines. Many of
NAICC’s competitors have larger volumes of business,
greater financial resources and higher financial strength
ratings. NAICC’s competitors having greater shares of the
California market sell automobile insurance either directly to
consumers, through independent agents and brokers or through
exclusive agency arrangements similar to SCJ.
The principal means by which our insurance business competes
with other automobile insurers is by its focus on meeting the
needs of the non-standard private passenger automobile market in
California where it believes it has competitive pricing,
underwriting and service capabilities. Our insurance business
also competes by using niche marketing efforts of its products
through SCJ.
The operating results of a property and casualty insurer are
influenced by a variety of factors including general economic
conditions, competition, regulation of insurance rates, weather,
frequency and severity of losses. The California non-standard
personal auto market in which NAICC operates has experienced a
recovery of rate adequacy coupled with stable competition.
Frequency of claims improved from 2002 to 2003 and remained
stable in 2004, while the average cost of settling claims has
steadily improved from 2002 to 2004.
REGULATION OF BUSINESS
Our Waste and Energy Services business and our insurance
business are both highly regulated.
Environmental Regulatory Laws Affecting Covanta’s Waste
and Energy Services Business
| Domestic |
Covanta’s 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 the related regulations are
referred to collectively as the “Environmental Regulatory
Laws” in this prospectus.
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” in this prospectus, make Covanta potentially liable
on a joint and several basis for any onsite or offsite
environmental contamination which may be associated with
Covanta’s activities and the activities at sites. These
include landfills that Covanta’s subsidiaries have owned,
operated or leased or, at which there has been disposal of
residue or other waste generated, handled or processed by such
subsidiaries. Some state and local laws also impose liabilities
for injury to persons or property caused by site contamination.
Some service agreements provide for indemnification of operating
subsidiaries from certain liabilities. In addition, other
subsidiaries involved in 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 for indemnification of the Covanta subsidiary
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-to-energy, independent power project or water
facility, and further require that permits be maintained
throughout the operating life of the facility. There can be no
assurance that
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all required permits will be issued or re-issued, and the
process of obtaining such permits can often cause lengthy
delays, including delays caused by third-party appeals
challenging permit issuance. Failure to meet conditions of these
permits or of the Environmental Regulatory Laws can subject an
operating subsidiary 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 “Risk Factors — Waste and Energy Services
Business-Specific Risks — Compliance with
environmental laws could adversely affect our results of
operations.” To date, Covanta has not incurred material
penalties, been required to incur material capital costs or
additional expenses, nor been subjected to material restrictions
on its operations as a result of violations of Environmental
Regulatory Laws or permit requirements.
Although Covanta’s operations are occasionally subject to
proceedings and orders pertaining to emissions into the
environment and other environmental violations, which may result
in fines, penalties, damages or other sanctions, Covanta
believes that it is in substantial compliance with existing
environmental laws and regulations. Covanta 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 laws. In
certain instances Covanta may be exposed to joint and several
liabilities for remedial action or damages. Covanta’s
ultimate liability in connection with such environmental claims
will depend on many factors, including its volumetric share of
waste, the total cost of remediation, the financial viability of
other companies that also sent waste to a given site and, in the
case of divested operations, its contractual arrangement with
the purchaser of such operations.
The Environmental Regulatory Laws are subject to revision. 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, it
may be required to be incorporated into new facilities or may
require major modifications to existing facilities. This new
technology may often be more expensive than that used previously.
The Environmental Remediation Laws prohibit disposal of
regulated hazardous waste at Covanta’s municipal solid
waste facilities. The service agreements recognize the potential
for improper deliveries of hazardous wastes and specify
procedures for dealing with hazardous waste that is delivered to
a facility. Although some service agreements require
Covanta’s subsidiary to be responsible for some costs
related to hazardous waste deliveries, to date no operating
subsidiary has incurred material hazardous waste disposal costs.
Domestic drinking water facilities are subject to regulation of
water quality by the state and federal agencies under the
federal Safe Drinking Water Act and by similar state laws. These
laws provide for the establishment of uniform minimum national
water quality standards, as well as governmental authority to
specify the type of treatment processes to be used for public
drinking water. Under the federal Clean Water Act, Covanta may
be required to obtain and comply with National Pollutant
Discharge Elimination System permits for discharges from its
treatment stations. Generally, under its current contracts,
Covanta is not responsible for fines and penalties resulting
from the delivery to Covanta’s treatment facility of water
not meeting standards set forth in those contracts.
| International |
Covanta aims to provide energy generating and other
infrastructure through environmentally protective project
designs, regardless of the location of a particular project.
This approach is consistent with the stringent environmental
requirements of multilateral financing institutions, such as the
World Bank, and also with Covanta’s experience in domestic
waste-to-energy projects, where environmentally protective
facility design and performance is required. Compliance with
environmental standards comparable to those of the United States
may be conditions to the provision of credit by multilateral
banking agencies as well as other lenders or credit providers.
The laws of other countries also may require regulation of
emissions into the environment, and provide governmental
entities with the authority to impose sanctions for violations,
although these
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requirements are generally not as rigorous as those applicable
in the United States. See “Risk Factors —
Waste and Energy Services Business-Specific Risks —
Exposure to international economic and political factors may
materially and adversely affect our Waste and Energy Services
business” and “Risk Factors — Waste and
Energy Services Business-Specific Risks — Compliance
with environmental laws could adversely affect our resources of
operations.” As with domestic project development,
there can be no assurance that all required permits will be
issued, and the process can often cause lengthy delays.
Energy and Water Regulations Affecting Covanta’s
Businesses
Covanta’s businesses are subject to the provisions of
federal, state and local energy laws applicable to the
development, ownership and operation of their domestic
facilities and to similar laws applicable to their foreign
operations. Federal laws and regulations applicable to many of
Covanta’s domestic energy businesses impose limitations on
the types of fuel used and prescribe the degree to which these
businesses are subject to federal and state utility-type
regulation. State regulatory regimes govern rate approval and
the other terms and conditions pursuant to which utilities
purchase electricity from independent power producers, except to
the extent such regulation is governed by federal law.
Pursuant to PURPA, the FERC has promulgated regulations that
exempt qualifying facilities (facilities meeting certain size,
fuel and ownership requirements, referred to as “QFs”
in this prospectus) from compliance with certain provisions of
the FPA, the Public Utility Holding Company Act of 1935,
referred to as “PUHCA” in this prospectus, 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 cogeneration
facilities and other facilities making use of non-fossil fuel
power sources, including waste-to-energy facilities. 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 Covanta and its competitors in the
waste-to-energy and independent power industries. Except with
respect to waste-to-energy 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, makes
certain changes to the federal energy laws applicable to
Covanta’s businesses, the most significant of which are
described below:
| • | The Energy Policy Act repeals PUHCA, effective February 2006, which eliminates any remote risk Covanta might have faced by being subject to extensive, utility-type regulation and reporting if it were considered a holding company under PUHCA. The repeal of PUHCA has been balanced with increased FERC authority to cause record keeping and conduct investigations under appropriate circumstances. FERC’s increased authority is not expected to have a material adverse effect on Covanta. | |
| • | The Energy Policy Act amends certain provisions of PURPA. It terminates PURPA’s mandatory purchase (and sale) obligation imposed on utilities or the benefits of QFs where the QF has nondiscriminatory access to competitive power markets. Existing contracts are grandfathered, but expansions, renewals and new development projects must rely on competitive power markets, rather than PURPA protections, in establishing and maintaining their viability in most geographic regions in which the Covanta businesses operate. The Energy Policy Act also eliminates the utility ownership limitation for QFs. This change might have the effect of making some transactions and development projects more likely to be consummated. This 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 waste-to-energy, other renewable energy and independent power, it could serve to increase competition with Covanta’s 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 expansions of Covanta’s businesses or to new development. | |
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Covanta presently has ownership and operating interests in
electric generating projects outside the United States.
Most countries have expansive systems for the regulation of the
power business. These generally include provisions relating to
ownership, licensing, rate setting and financing of generating
and transmission facilities.
Regulatory Laws Affecting Our Insurance Business
Insurance companies are subject to insurance laws and
regulations established by the states in which they transact
business. The agencies established pursuant to these state laws
have broad administrative and supervisory powers relating to the
granting and revocation of licenses to transact business,
regulation of trade practices, establishment of guaranty
associations, licensing of agents, approval of policy forms,
premium rate filing requirements, reserve requirements, the form
and content of required regulatory financial statements, capital
and surplus requirements and the maximum concentrations of
certain classes of investments. Most states also have enacted
legislation regulating insurance holding company systems,
including acquisitions, extraordinary dividends, the terms of
affiliate transactions and other related matters. We and our
insurance subsidiaries have registered as holding company
systems pursuant to such legislation in California and Montana
and routinely report to other jurisdictions. The National
Association of Insurance Commissioners has formed committees and
appointed advisory groups to study and formulate regulatory
proposals on such diverse issues as the use of surplus
debentures, accounting for reinsurance transactions and the
adoption of risk based capital requirements. It is not possible
to predict the impact of future state and federal regulation on
the operations of us or our insurance business.
Effective January 1, 2001, the National Association of
Insurance Commissioners’ codified statutory accounting
principles, referred to as “SAP” in this prospectus,
had been adopted by all U.S. insurance companies. The
purpose of such codification is to provide a comprehensive basis
of accounting and reporting to insurance departments. Although
codification is expected to be the foundation of a state’s
statutory accounting practice, it may be subject to modification
by practices prescribed or permitted by a state’s insurance
commissioner. Therefore, statutory financial statements will
continue to be prepared on the basis of accounting practice
prescribed or permitted by the insurance department of the state
of domicile.
| Dividends |
NAICC is an insurance company domiciled in the State of
California and is regulated by the California Department of
Insurance for the benefit of policyholders. The California
Insurance Code does not permit the payment of an extraordinary
shareholder dividend without prior approval from the California
Insurance Commissioner. Dividends are considered extraordinary
if they exceed the greater of net income or 10% of statutory
surplus as of the preceding December 31st. As of the date
of this prospectus, and into the foreseeable future, NAICC does
not have sufficient accumulated earned surplus to pay further
ordinary dividends.
| Capital Adequacy and Risk-Based Capital |
A model for determining the risk-based capital requirements,
referred to as “RBC requirements” in this prospectus,
for property and casualty insurance companies was adopted in
December 1993. The model generally assesses our assets at risk
and underwriting operations and determines policyholders’
surplus levels necessary to support such activity. NAICC has
calculated its RBC requirements under the most recent
RBC model and, as of December 31, 2004, it had capital
in excess of any regulatory action level.
The RBC model sets forth four levels of increasing regulatory
intervention:
| (1) Company Action Level (200% of an insurer’s Authorized Control Level), at which the insurer must submit to the regulator a plan for increasing such insurer’s capital; | |
| (2) Regulatory Action Level (150% of an insurer’s Authorized Control Level), at which the insurer must submit a plan for increasing its capital to the regulator and the regulator may issue corrective orders; | |
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| (3) Authorized Control Level, a multi-step calculation based upon information derived from an insurer’s most recent filed statutory annual statement, at which the regulator may take action to rehabilitate or liquidate the insurer; and | |
| (4) Mandatory Control Level (70% of an insurer’s Authorized Control Level), at which the regulator must rehabilitate or liquidate the insurer. | |
At December 31, 2004, the RBC of NAICC improved to 361%
compared to 252% in 2003.
As discussed in the section entitled “The
Business — General Overview” of this
prospectus, ACL filed for protection under Chapter 11 in
2002. As a result, it was determined that NAICC’s
investment in ACL was fully impaired for statutory accounting
purposes. At December 31, 2002, NAICC recognized a
statutory charge to its surplus of $7.4 million. This
charge, when combined with NAICC’s underwriting results and
investment losses, reduced its statutory surplus level below the
Company Action Level of NAICC’s RBC calculation. In
response, we repaid a $4.0 million note due May 2004 to
NAICC, and further contributed $4.0 million to NAICC to
increase its statutory capital during February 2003. With
permission from the California Department of Insurance, these
amounts were recorded as admitted assets for statutory
accounting purposes at December 31, 2002. After
consideration for the $8.0 million noted above,
NAICC’s reported capital and surplus as of
December 31, 2002 was above the Company Action Level of
NAICC’s RBC calculation.
In December 2003, we contributed $2.0 million to NAICC to
increase its statutory capital. No contributions were made by us
to its insurance operations in 2004.
EMPLOYEES
As of September 30, 2005, we employed 2,395 full-time
employees worldwide, of which a majority are employed in the
United States.
Of our employees in the United States, approximately 16% are
unionized. Currently, Covanta is party to seven collective
bargaining agreements: one of these agreements is scheduled to
expire in 2005, two in 2006, and one in 2008. With respect to
the remaining three agreements which have recently expired,
Covanta is in negotiations with the applicable collective
bargaining representatives and Covanta currently expects to
reach agreements with such representatives to extend such
agreements on their current or similar terms.
We consider relations with our employees to be good and do not
anticipate any significant labor disputes in 2005.
PROPERTIES
During 2004, we moved our executive offices from Chicago,
Illinois to Fairfield, New Jersey. Our executive offices are now
located at 40 Lane Road, Fairfield, New Jersey, in an office
building located on a 5.4 acre site owned by a subsidiary.
In 2004, we closed our office in Fairfax, Virginia, and
relocated an office in Redding, California to Anderson,
California. Additionally, Covanta sold its interests in two
landfill gas projects situated on leased sites in Sun Valley and
Los Angeles, California.
The following table summarizes certain information relating to
the locations of the properties we or our subsidiaries own or
lease:
| Approximate | ||||||||||||||
| Site Size | Nature of | |||||||||||||
| Location | (In Acres)(1) | Site Use | Interest(2) | |||||||||||
| OTHER SERVICES | ||||||||||||||
| 1. | Fairfield, New Jersey | 5.4 | Office space | Own | ||||||||||
| 2. | Long Beach, California(3) | 14,632 sq. ft. | Office space | Lease | ||||||||||
| WASTE AND ENERGY SERVICES | ||||||||||||||
| 3. | Anderson, California | 2,000 sq. ft | Office space | Lease | ||||||||||
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| Approximate | ||||||||||||||
| Site Size | Nature of | |||||||||||||
| Location | (In Acres)(1) | Site Use | Interest(2) | |||||||||||
| 4. | City of Industry, California | 953 sq. ft. | Office space | Lease | ||||||||||
| 5. | Marion County, Oregon | 15.2 | Waste-to-energy facility | Own | ||||||||||
| 6. | Alexandria/ Arlington, Virginia | 3.3 | Waste-to-energy facility | Lease | ||||||||||
| 7. | Bristol, Connecticut | 18.2 | Waste-to-energy facility | Own | ||||||||||
| 8. | Indianapolis, Indiana | 23.5 | Waste-to-energy facility | Lease | ||||||||||
| 9. | Stanislaus County, California | 16.5 | Waste-to-energy facility | Lease | ||||||||||
| 10. | Babylon, New York | 9.5 | Waste-to-energy facility | Lease | ||||||||||
| 11. | Haverhill, Massachusetts | 12.7 | Waste-to-energy facility | Lease | ||||||||||
| 12. | Haverhill, Massachusetts | 16.8 | Landfill Expansion | Lease | ||||||||||
| 13. | Haverhill, Massachusetts | 20.2 | Landfill | Lease | ||||||||||
| 14. | Lawrence, Massachusetts | 11.8 | RDF power plant(closed) | Own | ||||||||||
| 15. | Lake County, Florida | 15.0 | Waste-to-energy facility | Own | ||||||||||
| 16. | Wallingford, Connecticut | 10.3 | Waste-to-energy facility | Lease | ||||||||||
| 17. | Fairfax County, Virginia | 22.9 | Waste-to-energy facility | Lease | ||||||||||
| 18. | Union County, New Jersey | 20.0 | Waste-to-energy facility | Lease | ||||||||||
| 19. | Huntington, New York | 13.0 | Waste-to-energy facility | Lease | ||||||||||
| 20. | Warren County, New Jersey | 19.8 | Waste-to-energy facility | Lease | ||||||||||
| 21. | Hennepin County, Minnesota | 14.6 | Waste-to-energy facility | Lease | ||||||||||
| 22. | Onondaga County, New York | 12.0 | Waste-to-energy facility | Lease | ||||||||||
| 23. | Bataan, the Philippines | 30,049 sq. m. | Diesel power plant | Lease | ||||||||||
| 24. | Zhejiang Province, | 33,303 sq. m. | Coal-fired cogeneration facility | Land Use Right | ||||||||||
| People’s Republic of China |
reverts to China Joint Venture Partner upon termination of Joint Venture Agreement |
|||||||||||||
| 25. | Shandong Province, | 33,303 sq. m. | Coal-fired cogeneration facility | Land Use Right | ||||||||||
| People’s Republic of China |
reverts to China Joint Venture Partner upon termination of Joint China Venture Agreement |
|||||||||||||
| 26. | Jiangsu Province, | 65,043 sq. m. | Coal-fired cogeneration facility | Land Use Right | ||||||||||
| People’s Republic of China |
reverts to China Joint Venture Partner upon termination of Joint Venture Agreement |
|||||||||||||
| 27. | Rockville, Maryland | N/A | Landfill gas project | Lease | ||||||||||
| 28. | San Diego, California | N/A | Landfill gas project | Lease | ||||||||||
| 29. | Oxnard, California | N/A | Landfill gas project | Lease | ||||||||||
| 30. | Salinas, California | N/A | Landfill gas project | Lease | ||||||||||
| 31. | Santa Clara, California | N/A | Landfill gas project | Lease | ||||||||||
| 32. | Stockton, California | N/A | Landfill gas project | Lease | ||||||||||
| 33. | Burney, California | 40.0 | Wood waste project | Lease | ||||||||||
| 34. | Jamestown, California | 26.0 | Wood waste project | Own(50%) | ||||||||||
| 35. | Westwood, California | 60.0 | Wood waste project | Own | ||||||||||
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| Approximate | ||||||||||||||
| Site Size | Nature of | |||||||||||||
| Location | (In Acres)(1) | Site Use | Interest(2) | |||||||||||
| 36. | Oroville, California | 43.0 | Wood waste project | Own | ||||||||||
| 37. | Whatcom County, Washington | N/A | Hydroelectric project | Own(50%) | ||||||||||
| 38. | Weeks Falls, Washington | N/A | Hydroelectric project | Lease | ||||||||||
| 39. | Cavite, the Philippines | 13,122 sq. m. | Heavy fuel oil project | Lease | ||||||||||
| 40. | Cavite, the Philippines | 10,200 sq. m. | Heavy fuel oil project | Lease | ||||||||||
| 41. | Manila, the Philippines | 468 sq. m. | Office space | Lease | ||||||||||
| 42. | Bangkok, Thailand | 676 sq. m. | Office space | Lease | ||||||||||
| 43. | Chennai, India | 1797 sq. ft. | Office space | Lease | ||||||||||
| 44. | Samalpatti, India | 2,546 sq. ft. | Office space | Lease | ||||||||||
| 45. | Samayanallur, India | 1,300 sq. ft. | Office space | Lease | ||||||||||
| 46. | Samayanallur, India | 17.1 | Heavy fuel oil project | Lease | ||||||||||
| 47. | Samayanallur, India | 2.3 | Heavy fuel oil project | Lease | ||||||||||
| 48. | Samalpatti, India | 30.3 | Heavy fuel oil project | Lease | ||||||||||
| 49. | Shanghai, China | 145 sq. m. | Office space | Lease | ||||||||||
| 50. | Imperial County, California | 83.0 | Undeveloped Desert Land | Own | ||||||||||
| 51. | Montvale, New Jersey | 34,000 sq. ft. | Office space | Lease | ||||||||||
| 52. | Hempstead, New York | 14.9 | Waste-to-energy facility | Own | ||||||||||
| 53. | Newark, New Jersey | 15.4 | Waste-to-energy facility | Own | ||||||||||
| 54. | Preston, Connecticut | 11.9 | Waste-to-energy facility | Own(4) | ||||||||||
| 55. | Niagara Falls, New York | 12.5 | Waste-to-energy facility | Own | ||||||||||
| 56. | Rochester, Massachusetts | 123.2 | Waste-to-energy facility | Own(90%) | ||||||||||
| 57. | Braintree, Massachusetts | 6.7 | Transfer station | Own(5) | ||||||||||
| 58. | Chester, Pennsylvania | 51.2 | Resource Recovery facility | Lease | ||||||||||
| 59. | Lynn, Massachusetts | 1.4 | Transfer station | Own | ||||||||||
| (1) | All sizes are in acres unless otherwise indicated. |
| (2) | All ownership or leasehold interests relating to projects are subject to material liens in connection with the financing of the related project, except those listed above under items 10, 23-25, 27-32. In addition, all leasehold interests existed at least as long as the term of applicable project contracts, and several of the leasehold interests are subject to renewal and/or purchase options. |
| (3) | NAICC entered into a five year lease in July 2004 and lease payments began in February 2005. |
| (4) | Building is owned, the land the building is on is leased. |
| (5) | Transfer station is owned, the land the station is on is leased. |
LEGAL PROCEEDINGS
We and/or our subsidiaries are party to a number of claims,
lawsuits and pending actions, most of which are routine and all
of which are incidental to its business. We assess the
likelihood of potential losses on an ongoing basis, and when
losses are considered probable and reasonably estimable, record
as a loss an estimate of the 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. The
final consequences of these proceedings are not presently
determinable with certainty.
Covanta Energy Corporation
Generally, claims and lawsuits against Covanta and its
subsidiaries that had filed bankruptcy petitions and
subsequently emerged from bankruptcy arising from events
occurring prior to their respective petition dates, have been
resolved pursuant to the Covanta Plan of Reorganization, and
have been discharged pursuant
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to the March 5, 2004 order of the Bankruptcy Court which
confirmed the Covanta Plan of Reorganization. However, to the
extent that claims are not dischargeable in bankruptcy, such
claims may not be discharged. For example, the claims of certain
persons who were personally injured prior to the petition date,
but whose injury only became manifest thereafter, may not be
discharged pursuant to the Covanta Plan of Reorganization.
Environmental Matters
Covanta’s operations are subject to environmental
regulatory laws and environmental remediation laws. Although
Covanta’s operations are occasionally subject to
proceedings and orders pertaining to emissions into the
environment and other environmental violations, which may result
in fines, penalties, damages or other sanctions, Covanta
believes that it is in substantial compliance with existing
environmental laws and regulations.
Covanta 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 laws. In certain instances, Covanta may be exposed to
joint and several liabilities for remedial action or damages.
Covanta’s ultimate liability in connection with such
environmental claims will depend on many factors, including its
volumetric share of waste, the total cost of remediation, and
the financial viability of other companies that also sent waste
to a given site and, in the case of divested operations, its
contractual arrangement with the purchaser of such operations.
Generally such claims arising prior to the first petition date
were resolved in and discharged by Covanta’s
Chapter 11 cases.
The potential costs related to the matters described below and
the possible impact on future operations are uncertain due in
part to the complexity of governmental laws and regulations and
their interpretations, the varying costs and effectiveness of
cleanup technologies, the uncertain level of insurance or other
types of recovery and the questionable level of Covanta’s
responsibility. Although the ultimate outcome and expense of any
litigation, including environmental remediation, is uncertain,
Covanta believes that the following proceedings will not have a
material adverse effect on Covanta’s consolidated financial
position or results of operations.
In June 2001, the EPA named Covanta’s wholly-owned
subsidiary, Ogden Martin Systems of Haverhill, Inc., now known
as Covanta Haverhill, Inc., as one of 2,000 potentially
responsible parties, referred to as “PRPs” in this
prospectus, at the Beede Waste Oil Superfund Site, Plaistow, New
Hampshire, a former waste oil recycling facility. The total
quantity of waste oil alleged by the EPA to have been disposed
of by PRPs at the Beede site is approximately 14.3 million
gallons, of which Covanta Haverhill, Inc.’s contribution is
alleged to be approximately 44,000 gallons. On January 9,
2004, the EPA signed its Record of Decision with respect to the
cleanup of the site. The estimated cost to implement the
remedial alternative selected in the Record of Decision is
$48 million. By letter dated September 28, 2005, the
EPA invited Covanta Haverhill, Inc. and 94 other PRPs including,
among others, those PRPs that are alleged to have contributed
more than 20,000 gallons of waste oil to the Beede site, to
negotiate the voluntary performance and/or financing of the site
cleanup, including reimbursement of past costs incurred to date
by the EPA and the State of New Hampshire Department of
Environmental Services, referred to as “DES” in this
prospectus. Covanta Haverhill, Inc. is a member of a PRP group
at the Beede site and expects to participate in settlement
negotiations with the EPA and DES as part of that PRP group.
Covanta Haverhill, Inc.’s share of liability, if any,
cannot be determined at this time as a result of uncertainties
regarding the source and scope of contamination, the large
number of PRPs and the varying degrees of responsibility among
various classes of PRPs. Covanta believes that based on the
amount of waste oil materials Covanta Haverhill, Inc. is alleged
to have sent to the site, its liability will not be material to
Covanta’s results of operation and financial position.
By letters dated August 13, 2004 and May 3, 2005, the
EPA notified Covanta Essex Company, referred to as
“Essex” in this prospectus and formerly named American
Ref-Fuel Company of Essex County, that it was potentially liable
under CERCLA Section 107(a) for response actions in the
Lower Passaic River Study Area, referred to as “LPRSA”
in this prospectus, a 17 mile stretch of river in northern
New Jersey. Essex is one of at least 52 PRPs named thus far. The
EPA alleges that hazardous substances found in the LPRSA
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were being released from the Essex site, which abuts the river.
The EPA’s notice letters state that Essex may be liable for
costs related to a proposed $10 million study of the Lower
Passaic River, for certain past costs incurred by the EPA
totaling approximately $2.8 million, and for unspecified
natural resource damages. Considering the history of industrial
and other discharges into the LPRSA from other sources,
including named PRPs, Essex believes any releases from its site
to be de minimis in comparison; however, it is not possible at
this time to predict that outcome with certainty or to estimate
Essex’s ultimate liability in the matter, including for
natural resource damage. Given the uncertainty, Essex has
entered into an arrangement with the EPA and the cooperating PRP
group to settle the potential liability Essex might have for the
$2.8 million in past costs incurred by the EPA, by
contributing $0.25 million to the cost of the study and by
sharing in certain past and ongoing legal fees and other costs
of the cooperating PRP group.
Other Matters
Covanta Warren and the Warren Authority have been engaged in
negotiations for an extended time concerning a potential
restructuring of the parties’ rights and obligations under
various agreements related to Covanta Warren’s operation of
the Warren Facility. Those negotiations were in part
precipitated by a 1997 federal court of appeals decision
invalidating certain of the State of New Jersey’s
waste-flow laws, which resulted in significantly reduced
revenues for the Warren Facility. Since 1999, the State of New
Jersey has been voluntarily making all debt service payments
with respect to the project bonds issued to finance construction
of the Warren Facility, and Covanta Warren has been operating
the Warren Facility pursuant to an agreement with the Warren
Authority which modifies the existing service agreement.
Principal on the Warren Facility project debt is due annually in
December of each year, while interest is due semi-annually in
June and December of each year. The State of New Jersey has
provided sufficient funds to the project bond trustee to pay
principal and interest to bondholders when due during 2004 and
2005.
Also as part of Covanta’s emergence from bankruptcy,
Covanta and Covanta Warren entered into several agreements
approved by the Bankruptcy Court that permit Covanta Warren to
reimburse Covanta for employees and employee-related expenses,
provide for payment of a monthly allocated overhead expense
reimbursement in a fixed amount, and permit Covanta to advance
up to $2.0 million in super-priority debtor in possession
loans to Covanta Warren in order to meet any liquidity needs. As
of September 30, 2005, Covanta Warren owed Covanta
$1.4 million.
In September 2005, Covanta Warren facility filed a
reorganization plan after they reached agreements with the
Warren Authority and various contract counterparties. On
December 1, 2005, the bankruptcy court confirmed Covanta
Warren’s reorganization plan. Covanta Warren emerged from
bankruptcy on December 15, 2005 and will now be
consolidated in our financial statements. As a condition to the
consummation of the reorganization plan, Covanta Warren expects
to pay approximately $15 million to satisfy all amounts
then due with respect to the outstanding project debt, and to
pay certain amounts to project creditors and the Warren
Authority. The reorganization plan also contemplates that
Covanta Warren and the Warren Authority will enter into certain
agreements pursuant to which Covanta Warren will own and operate
the Warren Facility for its own account, without a committed
supply of waste from the Warren Authority or other municipal
entities, and that the Warren Authority will provide ash
disposal services to Covanta Warren at its landfill adjacent to
the Warren facility. Under the reorganization plan, Covanta
Warren’s creditors filed claims are expected to be paid in
full, in cash. See “Waste and Energy Services
Business — Domestic Waste and Energy Services
Business — Other Waste-to-Energy Project
Structures — Warren County, New Jersey,”
for additional information.
DIRECTOR AND EXECUTIVE OFFICER BIOGRAPHIES
David M. Barse has served as a director since 1996 and is a
member of the Compensation Committee. Mr. Barse’s
current one year term as a director will expire at our 2006
annual meeting of stockholders. Mr. Barse served as our
President and Chief Operating Officer from July 1996 until
July 24, 2002. Since February 1998, Mr. Barse has
served as President and, since June 2003, Chief Executive
Officer of Third Avenue Management LLC, an investment adviser to
mutual funds and separate accounts. From April 1995
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until February 1998, he served as the Executive Vice President
and Chief Operating Officer of Third Avenue Trust and its
predecessor, Third Avenue Value Fund, Inc. (together with its
predecessor, referred to as “Third Avenue Trust” in
this prospectus), before assuming the position of President in
May 1998 and Chief Executive Officer in September 2003. In 2001,
Mr. Barse became Trustee of both the Third Avenue Trust and
Third Avenue Variable Series Trust. Since June 1995,
Mr. Barse has been the President and, since July 1999,
Chief Executive Officer of M.J. Whitman, LLC and its
predecessor, a full service broker-dealer. Mr. Barse joined
the predecessor of M.J. Whitman LLC and Third Avenue in December
1991 as General Counsel. Mr. Barse also presently serves as
a director of American Capital Access Holdings, a privately held
financial insurance company. Mr. Barse is 43 years old.
Ronald J. Broglio has been a director since October 2004 and is
a member of the Public Policy Committee. Mr. Broglio’s
current one year term as a director will expire at our 2006
annual meeting of stockholders. Mr. Broglio has been the
President of RJB Associates, a consulting firm specializing in
energy and environmental solutions, since 1996. Mr. Broglio
was Managing Director of Waste to Energy for Waste Management
International Ltd. from 1991 to 1996. Prior to joining Waste
Management, Mr. Broglio held a number of positions with
Wheelabrator Environmental Systems Inc. from 1980 through 1990,
including Managing Director, Senior Vice President —
Engineering, Construction & Operations and Vice
President of Engineering & Construction.
Mr. Broglio served as Manager of Staff Engineering and as a
staff engineer for Rust Engineering Company from 1970 through
1980. Mr. Broglio is 65 years old.
Peter C. B. Bynoe has been a director since July 2004.
Mr. Bynoe’s current one year term as a director will
expire at our 2006 annual meeting of stockholders.
Mr. Bynoe is a member of the Compensation Committee and is
Chairman of the Public Policy Committee. Mr. Bynoe joined
the law firm of DLA Piper Rudnick Gray Cary US, LLP as a partner
in 1995 and currently serves on the firm’s executive
committee. Mr. Bynoe has been a principal of Telemat Ltd.,
a consulting and project management firm, since 1982. He is a
director of Rewards Network Inc. and he also serves as Chairman
of the Illinois Sports Facilities Authority, a joint venture of
the State of Illinois and City of Chicago, which owns
U.S. Cellular Field in Chicago. Mr. Bynoe is
54 years old.
Richard L. Huber has been a director since July 2002.
Mr. Huber’s current one year term as a director will
expire at our 2006 annual meeting of stockholders.
Mr. Huber is the Chairman of the Audit Committee.
Mr. Huber served as Chairman and the Interim Chief
Executive Officer of ACL from April 2004 until January 2005 and
continues as a director of ACL and various subsidiaries and
affiliates of ACL. Mr. Huber has been Managing Director,
Chief Executive Officer and Principal of the American direct
investment group Norte-Sur Partners, a direct private equity
investment firm focused on Latin America, since January 2001.
Mr. Huber held various positions with Aetna, Inc. since
1995, most recently as the Chief Executive Officer, until
February 2000. Mr. Huber has approximately forty years of
prior investment and merchant banking, international business
and management experience, including executive positions with
Chase Manhattan Bank, Citibank, Bank of Boston and Continental
Bank. Mr. Huber is also a director of Opticare Health
Systems, Inc., an integrated eye care services company.
Mr. Huber is 69 years old.
Anthony J. Orlando was named our President and Chief Executive
Officer in October 2004 and was elected as a director in
September 2005 and is a member of the Public Policy Committee.
Mr. Orlando’s current one year term as a director will
expire at our 2006 annual meeting of stockholders. Previously,
he had been President and Chief Executive Officer of Covanta
since November 2003. From March 2003 to November 2003 he served
as Senior Vice President, Business and Financial Management of
Covanta. From January 2001 until March 2003, Mr. Orlando
served as Covanta’s Senior Vice President, Waste-to-Energy.
Previously, he served as executive Vice President of Covanta
Energy Group, Inc. Mr. Orlando joined Covanta in 1987.
Mr. Orlando is 46 years old.
William C. Pate has been a director since 1999 and was our
Chairman of the Board from October 2004 through September 2005.
Mr. Pate’s current one year term as a director will
expire at our 2006 annual meeting of stockholders. Mr. Pate
is a member of the Audit Committee. Mr. Pate is Managing
Director of EGI, a privately-held investment firm. Mr. Pate
has been employed by EGI or its predecessor in various
capacities since 1994. Mr. Pate also serves as a director
of Adams Respiratory Therapeutic, Inc. Mr. Pate is
42 years old.
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Robert S. Silberman has been a director since December 2004 and
is a member of the Nominating and Governance Committee and
Public Policy Committee. Mr. Silberman’s current one
year term as a director will expire at our 2006 annual meeting
of stockholders. Mr. Silberman has been Chairman of the
Board of Directors of Strayer Education, Inc. since February
2003 and its Chief Executive Officer since March 2001.
Mr. Silberman was Executive in Residence at New Mountain
Capital, LLC from August 2000 to March 2001. From 1995 to 2000,
Mr. Silberman served in a variety of senior management
positions, including President and Chief Operating Officer of
CalEnergy Company, Inc. From 1993 to 1995, Mr. Silberman
was Assistant to the Chairman and Chief Executive Officer of
International Paper Company. From 1989 to 1993,
Mr. Silberman served in several senior positions in the
U.S. Department of Defense, including as Assistant
Secretary of the Army. In addition to Strayer Education, Inc.,
Mr. Silberman serves on the Board of Directors of Surgis,
Inc., and on the Management Advisory Board of New Mountain
Capital, LLC. He also serves on the Board of Visitors of The
Johns Hopkins University School of Advanced International
Studies. Mr. Silberman is a member of the Council on
Foreign Relations. Mr. Silberman is 48 years old.
Jean Smith has been a director since December 2003.
Ms. Smith’s current one year term as a director will
expire at our 2006 annual meeting of stockholders. She is a
member of the Audit Committee and the Nominating and Governance
Committee. Ms. Smith has been a private investor and
consultant since 2001. From 1998 to 2001, Ms. Smith was a
Managing Director of Corporate Finance for U.S. Bancorp
Libra, a unit of U.S. Bancorp Investments, Inc., a
subsidiary of U.S. Bancorp. Ms. Smith has
approximately 25 years of investment and international
banking experience, having held positions with Banker Trust
Company, Citicorp Investment Bank, Security Pacific Merchant
Bank and UBS Securities. Ms. Smith is 50 years old.
Clayton Yeutter has served as a director since July 2002.
Mr. Yeutter’s current one year term as a director will
expire at our 2006 annual meeting of stockholders.
Mr. Yeutter is the Chairman of the Nominating and
Governance Committee and a member of the Compensation Committee.
Mr. Yeutter has been Of Counsel to Hogan & Hartson
LLP, a law firm in Washington, D.C., since 1993 where he
has an international trade and agricultural law practice. From
1985 through 1991, he served in the Reagan Administration as
U.S. Trade Representative and in the first Bush
Administration as Secretary of Agriculture. During 1991-92, he
was Chairman of the Republican National Committee and then
returned to the Bush Administration as a Counselor to the
President for most of 1992. He was President and Chief Executive
Officer of the Chicago Mercantile Exchange from 1978 through
1985. In the 1970s, Mr. Yeutter held several positions in
the Nixon and Ford Administrations as Assistant Secretary of
Agriculture for Marketing and Consumer Services, Assistant
Secretary of Agriculture for International Affairs and Commodity
Programs and Deputy Special Trade Representative.
Mr. Yeutter is the Chairman of the Board of Oppenheimer
Funds, an institutional investment manager, Chairman of the
Board of Crop Solutions, Inc., a privately-owned agricultural
chemical company, Chairman of the Board of ACL and a director of
America First, a privately-owned investment management company.
Mr. Yeutter is 75 years old.
Samuel Zell, elected as our Chairman of the Board in September
2005, also previously served as a director from 1999 to 2004,
and as our President, Chief Executive Officer and Chairman of
the Board from July 2002 to October 2004. Mr. Zell’s
current one year term as our Chairman and as a director will
expire at our 2006 annual meeting of stockholders. Mr. Zell
has served as Chairman of the Board of Directors of EGI since
1999, and had been Chairman of the Board of its predecessor,
Equity Group Investments, Inc., for more than five years.
Mr. Zell has been a trustee and Chairman of the Board of
Trustees of Equity Office Properties Trust, an equity real
estate investment trust, commonly known as a “REIT,”
primarily focused on office buildings, since October 1996, and
was its President and Chief Executive Officer from April 2002
until November 2002. For more than the past five years,
Mr. Zell has served as Chairman of the Board of Anixter
International, Inc., a global distributor of electrical and
cable systems; as Chairman of the Board of Equity Lifestyle
Properties, Inc. (previously known as of Manufactured Home
Communities, Inc.), an equity REIT primarily engaged in the
ownership and operation of manufactured home resort communities;
as Chairman of the Board of Trustees of Equity Residential
Properties Trust, an equity REIT that owns and operates
multi-family residential properties and as Chairman of the Board
of Capital Trust, Inc., a specialized finance company.
Mr. Zell is 64 years old.
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In addition to Mr. Orlando, who is also a director, the
following individuals serve as our current executive officers:
Craig D. Abolt has served as our Senior Vice President and Chief
Financial Officer since October 2004. He has served as a
director and Senior Vice President and Chief Financial Officer
of Covanta since June 2004. Prior to joining Covanta,
Mr. Abolt served as chief financial officer of DIRECTV
Latin America, LLC, a majority-owned subsidiary of Hughes
Electronics Corporation and referred to as “DLA” in
this prospectus, from June 2001 until May 2004. From December
1991 until June 2001, he was employed by Walt Disney Company in
several executive finance positions. Mr. Abolt is
45 years old.
Timothy J. Simpson has served as our Senior Vice President,
General Counsel and Secretary since October 2004. Since March
2004 he has served as Senior Vice President, General Counsel and
Secretary of Covanta. From June 2001 to March 2004,
Mr. Simpson served as Vice President, Associate General
Counsel and Assistant Secretary of Covanta. Previously, he
served as Senior Vice President, Associate General Counsel and
Assistant Secretary of Covanta Energy Group, Inc.
Mr. Simpson joined Covanta in 1992. Mr. Simpson is
47 years old.
Thomas Bucks has served as our Vice President and Chief
Accounting Officer since April 12, 2005. Mr. Bucks
served as Covanta’s Controller from February 24, 2005
to April 11, 2005. Prior to joining us, 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. Mr. Bucks is 49 years old.
Messrs. Orlando and Simpson were both officers of Covanta
when it filed for bankruptcy and have continued as officers of
Covanta after its emergence from bankruptcy and confirmation of
its plan of reorganization. Covanta’s Chapter 11
proceedings commenced on April 1, 2002. Covanta and most of
its domestic subsidiaries filed voluntary petitions for relief
under Chapter 11 in the United States Bankruptcy Court for
the Southern District of New York. All of the bankruptcy cases
were jointly administered under the caption “In re Ogden
New York Services, Inc., et al., Case Nos. 02-40826 (CB),
et al.” On March 5, 2004, the Bankruptcy Court
entered an order confirming the our plan of reorganization and
plan for liquidation for subsidiaries involved in non-core
businesses and on March 10, 2004, both plans were effected.
Mr. Abolt served as the Chief Financial Officer of DLA when
it filed for bankruptcy in March 2003 and after its emergence
from bankruptcy and confirmation of its plan of reorganization
in February 2004. DLA filed a voluntary petition for
reorganization under Chapter 11 of the U.S. Bankruptcy
Code on March 18, 2003 in the United States Bankruptcy
Court for the District of Delaware, which entered an order
confirming DLA’s plan of reorganization on
February 13, 2004, and the plan became effective on
February 24, 2004.
There is no family relationship between any of our directors and
any other director or any executive officer of ours.
BOARD STRUCTURE AND COMPENSATION
Our Board of Directors is currently comprised of ten members and
one vacancy. The Board has determined that each of David Barse,
Ronald J. Broglio, Peter C.B. Bynoe, Richard L. Huber, William
Pate, Robert S. Silberman, Jean Smith and Clayton Yeutter are
independent under applicable New York Stock Exchange listing
standards.
Audit Committee
The current members of the Audit Committee of our Board of
Directors are Mr. Huber (Chair), Ms. Smith and
Mr. Pate. Each of the members of the Audit Committee is an
independent director under applicable New York Stock Exchange
listing standards and applicable SEC rules and regulations. The
Board has determined that Mr. Huber qualifies as an
“audit committee financial expert” under applicable
SEC rules.
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Compensation of the Board
As approved by the stockholders at the October 5, 2004
annual meeting, on an annual basis, at the annual meeting of
stockholders at which directors are elected, each non-employee
director received options to acquire 13,334 shares of
common stock at a price equal to the fair market value of a
share of our common stock on the date of grant and was awarded
1,500 shares of restricted stock, which restricted shares
will vest ratably over three years from the date of grant.
Mr. Barse waived his right to receive such grants of
options and restricted stock for 2005. Non-employee directors
will receive an annual fee of $30,000. The chairman of the Board
receives an additional annual fee of $10,000. In addition, the
chair of the Audit Committee will receive an additional annual
fee of $7,500 for such service and the chair of each of the
other committees of the Board, including without limitation, the
Compensation Committee, the Nominating and Governance Committee
and the Public Policy Committee, will be entitled to receive an
additional annual fee of $5,000 for such service. Non-employee
directors will be entitled to receive a meeting fee of $2,000
for each Audit Committee meeting and $1,500 for each other
committee meeting they attend. Directors who are appointed at a
date other than the annual meeting of stockholders, will be
entitled to receive a pro rata portion of the annual
compensation.
Equity Compensation Plans
The following table sets forth information as of
December 31, 2004, regarding the number of securities which
could be issued upon the exercise of outstanding options, the
weighted average exercise price of those options in the 1995
Stock and Incentive Plan, the Equity Award Plan for Employees
and Officers, referred to as the “Employees Plan” in
this prospectus, and our Equity Award Plan for Directors,
referred to as the “Directors Plan” in this
prospectus, and the number of securities then remaining for
future issuance under the Employees Plan and Directors Plan.
Upon adoption of the Employees and Directors Plans in October
2004, we terminated any future issuances under the 1995 Stock
Incentive Plan. We do not have any equity compensation plans
that have not been approved by its security holders.
| Number of | Number of Securities | ||||||||||||
| Securities to be | Remaining Available for | ||||||||||||
| Issued Upon | Weighted Average | Future Issuance Under | |||||||||||
| Exercise of | Exercise Price of | Equity Compensation | |||||||||||
| Outstanding | Outstanding | Plans (Excluding | |||||||||||
| Options, Warrants | Options, Warrants | Securities Reflected in | |||||||||||
| Plan Category | and Rights | and Rights | Column A) | ||||||||||
| (A) | (B) | (C) | |||||||||||
|
Equity Compensation Plans Approved By Security Holders
|
1,933,460 | $ | 6.38 | 2,862,217 | (1) | ||||||||
|
Equity Compensation Plans Not Approved By Security Holders
|
N/A | N/A | N/A | ||||||||||
|
Total
|
1,933,460 | $ | 6.38 | 2,862,217 | |||||||||
| (1) | Of the 2,862,217 shares then available for future issuance, 1,462,217 were then reserved for issuance under our equity compensation plans. Subsequent to December 31, 2004, our stockholders approved the issuance of an additional 2,000,000 shares of our common stock under the Employees Plan. |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following tables set forth information, as of
November 25, 2005, concerning:
| • | beneficial ownership of our common stock by (1) SZ Investments, together with Fund 05-07, and EGI, (2) Third Avenue and (3) Laminar, which are the only beneficial owners of 5% or more of our common stock; and | |
| • | beneficial ownership of our common stock by (1) all of our current directors, (2) those executive officers named in the Summary Compensation Table included in this prospectus and (3) all of the current directors and executive officers of ours together as a group. | |
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The number of shares beneficially owned by each entity, person,
current director, director nominee or named executive officer is
determined under the rules of the SEC, and the information is
not necessarily indicative of beneficial ownership for any other
purpose. Under such rules, beneficial ownership includes any
shares as to which the individual has the right to acquire
within 60 days after the date of this table, through the
exercise of any stock option or other right. Unless otherwise
indicated, each person has sole investment and voting power, or
shares such powers with his or her spouse or dependent children
within his or her household, with respect to the shares set
forth in the following table. Unless otherwise indicated, the
address for all current executive officers and directors is
c/o Covanta Holding Corporation, 40 Lane Road, Fairfield,
New Jersey 07004.
Equity Ownership of Certain Beneficial Owners
| Number of Shares | Approximate | ||||||||
| Name and Address of Beneficial Owner(1) | Beneficially Owned | Percent of Class | |||||||
|
SZ Investments LLC(2)
|
23,176,282 | 16.4% | |||||||
|
Two North Riverside Plaza Chicago, Illinois 60606 |
|||||||||
|
Third Avenue Management LLC(3)
|
8,816,889 | (4) | 6.2% | ||||||
|
622 Third Avenue, 32nd Floor New York, New York 10017 |
|||||||||
|
D. E. Shaw Laminar Portfolios, L.L.C.(5)
|
26,494,125 | 18.8% | |||||||
|
120 West Forty-Fifth Street Floor 39, Tower 45 New York, New York 10036 |
|||||||||
| (1) | In accordance with provisions of our certificate of incorporation, all certificates representing shares of common stock beneficially owned by holders of 5% or more of the common stock are owned of record by us, as escrow agent, and are physically held by us in that capacity. |
| (2) | This includes the shares owned as follows: (a) 19,500,900 shares that SZ Investments beneficially owns with shared voting and dispositive power, (b) 3,430,448 shares that Fund 05-07 beneficially owns with shared voting and dispositive power, and (c) 244,934 shares that EGI beneficially owns with shared voting and dispositive power. |
| SZ Investments is the managing member of Fund 05-07. SZ Investments, Fund 05-07 and EGI are each indirectly controlled by various trusts established for the benefit of Samuel Zell and members of his family, the trustee of each of which is Chai Trust Company, L.L.C., referred to as “Chai Trust” in this prospectus. Chai Trust has shared voting and dispositive power as to all such shares beneficially owned by SZ Investments, Fund 05-07 and EGI. Mr. Zell is not a director or officer of Chai Trust and thus disclaims beneficial ownership of all such shares, except to the extent of his pecuniary interest therein. | |
| Each of Messrs. Zell and Pate is an executive officer of EGI, Fund 05-07 and SZ Investments. One of the executive officers of SZ Investments, Fund 05-07 and EGI is also the President of Chai Trust. Mr. Zell was elected as our Chairman of the Board in September 2005 and he also previously served as a director from 1999 to 2004 and as our Chairman of the Board from July 2002 to October 2004, when he did not stand for re-election. In addition, Mr. Zell was our President and Chief Executive Officer from July 2002 until his resignation as of April 27, 2004. William C. Pate served as our Chairman of the Board of Directors from October 2004 through September 2005 and has been a director since 1999. The addresses of each of Fund 05-07 and EGI are as set forth in the table above for SZ Investments. | |
| (3) | Third Avenue, a registered investment advisor under Section 203 of the Investment Advisors Act of 1940, as amended, invests funds on a discretionary basis on behalf of investment companies registered under the Investment Company Act of 1940, as amended, and on behalf of individually managed separate accounts. David M. Barse has served as one of our directors since 1996 and was our President and Chief Operating Officer from July 1996 until July 2002. Since February 1998, Mr. Barse has served as President, and since June 2003, Chief Executive Officer of Third Avenue. Mr. Barse is also the Chief Executive Officer of Third Avenue. |
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| (4) | The shares beneficially owned by Third Avenue are held by Third Avenue Value Fund Series of the Third Avenue Trust. These shares do not include the following shares held by each of Martin Whitman and Mr. Barse: (a) 2,437,954 shares beneficially owned by Mr. Whitman (including 323,517 shares owned by Mr. Whitman’s wife and 619,130 shares beneficially owned by a private investment company of which Mr. Whitman is the principal shareholder), and (b) 621,502 shares beneficially owned by Mr. Barse (including shares underlying currently exercisable options to purchase an aggregate of 138,425 shares of common stock at exercise prices ranging from $5.31 to $7.06 per share). |
| (5) | Laminar shares voting and dispositive power with D. E. Shaw & Co., L.P., referred to as “Shaw LP” in this prospectus, D. E. Shaw & Co., L.L.C., referred to as “Shaw LLC” in this prospectus, and David Shaw. Each of Shaw LP, Shaw LLC and Mr. Shaw disclaims beneficial ownership of such 26,494,125 shares beneficially owned by Laminar. |
| This does not include the number of shares of common stock which Laminar will have the right to purchase in the offering covered by this prospectus. In this offering Laminar has the right to purchase our shares as a holder of the 9.25% Debentures due 2002 issued by Covanta that voted in favor of Covanta’s second reorganization plan on January 12, 2004. |
Equity Ownership of Management
| Number of Shares | Approximate | ||||||||
| Name | Beneficially Owned(1) | Percent of Class | |||||||
|
Craig D. Abolt
|
90,615 | (2) | * | ||||||
|
David M. Barse
|
9,438,391 | (3) | 6.68 | % | |||||
|
Ronald J. Broglio
|
16,334 | (4) | * | ||||||
|
Peter C. B. Bynoe
|
29,684 | * | |||||||
|
Richard L. Huber
|
177,850 | (5) | * | ||||||
|
Anthony J. Orlando
|
211,258 | (2) | * | ||||||
|
William C. Pate
|
360,061 | (6) | * | ||||||
|
Robert Silberman
|
24,985 | * | |||||||
|
Timothy J. Simpson
|
72,472 | (2) | * | ||||||
|
Jean Smith
|
41,369 | * | |||||||
|
Clayton Yeutter
|
112,682 | (7) | * | ||||||
|
Samuel Zell
|
23,203,200 | (8) | 16.44 | % | |||||
|
Two North Riverside Plaza Chicago, Illinois 60606 |
|||||||||
|
Jeffrey Horowitz
|
— | * | |||||||
|
Two North Riverside Plaza Chicago, Illinois 60606 |
|||||||||
|
All Officers and Directors as a group (12 persons)
|
33,778,901 | (9) | 23.88 | % | |||||
| * | Percentage of shares beneficially owned does not exceed 1% of the outstanding common stock. |
| (1) | In accordance with provisions of our certificate of incorporation, all certificates representing shares of common stock beneficially owned by holders of 5% or more of the common stock are owned of record by us, as escrow agent, and are physically held by us in that capacity. |
| (2) | Includes restricted stock awarded pursuant to the terms and conditions of the employment agreements as described under “Executive Compensation — Employment Arrangements” of this prospectus. Messrs. Orlando, Abolt and Simpson received 49,656, 20,690 and 17,242 shares of our restricted stock, respectively, under such employment agreements. The restricted stock vests, subject to forfeiture and meeting certain performance-based metrics of Covanta as approved by the Board, under their respective employment agreements in equal installments over three years, with the first 1/3 having vested on February 28, 2005. Also includes restricted stock awarded to Messrs. Orlando, Abolt and Simpson pursuant to the Employees Plan on July 7, 2005, in the amounts of 48,000, 22,000 and 19,200 shares of |
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| our restricted stock, respectively. Also includes shares underlying currently exercisable options held by Messrs. Orlando, Abolt and Simpson to purchase 53,209, 14,875 and 13,105, shares of common stock respectively, at an exercise price of $7.43 per share. | |
| (3) | Includes 8,816,889 shares beneficially owned by Third Avenue, which is affiliated with Mr. Barse. Mr. Barse disclaims beneficial ownership of these shares. Also includes shares underlying currently exercisable options to purchase 50,000 shares of common stock at an exercise price of $5.69, shares underlying currently exercisable options to purchase 50,000 shares of common stock at an exercise price of $7.06 and shares underlying currently exercisable options to purchase 38,425 shares of common stock at an exercise price of $5.31 per share. |
| (4) | Includes shares underlying currently exercisable options to purchase 13,334 shares of common stock at an exercise price of $7.43 per share. |
| (5) | Includes shares underlying currently exercisable options to purchase 26,667 shares of common stock at an exercise price of $4.26 per share. |
| (6) | Includes shares underlying currently exercisable options to purchase 13,334 shares of common stock at an exercise price of $7.43 per share. |
| (7) | Includes shares underlying currently exercisable options to purchase 13,334 shares of common stock at an exercise price of $4.26 per share. |
| (8) | Mr. Zell disclaims beneficial ownership as to (a) 19,500,900 shares beneficially owned by SZ Investments, (b) 3,430,448 shares beneficially owned by Fund 05-07, and (c) 244,934 shares beneficially owned by EGI. SZ Investments, Fund 05-07 and EGI are each indirectly controlled by various trusts established for the benefit of Mr. Zell and members of his family, the trustee of each of which is Chai Trust. Mr. Zell is not a director or officer of Chai Trust and thus disclaims beneficial ownership of all such shares, except to the extent of his pecuniary interest therein. Also, Mr. Zell disclaims beneficial ownership as to 25,418 shares beneficially owned by the Helen Zell Revocable Trust, the trustee of which is Helen Zell, Mr. Zell’s spouse, as to which shares Mr. Zell disclaims beneficial ownership, except to the extent of his pecuniary interest therein. |
| (9) | Includes shares underlying currently exercisable options to purchase 286,283 shares of common stock that our directors and executive officers have the right to acquire within 60 days of the date of this table. |
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EXECUTIVE COMPENSATION
The following table sets forth information concerning the annual
and long-term compensation for services in all capacities to us
or our subsidiary companies or their predecessors for 2002
through 2004 of those persons who served as (a) all
individuals serving as our Chief Executive Officer during 2004,
and (b) the two most highly compensated executive officers,
other than the Chief Executive Officer, employed by us as of
December 31, 2004, whose total annual salary and bonus
exceeded $100,000 collectively, referred to as the “Named
Executive Officers” in this prospectus:
Summary Compensation Table
| Long-Term | |||||||||||||||||||||||||||||
| Compensation Awards | |||||||||||||||||||||||||||||
| Annual Compensation | Restricted | Securities | |||||||||||||||||||||||||||
| Other Annual | Stock | Underlying | All Other | ||||||||||||||||||||||||||
| Name and Principal Position | Year | Salary | Bonus(6) | Compensation | Awards(7) | Options | Compensation(8) | ||||||||||||||||||||||
|
Anthony J. Orlando
|
2004 | $ | 380,769 | $ | 393,750 | $ | 0 | $ | 360,000 | $ | 0 | $ | 79,837 | ||||||||||||||||
| President and Chief Executive Officer (October 5, 2004 — Present)(1)(2) | |||||||||||||||||||||||||||||
|
Jeffery R. Horowitz
|
2004 | $ | 245,708 | $ | 372,720 | $ | 0 | $ | 0 | $ | 0 | $ | 1,467,409 | ||||||||||||||||
| President and Chief Executive Officer (April 27, 2004 — October 5, 2004)(3) | |||||||||||||||||||||||||||||
|
Samuel Zell
|
2004 | $ | 65,000 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||||||||
| President and Chief Executive | 2003 | $ | 200,000 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||||||||
| Officer (July 24, 2002 — | 2002 | $ | 87,949 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||||||||
| April 27, 2004)(3) | |||||||||||||||||||||||||||||
|
Craig D. Abolt
|
2004 | $ | 206,250 | $ | 75,000 | $ | 0 | $ | 150,000 | $ | 0 | $ | 199,633 | ||||||||||||||||
| Senior Vice President and Chief Financial Officer(1)(4) | |||||||||||||||||||||||||||||
|
Timothy J. Simpson
|
2004 | $ | 240,180 | $ | 150,000 | $ | 0 | $ | 125,000 | $ | 0 | $ | 38,058 | ||||||||||||||||
| Senior Vice President, General Counsel and Secretary(1)(5) | |||||||||||||||||||||||||||||
| (1) | The compensation included in the table above for Messrs. Orlando, Abolt and Simpson includes compensation for their services to both us and Covanta as they are compensated for their services as an officer of both us and Covanta under the employment agreements they each entered into on October 5, 2004 with both us and Covanta. Under the employment agreements entered into and dated October 5, 2005, Messrs. Orlando, Abolt and Simpson initial base annual salaries are $400,000, $325,000 and $240,180, respectively. Mr. Orlando’s prior employment agreement with Covanta entitled him to a base annual salary of $375,000, which contract was rejected by Covanta in March 2004 pursuant to Covanta’s emergence from Chapter 11. Messrs. Abolt and Simpson did not have prior employment agreements with Covanta. |
| (2) | $290,000 of Mr. Orlando’s salary was paid by Covanta prior to his appointment on October 5, 2004 as an officer of both us and Covanta. |
| (3) | Mr. Horowitz served as our Interim President and Chief Executive Officer from April 2004 until October 5, 2004. Mr. Zell served as our President and Chief Executive Officer from July 2002 until March 2004. |
| (4) | $132,500 of Mr. Abolt’s salary was paid by Covanta prior to his appointment on October 5, 2004 as an officer of both us and Covanta. |
| (5) | $185,678 of Mr. Simpson’s salary was paid by Covanta prior to his appointment on October 5, 2004 as an officer of both us and Covanta. |
| (6) | The amounts shown represent the full amount of the annual bonuses attributable to each year, which were generally paid in the first fiscal quarter of the following year. |
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| (7) | Reflects the value of the restricted stock awarded pursuant to the terms and conditions of the employment agreements described below under “Employment Arrangements” on the date of grant. |
| Messrs. Orlando, Abolt and Simpson received 49,656, 20,690 and 17,242 shares of restricted common stock of us, respectively, under such employment agreements. The restricted stock vests, subject to forfeiture and meeting certain performance-based metrics of Covanta as approved by the Board of Directors, under their respective employment agreements in equal installments over three years, with the first 1/3 having vested on February 28, 2005. |
| (8) | Includes for the fiscal year ending December 31, 2004: (a) contributions in the amount of $8,200 credited to the account balances of each of Messrs. Orlando, Horowitz and Simpson under our 401(k) Savings Plan; (b) a cash payment to Messrs. Orlando, Horowitz and Simpson in the amount of $16,971, $14,117 and $6,858, respectively, representing the excess of the contribution that could have been made to each such individual’s Covanta 401(k) Savings Plan account pursuant to the formula applicable to all employees over the maximum contribution to such plan permitted by the Internal Revenue Code of 1976, as amended; (c) a cash payment to Messrs. Orlando, Horowitz and Simpson in the amount of $54,667, $58,116 and $23,000, respectively, representing retention bonuses paid by Covanta during 2004; (d) payments and reimbursements for relocation expenses of Mr. Abolt; and (e) special pay of $66,923, severance of $1,317,746, and sellback of current vacation of $2,307 paid to Mr. Horowitz. |
Option/ SAR Grants in Last Fiscal Year
The stock options granted to our Named Executive Officers in
2004 are as follows:
| % of Total | Potential Realizable Value at | |||||||||||||||||||||||
| Number of | Options/SARs | Assumed Annual Rates of | ||||||||||||||||||||||
| Securities | Granted to | Stock Price Appreciation or | ||||||||||||||||||||||
| Underlying | Exercise | Option Term | ||||||||||||||||||||||
| Options/SARs | Employees in | Price per | Expiration | |||||||||||||||||||||
| Name | Granted | 2004 | Share | Date | 5% | 10% | ||||||||||||||||||
|
Anthony J. Orlando
|
200,000 | 19.6 | % | $ | 7.43 | 10/05/2014 | $ | 934,537 | $ | 2,368,301 | ||||||||||||||
|
Jeffrey Horowitz
|
— | — | — | — | — | — | ||||||||||||||||||
|
Samuel Zell
|
— | — | — | — | — | — | ||||||||||||||||||
|
Craig D. Abolt
|
85,000 | 8.3 | % | $ | 7.43 | 10/05/2014 | $ | 397,178 | $ | 1,006,528 | ||||||||||||||
|
Timothy J. Simpson
|
75,000 | 7.4 | % | $ | 7.43 | 10/05/2014 | $ | 350,452 | $ | 888,113 | ||||||||||||||
Aggregated Option Exercises In Last Fiscal Year and Fiscal
Year-End Option Values
The following table sets forth the number of securities
underlying unexercised options held by each of the Named
Executive Officers and the value of such options at the end of
fiscal 2004:
| Number of Securities | Value of Unexercised | |||||||||||||||
| Underlying Unexercised | In-the-Money Options at | |||||||||||||||
| Shares Acquired | Value | Options at Fiscal Year End | Fiscal Year End | |||||||||||||
| Name | on Exercise | Realized | Exercisable/Unexercisable | Exercisable/Unexercisable | ||||||||||||
|
Anthony J. Orlando
|
— | $ | 0 | 0/200,000 | 0/$ | 204,000 | ||||||||||
|
Jeffrey Horowitz
|
— | — | — | — | ||||||||||||
|
Samuel Zell
|
— | — | — | — | ||||||||||||
|
Craig D. Abolt
|
— | $ | 0 | 0/85,000 | 0/$ | 86,700 | ||||||||||
|
Timothy J. Simpson
|
— | $ | 0 | 0/75,000 | 0/$ | 76,500 | ||||||||||
Employment Arrangements
Anthony J. Orlando was named our President and Chief Executive
Officer effective October 5, 2004. Other than the
employment agreement and compensation matters described below,
Mr. Orlando has not engaged in any reportable transactions
with us or any of our subsidiaries during our last fiscal year,
and he is not a party to any currently proposed transactions
with us. Mr. Orlando does not have any family relationship
with any other executive officer or director of ours.
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Mr. Orlando continues to serve as the President and Chief
Executive Officer of Covanta, a position he has held since
November 2003.
We and Covanta entered into a five-year employment agreement
with Mr. Orlando, commencing October 5, 2004. Pursuant
to his employment agreement, Mr. Orlando is entitled to an
initial base salary of $400,000 per year and an annual
target bonus of 80% of his base salary, depending upon
Covanta’s achievement of certain financial targets and
other criteria approved by our Board of Directors.
Mr. Orlando also received a grant of 49,656 shares of
restricted stock, valued at $360,000 at the date of grant, and
options to purchase 200,000 shares of our common stock
at a price of $7.43 per share pursuant to the Employees
Plan. The restricted stock vests in equal installments over
three years, with 50% of such shares vesting in three equal
annual installments commencing February 28, 2005, so long
as Mr. Orlando is employed us, and 50% vesting in
accordance with Covanta’s achievement of certain operating
cash flow or other performance-based metrics of Covanta as
approved by the Board of Directors, commencing February 28,
2005. The options vest over three years in equal installments,
commencing February 28, 2006, and were subsequently
accelerated to begin vesting on March 21, 2005 with the
remaining tranches continuing to vest on February 28, 2007
and February 28, 2008. Mr. Orlando’s employment
is subject to non-compete, non-solicitation and confidentiality
provisions as set forth in the employment agreement. In the
event that Mr. Orlando is terminated for any reason other
than for “cause,” he shall be entitled to payment of
his average annual compensation, consisting of his then current
annual base salary plus his average annual target bonus, for
(a) 36 months if such termination occurs in the first
three years of his employment contract, or
(b) 24 months if such termination occurs in the last
two years of his employment contract. Upon termination other
than for “cause,” Mr. Orlando shall forfeit all
rights and interests to any unvested equity awards, except for
those equity awards that would otherwise vest within three
months of the date of his termination. The employment agreement
also provides for the acceleration of the vesting of the equity
awards in the event of a change in control of us or Covanta.
Craig D. Abolt was named as the Senior Vice President and Chief
Financial Officer of ours effective October 5, 2004. Other
than the employment agreement and compensation matters described
below, Mr. Abolt has not engaged in any reportable
transactions with us or any of our subsidiaries during our last
fiscal year, and he is not a party to any currently proposed
transactions with us. Mr. Abolt does not have any family
relationship with any other executive officer or director of
ours.
Mr. Abolt continues to serve as the Senior Vice President
and Chief Financial Officer of Covanta, a position he has held
since June 2004.
We and Covanta entered into a five-year employment agreement
with Mr. Abolt, commencing October 5, 2004. Pursuant
to his employment agreement, Mr. Abolt is entitled to an
initial base salary of $325,000 per year and an annual
target bonus of 55% of his base salary, depending upon
Covanta’s achievement of certain financial targets and
other criteria approved by our Board of Directors.
Mr. Abolt also received a grant of 20,690 shares of
restricted stock, valued at $150,000 at the date of grant, and
options to purchase 85,000 shares of our common stock
at a price of $7.43 per share pursuant to the Employees
Plan. The restricted stock vests in equal installments over
three years, with 50% of such shares vesting in three equal
annual installments commencing February 28, 2005, so long
as Mr. Abolt is employed by us, and 50% vesting in
accordance with Covanta’s achievement of certain operating
cash flow or other performance-based metrics of Covanta as
approved by the Board of Directors, commencing February 28,
2005. The options vest over three years in equal installments,
commencing February 28, 2006 and were subsequently
accelerated to begin vesting on March 21, 2005 with the
remaining tranches continuing to vest on February 28, 2007
and February 28, 2008. Mr. Abolt’s employment is
subject to non-compete, non-solicitation and confidentiality
provisions as set forth in the employment agreement. In the
event that Mr. Abolt is terminated for any reason other
than for “cause,” he shall be entitled to payment of
his average annual compensation, consisting of his then current
annual base salary plus his average annual target bonus, for
(a) 24 months if such termination occurs in the first
two years of his employment contract, or (b) 18 months
if such termination occurs in the last three years of his
employment contract. Upon termination other than for
“cause,” Mr. Abolt shall forfeit all rights and
interests to any unvested equity awards, except for those equity
awards that would otherwise vest
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within three months of the date of his termination. The
employment agreement also provides for the acceleration of the
vesting of the equity awards in the event of a change in control
of us or Covanta.
Timothy J. Simpson has served as our Senior Vice President,
General Counsel and Secretary since October 2004. Other than the
employment agreement and compensation matters described below,
Mr. Simpson has not engaged in any reportable transactions
with us or our subsidiaries during our last fiscal year, and he
is not a party to any currently proposed transactions with us.
Mr. Simpson does not have any family relationship with any
other executive officer or director of ours.
Mr. Simpson continues to serve as the Senior Vice
President, General Counsel and Secretary of Covanta, a position
he has held since March 2004.
We and Covanta entered into a five-year employment agreement
with Mr. Simpson, commencing October 5, 2004. Pursuant
to his employment agreement, Mr. Simpson is entitled to an
initial base salary of $240,180 per year and an annual
target bonus of 45% of his base salary, depending upon
Covanta’s achievement of certain financial targets and
other criteria approved by our Board of Directors.
Mr. Simpson also received a grant of 17,242 shares of
restricted stock, valued at $125,000 at the date of grant, and
options to purchase 75,000 shares of our common stock
at a price of $7.43 per share pursuant to the Employees
Plan. The restricted stock vests in equal installments over
three years, with 50% of such shares vesting in equal annual
installments commencing February 28, 2005, so long as
Mr. Simpson is employed by us, and 50% vesting in
accordance with Covanta’s achievement of certain operating
cash flow or other performance-based metrics of Covanta as
approved by the Board of Directors, commencing February 28,
2005. The options vest over three years in equal installments,
commencing on February 28, 2006 and were subsequently
accelerated to begin vesting on March 21, 2005 with the
remaining tranches continuing to vest on February 28, 2007
and February 28, 2008. Mr. Simpson’s employment
is subject to non-compete, non-solicitation and confidentiality
provisions as set forth in the employment agreement. In the
event that Mr. Simpson is terminated for any reason other
than for “cause,” he shall be entitled to payment of
his average annual compensation, consisting of his then current
annual base salary plus his average annual target bonus, for
(a) 24 months if such termination occurs in the first
two years of his employment contract, or (b) 18 months
if such termination occurs in the last three years of his
employment contract. Upon termination other than for
“cause,” Mr. Simpson shall forfeit all rights and
interests to any unvested equity awards, except for those equity
awards that would otherwise vest within three months of the date
of his termination. The employment agreement also provides for
the acceleration of the vesting of the equity awards in the
event of a change in control of us or Covanta.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Employment Arrangements
See the descriptions of our employment agreements with Anthony
J. Orlando, Craig D. Abolt and Timothy J. Simpson contained in
“Executive Compensation — Employment
Arrangements” above.
Related Party Agreements
Following ACL’s emergence from bankruptcy, we sold our
entire 50% interest in Vessel Leasing to ACL on January 13,
2005 for $2.5 million. The price and other terms and
conditions of the sale were negotiated on an arm’s
length-basis for us by a special committee of our Board of
Directors.
We entered into a corporate services agreement dated as of
September 2, 2003, pursuant to which EGI agreed to provide
certain administrative services to us, including, among others,
shareholder relations, insurance procurement and management,
payroll services, cash management, tax and treasury functions,
technology services, listing exchange compliance and financial
and corporate record keeping. Samuel Zell is also the Chairman
of EGI, and William Pate is also an executive officer of EGI. We
paid EGI $20,000 per month plus specified out-of-pocket
fees and expenses incurred by EGI under this corporate services
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agreement. We and EGI terminated this agreement with the
integration of Covanta’s operations with ours as of
November 2004.
As part of the investment and purchase agreement dated as of
December 2, 2003, pursuant to which we agreed to acquire
Covanta, we arranged for a new replacement letter of credit
facility for Covanta, secured by a second priority lien on
Covanta’s available domestic assets, consisting of
commitments for the issuance of standby letters of credit in the
aggregate amount of $118 million. This financing was
provided by SZ Investments, Third Avenue and Laminar, a
significant creditor of Covanta. Each of SZ Investments, Third
Avenue Trust and Laminar, referred to as the “Bridge
Lenders” in this prospectus, or an affiliate own over 5% of
our common stock. Samuel Zell and William Pate are affiliated
with SZ Investments. David Barse, one of our current directors,
is affiliated with Third Avenue. The second lien credit facility
had a term of five years. The letter of credit component of the
second lien credit facility required cash collateral to be
posted for issued letters of credit in the event Covanta has
cash in excess of specified amounts. Covanta also paid an
upfront fee of $2.36 million upon entering into the second
lien credit agreement, and (1) a commitment fee equal to
0.5% per annum of the daily calculation of available
credit, (2) an annual agency fee of $30,000, and
(3) with respect to each issued letter of credit an amount
equal to 6.5% per annum of the daily amount available to be
drawn under such letter of credit. Amounts paid with respect to
drawn letters of credit bore interest at the rate of 4.5% over
the base rate on issued letters of credit, increasing to 6.5%
over the base rate in specified default situations. Subsequent
to the signing of the investment and purchase agreement, each of
the Bridge Lenders assigned approximately 30% of their
participation in the second lien letter of credit facility to
Goldman Sachs Credit Partners, L.P., Laminar assigned the
remainder of its participation in the second lien letter of
credit facility to TRS Elara, LLC. This debt was refinanced and
paid off in connection with the Ref-Fuel acquisition in July
2005.
We obtained the financing for our acquisition of Covanta
pursuant to a note purchase agreement dated December 2,
2003, from the Bridge Lenders. Pursuant to the note purchase
agreement, the Bridge Lenders provided us with $40 million
of bridge financing in exchange for notes we issued. We repaid
these notes with the proceeds from a rights offering of our
common stock which was completed in June 2004 and by conversion
of a portion of the note held by Laminar into 8.75 million
shares of our common stock pursuant to the note purchase
agreement. In consideration for the $40 million of bridge
financing, the arrangement by the Bridge Lenders of the
$118 million second lien credit facility and the
arrangement by Laminar of a $10 million international
revolving credit facility secured by Covanta’s
international assets, we issued to the Bridge Lenders an
aggregate of 5,120,853 shares of our common stock.
Pursuant to registration rights agreements, we filed a
registration statement with the SEC to register the shares of
common stock issued to the Bridge Lenders under the note
purchase agreement. The registration statement was declared
effective on August 24, 2004.
As part of our negotiations with Laminar and Laminar becoming a
5% stockholders of ours, pursuant to a letter agreement dated
December 2, 2003, Laminar agreed to transfer restrictions
on the shares of common stock that Laminar acquired pursuant to
the note purchase agreement. Further, in accordance with the
transfer restrictions contained in Article Fifth of our
certificate of incorporation restricting the resale of our
common stock by 5% stockholders, we have agreed with Laminar to
provide it with limited rights to resell the common stock that
it holds.
Also in connection with the financing for the acquisition of
Covanta, we agreed to pay up to $0.9 million in the
aggregate to the Bridge Lenders as reimbursement for expenses
incurred by them in connection with the note purchase agreement.
The note purchase agreement and other transactions involving SZ
Investments, Third Avenue and Laminar were negotiated, reviewed
and approved by a special committee of our Board of Directors
composed solely of disinterested directors and advised by
independent legal and financial advisors.
We and Covanta have also entered into Amendment No. 1 to
Tax Sharing Agreement among us, Covanta and CPIH, dated as of
June 24, 2005, which amended the Tax Sharing Agreement
among us, Covanta and CPIH, dated as of March 10, 2004,
which we refer to as the “Tax Sharing Agreement” in
this
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prospectus. The amendment to the Tax Sharing Agreement added
Ref-Fuel to the group of Covanta affiliates covered by the Tax
Sharing Agreement and amended certain schedules to the Tax
Sharing Agreement.
On June 24, 2005, we, through Covanta, purchased 100% of
the issued and outstanding capital stock of Ref-Fuel for
$740 million in cash and the assumed consolidated net debt
of Ref-Fuel of $1.3 billion ($1.5 billion of
consolidated indebtedness and $0.2 billion of cash and
restricted cash).
We financed our purchase of Ref-Fuel through a combination of
debt and equity financing. The equity component of the financing
consisted of the approximately $400 million Ref-Fuel rights
offering. In the Ref-Fuel rights offering, our existing
stockholders were issued rights to purchase our stock on a pro
rata basis, with each holder entitled to purchase
0.9 shares of our common stock for each share of our common
stock held as of May 27, 2005, the record date.
SZ Investments (including Fund 05-07), Third Avenue and
Laminar, then representing ownership of approximately 40.4% of
our outstanding common stock, each separately committed to
participate in the Ref-Fuel rights offering and acquired at
least their respective pro rata portion of the shares. As
consideration for their commitments, we paid each of these
stockholders an amount in cash equal to 1.75% of their
respective equity commitments which in the aggregate was
$2.8 million. We 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 Ref-Fuel in order to
provide such stockholders with liquidity.
We are required to conduct the offering covered by this
prospectus and registration statement in order to satisfy our
obligations as the sponsor of the plan of reorganization of
Covanta and to comply with terms of a letter agreement we have
executed with Laminar. As of January 12, 2004, Laminar held
approximately $10.4 million of the 9.25% Debentures.
Other than confirmation of the restructuring of this offering to
include the Contingent Offering, we have not had any discussions
with Laminar regarding their participation in this offering.
SZ Investments, a company affiliated with Samuel Zell (the
former Chief Executive Officer and President and current
Chairman of our Board of Directors) and William Pate, one of our
directors, was a holder through its affiliate, HY I Investments,
L.L.C., referred to as “HYI” in this prospectus, of
approximately 42% of the senior notes and payment-in-kind notes
of ACL, a former unconsolidated subsidiary of ours. ACL’s
plan of reorganization was confirmed (without material
conditions) on December 30, 2004 and it emerged from
Chapter 11 bankruptcy proceedings in January 2005. Pursuant
to the terms of ACL’s plan of reorganization, the notes
held by HYI were converted into equity of ACL and
Fund 05-07 received equity in ACL. As disclosed in a
Schedule 13D dated and filed with the SEC on
October 11, 2005 by HYI, SZ Investments,
Fund 05-07 and other of their related entities with respect
to that filing group’s ownership of ACL’s common
stock, on October 6, 2005, HYI made a distribution of the
ACL common stock it then held to its members on a pro rata
basis. Upon such distribution, SZ Investments, as a member of
HYI, received its pro rata share of such ACL common stock.
Clayton Yeutter, one of our current directors, is of counsel to
the law firm of Hogan & Hartson LLP. Hogan &
Hartson provided Covanta with certain legal services during 2004
as it has for many years prior thereto. This relationship
preceded our acquisition of Covanta and Mr. Yeutter did not
direct or have any direct or indirect involvement in the
procurement or the provision of such legal services and does not
directly or indirectly benefit from fees for those services. Our
Board has determined that such relationship does not interfere
with Mr. Yeutter’s exercise of independent judgment as
a director.
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USE OF PROCEEDS
Assuming full participation in the Base Offering, we expect to
receive gross proceeds of $4,590,000. Assuming full
participation in the Contingent Offering, we expect to receive
gross proceeds of $16,200,000, for total gross proceeds of this
offering of $20,790,000. We have estimated that we will incur
approximately $750,000 of expenses in this offering.
The proceeds from this offering will be used for general
corporate purposes. We currently have no other specific plans
for the proceeds of this offering. There is no minimum condition
to participation in either the Base Offering or Contingent
Offering. For additional information on the reasons for this
offering see “Summary — About the Contingent
Offering” and “Summary — The
Offering — Reason for Offering.”
We have not engaged an underwriter so no underwriting fees or
commission will be payable in connection with this offering.
Assuming full participation by the eligible offerees in this
offering, we would expect to have a net cash inflow as shown
below:
| (In millions of | ||||
| dollars) | ||||
|
Expected proceeds from this offering
|
$ | 20.79 | ||
|
Estimated offering expenses of this offering
|
(0.75 | ) | ||
|
Net cash
|
$ | 20.04 | ||
Assuming full participation in this offering, information as to
share issuance and resulting outstanding shares follows:
|
Common stock issuable under this offering
|
5.7 million shares | |||
|
Common stock outstanding prior to this offering
|
141.2 million shares | |||
|
Common stock outstanding following issuances in this offering
|
146.9 million shares | |||
Although our common stock is currently trading at a significant
premium to the exercise prices applicable to the Base Offering
and the Contingent Offering, there can be no assurances as to
the extent of the participation in this offering. If, for
example, only 50% of the shares offered under the Base Offering
and the Contingent Offering were purchased the eligible offerees
(for example, 1.5 million shares under the Base Offering
and 1.35 million shares under the Contingent Offering) the
net cash result would be as follows:
| (In millions of | ||||
| dollars) | ||||
|
Expected proceeds from 50% of Base Offering
|
$ | 2.30 | ||
|
Expected proceeds from 50% of Contingent Offering
|
8.10 | |||
|
Estimated offering expenses of this offering
|
(0.75 | ) | ||
|
Net cash
|
$ | 9.65 | ||
THE OFFERING
We are conducting an offering in which we are offering to
eligible offerees at no charge the right to purchase, in the
form of a Base Warrant, their allocable portion of up to
3,000,000 shares of our common stock at a purchase price of
$1.53 per share and, for each share so purchased, a
Contingent Warrant will automatically and immediately be issued,
without any additional action required on the part of the
eligible offeree, with the right to purchase 0.9 shares of
our common stock at an exercise price of $6.00 per share.
If all of these Contingent Warrants are issued and exercised, we
will issue an additional 2,700,000 shares of our common
stock.
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In the Covanta Plan of Reorganization, as sponsored by us, we
agreed to conduct the Base Offering of up to
3,000,000 shares of our common stock at a price of
$1.53 per share. Under the letter agreement that we entered
into with Laminar in connection with our acquisition of
Ref-Fuel, as described more fully in this prospectus under
“Summary — The Offering — Reason for
Offering,” we also agreed to amend the terms of the
Base Offering in order to give eligible offerees the generally
equivalent opportunity, as reflected in the Contingent Offering,
to purchase shares of our common stock at $6.00 per share
as if the Base Offering had been completed prior to the
commencement of the Ref-Fuel rights offering.
The Base Offering is being made solely to eligible offerees who
are the holders as of January 12, 2004 of the $100,000,000
of principal amount of 9.25% Debentures issued by Covanta
who voted in favor of the Covanta Plan of Reorganization, as
sponsored by us. Each eligible offeree is entitled to purchase
its pro rata portion of the 3,000,000 shares of common
stock being offered for purchase through the Base Offering at
$1.53 per share. This pro rata portion is determined by
multiplying by 3,000,000 the ratio of the principal amount of
9.25% Debentures held by each eligible offeree over
$93,593,000, the principal amount of all outstanding
9.25% Debentures voted in favor of the Covanta Plan of
Reorganization.
In addition, the Contingent Offering is being made solely to
eligible offerees who purchase shares in the Base Offering in
the form of contingently issuable, non-transferable warrants. We
will issue Contingent Warrants to purchase 0.9 shares of
our common stock at $6.00 per share for each share of
common stock purchased by an eligible offeree through the
exercise of Base Warrants in the Base Offering.
The warrants to purchase shares of our common stock under the
Base Offering and the Contingent Offering will commence upon the
date of this prospectus and will expire if they are not
exercised by 5:00 p.m., Eastern Time,
on ,
2005 and have no further value. There are no oversubscription
privileges being offered under the offering and warrants not
exercised will not be reallocated to other eligible offerees nor
may any such warrants be transferred in any way or to any person.
The offering is eligible for ASOP. Since all record holders of
the 9.25% Debentures are DTC participants, we are requiring
that all rights be exercised through ASOP.
Eligible offerees should note that immediately available funds
must be received by the expiration date for the warrant exercise
to be valid. See “— ASOP Procedures”
and “— Exercise Prices” in this
section of the prospectus. We reserve the right to limit the
exercise of any warrants that would result in a risk of any
stockholder becoming the owner of 5% or more of our common
stock. See “Risk Factors — Risks Related to
the Offering — We Have The Right to Limit The Purchase
of our common stock” and “The
Offering — Certificate of Incorporation Restrictions;
Escrow Protection Mechanics.” Eligible offerees who
exercise their warrants offered in the offering will not be
entitled to revoke their exercise. Eligible offerees who do not
exercise their rights will relinquish any value inherent in the
warrants.
To avoid the inconvenience of issuing fractional shares, you
will not receive fractional shares of our common stock, but
instead, you will receive cash in lieu of fractional shares of
our common stock as a result of your warrant exercise(s),
calculated as the product of the fraction of a share of common
stock multiplied by the difference between the current market
price of a share of common stock and the applicable exercise
price.
ASOP Procedures
Eligible offerees that are exercising warrants issued in the
offering must transmit their notices by electronic message
through ASOP. Your notice must specify the number of Base
Warrants and also specify, if applicable, the number of
Contingent Warrants that you are exercising. DTC will then send
an agent’s message to the warrants agent for the offering,
Wells Fargo Bank, National Association, for its acceptance.
Delivery of the agent’s message by DTC indicates that you
agree to be bound to the terms and conditions of the offering
(including the authorization that the exercise price be debited
from your DTC account).
Expiration of the Offering
You may exercise Base Warrants and Contingent Warrants at any
time before 5:00 p.m., Eastern Time,
on ,
2005. If you do not exercise your warrants before the expiration
date, your unexercised warrants,
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will be null and void. We will not be obligated to honor your
exercise of warrants if the warrant agent receives the
agent’s message relating to your exercise after the
offering expires.
Exercise Prices
The warrants issued under the Base Offering and the Contingent
Offering each have a different per share exercise price. The
exercise price for Base Warrants issued under the Base Offering
is $1.53 per share and the exercise price for Contingent
Warrants issued under the Contingent Offering is $6.00 per
share.
The $1.53 per share purchase price in the Base Offering was
a negotiated purchase price which was contractually agreed upon
in the Covanta Plan of Reorganization. This price was
established at the time of the bridge financing for the
acquisition of Covanta, at a price in excess of the then current
market price of $1.40 per share. In connection with
establishing the purchase price, which was also the conversion
price of the bridge financing obtained in connection with our
acquisition of Covanta and the exercise price in a previous pro
rata rights offering that we conducted in order to refinance
$40 million of indebtedness that we incurred in order to
finance our acquisition of Covanta, we were advised by an
independent, nationally recognized financial advisor and a
special committee of the Board of Directors considered the
transaction. At that time, we agreed to conduct the Base
Offering at the same price of $1.53 per share as the pro
rata rights offering previously conducted. The number of shares
to be offered, however, was not determinable at such time.
The $6.00 per share purchase price in the Contingent
Offering was the same price that was offered to our stockholders
in the Ref-Fuel rights offering that we conducted to finance the
acquisition of Ref-Fuel. We are using the same purchase price in
the Contingent Offering to provide the eligible offerees a
generally economic equivalent offering as if the Base Offering
had been closed on or prior to the record date of the Ref-Fuel
rights offering.
The purchase price of all shares of common stock you purchase in
the offering is payable by debiting your account at DTC when the
agent’s message is electronically sent to the warrant
agent. If the conditions to the completion of the offering are
not satisfied or the offering is otherwise terminated, your
funds will be returned to you as soon as practicable by
crediting your DTC account, without interest or deduction.
Purchase of Shares
You may purchase the shares of common stock pursuant to the
exercise of warrants by delivering your electronic notice
through ASOP prior to 5:00 p.m., Eastern Time, on the
expiration date.
Certificate of Incorporation Restrictions; Escrow Protection
Mechanics
Our ability to utilize our NOLs would be substantially reduced
if we were to undergo an ownership change within the meaning of
Section 382 of the Internal Revenue Code. In order to
reduce the risk of an ownership change, our certificate of
incorporation restricts the ability of any record or beneficial,
direct or indirect, holder of 5% or more of our common stock,
however acquired, including acquisition though exercise of
rights to purchase shares granted by us, to sell, transfer,
pledge, encumber or dispose of any shares owned by such 5%
stockholder, or to purchase, acquire, or otherwise receive
additional shares of our common stock without our prior consent.
Our certificate of incorporation also restricts the ability of
any other holder, whether direct or indirect, record or
beneficial, to make an acquisition of our common stock which
will result in total ownership, either direct or indirect,
record or beneficial, by such stockholder of 5% or more of our
common stock without our prior consent. These restrictions will
apply unless and until we determine that such acquisition will
not result in an unreasonable risk of an ownership change. In
determining 5% ownership, the following attribution provisions
apply for purposes of Section 382 of the Internal Revenue
Code:
| • | Any family group consisting of an individual, spouse, children, grandchildren and parents are treated as one person. Note that an individual can be treated as a member of several different family groups. For example, your family group would include your spouse, children, father and mother, but your mother’s family group would include her spouse, all her children and her grandchildren. |
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| • | Any common stock owned by any entity will generally be attributed proportionately to the ultimate owners of that entity. Such attribution will also occur through tiered entity structures. | |
| • | Any persons or entities acting in concert or having a formal or informal understanding among themselves to make a coordinated purchase of common stock will be treated as one stockholder. | |
| • | In determining stock ownership, any person or entity that holds an option to acquire either common stock or another option or right to acquire common stock should be treated as owning the underlying common stock. | |
| • | Ownership may not be structured with an abusive principal purpose of avoiding these rules. |
We have the right, in our sole and absolute discretion, to limit
the exercise of warrants, including instructing the warrant
agent to refuse to honor any exercise of warrants, by 5%
stockholders.
The total number of our common shares expected to be outstanding
upon completion of the offering, assuming all of the shares of
common stock are purchased, is 146,876,122. 5% of 146,876,122 is
7,343,806.
In order to avoid an “ownership change” for federal
income tax purposes, we have implemented the escrow protection
mechanics as follows:
| (1) by purchasing shares of common stock, each purchaser will represent to us that such purchaser will not be, after giving effect to the purchase of the common stock, an owner, either direct or indirect, record or beneficial, or by application of Section 382 attribution provisions summarized above, of more than approximately 6,600,000 shares, constituting approximately 4.5% of our outstanding common stock; | |
| (2) if such exercise would result in such purchaser owning more than 6,600,00 shares of our common stock, constituting approximately 4.5% of our outstanding common stock, such purchaser must notify the warrant agent at the telephone number set forth under “The Warrants Agent;” | |
| (3) if requested, each purchaser will be required to provide us with additional information regarding the amount of common stock that the purchaser owns; and | |
| (4) we shall have the right to instruct the warrant agent to refuse to honor such purchaser’s exercise to the extent such exercise might, in our sole and absolute discretion, result in such purchaser owning 5% or more of our common stock. | |
By exercising warrants in the offering, you agree that the
escrow protection mechanics are valid, binding and enforceable
against you.
The escrow protection mechanics are meant to be applied in
conjunction with the restrictions in our certificate of
incorporation and to provide us with a means to both supplement
and enforce such restrictions with regard to the exercise of the
warrants issued in the offering. We have received opinions of
counsel that the provisions in our certificate of incorporation
and the escrow protection mechanics are legal, valid, binding
and enforceable under Delaware law. We intend to vigorously
challenge any attempt to violate these restrictions and to
pursue all available remedies in the event of any violation. Any
purported exercise of warrants, in violation of either the
restrictions in our certificate of incorporation or the escrow
protection mechanics section, will be void and of no force and
effect.
Conditions to the Offering
We may terminate the offering if at any time before completion
of the offering there is any judgment, order, decree,
injunction, statute, law or regulation entered, enacted, amended
or held to be applicable to the offering that in the reasonable
judgment of our board of directors would or could make the
offering or its completion illegal or materially more burdensome
to us or otherwise restrict or prohibit completion of the
offering. We may waive any of these conditions and choose to
proceed with the offering even if one or more of these events
occurs. To the extent that any of these conditions are
applicable to all stockholders, we will not waive such condition
with respect to an individual stockholder unless that condition
is waived for all stockholders.
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In addition, if we determine that the purchase of the shares of
common stock would cause an unreasonable risk of a
Section 382 ownership change, we may terminate the
offering. See “United States Federal Income Tax
Consequences — Section 382 and Limitations on our
Use of Losses.”
If the conditions to completion of the offering are not
satisfied or we otherwise terminate the offering, all rights
will expire without value and all exercise payments received by
the warrant agent will be returned promptly, without interest or
deduction.
Amendments
We reserve the right to amend the terms or conditions of the
offering.
We may amend the terms of the warrants only to cure an ambiguity
or correct or supplement a provision which may be defective or
inconsistent with other provisions. We may also add provisions
relating to questions or matters which arise and additions which
we and the warrant agent deem necessary or desirable and which
will not adversely affect the interests of the eligible
offerees. If we amend the terms or conditions of the offering, a
new prospectus will be distributed to all eligible offerees who
have previously exercised warrants and to eligible offerees of
record of unexercised warrants on the date we amend the terms.
In addition, all eligible offerees who have previously exercised
warrants, or who exercise warrants within four business days
after the mailing of the new prospectus, will be asked to
confirm through ASOP their exercise of warrants under the terms
of the offering as amended by us. An eligible offeree who has
previously exercised any warrants, or who exercises warrants
within four business days after the mailing of the new
prospectus, and who does not confirm through ASOP the exercise
of the warrants under the amended terms within five business
days after our request for confirmation will be deemed to have
cancelled such eligible offeree’s exercise of warrants, and
the full amount of the exercise price previously paid by such
eligible offeree will be promptly returned by crediting such
eligible offeree’s DTC account, without interest or
deduction. Any agent’s message received by the warrant
agent five or more business days after the date of the amendment
will be deemed to constitute the consent of the eligible offeree
who sent such agent’s message to the amended terms.
If we extend or withdraw the offering, we will notify eligible
offerees of such an extension or withdrawal by sending eligible
offerees a written notice via our warrant agent, Wells Fargo
Bank, National Association.
The Warrant Agent
We have appointed Wells Fargo as warrant agent for the offering.
Any questions regarding your status as an eligible offeree, the
number of shares you are entitled to purchase or requests for
additional copies of this prospectus or any ancillary documents
may be directed to the warrant agent at the following address
and telephone number:
Patty Adams
Wells Fargo Bank
Corporate Trust Services
Sixth & Marquette
MAC N9303-120
Minneapolis, MN 55479
Telephone: (612) 667-1102
Facsimile: (612) 667-9825
Wells Fargo, as warrant agent, will verify all exercises of
warrants and will certify to us that the warrants have been
properly allocated and exercised in accordance with the terms of
the offering. We will pay the warrant agent customary fees and
reimbursements for its expenses. We have also agreed to
indemnify the warrant agent against any liabilities that it may
incur in connection with the offering, subject to its failure to
follow the terms of the offering or its willful misconduct or
gross negligence.
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Method of Payment
Your payment of the purchase price will be made by debiting your
DTC account at the time DTC sends the agent’s message to
the warrant agent through ASOP and will be considered received
by the warrants agent at such time.
Your Funds Will Be Held by the Warrant Agent until Shares of
Common Stock are Issued
The warrant agent will hold your payment of the exercise price
payment in a segregated account with other payments received
from other eligible offerees until we issue your shares to you
or return your payment, without interest or deduction.
Issuance of Shares
Our transfer agent and registrar, American Stock
Transfer & Trust Company, will make the necessary
book-entry transfers, or upon your request, will deliver to you
certificates, representing the shares that you purchase upon the
exercise of your warrants as soon as practicable after the
offering has expired.
Notice to Record Holders
If you are a bank, broker, trustee, depository or other nominee
who held the 9.25% Debentures for the account of others on
the record date, you should notify the respective beneficial
owners of such 9.25% Debentures as of January 12, 2004
of the offering as soon as possible to find out their intentions
with respect to exercising their Base Warrants, and if
applicable, Contingent Warrants. You should obtain instructions
from the beneficial owner with respect to each of the warrants,
as set forth in the instructions we have provided to you for
your distribution to beneficial owners. If the beneficial owner
instructs you to exercise the Base Warrants and Contingent
Warrants, you should send the appropriate electronic notice to
DTC. When you exercise warrants on behalf of beneficial owners
through ASOP, you will be required to certify that each
beneficial owner for whom you are exercising warrants is an
eligible offeree.
Beneficial Owners
If you were the beneficial owner of the 9.25% Debentures on
January 12, 2004 and voted in favor of our plan of
reorganization or have otherwise been authorized to participate
in this offering by the Bankruptcy Court having jurisdiction
over the Covanta Plan of Reorganization, we will ask your bank,
broker, trustee, depository or other nominee to notify you of
the offering. If you wish to exercise your Base Warrants, and if
applicable, Contingent Warrants, you will need to have your
bank, broker, trustee, depository or other nominee act for you.
To indicate your decision with respect to exercising warrants,
you should complete and return to your bank, broker, trustee,
depository or other nominee the form entitled “Beneficial
Owner Election Form,” specifying the number of Base
Warrants and the number, if applicable, of Contingent Warrants
being exercised. You should receive this form from your bank,
broker, trustee, depository or other nominee with the other
offering materials.
Determinations Regarding the Exercise of Your Warrants
We and the warrant agent will decide all questions concerning
the timeliness, validity, form and eligibility of your warrant
exercise(s) and these determinations will be final and binding.
We, in our sole discretion, may waive any defect or
irregularity, or permit a defect or irregularity to be corrected
within such time as we may determine. We may reject the exercise
of any of your warrants because of any defect or irregularity.
We will not receive or accept any exercise until all
irregularities have been waived by us or cured by you within
such time as we decide, in our sole discretion.
Neither we nor the warrant agent will be under any duty to
notify you of any defect or irregularity in connection with your
submission of exercise notices and we will not be liable for
failure to notify you of any defect or irregularity. We reserve
the right to reject your exercise of warrants if your exercise
is not in accordance with the terms of the offering or in proper
form. We will also not accept your exercise of warrants
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if our issuance of shares of our common stock to you could be
deemed to violate our certificate of incorporation, be unlawful
under applicable law, is materially burdensome to us or as
otherwise described under “— Conditions to the
Offering.”
Questions about Exercising Your Warrants
If you have any questions, require assistance regarding the
method of exercising your Base Warrants, and if applicable,
Contingent Warrants or have any requests for additional copies
of this prospectus, you should contact the warrant agent at the
address and telephone number set forth above under
“— The Warrant Agent.”
Shares of Common Stock Outstanding after The Offering
If all the warrants are exercised in the Base Offering and
Contingent Offering, 146,876,122 shares of our common stock
will be issued and outstanding, based on the number of shares
outstanding on November 25, 2005. Based on the
141,176,122 shares of our common stock issued and
outstanding as of November 25, 2005, our issuance of shares
in the offering would result, on a pro forma basis in an
approximately 4% increase in the number of outstanding shares of
our common stock.
Other Matters
We are not making the offering in any state or other
jurisdiction in which it is unlawful to do so, nor are we
selling or accepting any offers to purchase any shares of our
common stock from eligible offerees who are residents of those
states or other jurisdictions. We may delay the commencement of
the offering in those states or other jurisdictions, or change
the terms of the offering, in order to comply with the
securities law requirements of those states or other
jurisdictions. We may decline to make modifications to the terms
of the offering requested by those states or other
jurisdictions, in which case, if you are a resident in those
states or jurisdictions you will not be eligible to participate
in the offering.
Determination of Terms of Offering
The terms of the Base Warrants issued in the Base Offering were
determined as part of the Covanta Plan of Reorganization, as
sponsored by us. Under this plan, part of the consideration to
be provided to holders of the 9.25% Debentures (who are
considered to be holders of approved subclass 3B claims
under the terms of the Covanta Plan of Reorganization) who voted
in favor the Covanta Plan of Reorganization have the right to
participate in the Base Offering. Subsequently, on
September 30, 2005 and October 14, 2005, the
Bankruptcy Court having jurisdiction over the Covanta Plan of
Reorganization authorized the participation of certain holders
of the 9.25% Debentures whose votes were not properly
included on January 12, 2004 to participate in the offering.
The terms of the Contingent Warrants that are contingently
issuable in the Contingent Offering were determined as part of
our January 31, 2005 letter agreement with Laminar in which
we agreed that if the Base Offering to eligible offerees,
including Laminar, was not closed prior to the record date for
the Ref-Fuel rights offering, we would restructure the offering
covered by this prospectus to offer additional shares of our
common stock at the same purchase price and in an amount equal
to the number of shares of common stock that such eligible
offerees would have been entitled to purchase in the Ref-Fuel
rights offering if this offering was consummated on or prior to
the record date of the Ref-Fuel rights offering.
Since the record date of the Ref-Fuel rights offering has passed
and that offering has been completed with each stockholder
during the offering period being eligible to purchase
0.9 shares of our common stock at $6.00 per share for
each share that they then owned, consistent with the
January 31, 2005 letter agreement, we are offering under
the Contingent Offering the right to eligible offerees to
receive and exercise contingently issuable warrants to purchase
0.9 shares of our common stock at $6.00 per share for
each share of our common stock that they purchase at
$1.53 per share in the Base Offering. The Contingent
Offering will enable eligible offerees to purchase our common
stock at similar prices and amounts as if Base Offering had been
completed prior to the commencement of the Ref-Fuel rights
offering.
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While our common stock has traded at a price in excess of the
exercise price on the date of this prospectus under both the
Base Offering and the Contingent Offering, there can be no
assurance that the market price of our common stock will not
decline during the exercise period to a level equal to or below
the exercise price under the Base Offering and/or Contingent
Offering or that, following the issuance of our common stock
upon exercise of warrants under the Base Offering and/or
Contingent Offering, an exercising holder will be able to sell
shares purchased in the offering at a price equal to or greater
than the applicable exercise price. See “Risk
Factors” for a more complete discussion of risks
associated with the offering and our businesses.
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of material U.S. federal income
tax consequences of the issuance of the Base Warrants in the
Base Offering and the contingent issuance of the Contingent
Warrants in the Contingent Offering and of the exercise of the
Base Warrants and Contingent Warrants, respectively. The
discussion is based upon the Internal Revenue Code, treasury
regulations, judicial authorities, published positions of the
IRS and other applicable authorities, all as in effect on the
date hereof and all of which are subject to change or differing
interpretations possibly with retroactive effect. The discussion
does not address all of the tax consequences that may be
relevant to a particular eligible offeree or to holders subject
to special treatment under federal income tax laws such as
financial institutions, insurance companies, broker-dealers,
tax-exempt organizations, foreign persons, or persons holding
our common stock as part of a straddle or conversion
transaction. This discussion is limited to U.S. persons
that hold our common stock, or would hold our common stock
acquired upon the exercise of warrants issued in the offering,
as capital assets. Except as otherwise stated herein, no ruling
has been or will be sought from the IRS regarding any matter
discussed herein. Considerable uncertainty exists as to the
federal income tax consequences of the receipt of the warrants
under the offering and the exercise of such warrants. Our
counsel has not rendered any legal opinion regarding any tax
consequences relating to us, an investment in us or the receipt
or exercise of the warrants issued in the offering. No assurance
can be given that the IRS would not assert, or that a court
would not sustain, a position contrary to any of the tax aspects
set forth below. Eligible offerees should consult their tax
advisors as to the federal income tax consequences of the
offering and any exercise of warrants received, including those
that are relevant to their particular situations, as well as the
effects of state, local and non-U.S. tax laws.
For purposes of this discussion, a U.S. person means any
one of the following:
| • | an individual citizen or resident of the United States; | |
| • | a partnership, corporation or other entity created or organized in or under the laws of the United States or any political subdivision thereof; | |
| • | a trust if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more United States persons have the authority to control all substantial decisions of the trust or the trust has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person; or | |
| • | an estate, the income of which is includible in gross income for U.S. federal income tax purposes regardless of its source. |
Issuance of Warrants, Basis and Holding Period of Warrants
We agreed to make this offering of Base Warrants under the Base
Offering as an inducement to holders of the
9.25% Debentures to approve the Covanta Plan of
Reorganization and we agreed to make the Contingent Offering of
the Contingent Warrants pursuant to the January 31, 2005
letter agreement with Laminar. It is likely that the IRS would
take the position that each eligible offeree will recognize
ordinary income for federal income tax purposes in an amount
equal to the value of the warrants received upon receipt, and,
as discussed below under “Backup Withholding and
Information Reporting,” we will take this position for
purposes of reporting the tax consequences of the offering to
the IRS. If an eligible offeree were required to recognize
ordinary income upon receipt of the warrants, such eligible
offeree would have a tax basis in the
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warrants received equal to the income recognized by such offeree
upon receipt of the warrants. The holding period for each
warrant would commence upon receipt of each warrant.
The federal income tax treatment of the receipt of the warrants
is uncertain, and alternative positions as to the appropriate
federal income tax consequences of a receipt of Base Warrants in
the Base Offering or a receipt of Contingent Warrants (if any)
in the Contingent Offering may be supportable under applicable
legal authorities. Consequently, eligible offerees should
consult their tax advisors as to the federal income tax
consequences to them of the offering, including those federal
income tax consequences that are relevant to their particular
situations.
Expiration of the Warrants
Eligible offerees whose warrants expire unexercised, and for
whom our common stock would be a capital asset, will recognize a
short-term capital loss equal to their basis in the expired
warrants upon the expiration of the warrants.
Exercise of the Warrants, Basis and Holding Period of
Acquired Shares
No gain or loss will be recognized by a holder upon the exercise
of warrants received in the offering (except with respect to
cash received in lieu of fractional shares) if such holder is
required to recognize ordinary income for federal income tax
purposes in an amount equal to the value of the warrants upon
receipt. For such a holder, the basis of the common stock
acquired through exercise of each warrant will be equal to the
sum of the exercise price paid for such stock and the basis of
the warrant exercised. The holding period for the common stock
acquired through exercise of the warrants received in the
offering will begin on the date of the closing of the offering
(i.e., upon exercise of the warrants).
The federal income tax consequences of exercising warrants
received in the offering is uncertain, and alternative positions
as to the appropriate federal income tax treatment of such
warrant exercises may be supportable under applicable legal
authorities. Consequently, holders should consult their tax
advisors as to the federal income tax consequences to them of
any exercise of warrants received in the offering, including the
federal income tax consequences that are relevant to their
particular situations.
Backup Withholding and Information Reporting
Generally, we must report annually to the IRS and to each
stockholder the amount, if any, of the dividends paid to such
stockholder with respect to our stock and the amount of tax, if
any, that we withheld on such distribution. In addition,
pursuant to the information reporting requirements of the
Internal Revenue Code of 1986, as amended, we will report to the
IRS and to each eligible offeree such eligible offeree’s
receipt of warrants issued in the offering as its receipt of an
amount of ordinary income that is equal to the value of the
warrants received upon receipt. Under current U.S. Treasury
Regulations, backup withholding tax will generally apply unless
the stockholder or eligible offeree, as applicable, furnishes a
correct taxpayer identification number and provides any other
required certifications or is otherwise exempt from backup
withholding.
Backup withholding is not an additional tax. Any amounts
withheld under the backup withholding rules will be refunded or
credited against the holder’s U.S. federal income tax
liability if certain required information is furnished to the
IRS.
Section 382 and Limitations on our Use of Losses
As of December 31, 2004 we reported that we had NOLs
estimated to be approximately $516 million for federal
income tax purposes, which expire in various amounts, if not
used before December 31, 2023. Some or all of these NOLs
may be available to offset our future taxable income, if any,
but the continued availability of our NOLs is subject to the
rules of Section 382 of the Internal Revenue Code.
Section 382 generally restricts the use of an NOL after an
“ownership change,” generally a more than 50% increase
in stock ownership, measured by value, during a 3-year testing
period by “5% stockholders.” In the event of an
ownership change,
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the amount of our NOLs that could be utilized in any taxable
year would be generally limited to the product of the value of
our stock on the date of the ownership change, multiplied by the
long-term tax-exempt rate, which is a measure of interest rates
on long-term tax-exempt bonds.
We believe that the offering will not result in an ownership
change. The offering has been structured to substantially comply
with applicable treasury regulations.
In addition, our certificate of incorporation contains
restrictions on the transfer and acquisition of our shares,
which were designed to prevent an involuntary ownership change,
although such restrictions cannot prevent an involuntary
ownership change in all circumstances. The offering also
contains certain other provisions which will be applied in
conjunction with the restrictions in our certificate of
incorporation to provide us with a means to enforce such
restrictions with regard to the exercise of the warrants issued
in the offering. See “The Offering —
Certificate of Incorporation Restrictions; Escrow Protection
Mechanics” for a more complete discussion. We cannot be
certain, however, that these restrictions will prevent a
transaction that is outside of our control from triggering an
ownership change.
PLAN OF DISTRIBUTION
The common stock covered by this prospectus will be issued
directly to the purchasers by us without the use of any
underwriter, selling agent, broker, dealer or finder. The
expenses of the offering are being paid for by us.
DESCRIPTION OF COMMON STOCK
We are authorized to issue 260,000,000 shares of capital
stock. The number of shares of common stock authorized is
250,000,000 with each share having a par value of $0.10 per
share.
Voting Rights
Each holder of an outstanding share of our common stock is
entitled to cast one vote for each share registered. Any
consolidation or merger pursuant to which shares of our common
stock would be converted into or exchanged for any securities or
other consideration, would require the affirmative vote of a
majority of the outstanding shares of the common stock holders.
Dividends
Subject to the rights and preferences of any outstanding
preferred stock and limitations imposed by the note purchase
agreement, we will award dividends on common stock payable out
of our funds if and when our board of directors declares them.
However, we will not pay any dividend, set aside payment for
dividends, or distribute on common stock unless:
| • | we have paid or set apart all accrued and unpaid dividends for the preferred stock and any stock ranking on its parity; and | |
| • | we have set apart sufficient funds for the payment of the dividends for the current dividend period with respect to the preferred stock and any of the stock ranking on its parity. |
Rights in Liquidation
Upon our liquidation, dissolution or winding up, all holders of
our common stock are entitled to share ratably in any assets
available for distribution to holders of our common stock, after
payment of any preferential amounts due to the holders of any
series of our preferred stock.
Preemptive Rights
Shares of our common stock do not entitle a stockholder to any
preemptive rights to purchase additional shares of our common
stock.
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Transfer Restrictions
Our common stock is subject to the following transfer
restrictions: No holder of 5% or more of our common stock,
including any holder who proposes to acquire common stock which
would result in that holder owning 5% or more of our common
stock, may purchase or receive additional shares of our common
stock, or sell or transfer any of our shares of common stock,
without our determining that the transaction will not result in,
or create an unreasonable risk of, an “ownership
change” within the meaning of Section 382(g) of the
Internal Revenue Code, or any similar provisions relating to
preservation of our NOLs. This 5% limitation on ownership of
stock may preserve effective control of us by our principal
stockholders and preserve our board’s and management’s
tenure.
In order to ensure compliance with this restriction, and to
establish a procedure for processing the requests of a 5%
stockholder to acquire or transfer common stock, as described in
Article Fifth of our certificate of incorporation the
following provisions apply to all 5% stockholders:
Delivery of Shares and Escrow Receipts. We will issue all
shares of common stock of a 5% stockholder in the name of
“Covanta Holding Corporation, as Escrow Agent” and we
will hold them in escrow. In lieu of certificates reflecting
ownership of the escrowed common stock, we will issue the 5%
stockholders an escrow receipt reflecting their beneficial
ownership of common stock and recording ownership of the
escrowed stock. Escrow receipts are non-transferable. The 5%
stockholders retain full voting and dividend rights for all
escrowed stock.
Duration of Our Holding the Escrowed Stock. As escrow
agent, we hold all shares of escrowed stock until the
termination of the escrow account. If a 5% stockholder desires
to transfer escrowed stock to a non-5% stockholder, we will hold
all shares of escrowed stock until we receive a favorable
opinion from our tax counsel that the transfer may be made
without creating an unreasonable risk of resulting in an
ownership change under the tax law.
Acquisitions and Transfers. We will treat all requests by
5% stockholders to acquire or transfer escrowed stock on a
“first to request, first to receive” basis. All
requests must be in writing and delivered to us at our principal
executive office, attention General Counsel, by registered mail,
return receipt requested, or by hand. In the event that we are
unable to conclude that a requested acquisition or transfer can
be made without an ownership change under the tax law, then
provided the 5% stockholder has acquired our common stock in
accordance with the procedures set forth in our certificate of
incorporation:
| • | we will advise the requesting party in writing; and | |
| • | we will approve any subsequent request by other 5% stockholders of a type that we had previously denied only after we give all previously denied requests (in the order denied) the opportunity to complete the previously desired transaction. In addition, we may approve any requested transaction in any order of receipt if, in our business judgment, the transaction is in our best interests. |
Termination of the Stock Escrow Account. The stock escrow
will terminate upon the first to occur of the following:
| • | we conclude that the restrictions are no longer necessary in order to avoid a loss of the NOLs; | |
| • | the NOLs are no longer available to us; or | |
| • | our Board of Directors concludes, in its business judgment, that preservation of the NOLs are no longer in our interest. | |
Upon termination of the stock escrow, each 5% stockholder will
receive a notice that the stock escrow has been terminated and
will receive a common stock certificate evidencing ownership of
the previously escrowed stock.
Our certificate of incorporation provides that we are held
harmless and released from any liability to 5% stockholders
arising from our actions as escrow agent, except for liabilities
arising from our intentional misconduct. In performing our
duties we are entitled to rely upon the written advice of our
tax counsel and our
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other experts. In the event that we require further advice
regarding our role as escrow agent, we may deposit the escrowed
stock at issue with a court of competent jurisdiction and make
further transfers in a manner consistent with the rulings of the
court.
Disclosure of Commission Position on Indemnification for
Securities Act Liabilities
Under Section 145 of Delaware General Corporation Law,
referred to as the “DGCL” in this prospectus, a
corporation has the authority to indemnify any person who was or
is a party or is threatened to be made a party to an action
(other than an action by or in the right of the corporation) by
reason of such person’s service as a director of officer of
the corporation, or such person’s service, at the
corporation’s request, as a director, officer, employee or
agent of another corporation or other enterprise, against
amounts paid and expenses incurred in connection with the
defense or settlement of such action, if such person acted in
good faith and in a manner such person reasonably believed to be
in or not opposed to the corporation’s best interests and,
with respect to any criminal action or proceeding, had no
reasonable cause to believe that such person’s conduct was
unlawful. If such person has been judged liable to the
corporation in any action or proceeding brought by or in the
right of the corporation, however, indemnification is only
permitted to the extent that the adjudicating court (or the
court in which the action was brought) determines, despite the
adjudication of liability, that such indemnification is proper.
As permitted by Section 145 of the DGCL, our restated
certificate of incorporation and by-laws authorize us to
indemnify any officer, director and employee of Covanta against
amounts paid or expenses incurred in connection with any action,
suit or proceeding (other than any such action by or in the
right of the corporation) to which such person is or is
threatened to be made a party as a result of such positions if
the Board of Directors or stockholders of or independent legal
counsel to us, in a written opinion, determine that
indemnification is proper.
We have agreed to indemnify and hold KPMG LLP, referred to as
“KPMG” in this prospectus, harmless against and from
any and all legal costs and expenses incurred by KPMG in
successful defense of any legal action or proceeding that arises
as a result of KPMG’s consent to the incorporation by
reference of its report on our past financial statements
incorporated by reference in this registration statement.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to the directors,
officers or persons controlling Covanta pursuant to the
foregoing provisions, we have been informed that in the opinion
of the Securities and Exchange Commission such indemnification
is against public policy as expressed in the Securities Act of
1933 and is, therefore, unenforceable.
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MARKET FOR OUR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock is listed and traded on the New York Stock
Exchange (symbol: CVA). On November 25, 2005 there were
approximately 1,174 holders of record of common stock. On
November 30, 2005, the closing price of the common stock on
the New York Stock Exchange was $13.04.
The following table sets forth the high, low and closing stock
prices of our common stock for the first three quarters of this
year and the last two years. These prices are as reported on the
American Stock Exchange Composite Tape with respect to dates
through the close of business on October 4, 2005 and these
prices are as reported on the New York Stock Exchange Composite
Tape with respect to dates on and after October 5, 2005.
Effective as of the close of trading on October 4, 2005, we
delisted from the American Stock Exchange and as of
October 5, 2005, our shares have been listed for trading on
the New York Stock Exchange.
| 2005 | 2004 | 2003 | ||||||||||||||||||||||||||||||||||
| High | Low | Close | High | Low | Close | High | Low | Close | ||||||||||||||||||||||||||||
|
First Quarter
|
$ | 17.34 | $ | 7.95 | $ | 17.25 | $ | 10.03 | $ | 2.87 | $ | 9.30 | $ | 1.55 | $ | 0.64 | $ | 0.74 | ||||||||||||||||||
|
Second Quarter
|
17.70 | 10.42 | 12.17 | 10.40 | 5.40 | 6.91 | 1.60 | 0.71 | 1.60 | |||||||||||||||||||||||||||
|
Third Quarter
|
13.64 | 11.67 | 13.43 | 7.15 | 5.52 | 6.09 | 1.80 | 1.27 | 1.37 | |||||||||||||||||||||||||||
|
Fourth Quarter(1)
|
13.78 | 10.75 | 13.04 | 8.60 | 6.00 | 8.45 | 3.25 | 1.26 | 2.91 | |||||||||||||||||||||||||||
| (1) | Through close of trading on November 30, 2005. |
We have not paid dividends on our common stock and do not expect
to declare or pay any dividends in the foreseeable future. Under
current financing arrangements there are material restrictions
on the ability of our subsidiaries to transfer funds to us in
the form of cash dividends, loans or advances that would likely
materially limit the future payment of dividends on common
stock. See “Management’s Discussion and Analysis of
Financial Condition and Results of Operations —
Management’s Discussion and Analysis of Liquidity and
Capital Resources — Waste and Energy Services
Segment” for more detailed information on our credit
agreements.
On December 2, 2003, we entered into a note purchase
agreement with the Bridge Lenders pursuant to which in
consideration for the $40 million of bridge financing in
the form of convertible notes, the agreement by the Bridge
Lenders to arrange or provide for the $118 million second
lien letter of credit facility and for Laminar to arrange or
provide for the $10 million international revolving credit
facility, we issued to the Bridge Lenders an aggregate of
5,120,853 shares of common stock. At the time that we
entered into the note purchase agreement, agreed to issue the
notes convertible into shares of common stock and issued the
equity compensation to the Bridge Lenders, the closing price of
the common stock on the American Stock Exchange on the day prior
to announcement of the Covanta acquisition was $1.40 per
share, which was below the $1.53 per share conversion price
of the notes.
Pursuant to their terms, the notes were convertible into common
stock at a price of $1.53 per share without action by the
Bridge Lenders if all or any portion of the notes are not repaid
pursuant to a rights offering, subject to certain agreed upon
limitations necessitated by our NOLs.
In addition, under the note purchase agreement, Laminar agreed
to convert an amount of convertible notes in order to acquire up
to an additional 8.75 million shares of the common stock at
$1.53 per share based upon the levels of public
participation in the rights offering. We issued the maximum of
8.75 million shares to Laminar pursuant to the conversion
of approximately $13.4 million in principal amount of
notes. Consequently, the $20 million principal amount of
notes held by Laminar plus accrued but unpaid interest was
repaid in full on June 11, 2004 through the issuance of
8.75 million shares of our common stock to Laminar and
$7.9 million of the proceeds from the rights offering.
The Bridge Lenders were all sophisticated investors that
conducted due diligence on us and were either affiliated with
members of, or had the opportunity to ask questions of,
management in connection with the drafting and negotiation of
the note purchase agreement. The issuance of the common stock
issued to the
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Bridge Lenders was exempt from registration pursuant to private
offering exemption of Section 4(2) of the Securities Act of
1933, as amended.
In May 2004 we commenced offering as contemplated by the note
purchase agreement, and in June 2004 received proceeds of
$26.6 million, which it used in part to repay the bridge
lenders in full. Pursuant to a registration rights agreement, we
filed a shelf registration statement which was declared
effective on August 24, 2004, to register the resale of
17,711,491 shares held by the Bridge Lenders.
EXPERTS
The consolidated financial statements included for the year
ended December 31, 2004 included in Appendix A to this
prospectus, have been audited by Ernst & Young,
independent registered public accounting firm, as set forth in
its report thereon. Such financial statements have been included
in the prospectus in reliance upon such report given on the
authority of such firm as experts in accounting and auditing.
The consolidated financial statements of Quezon Power, Inc. at
December 31, 2004, 2003 and 2002, and for each of the years
then ended, have been audited by Sycip Gorres Velayo &
Co., a member practice of Ernst & Young Global,
independent registered public accounting firm, as set forth in
its report thereon included in this prospectus and registration
statement in reliance upon such report given on the authority of
such firm as an expert in accounting and auditing.
The consolidated financial statements and the related financial
statement schedules of Covanta (Debtor in Possession) and
subsidiaries as of December 31, 2003, and for each of the
two years in the period ended December 31, 2003, included
in this prospectus and registration statement, have been audited
by Deloitte & Touche LLP, an independent registered
public accounting firm, as stated in their report (which report
expresses an unqualified opinion and includes explanatory
paragraphs relating to Covanta and various domestic subsidiaries
having filed voluntary petitions for reorganization under
Chapter 11 of the Federal Bankruptcy Code, the Bankruptcy
Court having entered an order confirming Covanta’s plan of
reorganization which became effective after the close of
business on March 10, 2004, substantial doubt about
Covanta’s ability to continue as a going concern,
Covanta’s adoption of SFAS No. 143,
“Accounting for Asset Retirement Obligations” in 2003,
SFAS No. 142, “Goodwill and Other Intangible
Assets,” SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets” in 2002, and
the restatements described in Note 35 to such financial
statements) in reliance upon the report of such firm given upon
their authority as experts in accounting and auditing.
The consolidated financial statements of Covanta for the periods
January 1, 2004 through March 10, 2004, Covanta is
referred to as “Predecessor” during this time period,
and March 11, 2004 through December 31, 2004, Covanta
is referred to as “Successor” during this time period
(including schedules appearing therein), have been audited by
Ernst & Young, independent registered public accounting
firm, as set forth in its report thereon. Such financial
statements have been included in this prospectus in reliance
upon such report given on the authority of such firm as experts
in accounting and auditing.
The audited historical financial statements of Ref-Fuel and
subsidiaries for the period from January 1, 2003 to
December 12, 2003 have been included in this prospectus and
have been so included in reliance on the report of
PricewaterhouseCoopers LLP, an independent registered public
accounting firm, given on the authority of said firm as experts
in auditing and accounting.
The audited historical financial statements of Ref-Fuel and
subsidiaries at December 31, 2004 and 2003, and for the
year ended December 31, 2004, and the period from
December 12, 2003 to December 31, 2003, have been
included in this prospectus and have been so included in
reliance on the report of PricewaterhouseCoopers LLP, an
independent registered public accounting firm, given on the
authority of said firm as experts in auditing and accounting.
The consolidated financial statements of Covanta ARC Holdings,
Inc. (formerly known as American Ref-Fuel Holdings Corp.) and
subsidiaries for the year ended December 31, 2002, have
been included in this
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prospectus and registration statement in reliance upon the
report of KPMG, independent registered public accounting firm,
included in this prospectus, and upon the authority of said firm
as experts in accounting and auditing. We have agreed to
indemnify and hold KPMG harmless against and from any and all
legal costs and expenses incurred by KPMG in successful defense
of any legal action or proceeding that arises as a result of
KPMG’s consent to the inclusion of its audit report on
Ref-Fuel’s past consolidated financial statements included
in this registration statement.
The audited historical financial statements of Ref-Fuel Holdings
and subsidiaries at December 31, 2004 and 2003, for the
year ended December 31, 2004, and the period from
December 12, 2003 to December 31, 2003, have been
included herein in reliance on the report of
PricewaterhouseCoopers LLP, an independent registered public
accounting firm, given on the authority of said firm as experts
in auditing and accounting.
The audited historical financial statements of Ref-Fuel Holdings
and subsidiaries at December 31, 2002 for the period from
January 1, 2003 to December 12, 2003 and for the year
ended December 31, 2002, have been included herein in
reliance on the report of PricewaterhouseCoopers LLP, an
independent registered public accounting firm, given on the
authority as experts in auditing and accounting.
LEGAL MATTERS
The validity of the securities offered hereby will be passed
upon for us by Neal, Gerber & Eisenberg
llp of Chicago,
Illinois.
WHERE YOU CAN FIND MORE INFORMATION
Covanta Holding Corporation
This prospectus is part of a registration statement on
Form S-1 we filed with the SEC under the Securities Act of
1933. You should rely only on the information or representations
provided in this prospectus. We have authorized no one to
provide you with different information. We are not making an
offer of these securities in any state where the offer is not
permitted. You should not assume that the information in this
prospectus is accurate as of any date other than the date on the
front of the document.
We are subject to the information and reporting requirements of
the Securities Exchange Act of 1934, under which we file annual,
quarterly and special reports, proxy statements and other
information with the SEC. You may read and copy any materials we
file 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 material 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. Our SEC filings are also available to the
public on our corporate website, www.covantaholding.com.
Our common stock is traded on the New York Stock Exchange.
Material filed by us can be inspected at the offices of the New
York Stock Exchange at 20 Broad Street, New York, NY 10005.
Covanta Energy Corporation
As of June 30, 2005 Covanta does not file periodic reports
or other information with the SEC. Covanta’s historic
reports and other information filed by Covanta with the SEC can
be read and copied at the public reference room of the SEC at
the address set forth above. Copies of such material 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 the number set forth above for
further information on the public reference room. Information on
Covanta is also available to the public on our corporate website
at www.covantaholding.com.
Covanta ARC Holdings, Inc.
Ref-Fuel is a wholly-owned subsidiary of Covanta and does not
currently file periodic reports or other information with the
SEC. However, both MSW I and MSW I Finance, collectively, and
MSW II and
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MSW II Finance, collectively, file periodic reports and
other information with the SEC. Such reports and other
information filed these entities with the SEC can be read and
copied at the public reference room of the SEC at the address
set forth above. Copies of such material 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 the number set forth above for further
information on the public reference room. These SEC filings are
also available to the public on our corporate website at
www.covantaholding.com.
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INDEX TO FINANCIAL STATEMENTS AND APPENDIXES
| Covanta Holding Corporation: | ||||||
| Audited Consolidated Financial Statements as of December 31, 2004 and December 31, 2003 and for the years ended December 31, 2004 and 2003 and December 27, 2002 | A-1 | |||||
| Covanta Holding Corporation: | ||||||
| Interim Condensed Consolidated Financial Statements as of September 30, 2005 (Unaudited) and December 31, 2004 and for the three and nine-month periods ended September 30, 2005 and 2004 (Unaudited) | B-1 | |||||
| Covanta ARC Holdings, Inc. and Subsidiaries: | ||||||
| Consolidated Financial Statements for Covanta ARC Holdings, Inc. and Subsidiaries and Covanta Ref-Fuel Holdings LLC and Subsidiaries as of December 31, 2004 and 2003 and for the year ended December 31, 2004, the period from December 12, 2003 through December 31, 2003 and the period from January 1, 2003 through December 12, 2003 and the year ended December 31, 2002 | C-1 | |||||
| Covanta ARC Holdings, Inc. and Subsidiaries: | ||||||
| Condensed Consolidated Financial Statements as of September 30, 2005 and December 31, 2004 and for the period January 1, 2005 through June 24, 2005, the period June 25, 2005 through September 30, 2005, the three months ended September 30, 2005 and 2004, and nine months ended September 30, 2004 (Unaudited) | D-1 | |||||
| Covanta Energy Corporation and Subsidiaries: | ||||||
| Audited Consolidated Financial Statements of Covanta Energy Corporation and Subsidiaries as of December 31, 2004 and December 31, 2003 and for the periods January 1, 2004 through March 10, 2004 and March 11, 2004 through December 31, 2004 and for the years ended December 31, 2003 and 2002 | E-1 |
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APPENDIX A
Audited Annual Financial Statements of Covanta Holding
Corporation
|
Audited Consolidated Financial Statements as of
December 31, 2004 and December 31, 2003 and for the
years ended December 31, 2004 and 2003 and
December 27, 2002:
|
||||||||
|
Report of Independent Registered Public Accounting Firm
|
A-2 | |||||||
|
Consolidated Statements of Operations for the Years ended
December 31, 2004 and 2003 and December 27, 2002
|
A-3 | |||||||
|
Consolidated Balance Sheets — December 31, 2004
and 2003
|
A-5 | |||||||
|
Consolidated Statements of Cash Flows for the Years ended
December 31, 2004 and 2003 and December 27, 2002
|
A-7 | |||||||
|
Statements of Stockholders’ Equity for the Years ended
December 31, 2004 and 2003 and December 27, 2002
|
A-9 | |||||||
|
Notes to Consolidated Financial Statements
|
A-11 | |||||||
|
Financial Statement Schedules:
|
||||||||
|
Schedule I Parent Company Financial Statements
|
A-68 | |||||||
|
Schedule II Valuation and Qualifying Accounts
|
A-71 | |||||||
|
Schedule V Supplemental Information
|
A-72 | |||||||
|
Financial Statements of fifty percent or less owned persons:
|
||||||||
|
Quezon Power, Inc. Audited Consolidated Financial Statements as
of December 31, 2004 and 2003 and for each of the three
years ended in the period ending December 31, 2004:
|
||||||||
|
Report of Independent Registered Public Accounting Firm
|
A-74 | |||||||
|
Consolidated Balance Sheets — December 31, 2004
and 2003
|
A-75 | |||||||
|
Consolidated Statements of Operations for the Years ended
December 31, 2004, 2003 and 2002
|
A-76 | |||||||
|
Consolidated Statements of Cash Flows for the Years ended
December 31, 2004, 2003 and 2002
|
A-77 | |||||||
|
Consolidated Statements of Stockholders’ Equity for the
Years ended December 31, 2004, 2003 and 2002
|
A-78 | |||||||
|
Notes to Consolidated Financial Statements
|
A-79 | |||||||
A-1
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Danielson Holding
Corporation
We have audited the accompanying consolidated balance sheets of
Danielson Holding Corporation and subsidiaries (the
“Company”) as of December 31, 2004 and 2003, and
the consolidated statements of operations, stockholders’
equity, and cash flows for the years ended December 31,
2004 and 2003 and the year ended December 27, 2002. 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 Danielson Holding Corporation and
subsidiaries at December 31, 2004 and 2003, and the
consolidated results of their operations and cash flows for the
years ended December 31, 2004 and 2003 and the year ended
December 27, 2002, 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.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Danielson Holding Corporation’s internal
control over financial reporting as of December 31, 2004,
based on criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report [NOT
INCLUDED HEREIN] dated March 14, 2005 expressed an
unqualified opinion on management’s assessment and an
adverse opinion on the effectiveness of internal control over
financial reporting.
/s/ Ernst & Young LLP
MetroPark, New Jersey
March 14, 2005
A-2
Table of Contents
DANIELSON HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
| Years Ended | |||||||||||||||
| December 31, | December 31, | December 27, | |||||||||||||
| 2004 | 2003 | 2002 | |||||||||||||
| (In thousands, except per share amounts) | |||||||||||||||
|
ENERGY SERVICES:
|
|||||||||||||||
|
OPERATING REVENUES:
|
|||||||||||||||
|
Service revenues
|
$ | 374,622 | $ | — | $ | — | |||||||||
|
Electricity and steam sales
|
181,074 | — | — | ||||||||||||
|
Construction revenues
|
1,506 | — | — | ||||||||||||
|
Total Energy Services operating revenues
|
557,202 | — | — | ||||||||||||
|
OPERATING EXPENSES:
|
|||||||||||||||
|
Plant operating expenses
|
354,542 | — | — | ||||||||||||
|
Depreciation and amortization
|
52,632 | — | — | ||||||||||||
|
Net interest on project debt
|
32,586 | — | — | ||||||||||||
|
Other operating costs and expenses
|
1,366 | — | — | ||||||||||||
|
Net gain on sale of business
|
(245 | ) | — | — | |||||||||||
|
Selling, general and administrative expenses
|
38,076 | — | — | ||||||||||||
|
Other
|
(1,953 | ) | — | — | |||||||||||
|
Total Energy Services operating expenses
|
477,004 | — | — | ||||||||||||
|
Operating income from Energy Services
|
80,198 | — | — | ||||||||||||
|
INSURANCE SERVICES:
|
|||||||||||||||
|
OPERATING REVENUES:
|
|||||||||||||||
|
Net earned premiums
|
17,998 | 35,851 | 62,164 | ||||||||||||
|
Net investment income
|
2,405 | 3,999 | 5,603 | ||||||||||||
|
Net realized investment gains (losses)
|
201 | 990 | 1,007 | ||||||||||||
|
Other income
|
264 | 283 | 623 | ||||||||||||
|
Total Insurance Services operating revenues
|
20,868 | 41,123 | 69,397 | ||||||||||||
|
OPERATING EXPENSES:
|
|||||||||||||||
|
Net losses and loss adjustment expenses
|
12,861 | 36,684 | 59,881 | ||||||||||||
|
Policy acquisition expenses
|
4,420 | 7,947 | 14,115 | ||||||||||||
|
General and administrative
|
4,398 | 6,664 | 5,893 | ||||||||||||
|
Total Insurance Services operating expenses
|
21,679 | 51,295 | 79,889 | ||||||||||||
|
Operating loss from Insurance Services
|
(811 | ) | (10,172 | ) | (10,492 | ) | |||||||||
|
MARINE SERVICES:
|
|||||||||||||||
|
OPERATING REVENUES:
|
|||||||||||||||
|
Marine revenues
|
— | — | 455,499 | ||||||||||||
|
Marine revenues — related party
|
— | — | 6,605 | ||||||||||||
|
Total Marine Services operating revenues
|
462,104 | ||||||||||||||
|
OPERATING EXPENSES:
|
|||||||||||||||
|
Materials, supplies and other
|
— | — | 195,794 | ||||||||||||
|
Rent
|
— | — | 32,847 | ||||||||||||
|
Labor and fringe benefits
|
— | — | 108,132 | ||||||||||||
|
Fuel
|
— | — | 49,954 | ||||||||||||
|
Depreciation and amortization
|
— | — | 41,785 | ||||||||||||
|
Taxes, other than income
|
— | — | 15,934 | ||||||||||||
|
Total Marine Services’ operating expenses
|
— | — | 444,446 | ||||||||||||
|
Operating income from Marine Services
|
— | — | 17,658 | ||||||||||||
A-3
Table of Contents
DANIELSON HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF
OPERATIONS — (Continued)
| Years Ended | ||||||||||||||
| December 31, | December 31, | December 27, | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||||
| (In thousands, except per share amounts) | ||||||||||||||
|
PARENT COMPANY:
|
||||||||||||||
|
Net investment income
|
233 | 344 | 640 | |||||||||||
|
Net realized investment gains
|
252 | 1,090 | 438 | |||||||||||
|
Investment income related to ACL debt
|
— | — | 8,402 | |||||||||||
|
Administrative expenses
|
(2,517 | ) | (4,168 | ) | (4,911 | ) | ||||||||
|
Operating loss from Parent company
|
(2,032 | ) | (2,734 | ) | 4,569 | |||||||||
|
Operating income (loss)
|
77,355 | (12,906 | ) | 11,735 | ||||||||||
|
OTHER (EXPENSES) INCOME:
|
||||||||||||||
|
Interest income
|
1,858 | — | — | |||||||||||
|
Interest expense
|
(43,739 | ) | (1,424 | ) | (38,735 | ) | ||||||||
|
Other, net
|
— | — | (5,609 | ) | ||||||||||
|
Total other (expenses) income
|
(41,881 | ) | (1,424 | ) | (44,344 | ) | ||||||||
|
Income (loss) before income tax expense, equity in net income
(loss) from unconsolidated investments and minority interests
|
35,474 | (14,330 | ) | (32,609 | ) | |||||||||
|
Income tax expense
|
(11,535 | ) | (18 | ) | (346 | ) | ||||||||
|
Minority interests, energy
|
(6,869 | ) | — | — | ||||||||||
|
Equity in net income (loss) of unconsolidated investments
|
17,024 | (54,877 | ) | — | ||||||||||
|
NET INCOME (LOSS)
|
$ | 34,094 | $ | (69,225 | ) | $ | (32,955 | ) | ||||||
|
INCOME (LOSS) PER SHARE OF COMMON STOCK — BASIC
|
$ | 0.54 | $ | (1.46 | ) | $ | (0.82 | ) | ||||||
|
INCOME (LOSS) PER SHARE OF COMMON STOCK — DILUTED
|
$ | 0.52 | $ | (1.46 | ) | $ | (0.82 | ) | ||||||
The accompanying notes are an integral part of the consolidated
financial statements.
A-4
Table of Contents
DANIELSON HOLDING CORPORATION
CONSOLIDATED BALANCE SHEETS
| December 31, | ||||||||||
| 2004 | 2003 | |||||||||
| (In thousands, except per | ||||||||||
| share amounts) | ||||||||||
| ASSETS | ||||||||||
|
ENERGY SERVICES’ ASSETS
|
||||||||||
|
Current:
|
||||||||||
|
Cash and cash equivalents
|
$ | 78,112 | $ | — | ||||||
|
Marketable securities available for sale
|
3,100 | — | ||||||||
|
Restricted funds for emergence costs
|
32,805 | — | ||||||||
|
Restricted funds held in trust
|
116,092 | — | ||||||||
|
Receivables, (less allowances of $434)
|
131,301 | — | ||||||||
|
Unbilled service receivables
|
58,206 | — | ||||||||
|
Deferred income taxes
|
8,868 | — | ||||||||
|
Prepaid expenses and other
|
60,893 | — | ||||||||
|
Total current assets
|
489,377 | — | ||||||||
|
Property, plant and equipment, net
|
819,175 | — | ||||||||
|
Restricted funds held in trust
|
123,826 | — | ||||||||
|
Unbilled service receivables
|
98,248 | — | ||||||||
|
Other non-current receivables (less allowances of $170)
|
13,798 | — | ||||||||
|
Service and energy contracts and other intangible assets, net
|
177,290 | — | ||||||||
|
Investments in and advances to investees and joint ventures
|
61,656 | — | ||||||||
|
Other assets
|
30,672 | — | ||||||||
|
Total Energy Services’ Assets
|
1,814,042 | — | ||||||||
|
PARENT COMPANY’S AND INSURANCE SERVICES’ ASSETS:
|
||||||||||
|
Cash and cash equivalents
|
18,036 | 17,952 | ||||||||
|
Restricted cash, Covanta escrow
|
— | 37,026 | ||||||||
|
Investments:
|
||||||||||
|
Fixed maturity debt, available for sale at fair value (cost:
$60,564 and $69,840)
|
60,510 | 70,656 | ||||||||
|
Equity securities, available for sales at fair value (cost:
$1,324 and $367)
|
1,432 | 401 | ||||||||
|
Accrued investment income
|
608 | 966 | ||||||||
|
Premium and consulting receivables, net of allowances of $128
and $462
|
1,306 | 2,261 | ||||||||
|
Reinsurance recoverable on paid losses, net of allowances of
$893 and $1,898
|
779 | 1,448 | ||||||||
|
Reinsurance recoverable on unpaid losses, net of allowances of
$236 and $237
|
18,042 | 18,238 | ||||||||
|
Ceded unearned premiums
|
— | 508 | ||||||||
|
Property, plant and equipment, net
|
225 | 254 | ||||||||
|
Investments in unconsolidated Marine Services subsidiaries
|
2,500 | 4,425 | ||||||||
|
Deferred financing costs (net amortization of $1,024 in 2003)
|
— | 6,145 | ||||||||
|
Deferred income taxes
|
18,042 | — | ||||||||
|
Other assets
|
3,559 | 2,368 | ||||||||
|
Total Parent Company’s and Insurance Services Assets
|
125,039 | 162,648 | ||||||||
|
Total Assets
|
$ | 1,939,081 | $ | 162,648 | ||||||
A-5
Table of Contents
DANIELSON HOLDING CORPORATION
CONSOLIDATED BALANCE SHEETS — (Continued)
| December 31, | ||||||||||
| 2004 | 2003 | |||||||||
| (In thousands, except per | ||||||||||
| share amounts) | ||||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||
|
ENERGY SERVICES’ LIABILITIES:
|
||||||||||
|
Current portion of recourse debt
|
$ | 112 | $ | — | ||||||
|
Current portion of project debt
|
109,701 | — | ||||||||
|
Accounts payable
|
16,199 | — | ||||||||
|
Accrued expenses
|
118,998 | — | ||||||||
|
Accrued emergence costs
|
32,805 | — | ||||||||
|
Deferred revenue
|
13,965 | — | ||||||||
|
Total current liabilities
|
291,780 | — | ||||||||
|
Long-term recourse debt
|
312,784 | — | ||||||||
|
Long-term project debt
|
835,036 | — | ||||||||
|
Deferred income taxes
|
109,465 | — | ||||||||
|
Other liabilities
|
97,848 | — | ||||||||
|
Total Energy Services liabilities
|
1,646,913 | — | ||||||||
|
PARENT COMPANY’S AND INSURANCE SERVICES’
LIABILITIES:
|
||||||||||
|
Unpaid losses and loss adjustment expenses
|
64,270 | 83,380 | ||||||||
|
Unearned premiums
|
1,254 | 4,595 | ||||||||
|
Funds withheld on ceded reinsurance
|
1,186 | 1,516 | ||||||||
|
Interest payable
|
— | 400 | ||||||||
|
Parent company debt payable to related parties
|
— | 40,000 | ||||||||
|
Bank overdraft.
|
— | 1,436 | ||||||||
|
Income taxes payable
|
3,421 | 3,530 | ||||||||
|
Other liabilities
|
3,872 | — | ||||||||
|
Total Parent Company’s and Insurance Services’
liabilities
|
74,003 | 134,857 | ||||||||
|
Total liabilities
|
1,720,916 | 134,857 | ||||||||
|
MINORITY INTERESTS
|
83,350 | — | ||||||||
|
Stockholders’ Equity:
|
||||||||||
|
Preferred stock ($0.10 par value; authorized
10,000 shares; none issued and outstanding) Common stock
($0.10 par value; authorized 150,000 shares; issued
73,441 and 35,793 shares; outstanding 73,430 and
35,782 shares)
|
7,344 | 3,579 | ||||||||
|
Additional paid-in capital
|
194,783 | 123,446 | ||||||||
|
Unearned compensation
|
(3,489 | ) | (289 | ) | ||||||
|
Accumulated other comprehensive income (loss)
|
583 | (445 | ) | |||||||
|
Accumulated deficit
|
(64,340 | ) | (98,434 | ) | ||||||
|
Treasury stock (cost of 11 shares)
|
(66 | ) | (66 | ) | ||||||
|
Total stockholders’ equity
|
134,815 | 27,791 | ||||||||
|
Total Liabilities and Stockholders’ Equity
|
$ | 1,939,081 | $ | 162,648 | ||||||
The accompanying notes are an integral part of the consolidated
financial statements.
A-6
Table of Contents
DANIELSON HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For the Years Ended December, | |||||||||||||||
| 2004 | 2003 | 2002 | |||||||||||||
| (In thousands) | |||||||||||||||
|
Cash Flows From Operating Activities:
|
|||||||||||||||
|
Net income (loss)
|
$ | 34,094 | $ | (69,225 | ) | $ | (32,955 | ) | |||||||
|
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
|
|||||||||||||||
|
Gain related to ACL debt contributed in acquisition of ACL
|
— | — | (13,614 | ) | |||||||||||
|
Net realized investment (gains) losses
|
(360 | ) | (2,080 | ) | 2,799 | ||||||||||
|
Depreciation and amortization
|
52,783 | 375 | 42,359 | ||||||||||||
|
Amortization of deferred financing costs
|
7,045 | 1,024 | — | ||||||||||||
|
Amortization of project debt premium and discount
|
(10,457 | ) | — | — | |||||||||||
|
Accretion on principal of senior secured notes
|
2,736 | — | — | ||||||||||||
|
Provision for doubtful accounts
|
733 | — | — | ||||||||||||
|
Stock option and unearned compensation expense
|
1,425 | 521 | 920 | ||||||||||||
|
Interest accretion and amortization
|
433 | — | 4,184 | ||||||||||||
|
Other operating activities
|
— | (156 | ) | 6,037 | |||||||||||
|
Undistributed (earnings) loss of unconsolidated Marine
Services subsidiaries
|
511 | 54,877 | — | ||||||||||||
|
Undistributed earnings of unconsolidated Energy subsidiaries
|
(17,535 | ) | — | — | |||||||||||
|
Dividends from Energy Services’ equity investments
|
3,106 | — | — | ||||||||||||
|
Minority interests
|
6,919 | — | — | ||||||||||||
|
Deferred income taxes
|
12,335 | — | — | ||||||||||||
|
Gain on sale of assets and businesses
|
(344 | ) | — | — | |||||||||||
|
Management of Operating Assets and Liabilities:
|
|||||||||||||||
|
Accrued investment income
|
318 | 242 | 336 | ||||||||||||
|
Restricted funds for emergence costs
|
65,681 | — | — | ||||||||||||
|
Receivables
|
10,947 | — | (13,743 | ) | |||||||||||
|
Unbilled service receivables
|
11,221 | — | — | ||||||||||||
|
Premium and consulting receivables
|
955 | 5,377 | 7,238 | ||||||||||||
|
Reinsurance recoverable on paid losses
|
668 | 1,676 | (983 | ) | |||||||||||
|
Reinsurance recoverable on unpaid losses
|
196 | 3,819 | (4,323 | ) | |||||||||||
|
Ceded unearned premiums
|
508 | 583 | 986 | ||||||||||||
|
Deferred policy acquisition costs
|
577 | — | — | ||||||||||||
|
Deferred tax asset
|
(15,591 | ) | — | — | |||||||||||
|
Other assets
|
(5,034 | ) | 1,784 | 6,178 | |||||||||||
|
Unpaid losses and loss adjustment expenses
|
(19,110 | ) | (17,869 | ) | (4,496 | ) | |||||||||
|
Unearned premiums
|
(3,341 | ) | (6,027 | ) | (10,496 | ) | |||||||||
|
Reinsurance payables and funds withheld
|
(237 | ) | — | — | |||||||||||
|
Accounts payable
|
(8,053 | ) | — | — | |||||||||||
|
Materials and supplies
|
— | — | 1,910 | ||||||||||||
|
Accrued expenses
|
8,034 | — | — | ||||||||||||
|
Accrued emergence costs
|
(65,681 | ) | — | — | |||||||||||
|
Deferred revenue
|
(1,395 | ) | — | — | |||||||||||
|
Interest payable
|
(400 | ) | 400 | 15,378 | |||||||||||
|
Other liabilities
|
10,135 | 1,508 | (7,667 | ) | |||||||||||
|
Other, net
|
4,244 | — | — | ||||||||||||
|
Net cash provided by (used in) operating activities
|
88,066 | (23,171 | ) | 48 | |||||||||||
A-7
Table of Contents
DANIELSON HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF CASH
FLOWS — (Continued)
| For the Years Ended December, | ||||||||||||||
| 2004 | 2003 | 2002 | ||||||||||||
| (In thousands) | ||||||||||||||
|
Cash Flows From Investing Activities:
|
||||||||||||||
|
(Increase) decrease in restricted cash, Covanta escrow
|
37,026 | (37,026 | ) | — | ||||||||||
|
Purchase of Covanta
|
(36,400 | ) | — | — | ||||||||||
|
Cash acquired from Covanta
|
57,795 | — | — | |||||||||||
|
Purchase of ACL, GMS and Vessel Leasing
|
— | — | (42,665 | ) | ||||||||||
|
Cash acquired from Marine Services companies
|
— | — | 21,839 | |||||||||||
|
Collection of notes receivable from affiliate
|
— | 6,035 | — | |||||||||||
|
Matured or called investment securities
|
27,307 | 47,598 | 33,043 | |||||||||||
|
Proceeds from the sale of investment securities
|
1,661 | 10,768 | 2,904 | |||||||||||
|
Purchase of investment securities
|
(24,828 | ) | (36,624 | ) | (19,378 | ) | ||||||||
|
Purchase of property, plant and equipment
|
(11,999 | ) | (96 | ) | (18,152 | ) | ||||||||
|
Distributions received from unconsolidated subsidiaries
|
14,705 | 58 | — | |||||||||||
|
Proceeds from the sale of assets
|
3,311 | — | 3,116 | |||||||||||
|
Other
|
1,233 | (979 | ) | (670 | ) | |||||||||
|
Net cash provided by (used in) investing activities
|
69,811 | (10,266 | ) | (19,963 | ) | |||||||||
|
Cash Flows From Financing Activities:
|
||||||||||||||
|
Bank overdrafts
|
(1,436 | ) | 1,436 | (1,785 | ) | |||||||||
|
Cash received for restricted stock
|
— | 14 | — | |||||||||||
|
Borrowings under note purchase agreement
|
— | 40,000 | — | |||||||||||
|
Proceeds from rights offering
|
41,021 | — | 42,228 | |||||||||||
|
Proceeds from exercise of warrants for common stock
|
— | — | 9,500 | |||||||||||
|
Short–term borrowings, net
|
— | — | 7,000 | |||||||||||
|
Long–term debt issued
|
— | — | 3,206 | |||||||||||
|
Proceeds from the exercise of options for common stock
|
3,474 | — | 1,088 | |||||||||||
|
Repayment of bridge financing
|
(26,612 | ) | — | — | ||||||||||
|
Borrowings for facilities
|
14,488 | — | — | |||||||||||
|
Payment of recourse debt
|
(19,673 | ) | — | (31,502 | ) | |||||||||
|
Payment of project debt
|
(67,943 | ) | — | — | ||||||||||
|
Increase in restricted funds held in trust
|
(13,839 | ) | — | — | ||||||||||
|
Distribution to minority partners
|
(8,261 | ) | — | — | ||||||||||
|
Parent company debt issue costs
|
(900 | ) | — | (1,035 | ) | |||||||||
|
Other financing activities
|
— | — | (1,468 | ) | ||||||||||
|
Net cash provided by (used in) financing activities
|
(79,681 | ) | 41,450 | 27,232 | ||||||||||
|
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
78,196 | 8,013 | 7,317 | |||||||||||
|
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
|
17,952 | 25,183 | 17,866 | |||||||||||
|
Deconsolidation of ACL, GMS and Vessel Leasing
|
— | (15,244 | ) | — | ||||||||||
|
CASH AND CASH EQUIVALENTS, END OF YEAR
|
$ | 96,148 | $ | 17,952 | $ | 25,183 | ||||||||
The accompanying notes are an integral part of the consolidated
financial statements.
A-8
Table of Contents
DANIELSON HOLDING CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
| Accumulated | ||||||||||||||||||||||||||||||||||||||
| Common Stock | Additional | Other | Treasury Stock | |||||||||||||||||||||||||||||||||||
| Paid-In | Unearned | Comprehensive | Retained | |||||||||||||||||||||||||||||||||||
| Shares | Amount | Capital | Compensation | (Loss) Income | (Deficit) | Shares | Amount | Total | ||||||||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||||||||||||
|
Balance December 31, 2001
|
19,517 | $ | 1,952 | $ | 63,115 | — | $ | 5,716 | $ | 3,746 | 11 | $ | (66 | ) | $ | 74,463 | ||||||||||||||||||||||
|
Exercise of options to purchase common stock
|
265 | 26 | 1,061 | 1,087 | ||||||||||||||||||||||||||||||||||
|
Exercise of warrants to purchase common stock
|
2,002 | 200 | 9,300 | 9,500 | ||||||||||||||||||||||||||||||||||
|
Common stock issued pursuant to Rights Offering, net of expenses
|
8,705 | 871 | 41,357 | 42,228 | ||||||||||||||||||||||||||||||||||
|
Restricted common stock issued to ACL management
|
339 | 34 | 1,661 | (1,695 | ) | — | ||||||||||||||||||||||||||||||||
|
Stock compensation expense
|
920 | 920 | ||||||||||||||||||||||||||||||||||||
|
Adjustment of unearned compensation for terminated employees
|
(266 | ) | 266 | — | ||||||||||||||||||||||||||||||||||
|
Amortization of unearned compensation
|
297 | 297 | ||||||||||||||||||||||||||||||||||||
|
Treasury stock purchases
|
— | |||||||||||||||||||||||||||||||||||||
|
Comprehensive loss:
|
||||||||||||||||||||||||||||||||||||||
|
Net loss
|
(32,955 | ) | (32,955 | ) | ||||||||||||||||||||||||||||||||||
|
Net unrealized gain on available for sale securities
|
(1,989 | ) | (1,989 | ) | ||||||||||||||||||||||||||||||||||
|
Net gain on fuel swaps designated as cash flow hedging
instruments
|
68 | 68 | ||||||||||||||||||||||||||||||||||||
|
Net loss on interest rate swaps designated as cash flow hedging
instruments
|
(355 | ) | (355 | ) | ||||||||||||||||||||||||||||||||||
|
Foreign currency translation
|
453 | 453 | ||||||||||||||||||||||||||||||||||||
|
Minimum pension liability adjustment — Marine Services
|
(15,485 | ) | (15,485 | ) | ||||||||||||||||||||||||||||||||||
|
Minimum pension liability adjustment — Insurance
Services
|
(872 | ) | (872 | ) | ||||||||||||||||||||||||||||||||||
|
Total comprehensive loss
|
(18,180 | ) | (32,955 | ) | (51,135 | ) | ||||||||||||||||||||||||||||||||
|
Balance at December 27, 2002
|
30,828 | 3,083 | 117,148 | (1,132 | ) | (12,464 | ) | (29,209 | ) | 11 | (66 | ) | 77,360 | |||||||||||||||||||||||||
|
Common stock issued pursuant to Note Purchase Agreement
|
5,121 | 512 | 6,657 | 7,169 | ||||||||||||||||||||||||||||||||||
|
Stock option compensation expense
|
137 | 137 | ||||||||||||||||||||||||||||||||||||
|
Amortization of unearned compensation
|
384 | 384 | ||||||||||||||||||||||||||||||||||||
|
Adjustment of unearned compensation for terminated employees
|
(156 | ) | (16 | ) | (496 | ) | 459 | (53 | ) | |||||||||||||||||||||||||||||
A-9
Table of Contents
DANIELSON HOLDING CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS’
EQUITY — (Continued)
| Accumulated | ||||||||||||||||||||||||||||||||||||||
| Common Stock | Additional | Other | Treasury Stock | |||||||||||||||||||||||||||||||||||
| Paid-In | Unearned | Comprehensive | Retained | |||||||||||||||||||||||||||||||||||
| Shares | Amount | Capital | Compensation | (Loss) Income | (Deficit) | Shares | Amount | Total | ||||||||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||||||||||||
|
Comprehensive loss:
|
||||||||||||||||||||||||||||||||||||||
|
Net loss
|
(69,225 | ) | (69,225 | ) | ||||||||||||||||||||||||||||||||||
|
Minimum pension liability — Insurance Services
|
(426 | ) | (426 | ) | ||||||||||||||||||||||||||||||||||
|
Net unrealized loss on available for sale securities
|
(2,877 | ) | (2,877 | ) | ||||||||||||||||||||||||||||||||||
|
Net reclassification adjustment for amount included in equity in
net loss of unconsolidated Marine Services subsidiaries
|
15,322 | 15,322 | ||||||||||||||||||||||||||||||||||||
|
Total comprehensive income (loss)
|
12,019 | (69,225 | ) | (57,206 | ) | |||||||||||||||||||||||||||||||||
|
Balance at December 31, 2003
|
35,793 | 3,579 | 123,446 | (289 | ) | (445 | ) | (98,434 | ) | 11 | (66 | ) | 27,791 | |||||||||||||||||||||||||
|
Stock option compensation expense
|
181 | 181 | ||||||||||||||||||||||||||||||||||||
|
Amortization of unearned compensation
|
1,345 | 1,345 | ||||||||||||||||||||||||||||||||||||
|
Adjustment of unearned compensation for terminated employees
|
(41 | ) | (4 | ) | (200 | ) | 68 | (136 | ) | |||||||||||||||||||||||||||||
|
Shares issued in Rights Offering, net of costs
|
27,438 | 2,744 | 38,277 | 41,021 | ||||||||||||||||||||||||||||||||||
|
Right cancelled for terminated employees
|
(12 | ) | (1 | ) | (18 | ) | (19 | ) | ||||||||||||||||||||||||||||||
|
Exercise of options to purchase common stock
|
966 | 96 | 5,520 | 5,616 | ||||||||||||||||||||||||||||||||||
|
Shares cancelled in exercise of options
|
(89 | ) | (9 | ) | (785 | ) | (794 | ) | ||||||||||||||||||||||||||||||
|
Conversion of portion of bridge financing
|
8,750 | 875 | 12,513 | 13,388 | ||||||||||||||||||||||||||||||||||
|
Share issued in restricted stock award
|
636 | 64 | 4,549 | (4,613 | ) | — | ||||||||||||||||||||||||||||||||
|
Stock purchase rights issued to Covanta creditors (Note 2)
|
— | — | 11,300 | 11,300 | ||||||||||||||||||||||||||||||||||
|
Comprehensive (loss), net of income taxes:
|
||||||||||||||||||||||||||||||||||||||
|
Net income
|
34,094 | 34,094 | ||||||||||||||||||||||||||||||||||||
|
Foreign currency translation
|
549 | 549 | ||||||||||||||||||||||||||||||||||||
|
Minimum Pension Liability
|
1,225 | 1,225 | ||||||||||||||||||||||||||||||||||||
|
Net Unrealized gain on securities on available for sale
securities
|
(746 | ) | (746 | ) | ||||||||||||||||||||||||||||||||||
|
Total comprehensive income
|
1,028 | 34,094 | 35,122 | |||||||||||||||||||||||||||||||||||
|
Balance at December 31, 2004
|
73,441 | $ | 7,344 | $ | 194,783 | $ | (3,489 | ) | $ | 583 | $ | (64,340 | ) | 11 | $ | (66 | ) | $ | 134,815 | |||||||||||||||||||
A-10
Table of Contents
DANIELSON HOLDING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share amounts)
| 1. | Basis of Presentation |
Danielson is a holding company that owns subsidiaries engaged in
a number of diverse business activities. The most significant of
these is the energy business of Covanta Energy Corporation
(“Covanta”) acquired on March 10, 2004 (the
“Effective Date”). During 2004, Danielson also had
investments in subsidiaries engaged in insurance operations in
the western United States, primarily California, and in American
Commercial Lines LLC (“ACL”), an integrated marine
transportation and service company which throughout 2004 was in
bankruptcy proceedings under Chapter 11 of the United
States Bankruptcy Code (“Chapter 11”). ACL is no
longer a subsidiary of Danielson. On December 30, 2004, ACL
confirmed a plan of reorganization and has since emerged from
bankruptcy. As part of ACL’s plan of reorganization,
Danielson’s stock in ACL was cancelled, and its ownership
interest terminated. Danielson received no distribution under
the ACL plan of reorganization, but received from ACL’s
creditors, in January 2005, warrants to purchase three percent
of ACL stock.
Covanta is engaged in developing, constructing, owning and
operating for others, key infrastructure for the conversion of
waste–to–energy and independent power production in
the United States and abroad. On March 10, 2004, Covanta
consummated a plan of reorganization and emerged from its
reorganization proceeding under Chapter 11. Pursuant to the
plan of reorganization (“Reorganization Plan”),
Danielson acquired 100% of the equity in Covanta. This
transaction is more fully described in Note 2.
Covanta’s subsidiaries owning and operating Covanta’s
Warren County, New Jersey and Lake County, Florida
waste-to-energy facilities and which were engaged in the Tampa
Bay, Florida desalination project remained debtors-in-possession
(the “Remaining Debtors”) after the Effective Date,
and were not the subject of either plan. As a result, Covanta
recorded its investment in the Remaining Debtors using the
equity method as of March 10, 2004. Subsequent to the
Effective Date, the Tampa Bay, Florida subsidiaries and the Lake
County, Florida subsidiaries reached agreements with their
counterparties and emerged from bankruptcy on August 6,
2004 and December 14, 2004, respectively. Covanta has
included these entities as consolidated subsidiaries in its
financial statements since their respective emergence dates. See
Note 34 to the Consolidated Financial Statements for
additional information regarding these settlements.
Three of the Company’s subsidiaries, which relate to the
Warren county project, have not reorganized or filed a
liquidation plan under Chapter 11 of the United States
Bankruptcy Code. While Covanta exercises significant influence
over the operating and financial policies of these subsidiaries,
these subsidiaries will continue to operate as debtors in
possession in the Chapter 11 case until they reorganize or
liquidate. Because any plan of reorganization or liquidation
relating to these debtors would have to be approved by the
Bankruptcy Court, and possibly their respective creditors,
Covanta does not control these debtors or the ultimate outcome
of their respective Chapter 11 case. Accordingly, Covanta
does not include these subsidiaries as consolidated subsidiaries
in the Financial Statements. Covanta’s investment in these
subsidiaries is recorded using the equity method effective as of
March 10, 2004. Unless these subsidiaries emerge from
bankruptcy under Covanta’s control, it is unlikely that
they will contribute to Covanta’s results of operations.
Danielson holds all of the voting stock of Danielson Indemnity
Company (“DIND”). DIND owns 100% of the common stock
of National American Insurance Company of California,
Danielson’s principal operating insurance subsidiary, which
owns 100% of the common stock of Valor Insurance Company,
Incorporated. National American Insurance Company of California
and its subsidiaries are collectively referred to herein as
“NAICC”. The operations of NAICC are in property and
casualty insurance. NAICC writes non–standard private
automobile insurance in the western United States, primarily
California. Effective September 7, 2003, NAICC discontinued
writing all commercial automobile insurance. Effective January,
2002, NAICC discontinued writing all workers’ compensation
insurance.
A-11
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
Danielson acquired a 100% ownership interest in ACL in May,
2002, thereby entering into the marine transportation,
construction and related service provider businesses. On
January 31, 2003, ACL and many of its subsidiaries and its
immediate direct parent entity, American Commercial Lines
Holdings, LLC, referred to herein as “ACL Holdings,”
filed a petition with the U.S. Bankruptcy Court to
reorganize under Chapter 11. Danielson, its subsidiaries
and equity investees, operating in the marine services
industries, were not guarantors of ACL’s debt, nor were
they contractually liable for any of ACL’s liabilities.
Danielson’s other investees in the marine services business
consisted of Global Materials Services, LLC (“GMS”)
and Vessel Leasing, LLC (“Vessel Leasing”). GMS was a
joint venture of ACL, a third party and Danielson, in which
Danielson held a 5.4% interest. Danielson sold its interests in
GMS as of October 6, 2004. Vessel Leasing was a joint
venture of ACL and Danielson. Danielson sold its interest in
Vessel Leasing on January 13, 2005.
As a result of the ACL bankruptcy filing, Danielson no longer
maintains control of ACL. Accordingly, beginning for the year
ended December 31, 2003, Danielson has accounted for its
investments in ACL, GMS and Vessel Leasing, using the equity
method of accounting. Under the equity method of accounting,
Danielson reports its share of the equity investees’ income
or loss based on its ownership interest. Danielson has fully
written off its investment in ACL, accordingly Danielson ceased
recognizing losses on its investment as Danielson is not liable
either directly or as guarantor for such losses.
SZ Investments, LLC, a significant stockholder of Danielson, and
a company affiliated with Samuel Zell, former Chairman of
Danielson’s Board of Directors, William Pate,
Danielson’s current Chairman of the Board of Directors and
Philip Tinkler, Danielson’s former Chief Financial Officer,
is a holder through its affiliate, HY I Investments, LLC, of
approximately 42% of ACL’s senior notes and
payment–in–kind notes. As a result, a special
committee of Danielson’s Board of Directors was formed in
November 2002, composed solely of disinterested directors, to
oversee Danielson’s investment in ACL and its related
Chapter 11 bankruptcy proceedings.
Covanta Energy Corporation is referred to herein as
“Energy” or as “Covanta”. “Domestic
Covanta” refers to Covanta and its subsidiaries engaged in
the waste–to–energy, water and independent power
businesses in the United States; and “CPIH” refers to
Covanta’s subsidiary, Covanta Power International Holdings,
Inc. and its subsidiaries engaged in the independent power
business outside the United States. Danielson’s insurance
subsidiaries are referred to herein as “Insurance
Services”. ACL, GMS and Vessel Leasing are together
referred to herein as “Marine Services”.
| 2. | Covanta Acquisition and Financing Agreements |
On December 2, 2003, Danielson executed a definitive
investment and purchase agreement to acquire Covanta in
connection with Covanta’s emergence from Chapter 11
proceedings after the non–core and geothermal assets of
Covanta were divested. The primary components of the transaction
were: (1) the purchase by Danielson of 100% of the equity
of Covanta in consideration for a cash purchase price of
approximately $30 million, and (2) agreement as to new
letter of credit and revolving credit facilities for
Covanta’s domestic and international operations, provided
by some of the existing Covanta lenders and a group of
additional lenders organized by Danielson.
This agreement was amended on February 23, 2004 which
reduced the purchase price and released from an escrow account
$0.2 million to purchase Danielson’s equity interest
in Covanta Lake, Inc. A limited liability company was formed by
Danielson and one of Covanta’s subsidiaries and it acquired
an equity interest in Covanta Lake II, Inc., an indirect
subsidiary of Covanta, in a transaction separate and distinct
from the acquisition of Covanta out of bankruptcy.
As required by the investment and purchase agreement, Covanta
filed a proposed plan of reorganization, a proposed plan of
liquidation for specified non–core businesses, and the
related draft disclosure statement, each reflecting the
transactions contemplated under the investment and purchase
agreement, with the
A-12
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
Bankruptcy Court. On March 5, 2004, the Bankruptcy Court
confirmed the Covanta Reorganization Plan. On March 10,
2004, Danielson acquired 100% of Covanta’s equity in
consideration for approximately $30 million.
With the purchase of Covanta, Danielson acquired a leading
provider of waste–to–energy services and independent
power production in the United States and abroad.
Danielson’s equity investment and ownership provided
Covanta’s businesses with improved liquidity and capital
resources to finance their business activities and emerge from
bankruptcy.
The aggregate purchase price was $47.5 million which
included the cash purchase price of $30 million,
approximately $6.4 million for professional fees and other
estimated costs incurred in connection with the acquisition, and
an estimated fair value of $11.3 million for
Danielson’s commitment to sell up to 3 million shares
of its common stock at $1.53 per share to certain creditors
of Covanta, subject to certain limitations as more fully
described below.
The following table summarizes a preliminary allocation of
values to the assets acquired and liabilities assumed at the
date of acquisition in conformity with Statement of Financial
Accounting Standards (“SFAS”) No. 141
“Business Combinations” and SFAS No. 109
“Accounting for Income Taxes”. In addition to the
purchase price allocation adjustments, Covanta’s emergence
from Chapter 11 proceedings on March 10, 2004 resulted
in Covanta becoming a new reporting entity and adoption of fresh
start accounting as of that date, in accordance with AICPA
Statement of Position (“SOP”) 90–7,
“Financial Reporting by Entities in Reorganization Under
the Bankruptcy Code”. Preliminary fair value determinations
of the tangible and intangible assets were made by management
based on anticipated discounted cash flows using currently
available information. Management’s estimate of the fair
value of long term debt was based on the new principal amounts
of recourse debt that was part of the reorganized capital
structure of Covanta upon emergence. Management’s estimate
of the fair value of project debt was based on market
information available to the Company. The Company has engaged
valuation consultants to review its valuation methodology and
their work is ongoing.
In accordance with SFAS No. 141, the preliminary
purchase price allocation is subject to additional adjustment
within one year after the acquisition as additional information
on asset and liability valuations becomes available. The Company
expects that adjustments to recorded fair values may include
those relating to:
| • | property, plant, and equipment, intangibles, debt, and equity investments, all of which may change based on consideration of additional analysis by the Company and its valuation consultants; | |
| • | accrued expenses which may change based on identification of final fees and costs associated with Covanta’s emergence from bankruptcy resolution of disputed claims; | |
| • | the final principal amount of the unsecured notes (recorded as an estimated principal amount of $28 million, which estimate excludes any notes that may be issued if and when Remaining Debtors emerge from bankruptcy), and which will be adjusted based upon the resolution of claims of creditors entitled to such notes as distributions; and | |
| • | tax liabilities and deferred taxes, which may be adjusted based upon additional information to be received from taxing authorities and which result from changes in the allocated book basis of items for which deferred taxes are provided. | |
A-13
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
The following depicts the summary balance sheet of Covanta after
the purchase price allocation as of March 10, 2004:
|
Current assets
|
$ | 521,295 | |||
|
Property, plant and equipment
|
813,895 | ||||
|
Intangible assets
|
191,761 | ||||
|
Other assets
|
326,027 | ||||
|
Total assets acquired
|
$ | 1,852,978 | |||
|
Current liabilities
|
$ | 362,061 | |||
|
Long–term debt
|
328,053 | ||||
|
Project debt
|
850,591 | ||||
|
Deferred income taxes
|
87,940 | ||||
|
Other liabilities
|
176,808 | ||||
|
Total liabilities assumed
|
$ | 1,805,453 | |||
|
Net assets acquired
|
$ | 47,525 | |||
The acquired intangible assets of $191.8 million primarily
relate to service agreements on publicly owned
waste–to–energy projects with an approximate
17–year weighted average useful life. However, many such
contracts have remaining lives that are significantly shorter.
In its initial purchase price allocation as of March 10,
2004, goodwill of $24.5 million was recorded to reflect the
excess of cost over the preliminary fair value of acquired net
assets. The Company has subsequently refined various estimates
of fair values of the assets acquired and liabilities assumed.
The most significant adjustments were decreases of
(a) property, plant and equipment — net of
$220.9 million, (b) intangible assets of
$126.4 million, (c) deferred income tax liabilities of
$217.8 million and (d) other liabilities of
$149.9 million. Goodwill was eliminated as a result of
these fair value adjustments and the resulting excess of fair
value over the purchase price paid was allocated on a pro rata
basis to reduce the carrying value of the Company’s
eligible non–current assets.
The results of operations from Covanta are included in
Danielson’s consolidated results of operations from
March 11, 2004. The following table sets forth certain
unaudited consolidated operating results for the years ended
December 31, 2004 and 2003, as if the acquisition of
Covanta were consummated on the same terms at the beginning of
each period.
| December 31, | |||||||||
| 2004 | 2003 | ||||||||
| ProForma | ProForma | ||||||||
|
Total revenues
|
$ | 715,485 | $ | 791,662 | |||||
|
Income (loss) from continuing operations before change in
accounting principle
|
$ | 39,634 | $ | (7,330 | ) | ||||
|
Cumulative effect of change in accounting principle
|
— | $ | (8,538 | ) | |||||
|
Net income (loss)
|
$ | 39,634 | $ | (15,868 | ) | ||||
|
Basic income (loss) per share:
|
|||||||||
|
Income (loss) from continuing operations
|
$ | 0.66 | $ | (0.12 | ) | ||||
|
Cumulative effect of accounting change
|
— | (0.13 | ) | ||||||
|
Net income (loss) per share
|
$ | 0.66 | $ | (0.25 | ) | ||||
|
Diluted net income (loss) per share
|
$ | 0.64 | $ | (0.25 | ) | ||||
A-14
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
As part of the investment and purchase agreement, Danielson
arranged for a new $118 million replacement letter of
credit facility for Covanta, secured by a second lien on
Covanta’s domestic assets. This financing was provided by
SZ Investments, LLC, a Danielson stockholder (“SZ
Investments”), Third Avenue Trust, on behalf of Third
Avenue Value Fund Series, a Danielson stockholder
(“TAVF”), and D. E. Shaw Laminar Portfolios, LLC, a
creditor of Covanta and a Danielson stockholder
(“Laminar”). Subsequent to the signing of the
investment and purchase agreement, each of TAVF, Laminar and SZ
Investments assigned approximately 30% of their participation in
the second lien letter of credit facility to Goldman Sachs
Credit Partners, L.P. and Laminar assigned the remainder of its
participation in the second lien letter of credit facility to
TRS Elara, LLC. In addition, in connection with a note purchase
agreement described below, Laminar arranged for a
$10 million revolving loan facility for CPIH, secured by
CPIH’s assets. Covanta also paid an upfront fee of
$2.4 million upon entering into the second lien credit
agreement, and will pay (i) a commitment fee equal to
0.5% per annum of the daily calculation of available
credit, (ii) an annual agency fee of $30,000 and,
(iii) with respect to each issued letter of credit an
amount equal to 6.5% per annum of the daily amount
available to be drawn under such letter of credit.
Danielson obtained the financing necessary for the Covanta
acquisition pursuant to a note purchase agreement dated
December 2, 2003, with each of SZ Investments, TAVF and
Laminar, referred to collectively as the “Bridge
Lenders”. Pursuant to the note purchase agreement, the
Bridge Lenders severally provided Danielson with an aggregate of
$40 million of bridge financing in exchange for notes which
were convertible under certain circumstances into shares of
Danielson common stock at a price of $1.53 per share,
subject to agreed upon limitations. Danielson used
$30 million of the proceeds from the notes to post an
escrow deposit prior to the closing of the transactions
contemplated by the investment and purchase agreement with
Covanta. At closing, the deposit was used to purchase Covanta.
Danielson will use the remainder of the proceeds to pay
transaction expenses and for general corporate purposes. These
notes were repaid on June 11, 2004 through the conversion
of a portion of the notes held by Laminar and from the proceeds
of a pro rata rights offering made to all stockholders on
May 18, 2004.
Danielson issued to the Bridge Lenders an aggregate of
5,120,853 shares of Danielson’s common stock in
consideration for the $40 million of bridge financing. At
the time that Danielson entered into the note purchase
agreement, agreed to issue the notes convertible into shares of
Danielson common stock and issued the equity compensation to the
Bridge Lenders, the trading price of the Danielson common stock
was below the $1.53 per share conversion price of the
notes. On December 1, 2003, the day prior to the
announcement of the Covanta acquisition, the closing price of
Danielson common stock on the American Stock Exchange was
$1.40 per share.
In addition, under the note purchase agreement, Laminar agreed
to convert an amount of notes to acquire up to an additional
8.75 million shares of Danielson common stock at
$1.53 per share based upon the levels of public
participation in the May 18, 2004 rights offering. Based
upon the public participation in the rights offering, Danielson
issued the maximum of 8.75 million shares to Laminar
pursuant to the conversion of approximately $13.4 million
in principal amount of notes. Consequently, the $20 million
principal amount of notes held by Laminar plus accrued but
unpaid interest was repaid in full on June 11, 2004 through
the issuance of 8.75 million shares of Danielson common
stock to Laminar and $7.9 million of the proceeds from the
rights offering.
Danielson has agreed to commence an offering of shares to a
class of creditors of Covanta that are entitled to participate
in an offering of up to 3 million shares of Danielson
common stock at a price of $1.53 per share pursuant to the
Covanta Reorganization Plan.
As part of Danielson’s negotiations with Laminar and its
becoming a five percent stockholder, pursuant to a letter
agreement dated December 2, 2003, Laminar has agreed to
additional restrictions on the transferability of the shares of
Danielson common stock that Laminar holds or will acquire.
Further, in accordance with the transfer restrictions contained
in Article Fifth of Danielson’s charter restricting
the resale of Danielson common stock by 5% stockholders,
Danielson has agreed with Laminar to provide it with limited
rights to
A-15
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
resell the Danielson common stock that it holds. Finally,
pursuant to its agreement with the Bridge Lenders on
July 28, 2004, Danielson has filed a registration statement
with the SEC to register the shares of Danielson common stock
issued to or acquired by them under the note purchase agreement.
The registration statement was declared effective on
August 24, 2004.
Samuel Zell, Danielson’s former Chairman of the Board of
Directors, Philip Tinkler, Danielson’s former Chief
Financial Officer and William Pate, current Chairman of
Danielson, are affiliated with SZ Investments. David Barse,
Director of Danielson, is affiliated with TAVF. The note
purchase agreement and other transactions involving the Bridge
Lenders were negotiated, reviewed and approved by a special
committee of Danielson’s Board of Directors composed solely
of disinterested directors and advised by independent legal and
financial advisors.
See Notes 17 through 20 for additional information
regarding Covanta’s credit and debt arrangements.
| 3. | ACL Chapter 11 Filing |
During 2002, ACL experienced a decline in barging rates, reduced
shipping volumes and excess barging capacity during a period of
slow economic growth. Due to these factors, ACL’s revenues
and earnings did not meet expectations and ACL’s liquidity
was significantly impaired. Debt covenant violations occurred
and, as a result, ACL was unable to meet its financial
obligations as they became due. On January 31, 2003 (the
“Petition Date”), ACL filed a petition with the
U.S. Bankruptcy Court for the Southern District of Indiana,
New Albany Division (the “Bankruptcy Court”) to
reorganize under Chapter 11 under case number
03–90305. Included in the filing were ACL, ACL’s
direct parent (ACL Holdings), American Commercial Barge Line
LLC, Jeffboat LLC, Louisiana Dock Company LLC and ten other
U.S. subsidiaries of ACL (collectively with ACL, the
“ACL ACL Debtors”) under case numbers 03–90306
through 03–90319. These cases were jointly administered for
procedural purposes before the Bankruptcy Court under case
number 03–90305. The Chapter 11 petitions do not cover
any of ACL’s foreign subsidiaries or certain of its
U.S. subsidiaries. GMS and Vessel Leasing did not file
petitions under Chapter 11 and were not
debtors–in–possession.
Throughout 2004, ACL and the other ACL Debtors operated their
businesses as debtors–in–possession under the
jurisdiction of the Bankruptcy Court and in accordance with the
applicable provisions of Chapter 11 and orders of the
Bankruptcy Court. As debtors–in–possession, the ACL
Debtors were prohibited from engaging in transactions outside of
the ordinary course of business without approval, after hearing,
of the Bankruptcy Court.
As part of the bankruptcy filings, the ACL Debtors entered into
a Revolving Credit and Guaranty Agreement (“DIP Credit
Facility”) that provided up to $75 million of
financing during ACL’s Chapter 11 proceeding. The
obligations of the ACL Debtors under the DIP Credit Facility, by
court order, have super–priority administrative claim
status as provided under Chapter 11. Under Chapter 11,
a super–priority claim is senior to secured and unsecured
pre–petition claims and all administrative expenses
incurred in the Chapter 11 case. In addition, with certain
exceptions (including a carve–out for unpaid professional
fees and disbursements), the DIP Credit Facility obligations are
secured by (1) a first–priority lien on all
unencumbered pre– and post–petition property of the
ACL Debtors, (2) a first–priority priming lien on all
property of the ACL Debtors that is encumbered by the existing
liens securing the ACL Debtors’ pre–petition secured
lenders and (3) a junior lien on all other property of the
ACL Debtors that is encumbered by the pre–petition liens.
The DIP Credit Facility also contained certain restrictive
covenants that, among other things, restrict the ACL
Debtors’ ability to incur additional indebtedness or
guarantee the obligations of others, and required ACL to
maintain minimum cumulative EBITDA, as defined in the DIP Credit
Facility, limit its capital expenditures to defined levels and
restrict advances to certain subsidiaries.
A-16
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
Danielson believed it would receive little or no value with
respect to its equity interest in ACL Holdings or ACL.
Accordingly, Danielson wrote off its remaining investment in ACL
at the end of the first quarter of 2003 as an other than
temporary asset impairment. See Note 5 for additional
information.
On April 23, 2004, ACL announced the sale of its ownership
interest in UABL Limited (“UABL”), a South American
barging and terminalling company, and other assets being used by
UABL for $24.1 million of cash and other consideration. The
sale transaction closed on April 23, 2004. In connection
with the UABL sale, ACL recorded a pre–tax loss of
$35.2 million.
On June 8, 2004, ACL filed a Motion for Order Approving
Sale Procedures, Break–Up Fee and Authorizing the
Employment of Environmental Consultants to establish procedures
for the sale of its 50% membership interest in GMS, to request
approval of a break–up fee for a proposed “stalking
horse” bidder for ACL’s membership interest in GMS, to
fix procedures for rights of access and due diligence by
bidders, and to authorize the employment of a consulting firm to
prepare certain environmental reports. The proposal by the
stalking horse bidder also included a proposal for the
coterminous acquisition of Danielson’s 5.4% membership
interest in GMS. Midsouth Terminal Company L.P.
(“MST”), the holder of the remaining interests in GMS,
filed an objection to ACL’s motion and asserted their right
of first refusal to acquire ACL’s membership interest in
GMS pursuant to GMS’ Amended and Restated Limited Liability
Company Operating Agreement dated May 25, 2002. At a
hearing of the Bankruptcy Court, an order was issued on
June 24, 2004 granting the Motion, as amended, establishing
sale procedures, a break–up fee, and authorizing the
employment of environmental consultants, and preserving the
rights of MST to elect to exercise any right of first refusal it
may have, subject to further court review, on the same terms and
conditions as the stalking horse bidder, and further provided
such exercise occurred on or before July 14, 2004. On
July 13, 2004, MST notified ACL that it desired to exercise
its right of first refusal to acquire ACL’s membership
interest in GMS.
During September, 2004, Danielson and MST agreed on terms with
respect to the sale of Danielson’s membership interest in
GMS. On September 29, 2004, the Bankruptcy Court approved
the sale to MST of ACL’s membership interest in GMS as well
as the sale to MST of Danielson’s membership interest in
GMS. On October 6, 2004, the parties consummated the sale
of ACL’s and Danielson’s membership interests in GMS
to MST. Danielson received approximately $1.5 million in
connection with this transaction. Danielson does not expect to
recognize a significant gain or loss or this transaction.
On September 10, 2004, ACL filed in the Bankruptcy Court a
plan of reorganization (the “ACL Plan”) on behalf of
itself and the other debtors. The ACL Plan provided for among
other things, various distributions to creditors, and provides
that 100% of the equity in ACL will be held by a
newly–formed holding company owned by certain of ACL’s
creditors. The ACL Plan provided for the cancellation of
Danielson’s ownership interest in ACL, and for Danielson to
receive from certain creditors warrants entitling it to purchase
up to 168,230 shares of such holding company, representing
3% of the total number of issued shares therein.
On December 30, 2004, the Bankruptcy Court confirmed the
ACL Plan. ACL subsequently emerged from bankruptcy and is no
longer a subsidiary of Danielson.
| 4. | Summary of Significant Accounting Policies |
| Parent and Consolidated Entity |
| Principles of Consolidation |
The consolidated financial statements reflect the results of
operations, cash flows and financial position of Danielson and
its majority–owned or controlled subsidiaries. All
intercompany accounts and transactions have been eliminated.
Investments in companies that are not majority–owned or
controlled but in which Danielson has significant influence are
accounted for under the equity method.
A-17
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| Use of Estimates |
The preparation of financial statements requires management to
make estimates and assumptions that affect the reported amounts
of assets or liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements
and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those
estimates. Significant estimates include useful lives of
long-lived assets, cash flows and taxable income from future
operations, unpaid losses and loss adjustment expenses,
allowances for doubtful accounts receivable, and liabilities
related to pension obligations, and for workers’
compensation, severance and certain litigation.
| Cash and Cash Equivalents |
Cash and cash equivalents include all cash balances and highly
liquid investments having original maturities of three months or
less.
| Deferred Financing Costs |
At December 31, 2004 and 2003, Danielson had zero and $6.1,
respectively, of net deferred financing costs recorded on the
consolidated balance sheet. These costs were incurred in
connection with arranging its various financing arrangements.
These costs are being amortized over the expected period that
the related financing will be outstanding.
| Income Taxes |
Deferred income taxes are based on the difference between the
financial reporting and tax basis of assets and liabilities. The
deferred income tax provision represents the change during the
reporting period in the deferred tax assets and deferred tax
liabilities, net of the effect of acquisitions and dispositions.
Deferred tax assets include tax loss and credit carryforwards
and are reduced by a valuation allowance if, based on available
evidence, it is more likely than not that some portion or all of
the deferred tax assets will not be realized.
During the periods covered by the Consolidated Financial
Statements, Danielson filed a consolidated Federal income tax
return, which included all eligible United States subsidiary
companies. Foreign subsidiaries were taxed according to
regulations existing in the countries in which they do business.
Subsequent to March 10, 2004, Domestic Covanta is included
in Danielson’s consolidated tax group. CPIH and its United
States and foreign subsidiaries are not members of the Danielson
consolidated tax group after March 10, 2004. In addition
Covanta Lake is not a member of any consolidated tax group after
February 20, 2004.
| Pension and Postretirement Plans |
Danielson has pension and post–retirement obligations and
costs that are developed from actuarial valuations. Inherent in
these valuations are key assumptions including discount rates,
expected return on plan assets and medical trend rates. Changes
in these assumptions are primarily influenced by factors outside
Danielson’s control and can have a significant effect on
the amounts reported in the financial statements.
| Incentive Compensation Plans |
Stock–based compensation cost is measured using the
intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion No. 25 “Accounting
for Stock Issued to Employees” for Danielson’s
directors and employees. Pro forma net income (loss) and income
(loss) per share are disclosed
A-18
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
below as if the fair value based method of accounting under
SFAS No. 123 had been applied to all stock–based
compensation awards.
| 2004 | 2003 | 2002 | |||||||||||
|
Net income (loss) as reported
|
$ | 34,094 | $ | (69,225 | ) | $ | (32,955 | ) | |||||
|
Pro Forma compensation expense
|
(987 | ) | (970 | ) | (2,274 | ) | |||||||
|
Less:
|
|||||||||||||
|
Stock option expense recorded
|
128 | 137 | 920 | ||||||||||
|
Pro forma net income (loss)
|
$ | 33,235 | $ | (70,058 | ) | $ | (34,309 | ) | |||||
|
Basic earnings (loss) per share:
|
|||||||||||||
|
As reported
|
$ | 0.54 | $ | (1.46 | ) | $ | (0.82 | ) | |||||
|
Pro forma
|
$ | 0.52 | $ | (1.48 | ) | $ | (0.85 | ) | |||||
|
Diluted earnings (loss) per share:
|
|||||||||||||
|
As reported
|
$ | 0.52 | $ | (1.46 | ) | $ | (0.82 | ) | |||||
|
Pro Forma
|
$ | 0.50 | $ | (1.48 | ) | $ | (0.85 | ) | |||||
| Energy |
| Revenue Recognition |
Covanta’s revenues are generally earned under contractual
arrangements, and fall into three categories: service revenues,
electricity and steam revenues, and construction revenues.
Service revenues consist of the following:
| 1) Fees earned under contract to operate and maintain waste-to-energy, independent power and water facilities are recognized as revenue when earned, regardless of the period they are billed; | |
| 2) Fees earned to service project debt (principal and interest) where such fees are expressly included as a component on the service fee paid by the Client Community pursuant to applicable waste-to-energy Service Agreements. Regardless of the timing of amounts paid by Client Communities relating to project debt principal, Covanta records service revenue with respect to this principal component on a levelized basis over the term of the Service Agreement. Unbilled service receivables related to waste-to-energy operations are discounted in recognizing the present value for services performed currently in order to service the principal component of the Project debt. Such unbilled receivables amounted to $156 million December 31, 2004, respectively; | |
| 3) Fees earned for processing waste in excess of Service Agreement requirements are recognized as revenue beginning in the period Covanta processes waste in excess of the contractually stated requirements; | |
| 4) Tipping fees earned under waste disposal agreements are recognized as revenue in the period waste is received; and | |
| 5) Other miscellaneous fees such as revenue for scrap metal recovered and sold are generally recognized as revenue when scrap metal is sold. | |
| Electricity and Steam Sales |
Revenue from the sale of electricity and steam are earned at
energy facilities and are recorded based upon output delivered
and capacity provided at rates specified under contract terms or
prevailing market rates net of amounts due to Client Communities
under applicable Service Agreements.
A-19
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| Construction Revenues |
Revenues under fixed-price construction contracts, including
construction, are recognized on the basis of the estimated
percentage of completion of services rendered. Construction
revenues also include design, engineering and construction
management fees. In 2004, the Company incurred some preliminary
construction costs for which it has not billed the municipality
or received reimbursement. Covanta anticipates the contracts
will be finalized in 2005 at which time it expects to be fully
reimbursed for all costs.
| Pass Through Costs |
Pass through costs are costs for which Covanta receives a direct
contractually committed reimbursement from the municipal client
who sponsors a waste-to-energy the project. These costs
generally include utility charges, insurance premiums, ash
residue transportation and disposal, and certain chemical costs.
These costs are recorded net of municipal client reimbursements
in Covanta’s Financial Statements. Total pass through
expenses for the March 11, 2004 through December 31,
2004, January 1, 2004 through March 10, 2004, and for
2003 were $39.9 million, $10 million, and
$59.8 million, respectively.
| Property, Plant and Equipment |
As of March 10, 2004, the assets and liabilities of
Covanta’s energy business, including property, plant, and
equipment were recorded at management’s estimate of their
fair values. Additions, improvements and major expenditures are
capitalized if they increase the original capacity or extend the
useful life of the original asset more than one year.
Maintenance repairs and minor expenditures are expensed in the
period incurred. For financial reporting purposes, depreciation
is calculated by the straight–line method over the
estimated remaining useful lives of the assets, which range up
to 41 years for waste–to–energy facilities. The
original useful lives generally range from three years for
computer equipment to 50 years for
waste–to–energy facilities. Leaseholds are depreciated
over the life of the lease or the asset, whichever is shorter.
Landfill costs are amortized based on the quantities deposited
into each landfill compared to the total estimated capacity of
such landfill.
| Service and Energy Contracts and Other Intangible Assets |
As of March 10, 2004, service and energy contracts were
recorded at their estimated fair values in accordance with
SFAS No. 141 based upon discounted cash flows from the
service contracts on publicly owned projects and the “above
market” portion of the energy contracts on Covanta owned
projects using currently available information. Amortization is
calculated by the straight–line method over the estimated
contract lives of which the remaining weighted average life of
the agreements is approximately 17 years. However, many of
such contracts have remaining lives that are significantly
shorter. Other intangible assets are amortized by the
straight-line method over periods ranging from 15 to
25 years. (See Note 12 to the Notes to the
Consolidated Financial Statements.)
| Restricted Funds Held |
Restricted funds held in trust are primarily amounts received by
third party trustees relating to projects owned by Covanta, and
which may be used only for specified purposes. Covanta generally
does not control these accounts. They include debt service
reserves for payment of principal and interest on project debt,
deposits of revenues received with respect to projects prior to
their disbursement as provided in the relevant indenture or
other agreements, lease reserves for lease payments under
operating leases, and proceeds received from financing the
construction of energy facilities. Such funds are invested
principally in United States Treasury bills and notes and United
States government agency securities.
A-20
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| Project Development and Contract Acquisition Costs |
Covanta capitalizes project development costs once it is
determined that it is probable that such costs will be realized
through the ultimate construction of a plant. These costs
include outside professional services, permitting expense and
other third party costs directly related to the development of a
specific new project. Upon the start-up of plant operations or
the completion of an acquisition, these costs are generally
transferred to property, plant and equipment and are amortized
over the estimated useful life of the related plant or charged
to construction costs in the case of a construction contract for
a facility owned by a municipality. Capitalized project
development costs are charged to expense when it is determined
that the related project is impaired.
Contract acquisition costs are capitalized for external costs
incurred to acquire the rights to design, construct and operate
waste-to-energy facilities and are amortized over the life of
the contracts. Contract acquisition costs are presented net of
accumulated amortization of and were $46.6 million at
December 31, 2003. As of March 10, 2004, contract
acquisition costs were recorded at their fair value of zero.
| Interest Rate Swap Agreements |
The fair value of interest rate swap agreements are recorded as
assets and liabilities, with changes in fair value during the
year credited or charged to debt service revenue or debt service
charges, as appropriate.
| Impairment of Long–Lived Assets |
Long-lived assets, such as property, plant and equipment and
purchased intangible assets with finite lives, are evaluated for
impairment whenever events or changes in circumstances indicate
the carrying value of an asset may not be recoverable over their
estimated useful life in accordance with SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived
Assets.” Covanta reviews its long-lived assets for
impairment when events or circumstances indicate that the
carrying value of such assets may not be recoverable over the
estimated useful life. Determining whether an impairment has
occurred typically requires various estimates and assumptions,
including which cash flows are directly attributable to the
potentially impaired asset, the useful life over which the cash
flows will occur, their amount and the assets residual value, if
any. Also, impairment losses require an estimate of fair value,
which is based on the best information available. Covanta
principally uses internal discounted cash flow estimates, but
also uses quoted market prices when available and independent
appraisals as appropriate to determine fair value. Cash flow
estimates are derived from historical experience and internal
business plans with an appropriate discount rate applied.
| Foreign Currency Translation |
For foreign operations, assets and liabilities are translated at
year–end exchange rates and revenues and expenses are
translated at the average exchange rates during the year. Gains
and losses resulting from foreign currency translation are
included in the Consolidated Statements of Operations and
Comprehensive Income (Loss) as a component of Other
comprehensive income (loss). For subsidiaries whose functional
currency is deemed to be other than the U.S. dollar,
translation adjustments are included as a separate component of
Other Comprehensive income (loss) and Shareholders’ equity
(deficit). Currency transaction gains and losses are recorded in
Other–net in the Statements of Consolidated Operations and
Comprehensive Income (Loss).
| Insurance Services |
| Investments |
Insurance Services’ fixed maturity debt and equity
securities portfolio are classified as “available for
sale” and are carried at fair value. Changes in fair value
are credited or charged directly to stockholders’ equity as
unrealized gains or losses, respectively. All securities
transactions are recorded on the trade date. Investment gains or
losses realized on the sale of securities are determined using
the specific identification method.
A-21
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
“Other than temporary” declines in fair value are
recorded as realized losses in the statement of operations and
the cost basis of the security is reduced. Realized gains and
losses are recognized in the statements of operations based on
the amortized cost of fixed maturities and cost basis for equity
securities on the date of trade, subject to any previous
adjustments for “other than temporary” declines.
| Deferred Policy Acquisition Costs |
Insurance Services’ deferred policy acquisition costs,
consisting principally of commissions and premium taxes paid at
the time of issuance of the insurance policy, are deferred and
amortized over the period during which the related insurance
premiums are earned. Deferred policy acquisition costs are
limited to the estimated future profit after anticipated losses
and loss adjustment expenses (“LAE”) (based on
historical experience), maintenance costs, policyholder
dividends, and anticipated investment income. Deferred policy
acquisition costs were $0.3 million and $0.8 million
at December 31, 2004 and 2003, respectively, and are
included in other assets in the Consolidated Balance Sheet.
| Unpaid Losses and Loss Adjustment Expenses |
Unpaid losses and LAE are based on estimates of reported losses
and historical experience for incurred but unreported claims,
including losses reported by other insurance companies for
reinsurance assumed, and estimates of expenses for investigating
and adjusting all incurred and unadjusted claims. Management
believes that the provisions for unpaid losses and LAE are
adequate to cover the cost of losses and LAE incurred to date.
However, such liability is, by necessity, based upon estimates,
which may change in the near term, and there can be no assurance
that the ultimate liability will not exceed, or even materially
exceed, such estimates. Unpaid losses and LAE are continually
monitored and reviewed, and as settlements are made or reserves
adjusted, differences are included in current operations.
| Reinsurance |
In the normal course of business, Insurance Services seeks to
reduce the loss it may incur on the policies it writes by
reinsuring certain portions of the insured benefit with other
insurance enterprises or reinsurers.
Insurance Services accounts for its reinsurance contracts which
provide indemnification by reducing earned premiums for the
amounts ceded to the reinsurer and establishing recoverable
amounts for paid and unpaid losses and LAE ceded to the
reinsurer. Amounts recoverable from reinsurers are estimated in
a manner consistent with the claim liability associated with the
reinsured policy. Contracts that do not result in the reasonable
possibility that the reinsurer may realize a significant loss
from the insurance risk generally do not meet conditions for
reinsurance accounting and are accounted for as deposits. For
the years ended December 31, 2004 and 2003, Insurance
Services had no reinsurance contracts which were accounted for
as deposits.
| Earned Premiums |
Insurance Services’ earned premium income is recognized
ratably over the contract period of an insurance policy. A
liability is established for unearned insurance premiums that
represent the portion of premium received which is applicable to
the remaining portion of the unexpired terms of the related
policies. Reinsurance premiums are accounted for on a basis
consistent with those used in accounting for the original
policies issued and the terms of the reinsurance contracts.
Insurance Services establishes an allowance for premium
receivables and reinsurance recoverables through a charge to
general and administrative expenses based on historical
experience. After all collection efforts have been exhausted,
Insurance Services writes off the receivable balances and
reduces the previously established reserve.
A-22
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| New Accounting Pronouncements |
In December 2004, the FASB issued SFAS No. 123
(revised 2004), “Share-Based Payment”
(“SFAS 123R”), which replaces
SFAS No. 123 “Accounting for Stock-Based
Compensation” (“SFAS 123”) and supercedes
APB Opinion No. 25, “Accounting for Stock Issued to
Employees.” SFAS 123R requires all share-based
payments to employees, including grants of employee stock
options, to be recognized in the financial statements based on
their fair values, beginning with the first interim or annual
period after June 15, 2005, with early adoption encouraged.
The pro forma disclosures previously permitted under
SFAS 123, no longer will be an alternative to financial
statement recognition. Danielson is required to adopt
SFAS 123R in the third quarter of fiscal 2005, beginning
July 1, 2005. Under SFAS 123R, Danielson must
determine the appropriate fair value model to be used for
valuing share-based payments, the amortization method for
compensation cost and the transition method to be used at date
of adoption. The transition methods include prospective and
retroactive adoption options. Under the retroactive options,
prior periods may be restated either as of the beginning of the
year of adoption or for all periods presented. The prospective
method requires that compensation expense be recorded for all
unvested stock options and restricted stock at the beginning of
the first quarter of adoption of SFAS 123R, while the
retroactive methods would record compensation expense for all
unvested stock options and restricted stock beginning with the
first period restated. Danielson is evaluating the requirements
of SFAS 123R and expects that the adoption of
SFAS 123R will have a material impact on Danielson’s
consolidated results of operations and earnings per share.
Danielson has not yet determined the method of adoption or the
effect of adopting SFAS 123R, and it has not determined
whether the adoption will result in amounts that are similar to
the current pro forma disclosures under SFAS 123.
| Reclassification |
Certain prior period amounts, have been reclassified in the
Financial Statements to conform with the current period
presentation.
| 5. | Equity in Net Income and Losses of Unconsolidated Subsidiaries |
Through the acquisition of Covanta, Danielson is now party to
joint venture agreements in which Danielson has equity
investments in several operating projects. The joint venture
agreements generally provide for the sharing of operational
control as well as voting percentages. Danielson records its
share of earnings from its equity investees in equity in net
income from unconsolidated investments in its Consolidated
Statement of Operations.
Danielson is a party to a joint venture formed to design,
construct, own and operate a coal-fired electricity generation
facility in the Quezon Province, the Philippines (“Quezon
Joint Venture”). Danielson owns 26.125% of, and has
invested 27.5% of the total equity in, the Quezon Joint Venture.
This project commenced commercial operations in 2000.
Manila Electric Company (“Meralco”), the sole power
purchaser for Danielson’s Quezon Project, is engaged in
discussions and legal proceedings with instrumentalities of the
government of the Philippines relating to past billings to its
customers, cancellations of recent tariff increases, and
potential tariff increases. The outcome of these proceedings may
affect Meralco’s financial condition.
Quezon Project management continues to negotiate with Meralco
with respect to proposed amendments to the power purchase
agreement to modify certain commercial terms under the existing
contract, and to resolve issues relating to the Quezon
Project’s performance during its first year of operation.
Following the first year of the operation, in 2001, based on a
claim that the plant’s performance did not merit full
payment, Meralco withheld a portion of each of several monthly
payments to the Quezon Project that were due under the terms of
the power purchase agreement. The total withheld amount was
$10.8 million (U.S.). Although the Quezon Project was able
to pay all of its debt service and operational costs, the
withholding by Meralco
A-23
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
constituted a default by Meralco under the power purchase
agreement and a potential event of default under the project
financing agreements. To address this issue, Quezon Project
management agreed with project lenders to hold back cash from
distributions in excess of the reserve requirements under the
financing agreements in the amount of approximately
$20.5 million (U.S.).
In addition to the issues under the power purchase agreement,
issues under the financing agreements arose during late 2003 and
2004 regarding compliance with the Quezon Project operational
parameters and the Quezon Project’s inability to obtain
required insurance coverage. In October 2004, the Company and
other Quezon project participants, with the consent of the
Quezon Project lenders, amended certain of the Quezon Project
documents to address such operational matters, resolving all
related contract issues. Subsequently, the project lenders
granted a waiver with respect to the insurance coverage issue
because contractual coverage levels were not then commercially
available on reasonable terms. At approximately the same time,
Quezon Project management sought, and successfully obtained, a
reduction of the hold back amount discussed above, resulting in
a new excess hold back of approximately $10.5 million
(U.S.) with effect from November 2004.
Adverse developments in Meralco’s financial condition or
delays in finalizing the power purchase agreement amendments and
potential consequent lender actions are not expected to
adversely affect Covanta’s liquidity, although it may have
a material affect on CPIH’s ability to repay its debt prior
to maturity. In late 2004, Meralco successfully refinanced
$228 million in expiring short-term debt on a long-term
7 year basis, improving Meralco’s financial condition.
The December 31, 2004 aggregate carrying value of
Covanta’s investments in and advances to investees and
joint ventures of $61.6 million is less than Covanta’s
equity in the underlying net assets of these investees by
approximately $64.9 million. These differences of cost over
acquired net assets are mainly related to fresh start
adjustments related to property, plant, and equipment and power
purchase agreements of several investees.
At December 31, 2004 energy investments in and advances to
investees and joint ventures accounted for under the equity
method were as follows:
| Ownership | ||||||||
| Interest at | ||||||||
| December 31, | ||||||||
| 2004 | 2004 | |||||||
|
Ultrapower Chinese Station Plant (U.S.)
|
50% | $ | 5,112 | |||||
|
South Fork Plant (U.S.)
|
50% | 641 | ||||||
|
Koma Kulshan Plant (U.S.)
|
50% | 4,116 | ||||||
|
Haripur Barge Plant (Bangladesh)
|
45% | 6,983 | ||||||
|
Quezon Power (Philippines)
|
26% | 44,804 | ||||||
|
Total investments in power plants
|
$ | 61,656 | ||||||
A-24
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
The unaudited combined results of operations and financial
position of energy’s equity method affiliates are
summarized below.
| 2004 | ||||
|
Condensed Statements of Operations for the years ended
December 31:
|
||||
|
Revenues
|
$ | 219,016 | ||
|
Gross profit
|
102,908 | |||
|
Net income
|
60,724 | |||
|
Company’s share of net income
|
17,535 | |||
|
Condensed Balance Sheets at December 31:
|
||||
|
Current assets
|
$ | 145,969 | ||
|
Non-current assets
|
854,014 | |||
|
Total assets
|
999,983 | |||
|
Current liabilities
|
76,533 | |||
|
Non-current liabilities
|
512,759 | |||
|
Total liabilities
|
589,292 | |||
Danielson wrote off its investment in ACL during the quarter
ended March 28, 2003. The GMS and Vessel Leasing
investments were not considered by Danielson to be impaired.
Danielson and ACL sold its investment in GMS on October 6,
2004. Danielson sold its investment in Vessel Leasing to ACL on
January 13, 2005. The reported net income (loss) for the
year ended December 31, 2004 and 2003, included, under the
caption “Equity in Net Income Loss of Unconsolidated
Investments”, the following:
| 2004 | 2003 | |||||||
|
ACL’s reported loss as of March 31, 2003
|
$ | — | $ | (46,998 | ) | |||
|
Other than temporary impairment of remaining investment in ACL
as of March 28, 2003
|
— | (8,205 | ) | |||||
|
Total ACL loss
|
(55,203 | ) | ||||||
|
GMS income (loss) as of October 6, 2004
|
$ | 156 | 55 | |||||
|
Vessel leasing income
|
318 | 271 | ||||||
|
Write down of Vessel Leasing investment held for sale
|
(985 | ) | — | |||||
|
Equity in net income (loss) of unconsolidated Marine Services
Subsidiaries
|
(511 | ) | (54,877 | ) | ||||
|
Equity in net income of unconsolidated Energy Investments
|
17,535 | — | ||||||
| $ | 17,024 | $ | (54,877 | ) | ||||
Activity in the equity investees for the years ended
December 31, 2004 and 2003 was:
| Year Ended December 31, 2004 | ||||||||
| Haripur Barge | ||||||||
| Quezon Power | Plant | |||||||
| (The Philippines) | (Bangladesh) | |||||||
|
Revenues
|
$ | 214,865 | $ | 36,655 | ||||
|
Operating income
|
105,077 | 20,080 | ||||||
|
Net (Loss) income
|
65,047 | 9,397 | ||||||
A-25
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| Year Ended | ||||
| December 31, 2003 | ||||
| ACL | ||||
|
Revenues
|
$ | 620,071 | ||
|
Operating (loss) income*
|
367 | |||
|
Net (loss) income
|
$ | (61,576 | ) | |
| * | Before ACL Reorganization Expenses |
The following table summarizes the results of operations for the
Remaining Debtors for the period March 11, 2004 through
December 31, 2004. Due to uncertainty regarding the
realization of earnings of the Remaining Debtors, Covanta has
not recognized the earnings set forth below:
| For the Period | ||||
| March 11, 2004 | ||||
| through | ||||
| December 31, 2004 | ||||
|
Condensed Statements of Operations:
|
||||
|
Revenues
|
$ | 10,801 | ||
|
Operating income
|
339 | |||
|
Net income
|
318 | |||
| 6. | Gain (Loss) on Sale of Businesses |
The following is a list of assets sold or impaired during the
years ended December 31, 2004 the gross proceeds from those
sales, the realized gain or (loss) on those sales and the
write-down of or recognition of liabilities related to those
assets:
| Description of Business | Proceeds | Gain (Loss) | ||||||
|
2004
|
||||||||
|
Investment in GMS
|
$ | 1,512 | $ | 99 | ||||
|
Equity investment in Linasa plant
|
1,844 | 245 | ||||||
| 7. | Investments |
The cost or amortized cost, unrealized gains, unrealized losses
and fair value of Danielson’s investments as of the year
ended December 2004 and 2003, categorized by type of security,
were as follows:
| 2004 | |||||||||||||||||
| Cost or | |||||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | ||||||||||||||
| Cost | Gain | Loss | Value | ||||||||||||||
|
Fixed maturities — parent company
|
$ | 3,300 | $ | — | $ | — | $ | 3,300 | |||||||||
|
Fixed maturities — insurance services:
|
|||||||||||||||||
|
U.S. government/ Agency
|
27,024 | 174 | 129 | 27,070 | |||||||||||||
|
Mortgage–backed
|
13,625 | 22 | 206 | 13,440 | |||||||||||||
|
Corporate
|
16,615 | 216 | 131 | 16,700 | |||||||||||||
|
Total fixed maturities — insurance services
|
57,264 | 412 | 466 | 57,210 | |||||||||||||
|
Equity securities — insurance services
|
1,324 | 110 | 2 | 1,432 | |||||||||||||
|
Total available–for–sale
|
$ | 61,888 | $ | 522 | $ | 468 | $ | 61,942 | |||||||||
A-26
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| 2003 | |||||||||||||||||
| Cost or | |||||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | ||||||||||||||
| Cost | Gain | Loss | Value | ||||||||||||||
|
Fixed maturities — parent company
|
$ | 453 | $ | 35 | $ | — | $ | 488 | |||||||||
|
Fixed maturities — insurance services:
|
|||||||||||||||||
|
U.S. government/ Agency
|
22,887 | 391 | 70 | 23,208 | |||||||||||||
|
Mortgage–backed
|
15,598 | 81 | 231 | 15,448 | |||||||||||||
|
Corporate
|
30,902 | 716 | 106 | 31,512 | |||||||||||||
|
Total fixed maturities — insurance services
|
69,387 | 1,188 | 407 | 70,168 | |||||||||||||
|
Equity securities — insurance services
|
367 | 34 | — | 401 | |||||||||||||
|
Total available–for–sale
|
$ | 70,207 | $ | 1,257 | $ | 407 | $ | 71,057 | |||||||||
The following table sets forth a summary of NAICC’s
temporarily impaired investments at December 31, 2004:
| Fair | Unrealized | |||||||
| Description of Investments | Value | Losses | ||||||
|
U.S. Treasury and other direct U.S. Government
obligations
|
$ | 13,579 | $ | 129 | ||||
|
Federal agency MBS
|
10,583 | 206 | ||||||
|
Corporate Bonds
|
6,096 | 131 | ||||||
|
Equity Securities
|
148 | 2 | ||||||
|
Total temporarily impaired investments
|
$ | 30,406 | $ | 468 | ||||
Of the fixed maturity investments noted above 81.8% were
acquired subsequent to 2002 during an historic low interest rate
environment and are investment grade securities rated A or
better. The number of U.S. Treasury obligations, Federal
agency mortgage backed securities, corporate bonds and equity
securities temporarily impaired are 21, 27 and 3,
respectively. No security has a fair value less than 3.5% below
its amortized cost.
Fixed maturities of Danielson include mortgage–backed
securities and collateralized mortgage obligations, collectively
(“MBS”) representing 22.2% and 21.9% of the total
fixed maturities at years ended December 31, 2004 and 2003,
respectively. All MBS held by Danielson are issued by the
Federal National Mortgage Association (“Fannie Mae”)
or the Federal Home Loan Mortgage Corporation (“Freddie
Mac”), both of which are rated “AAA” by
Moody’s Investors Services. MBS and callable bonds, in
contrast to other bonds, are more sensitive to market value
declines in a rising interest rate environment than to market
value increases in a declining interest rate environment. This
is primarily because of payors’ increased incentive and
ability to prepay principal and issuers’ increased
incentive to call bonds in a declining interest rate
environment. Management does not believe that the inherent
prepayment risk in its portfolio is significant. However,
management believes that the potential impact of the interest
rate risk on Danielson’s consolidated financial statements
could be significant because of the greater sensitivity of the
MBS portfolio to market value declines and the classification of
the entire portfolio as available–for–sale. Danielson
has no MBS concentrations in any geographic region.
The expected maturities of fixed maturity securities, by
amortized cost and fair value, as of the year ended December
2004, are shown below. Expected maturities may differ from
contractual maturities due to borrowers having the right to call
or prepay their obligations with or without call or prepayment
penalties.
A-27
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
Expected maturities of MBS are estimated based upon the
remaining principal balance, the projected cash flows and the
anticipated prepayment rates of each security:
| Amortized Cost | Fair Value | ||||||||||
|
Available–for–sale:
|
|||||||||||
|
One year or less
|
$ | 3,977 | $ | 4,039 | |||||||
|
Over one year to five years
|
48,431 | 48,374 | |||||||||
|
Over five years to ten years
|
4,857 | 4,797 | |||||||||
|
More than ten years
|
3,300 | 3,300 | |||||||||
|
Total fixed maturities
|
$ | 60,564 | $ | 60,510 | |||||||
Danielson’s fixed maturity and equity securities portfolio
is classified as “available for sale” and is carried
at fair value. Changes in fair value are credited or charged
directly to stockholders’ equity as unrealized gains or
losses, respectively. “Other than temporary” declines
in fair value are recorded as realized losses in the statement
of operations and the cost basis of the security is reduced.
The following reflects the change in net unrealized (loss) gain
on available–for–sale securities included as a
separate component of accumulated other comprehensive income
(loss) in stockholders’ equity:
| 2004 | 2003 | 2002 | |||||||||||
|
Fixed maturities, net
|
$ | (874 | ) | $ | (4,284 | ) | $ | (907 | ) | ||||
|
Equity securities, net
|
74 | 1,407 | (1,082 | ) | |||||||||
|
Change in net unrealized loss on investments
|
$ | (800 | ) | $ | (2,877 | ) | $ | (1,989 | ) | ||||
The components of net unrealized (loss) gain on available for
sale securities for the years ended December 2004, 2003 and 2002
consist of the following:
| 2004 | 2003 | 2002 | |||||||||||
|
Net unrealized holding (losses) gains on available for sale
securities arising during the period
|
$ | (500 | ) | $ | (797 | ) | $ | (1,445 | ) | ||||
|
Reclassification adjustment for net realized gains on available
for sale securities included in net income (loss)
|
(300 | ) | (2,080 | ) | (544 | ) | |||||||
|
Net unrealized (loss) gain on available for sale securities
|
$ | (800 | ) | $ | (2,877 | ) | $ | (1,989 | ) | ||||
Danielson considers the following factors in determining whether
declines in the fair value of securities are “other than
temporary”:
a. the significance of the decline in fair value compared
to the cost basis,
b. the time period during which there has been a
significant decline in fair value,
| c. | whether the unrealized loss is credit–driven or a result of changes in market interest rates, |
| d. | a fundamental analysis of the business prospects and financial condition of the issuer, and |
| e | Danielson’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value. |
Based upon these factors, securities that have indications of
potential impairment are subject to further review. In the third
quarter of 2002, Danielson determined that two equity securities
had declines in fair value that were “other than
temporary” and Danielson, accordingly, recorded a realized
loss of $2.7 million. These securities were subsequently
sold in the fourth quarter of 2002. At year end 2002, Danielson
determined that one equity security had a decline in fair value
that was “other than temporary” and, accordingly,
recorded a
A-28
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
realized loss of $1 million. The net unrealized loss of
Danielson’s equity securities was $1.4 million at the
end of December 2002.
During 2003, three equity securities had declines in fair value
that were “other than temporary” and, accordingly,
Danielson recorded a realized loss of $1.9 million. All of
these securities were sold by December 31, 2003.
Net realized investment gains (losses) for the years ended in
December are as follows:
| 2004 | 2003 | 2002 | ||||||||||||
|
Parent Company
|
||||||||||||||
|
Fixed maturities
|
$ | 252 | $ | 1,090 | $ | 8,740 | ||||||||
|
Equity securities
|
— | — | 100 | |||||||||||
|
Net realized investment gains
|
$ | 252 | $ | 1,090 | $ | 8,840 | ||||||||
|
Insurance Services
|
||||||||||||||
|
Fixed maturities
|
$ | 219 | $ | 952 | $ | 6,087 | ||||||||
|
Equity services
|
(18 | ) | 38 | (5,080 | ) | |||||||||
|
Net realized investment gains
|
$ | 201 | $ | 990 | $ | 1,007 | ||||||||
Gross realized gains relating to fixed maturities were
$0.2 million, $1 million, and $14.8 million for
the years ended December 2004, 2003 and 2002, respectively.
Gross realized losses relating to fixed maturities were
approximately $0.02 million for each of the years ended
December 2004, 2003 and 2002, respectively. Gross realized gains
relating to equity securities were $0, $2 million and
$0.1 million for the years ended December 2004, 2003 and
2002, respectively. Gross realized losses relating to equity
securities were $0.2 million, $2 million and $5.1
million, for the years ended December 2004, 2003 and 2002,
respectively.
Net investment income for the years ended December 2004, 2003
and 2002 was:
| 2004 | 2003 | 2002 | |||||||||||||
|
Parent Company
|
|||||||||||||||
|
Fixed maturities
|
$ | 199 | $ | 302 | $ | 594 | |||||||||
|
Short–term investments
|
34 | 42 | 46 | ||||||||||||
|
Net investment income — parent company
|
$ | 233 | $ | 344 | $ | 640 | |||||||||
|
Insurance services
|
|||||||||||||||
|
Fixed maturities
|
$ | 2,497 | $ | 3,951 | $ | 5,467 | |||||||||
|
Short–term investments
|
— | 146 | 134 | ||||||||||||
|
Dividend income
|
40 | 32 | 42 | ||||||||||||
|
Other, net
|
107 | 44 | 95 | ||||||||||||
|
Total investment income
|
2,644 | 4173 | 5,738 | ||||||||||||
|
Less: investment expense
|
239 | 174 | 135 | ||||||||||||
|
Net investment income — insurance services
|
$ | 2,405 | $ | 3,999 | $ | 5,603 | |||||||||
At December 31, 2001, Danielson held $58.5 million
face amount of ACL Senior Notes 10.25%, due June 30,
2008, at a cost of $30 million and a fair value of
$32 million, representing 42.9% of stockholders’
equity. These notes were contributed to ACL Holdings in 2002 in
connection with the acquisition discussed in Note 3. There
were no other investments with a carrying value greater than ten
percent of stockholders’ equity as of years ended December
2004, 2003 or 2002.
A-29
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
In compliance with state insurance laws and regulations,
securities with a fair value of approximately $31.1 million
$43.4 million, and $45 million as of the years ended
December 2004, 2003 and 2002, respectively, were on deposit with
various states or governmental regulatory authorities. In
addition, as of the years ended December 2004, 2003 and 2002,
investments with a fair value of $7 million,
$7.2 million and $6.4 million, respectively, were held
in trust or as collateral under the terms of certain reinsurance
treaties and letters of credit. NAICC has letters of credit
outstanding of $3.1 million as of December 31, 2004.
| Energy Services |
The cost or amortized cost, unrealized gains, unrealized losses
and fair value of Energy Services’ investments as of the
year ended December 2004, categorized by type of security, were
as follows:
Marketable securities at December 31, 2004 include the
following:
| Cost or | Unrealized | Unrealized | Fair | |||||||||||||
| Amortized Cost | Gain | Loss | Value | |||||||||||||
|
Current investments:
|
||||||||||||||||
|
Fixed maturities — Energy
|
$ | 3,100 | $ | — | $ | — | $ | 3,100 | ||||||||
|
Fixed maturities — Energy
|
1,321 | — | — | — | ||||||||||||
|
Mutual and bond funds — Energy
|
2,325 | 53 | — | 2,378 | ||||||||||||
|
Total non-current investments
|
$ | 3,646 | $ | 53 | $ | — | $ | 3,699 | ||||||||
Non-current investments are classified in other long-term assets
in the Energy Services balance sheet.
Proceeds and realized gains and losses from the sales of
securities classified as available for sale from March 11,
2004 through December 31, 2004 were $0.3 million and
zero, respectively. For the purpose of determining realized
gains and losses, the cost of securities sold was based on
specific identification.
| 8. | Energy Service Revenues and Unbilled Service Receivables |
The following table summarized the components of Energy’s
Service Revenues at December 31, 2004.
| For the Period | ||||
| March 11, through | ||||
| December 31, | ||||
| 2004 | ||||
|
Service Revenue unrelated to project debt
|
$ | 313,543 | ||
|
Revenue earned explicitly to service project debt-principal
|
36,029 | |||
|
Revenue earned explicitly to service project debt-interest
|
25,050 | |||
|
Total service revenue
|
$ | 374,622 | ||
Unbilled service receivables include fees earned to service
project debt (principal and interest) where such fees are
expressly included as a component of the service fee paid by the
municipality pursuant to applicable waste-to-energy service
agreements. Regardless of the timing of amounts paid by
municipalities relating to project debt principal, Covanta
records service revenue with respect to this principal component
on a levelized basis over the term of the service agreement.
Long-term unbilled service receivables related to
waste-to-energy operations are recorded at their discounted
amount.
| 9. | Restricted Funds Held in Trust |
Restricted funds held in trust are primarily amounts received
and held by third party trustees relating to projects owned by
the Company, and which may be used only for specified purposes.
The Company generally does not control these accounts. They
include debt service reserves for payment of principal and
interest on
A-30
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
project debt, deposits of revenues received with respect to
projects prior to their disbursement as provided in the relevant
indenture or other agreements, lease reserves for lease payments
under operating leases, and proceeds received from financing the
construction of energy facilities. Such funds are invested
principally in United States Treasury bills and notes and United
States government agencies securities.
Fund balances were as follows:
| 2004 | ||||||||
| Current | Non-Current | |||||||
|
Debt service funds
|
$ | 46,655 | $ | 112,012 | ||||
|
Revenue funds
|
20,530 | — | ||||||
|
Lease reserve funds
|
3,970 | — | ||||||
|
Construction funds
|
264 | — | ||||||
|
Other funds
|
44,673 | 11,814 | ||||||
|
Total
|
$ | 116,092 | $ | 123,826 | ||||
| 10. | Reinsurance |
Reinsurance is the transfer of risk, by contract, from one
insurance company to another for consideration (premium).
Reinsurance contracts do not relieve Insurance Services from its
obligations to policyholders. Failure of reinsurers to honor
their obligations could result in losses to Insurance Services;
consequently, allowances are established for amounts deemed
uncollectible. Insurance Services evaluates the financial
condition of its reinsurers and monitors concentrations of
credit risk arising from similar geographic regions, activities,
or economic characteristics to reinsurers to minimize its
exposure to significant losses from reinsurer insolvencies.
NAICC has reinsurance under both excess of loss and quota share
treaties. NAICC cedes reinsurance on an excess of loss basis for
workers’ compensation risks in excess of $0.4 million
prior to January 1996, $0.5 million through March 2000 and
$0.2 million thereafter. Beginning in May 2001, NAICC
retained 50% of the loss between $0.2 million and
$0.5 million. For commercial automobile, NAICC cedes
reinsurance on an excess of loss basis risks in excess of
$0.25 million. Since January 1, 1999 the California
non-standard personal automobile quota share ceded percentage
was 10% and effective January 1, 2002 the quota share
treaty was terminated. The property and casualty book of
business of former affiliates contains both excess of loss and
quota share reinsurance protection. Typically all excess of loss
contracts effectively reduce NAICC’s net exposure to any
occurrence below $0.1 million.
The effect of reinsurance on written premiums and earned
premiums reflected in Danielson’s consolidated financial
statements is as follows:
| 2004 | 2003 | 2002 | ||||||||||
|
Direct written premium
|
$ | 15,165 | $ | 32,733 | $ | 56,462 | ||||||
|
Ceded written premium
|
— | (2,325 | ) | (3,807 | ) | |||||||
|
Net written premium
|
$ | 15,165 | $ | 30,408 | $ | 52,655 | ||||||
|
Direct earned premium
|
$ | 18,506 | $ | 38,805 | $ | 66,958 | ||||||
|
Ceded earned premium
|
(508 | ) | (2,954 | ) | (4,794 | ) | ||||||
|
Net earned premium
|
$ | 17,998 | $ | 35,851 | $ | 62,164 | ||||||
The effect of ceded reinsurance on loss and LAE incurred was a
decrease of $3.5 million, $3 million and
$10.4 million for the years ended December 2004, 2003 and
2002, respectively.
A-31
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
As of the year ended December 2004, General Reinsurance
Corporation (“GenRe”) was the only reinsurer that
comprised more than 10 percent of NAICC’s reinsurance
recoverable on paid and unpaid claims. NAICC monitors all
reinsurers, by reviewing A.M. Best reports and ratings,
information obtained from reinsurance intermediaries and
analyzing financial statements. As of December 31, 2004 and
2003, NAICC had reinsurance recoverable on paid and unpaid
balances of $12.4 million and $13.1 million from
GenRe, respectively. GenRe has an A.M. Best rating of A+ or
better. Allowances for paid and unpaid recoverables were
$1.1 million and $1.5 million at December 31,
2004 and 2003, respectively.
| 11. | Property, Plant and Equipment — Energy Services |
Property, plant and equipment consisted of the following at
December 31, 2004:
| Useful Lives | 2004 | |||||||
|
Land
|
$ | 4,725 | ||||||
|
Energy facilities
|
3-50 years | 782,965 | ||||||
|
Buildings and improvements
|
3-50 years | 51,464 | ||||||
|
Machinery and equipment
|
3-50 years | 5,514 | ||||||
|
Landfills
|
7,614 | |||||||
|
Construction in progress
|
5,403 | |||||||
|
Total
|
857,685 | |||||||
|
Less accumulated depreciation and amortization
|
(38,510 | ) | ||||||
|
Property, plant, and equipment — net
|
$ | 819,175 | ||||||
Depreciation and amortization related to property, plant and
equipment amounted to $37.4 million for the period, March
11 through December 31, 2004.
| 12. | Service and Energy Contracts and Other Intangibles Assets |
Service and Energy Contracts and other intangible assets
consisted of the following at December 31, 2004:
| Accumulated | ||||||||||||
| December 31, 2004 | Gross | Amortization | Net | |||||||||
|
Service and energy contracts
|
$ | 192,058 | $ | (15,121 | ) | $ | 176,937 | |||||
|
Land rights
|
442 | (89 | ) | 353 | ||||||||
|
Total
|
$ | 192,500 | $ | (15,210 | ) | $ | 177,290 | |||||
Amortization expense related to service and energy contracts and
other intangible assets was $15.2 million for the period
March 11, through December 31, 2004. The estimated
future amortization expense of service and energy contracts and
other intangible assets as of December 31, 2004 is as
follows:
|
2005
|
$ | 17,627 | ||
|
2006
|
17,627 | |||
|
2007
|
17,535 | |||
|
2008
|
15,868 | |||
|
2009
|
15,868 | |||
|
Thereafter
|
92,765 | |||
|
Total
|
$ | 177,290 | ||
A-32
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
13. Other Assets —
Energy Services
Other assets consisted of the following at December 31,2004:
| 2004 | ||||
|
Marketable securities available for sale
|
$ | 1,321 | ||
|
Unamortized bond issuance costs
|
1,736 | |||
|
Deferred financing costs
|
5,275 | |||
|
Non-current securities available for sale (see Note 6)
|
2,325 | |||
|
Interest rate swap
|
14,920 | |||
|
Other
|
5,439 | |||
|
Total
|
$ | 31,016 | ||
| Note 14. | Accrued Expenses — Energy Services |
Accrued expenses consisted of the following at December 31,
2004:
| 2004 | ||||
|
Operating expenses
|
$ | 30,803 | ||
|
Insurance
|
1,605 | |||
|
Debt service charges and interest
|
17,628 | |||
|
Municipalities’ share of energy revenues
|
36,897 | |||
|
Payroll
|
18,027 | |||
|
Payroll and other taxes
|
8,478 | |||
|
Lease payments
|
1,025 | |||
|
Pension and profit sharing
|
3,673 | |||
|
Other
|
2,877 | |||
|
Total
|
$ | 121,013 | ||
| 15. | Energy Services’ Deferred Revenue |
Deferred income consisted of the following at December 31,
2004:
| 2004 | ||||
|
Advance billings to municipalities
|
$ | 9,064 | ||
|
Other
|
4,901 | |||
|
Total
|
$ | 13,965 | ||
Advance billings to various customers are billed one or two
months prior to performance of service and are recognized as
income in the period the service is provided.
A-33
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| 16. | Unpaid Losses and Loss Adjustment Expenses |
The following table summarizes the activity in Insurance
Services’ liability for unpaid losses and LAE during the
three most recent years:
| 2004 | 2003 | 2002 | |||||||||||
|
Net unpaid losses and LAE at beginning of year
|
$ | 65,142 | $ | 79,192 | $ | 88,012 | |||||||
|
Incurred, net, related to:
|
|||||||||||||
|
Current year
|
10,343 | 23,199 | 49,474 | ||||||||||
|
Prior years
|
2,518 | 13,485 | 10,407 | ||||||||||
|
Total net incurred
|
12,861 | 36,684 | 59,881 | ||||||||||
|
Paid, net, related to:
|
|||||||||||||
|
Current year
|
(5,427 | ) | (10,133 | ) | (22,871 | ) | |||||||
|
Prior years
|
(26,348 | ) | (40,601 | ) | (45,830 | ) | |||||||
|
Total net paid
|
(31,775 | ) | (50,734 | ) | (68,701 | ) | |||||||
|
Net unpaid losses and LAE at end of year
|
46,228 | 65,142 | 79,192 | ||||||||||
|
Plus: Reinsurance recoverable on unpaid losses
|
18,042 | 18,238 | 22,057 | ||||||||||
|
Gross unpaid losses and LAE at end of year
|
$ | 64,270 | $ | 83,380 | $ | 101,249 | |||||||
The net losses and LAE incurred during 2004 related to prior
years is attributable to recognition of unfavorable development
in: commercial auto of $2.4 million primarily for accident
years 2001 through 2002, and property and casualty of
$1.6 million and unallocated loss adjustment expense for
all lines of $0.9 million. Favorable development on prior
periods was recognized in workers’ compensation and private
passenger automobile of $0.7 million and $1.8 million,
respectively. The net losses and LAE incurred during 2003
related to prior years is attributable to recognition of
unfavorable development in: commercial auto of $5.5 million
for accident years 2000 through 2002, workers’ compensation
of $5.5 million of which $3.9 million was attributable
to Valor, and property and casualty of $1.5 million, most
of which stems from unallocated LAE reserves. The net losses and
LAE incurred during 2002 related to prior years is attributable
to adverse development on both the California workers’
compensation line totaling $3.5 million, certain private
passenger automobile programs totaling $4.7 million and
commercial automobile totaling $2 million. All of the
workers’ compensation lines and the private passenger
automobile programs that caused higher than expected losses were
placed in run–off during 2001.
Insurance Services has claims for asbestos and environmental
cleanup (“A&E”) against policies issued prior to
1985 and which are currently in run–off. The principal
exposure from these claims arises from direct excess and primary
policies of current and past Fortune 500 companies, the
obligations of which were assumed by Insurance Services of
former affiliate companies. These direct excess and primary
claims are relatively few in number and have policy limits of
between $50,000 and $1 million, with reinsurance generally
above $50,000. Insurance Services also has A&E claims
primarily associated with participations in excess of loss
facultative reinsurance contracts and voluntary risk pools
assumed by Insurance Services same former affiliates. These
facultative reinsurance contracts have relatively low limits,
generally less than $25,000, and estimates of unpaid losses are
based on information provided by the primary insurance company.
The unpaid losses and LAE related to A&E is established
considering facts currently known and the current state of the
law and coverage litigation. Liabilities are estimated for known
claims (including the cost of related litigation) when
sufficient information has been developed to indicate the
involvement of a specific contract of insurance or reinsurance
and management can reasonably estimate its liability. Estimates
for unknown claims and development of reported claims are
included in Insurance Services’ unpaid losses and LAE. The
liability for the development of reported claims is based on
estimates of the range of potential losses
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
for reported claims in the aggregate. Estimates of liabilities
are reviewed and updated continually and there is the potential
that Insurance Services’ exposure could be materially in
excess of amounts which are currently recorded. Management does
not expect that liabilities associated with these types of
claims will result in a material adverse effect on the future
liquidity or financial position of Insurance Services. However,
claims such as these are based upon estimates and there can be
no assurance that the ultimate liability will not exceed or even
materially exceed such estimates. As of the years ended December
2004 and 2003, Insurance Services’ net unpaid losses and
LAE relating to A&E were approximately $8.2 million and
$8.3 million, respectively.
| 17. | Credit Arrangements |
Covanta entered into a secured revolving loan and letter of
credit facility (“the Master Credit Facility”) as of
March 14, 2001. The Master Credit Facility was secured by
substantially all of Covanta’s assets and was scheduled to
mature on May 31, 2002 but was not fully discharged by the
Debtor In Possession Credit Agreement (as amended, the “DIP
Credit Facility”) discussed below. This, as well as the
non-compliance with required financial ratios and possible other
item caused Covanta to be in default under its Master Credit
Facility. In connection with the bankruptcy petition, banks
which were parties to the Master Credit Facility were stayed
from enforcing remedies, and Covanta and most of its
subsidiaries entered into the DIP Credit Facility with the DIP
Lender, with the approval of the Bankruptcy Court. The DIP
Credit Facility was largely for the continuation of existing
letters of credit and was secured by all of the Company’s
domestic assets not subject to liens of others and generally 65%
of the stock of its foreign subsidiaries held by domestic
subsidiaries. The DIP Credit Facility was the operative debt
agreement with Covanta’s banks through March 10, 2004.
The Master Credit Facility remained in effect during the
Chapter 11 Cases to determine the rights of the lenders who
are a party to it with respect to obligations not continued
under the DIP Credit Facility. The DIP Credit Facility and the
Master Credit Facility were discharged upon the effectiveness of
the Reorganization Plan (see Note 2).
Upon Covanta’s emergence from bankruptcy, it entered into
new financing arrangements for liquidity and letters of credit
for its domestic and international businesses. The Domestic
Borrowers entered into the First Lien Facility and the Second
Lien Facility (together, the “Domestic Facilities”),
and CPIH entered into the CPIH Revolving Loan facility.
Material Terms of the Domestic Facilities. The First Lien
Facility provides commitments for the issuance of letters of
credit in the initial aggregate face amount of up to
$139 million with respect to Covanta’s Detroit,
Michigan waste-to-energy facility. The First Lien Facility
reduces semi-annually as the amount of the letter of credit
requirement for this facility reduces. As of December 31,
2004, this requirement was approximately $119.7 million.
The First Lien Facility is, secured by a first priority lien on
substantially all of the assets of the Domestic Borrowers not
subject to prior liens (the “Collateral”).
Additionally, the Domestic Borrowers entered into the Second
Lien Facility, secured by a second priority lien on the
Collateral. The Second Lien Facility is a letter of credit and
liquidity facility which provides commitments for the issuance
of additional letters of credit in support of the Company’s
domestic and international businesses, and for general corporate
purposes. The Second Lien facility provided commitments in an
aggregate amount of $118 million, up to $10 million of
which may be used for cash borrowings on a revolving basis for
general corporate purposes. As of December 31, 2004, an
aggregate amount of $71 million in letters of credit had
been issued under the Second Lien Facility, and the Company had
made no cash borrowings under the Second lien Facility. Both
facilities expire in March, 2009.
The First Lien Facility and the Second Lien Facility require
cash collateral to be posted for issued letters of credit if
Covanta has cash in excess of specified amounts. Covanta paid a
1% upfront fee upon entering into the First Lien Facility, and
will pay with respect to each issued letter of credit (i) a
fronting fee equal to the greater of $500 or 0.25% per
annum of the daily amount available to be drawn under such
letter of credit, (ii) a letter of credit fee equal to
2.5% per annum of the daily amount available to be drawn
under such letter of credit, and (iii) an annual fee of
$1,500.
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
The revolving loan component of the Second Lien Facility bears
interest at either (i) 4.5% over a base rate with reference
to either the Federal Funds rate of the Federal Reserve System
or Bank One’s prime rate, or (ii) 6.5% over a formula
Eurodollar rate, the applicable rate to be determined by Covanta
(increasing by 2% over the then applicable rate in specified
default situations). Covanta also paid an upfront fee of
$2.8 million upon entering into the Second Lien Facility,
and will pay (i) a commitment fee equal to 0.5% per
annum of the daily calculation of available credit, (ii) an
annual agency fee of $30,000, and (iii) with respect to
each issued letter of credit an amount equal to 6.5% per
annum of the daily amount available to be drawn under such
letter of credit.
The Domestic Facilities provide for mandatory prepayments of all
or a portion of amounts funded by the lenders under letters of
credit and the revolving loan upon the sales of assets,
incurrence of additional indebtedness, availability of annual
cash flow, or cash on hand above certain base amounts, and
change of control transactions. To the extent that no amounts
have been funded under the revolving loan or letters of credit,
Covanta is obligated to apply excess cash to collateralize its
reimbursement obligations with respect to outstanding letters of
credit, until such time as such collateral equals 105% of the
maximum amount that may at any time be drawn under outstanding
letters of credit.
The terms of both of these facilities require Covanta to furnish
the lenders with periodic financial, operating and other
information. In addition, these facilities further restrict,
without the consent of its lenders under these facilities,
Covanta’s ability to, among others:
| • | incur indebtedness, or incur liens on its property, subject to specific exceptions; | |
| • | pay any dividends on or repurchase any of its outstanding securities, subject to specific exceptions; | |
| • | make new investments, subject to specific exceptions; | |
| • | deviate from specified financial ratios and covenants, including those pertaining to consolidated net worth, adjusted EBITDA, and capital expenditures; | |
| • | sell any material amount of assets, enter into a merger transaction, liquidate or dissolve; | |
| • | enter into any material transactions with shareholders and affiliates; amend its organization documents; and | |
| • | engage in a new line of business. | |
All unpaid principal of and accrued interest on the revolving
loan, and an amount equal to 105% of the maximum amount that may
at any time be drawn under outstanding letters of credit, would
become immediately due and payable in the event that Covanta or
certain of its affiliates (including Danielson) become subject
to specified events of bankruptcy or insolvency. Such amounts
shall also become immediately due and payable, upon action taken
by a certain specified percentage of the lenders, in the event
that any of the following occurs after the expiration of
applicable cure periods:
| • | a failure by Covanta to pay amounts due under the Domestic Facilities or other debt instruments; | |
| • | breaches of representations, warranties and covenants under the Domestic Facilities; | |
| • | a judgment or judgments are rendered against Covanta that involve an amount in excess of $5 million, to the extent not covered by insurance; | |
| • | any event that has caused a material adverse effect on Covanta; | |
| • | a change in control; | |
| • | the Intercreditor Agreement or any security agreement pertaining to the Domestic Facilities ceases to be in full force and effect; | |
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| • | certain terminations of material contracts; or | |
| • | any securities issuance or equity contribution which is reasonably expected to have a material adverse effect on the availability of net operating losses. | |
Under these facilities, as described above, Covanta is obligated
to apply excess cash to collateralize its reimbursement
obligations with respect to outstanding letters of credit, until
such time as such collateral equals 105% of the maximum amount
that may at any time be drawn under outstanding letters of
credit. In accordance with the annual cash flow and the excess
cash on hand provisions of the First and Second Lien Facilities,
Domestic Covanta deposited $3.2 million and
$10.5 million on January 3, 2005 and March 1,
2005, respectively, into a restricted collateral account for
this purpose. This restricted collateral will become available
to the Domestic Borrowers if they are able to refinance their
current corporate debt.
Material Terms of the CPIH Revolving Loan Facility:
The CPIH Revolving Credit Facility is secured by a first
priority lien on the CPIH stock and substantially all of the
CPIH Borrowers’ assets not otherwise subject to security
interests existing as of the Effective Date, and consists of
commitments for cash borrowings of up to $10 million for
purposes of supporting the international businesses. This
$10 million commitment however is subject to permanent
reductions as CPIH asset sales occur. Permanent reductions to
the original commitment are determined by applying 50% of all
net asset sales proceeds as they occur subject to certain
specified limits. The CPIH revolving credit facility has a
maturity date of three years and to the extent drawn upon bears
interest at the rate of either (i) 7% over a base rate with
reference to either the Federal Funds rate, of the Federal
Reserve System or Deutsche Bank’s prime rate, or
(ii) 8% over a formula Eurodollar rate, the applicable rate
to be determined by CPIH (increasing by 2% over the then
applicable rate in specified default situations). CPIH also paid
a 2% upfront fee of $0.2 million, and will pay (i) a
commitment fee equal to 0.5% per annum of the average daily
calculation of available credit, and (ii) an annual agency
fee of $30,000. Through December 31, 2004, CPIH had not
sought to make draws on this facility and the outstanding
commitment amount has been reduced to $9.1 million.
The mandatory prepayment provisions, affirmative covenants,
negative covenants and events of default under the two
international credit facilities are similar to those found in
the Domestic Facilities.
The CPIH Revolving Credit Facility is non-recourse to Covanta
and its other domestic subsidiaries.
Of Covanta’s outstanding letters of credit at
December 31, 2004, approximately $5.6 million secures
indebtedness that is included in the Consolidated Balance Sheet
and approximately $187.3 million principally secured the
Company’s obligations under energy contracts to pay damages
in the event of non-performance by Covanta which Covanta
believes to be unlikely. These letters of credit were generally
available for drawing upon if Covanta defaulted on the
obligations secured by the letters of credit or failed to
provide replacement letters of credit as the current ones expire.
Certain Domestic Borrowers are guarantors of performance
obligations of some international projects or are the
reimbursement parties with respect to letters of credit issued
to secure obligations relating to some international projects.
Domestic Borrowers are entitled to reimbursements of operating
expenses incurred by the Domestic Borrowers on behalf of the
CPIH Borrowers and payments, if any, made with respect to the
above mentioned guarantees and reimbursement obligations. Any
such obligation to reimburse the Domestic Borrowers, should it
arise, would be senior to the repayment of principal on the CPIH
Term Loan described in Note 15.
| 18. | Parent — Debt |
Danielson’s debt as of December 31, 2003 consisted of
$40 million in bridge financing relating to the acquisition
of Covanta. Pursuant to the note purchase agreement, the Bridge
Lenders provided Danielson with bridge financing in exchange for
notes convertible under certain circumstances into shares of
Common Stock at a price of $1.53 per share. These notes had
a scheduled maturity date of January 2, 2005 and an extended
A-37
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
maturity date of July 15, 2005, and bear interest at a rate
of 12% per annum through July 15, 2004 and
16% per annum thereafter. In the event of a default or the
failure to pay a convertible note on its maturity, the interest
rate under the convertible note increases by 2%. These notes
were repaid on June 11, 2004 from the proceeds of a pro
rata rights offering made to all stockholders on May 18,
2004.
Under the note purchase agreement, Laminar agreed to convert an
amount of convertible notes to acquire up to an additional
8.75 million shares of Danielson common stock at
$1.53 per share based upon the levels of public
participation in a planned rights offering. If Danielson did not
refinance all of the other outstanding notes, the remainder of
the notes would be convertible, without action on the part of
the Bridge Lenders, into shares of Common Stock at the rights
offering price of $1.53 per share, subject to agreed upon
limitations necessitated by Danielson’s NOLs.
Danielson issued to the Bridge Lenders an aggregate of
5,120,853 shares of Danielson’s common stock in
consideration for the $40 million of bridge financing. At
the time that Danielson entered into the note purchase
agreement, agreed to issue the notes convertible into shares of
Danielson common stock and issued the equity compensation to the
Bridge Lenders, the trading price of the Danielson common stock
was below the $1.53 per share conversion price of the
notes. On December 1, 2003, the day prior to the
announcement of the Covanta acquisition, the closing price of
Danielson common stock on the American Stock Exchange was
$1.40 per share.
| 19. | Covanta Recourse Debt |
Recourse debt consisted of the following:
| Successor | ||||
| 2004 | ||||
|
High Yield Notes
|
$ | 207,735 | ||
|
Unsecured Notes (estimated)
|
28,000 | |||
|
CPIH term loan facility
|
76,852 | |||
|
9.25% debentures due 2022
|
— | |||
|
Other long-term debt
|
309 | |||
| 312,896 | ||||
|
Less amounts subject to compromise
|
— | |||
|
Less current portion of long term debt
|
(112 | ) | ||
|
Recourse debt
|
$ | 312,784 | ||
Recourse debt included the following obligations at
December 31, 2004:
| • | The High Yield Notes are secured by a third priority lien in the same collateral securing the First Lien Facility and the Second Lien Facility (See Note 14). The High Yield Notes were issued in the initial principal amount of $205 million, which will accrete to $230 million at maturity in seven years. Interest is payable at a rate of 8.25% per annum, semi-annually on the basis of the principal at final maturity; no principal is due prior to maturity of the High Yield Notes. | |
| • | Unsecured Notes in a principal amount of $4 million were issued on the effective date of the Reorganization Plan. The Company issued additional Unsecured Notes in the principal amount of $20 million after emergence and recorded additional Unsecured Notes in a principle amount of $4 million in 2004 which it expects to issue in 2005. Additional Unsecured Notes also may be issued to holders of allowed claims against the Remaining Debtors if and when they emerge from bankruptcy, and if the issuance of such notes is contemplated by the terms of any plan of reorganization confirmed with respect to such Remaining Debtors. The final principal amount of all Unsecured Notes will be equal to the amount of allowed unsecured claims against the Company’s operating subsidiaries which | |
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| were reorganizing Debtors, and such amount will be determined when such claims are resolved through settlement or further proceedings in the Bankruptcy Court. The principal amount of Unsecured Notes indicated in the table above represents the expected liability upon completion of the claims process, excluding any additional Unsecured Notes that may be issued if and when Remaining Debtors reorganize and emerge from bankruptcy. Notwithstanding the date on which Unsecured Notes are issued, interest on the Unsecured Notes accrues from March 10, 2004. Interest is payable semi-annually on the Unsecured Notes at a rate of 7.5% per annum; principal is paid annually in equal installments beginning in March, 2006. The Unsecured Notes mature in eight years. | ||
| • | The CPIH Borrowers entered into the CPIH Term Loan Facility in the principal amount of up to $95 million, of which $76.9 million was outstanding as of December 31, 2004. The CPIH Term Loan Facility is secured by a second priority lien on the same collateral as the CPIH Revolving Credit Facility, and bears interest at 10.5% per annum, 6.0% of such interest to be paid in cash and the remaining 4.5% to be paid in cash to the extent available and otherwise payable by adding it to the outstanding principal balance. The interest rate increases to 12.5% per annum in specified default situations. The CPIH Term Loan Facility matures in March 2007. The CPIH Term Loan Facility is non-recourse to Covanta and its other domestic subsidiaries. While the existing CPIH term loan and revolver are outstanding CPIH’s cash balance is not available to be transferred to Domestic Covanta. | |
The maturities on recourse debt including capital lease
obligations at December 31, 2004 were as follows:
|
2005
|
$ | 112 | ||
|
2006
|
4,024 | |||
|
2007
|
80,824 | |||
|
2008
|
3,900 | |||
|
2009
|
3,900 | |||
|
Thereafter
|
220,136 | |||
|
Total
|
312,896 | |||
|
Less current portion
|
(112 | ) | ||
|
Total long-term recourse debt
|
$ | 312,784 | ||
See Note 17 for a description of the credit arrangements of
Covanta.
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| 20. | Project Debt |
Project debt consisted of the following:
| 2004 | |||||
|
Revenue Bonds Issued by and Prime Responsibility of
Municipalities:
|
|||||
|
3.9-6.75% serial revenue bonds due 2005 through 2011
|
$ | 319,050 | |||
|
5.0-7.0% term revenue bonds due 2005 through 2015
|
223,518 | ||||
|
Adjustable-rate revenue bonds due 2006 through 2013
|
127,237 | ||||
|
Revenue Bonds Issued by Municipal Agencies with Sufficient
Service Revenues Guaranteed by Third Parties:
|
|||||
|
5.25-5.5% serial revenue bonds due 2005 through 2008
|
30,301 | ||||
|
Other Revenue Bonds:
|
|||||
|
4.85-5.5% serial revenue bonds due 2005 through 2015
|
72,954 | ||||
|
5.5-6.7% term revenue bonds due 2014 through 2019
|
69,094 | ||||
|
International project debt
|
102,583 | ||||
|
Total
|
944,737 | ||||
|
Less current portion of project debt
|
(109,701 | ) | |||
|
Long-term project debt
|
$ | 835,036 | |||
|
Revenue Bonds Issued by and Prime Responsibility of
Municipalities:
|
|||||
The net unamoritized debt premium was $37.9 million at
December 31, 2004.
Project debt associated with the financing of waste-to-energy
facilities is generally arranged by municipalities through the
issuance of tax-exempt and taxable revenue bonds. The category
“Revenue Bonds Issued by and Prime Responsibility of
Municipalities” includes bonds issued with respect to
projects owned by the Company for which debt service is an
explicit component of the Client Community’s obligation
under the related service agreement. In the event that a
municipality is unable to satisfy its payment obligations, the
bondholders’ recourse with respect to the Company is
limited to the waste-to-energy facilities and restricted funds
pledged to secure such obligations.
The category “Revenue Bonds Issued by Municipal Agencies
with Sufficient Service Revenues Guaranteed by Third
Parties” includes municipal bonds issued to finance one
facility for which contractual obligations of third parties to
deliver waste provide sufficient revenues to pay debt service,
although such debt service is not an explicit component of the
third parties’ service fee obligations.
The category “Other Revenue Bonds” includes bonds
issued to finance one facility for which current contractual
obligations of third parties to deliver waste to provide
sufficient revenues to pay debt service related to that facility
through 2011, although such debt service is not an explicit
component of the third parties’ service fee obligations.
Covanta anticipates renewing such contracts prior to 2011.
Payment obligations for the project debt associated with
waste-to-energy facilities owned by Covanta are limited recourse
to the operating subsidiary and non-recourse to Covanta, subject
to operating performance guarantees and commitments. These
obligations are secured by the revenues pledged under various
indentures and are collateralized principally by a mortgage lien
and a security interest in each of the respective
waste-to-energy facilities and related assets. At
December 31, 2004, such revenue bonds were collateralized
by property, plant and equipment with a net carrying value of
$773 million and restricted funds held in trust of
approximately $188.2 million.
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
The interest rates on adjustable-rate revenue bonds are adjusted
periodically based on current municipal-based interest rates.
The average adjustable rate for such revenue bonds was 1.96% at
December 31, 2004 and the average adjustable rate for such
revenue bonds was 1.24% during 2004.
Project debt includes the following obligations for 2004:
| • | $40 million due to financial institutions, of which $12.2 million is denominated in U.S. dollars and $27.8 million is denominated in Indian rupees at December 31, 2004. This debt relates to the construction of a heavy fuel oil fired diesel engine power plant in India. The U.S. dollar debt bears interest at the three-month LIBOR, plus 4.5% (6.51% at December 31, 2004). The Indian rupee debt bears interest at 7.75% at December 31, 2004. The debt extends through 2011, is non-recourse to Covanta, and is secured by the project assets. The power off-taker has failed to fund the escrow account or post the letter of credit required under the energy contract which failure constitutes a technical default under the project finance documents. The project lenders have not declared an event of default due to this matter and have permitted continued distributions of project dividends. | |
| • | $37.6 million at December 31, 2004, due to a financial institution which relates to the construction of a second heavy fuel oil fired diesel engine power plant in India. It is denominated in Indian rupees and bears interest at rates ranging from 7.5% to 16.15% in 2004. The debt extends through 2010, is non-recourse to Covanta and is secured by the project assets. The power off-taker has failed to fund the escrow account or post the letter of credit required under the energy contract which failure constitutes a technical default under the project finance documents. The project lenders have not declared an event of default due to this matter and have permitted continued distributions of project dividends. | |
At December 31, 2004, Covanta had one interest rate swap
agreement that economically fixes the interest rate on certain
adjustable-rate revenue bonds. The swap agreement was entered
into in September 1995 and expires in January 2019. This swap
agreement relates to adjustable rate revenue bonds in the
category “Revenue Bonds Issued by and Prime Responsibility
of Municipalities.” Any payments made or received under the
swap agreement, including fair value amounts upon termination,
are included as an explicit component of the Client
Community’s obligation under the related service agreement.
Therefore, all payments made or received under the swap
agreement are a pass through to the Client Community. Under the
swap agreement, Covanta will pay an average fixed rate of 9.8%
for 2003 through January 2005, and 5.18% thereafter through
January 2019, and will receive a floating rate equal to the rate
on the adjustable rate revenue bonds, unless certain triggering
events occur (primarily credit events), which results in the
floating rate converting to either a set percentage of LIBOR or
a set percentage of the BMA Municipal Swap Index, at the option
of the swap counterparty. In the event Covanta terminates the
swap prior to its maturity, the floating rate used for
determination of settling the fair value of the swap would also
be based on a set percentage of one of these two rates at the
option of the counterparty. For the year ended December 31,
2004 the floating rate on the swap averaged 1.24%. The notional
amount of the swap at December 31, 2004 was
$80.2 million and is reduced in accordance with the
scheduled repayments of the applicable revenue bonds. The
counterparty to the swap is a major financial institution.
Covanta believes the credit risk associated with nonperformance
by the counterparty is not significant. The swap agreement
resulted in increased debt service expense of $3.2 million
for 2004. The effect on Covanta’s weighted-average
borrowing rate of the project debt was an increase of 0.33% for
2004.
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
The maturities on long-term project debt at December 31,
2004 were as follows:
|
2005
|
$ | 109,701 | ||
|
2006
|
105,156 | |||
|
2007
|
103,734 | |||
|
2008
|
103,967 | |||
|
2009
|
82,319 | |||
|
Thereafter
|
439,860 | |||
|
Total
|
944,737 | |||
|
Less current portion
|
(109,701 | ) | ||
|
Total long-term project debt
|
$ | 835,036 | ||
| 21. | Interest Expense and Net Interest on Project Debt |
Interest expense in the consolidated statement of operations for
the years ended December 31, 2004 and 2003 was comprised of
the following:
| December 31, | December 31, | |||||||
| 2004 | 2003 | |||||||
|
Parent company recourse debt
|
$ | 9,033 | $ | 1,424 | ||||
|
Energy recourse debt (from date of acquisition)
|
34,706 | — | ||||||
| $ | 43,739 | $ | 1,424 | |||||
Interest on Parent company recourse debt is comprised of the
amortization of deferred financing costs of $7 million in
2004. Interest on the bridge financing of $2.2 million was
incurred during 2004.
Debt service charges for Covanta’s Project Debt consisted
of the following:
| For the Period | ||||
| March 1, | ||||
| through | ||||
| December 31, | ||||
| 2004 | ||||
|
Interest incurred on taxable and tax-exempt borrowings
|
$ | 33,492 | ||
|
Interest earned on temporary investment of certain restricted
funds
|
(906 | ) | ||
|
Net interest on project debt
|
$ | 32,586 | ||
Interest earned on temporary investment of certain unrestricted
funds to service principal and interest obligations is related
to the Alexandria, Virginia and Haverhill, Massachusetts
waste-to-energy facilities project debt.
| 22. | Leases |
Energy Services principal leases are for leaseholds, sale and
leaseback arrangements on waste-to-energy facilities and
independent power projects, trucks and automobiles, and
machinery and equipment. Some of these operating leases have
renewal options.
Insurance Services has entered into various non–cancelable
operating lease arrangements for office space and data
processing equipment and services. The terms of the operating
leases generally contain renewal options and escalation clauses
based on increases in operating expenses and other factors.
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
Rent expense under operating leases for the years ended December
2004, 2003 and 2002 were as follows:
| 2004 | 2003 | 2002 | |||||||||||
|
Energy Services
|
$ | 15,823 | $ | — | $ | — | |||||||
|
Insurance Services
|
1,273 | 1,229 | 1,387 | ||||||||||
|
Marine Services
|
— | — | 29,896 | ||||||||||
|
Total
|
$ | 17,096 | $ | 1,229 | $ | 31,283 | |||||||
The following is a schedule, by year, of future minimum rental
payments required under operating leases that have initial or
remaining non-cancelable lease terms in excess of one year as of
December 31, 2004:
|
2005
|
$ | 19,744 | ||
|
2006
|
19,722 | |||
|
2007
|
18,231 | |||
|
2008
|
21,312 | |||
|
2009
|
25,038 | |||
|
Later years
|
211,475 | |||
|
Total
|
$ | 315,522 | ||
Energy Services’ non-recourse rental payments are due as
follows:
|
2005
|
$ | 15,392 | ||
|
2006
|
15,555 | |||
|
2007
|
15,749 | |||
|
2008
|
19,278 | |||
|
2009
|
23,062 | |||
|
Later years
|
190,660 | |||
|
Total
|
$ | 279,696 | ||
Energy Services’ future minimum rental payment obligations
include $279.7 million of future non-recourse rental
payments that relate to energy facilities. Of this amount
$160.7 million is supported by third-party commitments to
provide sufficient service revenues to meet such obligations.
The remaining $119 million related to a waste-to-energy
facility at which Covanta serves as operator and directly
markets one half of the facility’s disposal capacity. This
facility currently generates sufficient revenues from short-,
medium-, and long-term contracts to meet rental payments.
Covanta anticipates renewing the contracts or entering into new
contracts to generate sufficient revenues to meet remaining
future rental payments.
Energy Services’ electricity and steam sales includes lease
income of approximately $64.7 million for the period from
March 11, 2004 to December 31, 2004 related to two
Indian and one Chinese power project that were deemed to be
operating lease arrangements under EITF 01-08
“Determining Whether an Arrangement Contains a Lease”
as of March 10, 2004. This amount represents contingent
rentals because the lease payments for each facility depend on a
factor directly related to the future use of the leased
property. The output deliverable and capacity provided by the
two Indian facilities have each been purchased by a single party
under long-term power purchase agreements which expire in 2016.
The electric power and steam take-off arrangements and
maintenance agreement for the Chinese facility are also with one
party and are presently contemplated to be continued through the
term of the joint venture which expires in 2017. Such
arrangements have effectively provided the purchaser
(lessee) with “rights to use” these facilities.
This EITF consensus must be applied prospectively to
arrangements agreed to, modified, or acquired in business
combinations in
A-43
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
fiscal periods beginning after May 28, 2003. This
determination did not have a material impact on Energy
Services’ results of operations and financial condition.
Property, plant and equipment under leases consisted of the
following as of December 31, 2004:
|
Land
|
$ | 33 | ||
|
Energy facilities
|
94,612 | |||
|
Buildings and improvements
|
936 | |||
|
Machinery and equipment
|
1,464 | |||
|
Total
|
97,045 | |||
|
Less accumulated depreciation and amortization
|
(6,947 | ) | ||
|
Property, plant, and equipment — net
|
$ | 90,098 | ||
| 23. | Other Liabilities -Energy Services |
Other liabilities consisted of the following at
December 31, 2004:
| 2004 | ||||
|
Interest rate swap
|
$ | 14,920 | ||
|
Pension benefit obligation
|
45,430 | |||
|
Asset retirement obligation
|
18,912 | |||
|
Service Contract Liabilities
|
7,873 | |||
|
Other
|
10,713 | |||
|
Total
|
$ | 97,848 | ||
| 24. | Employee Benefit Plans |
| Energy |
Covanta has defined benefit and defined contribution retirement
plans that cover substantially all of its employees. The defined
benefit plans provide benefits based on years of service and
either employee compensation or a fixed benefit amount.
Covanta’s funding policy for those plans is to contribute
annually an amount no less than the minimum funding required by
ERISA. Contributions are intended to provide not only benefits
attributed to service to date but also for those expected to be
earned in the future. Covanta expects to make contributions of
$3.1 million to its defined benefit plans and
$1.7 million to its post retirement benefit plans.
Covanta has recorded a pension plan liability equal to the
amount that the present value of projected benefit obligations
(using a discount rate of 5.75%) exceeded the fair value of
pension plan assets at March 10, 2004 in accordance with
the provisions of SFAS No. 141 “Business
Combinations”. Covanta made contributions of
$6.2 million to the plan in 2004.
In accordance with SFAS No. 141, on March 10,
2004 Covanta recorded a liability for the total projected
benefit obligation in excess of plan assets for the pension
plans and a liability for the total accumulated postretirement
benefit obligation in excess of the fair value of plan assets
for other benefit plans.
A-44
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
The following table sets forth the details of Covanta’s
defined benefit plans’ and other postretirement benefit
plans’ funded status (using a December 31 measurement
date) and related amounts recognized in Covanta’s
Consolidated Balance Sheets:
| Pension | Other | |||||||||
| Benefits | Benefits | |||||||||
| 2004 | 2004 | |||||||||
|
Change in benefit obligation:
|
||||||||||
|
Benefit obligation at March 10, 2004
|
$ | 62,226 | $ | 12,105 | ||||||
|
Service cost
|
6,716 | — | ||||||||
|
Interest cost
|
2,783 | 546 | ||||||||
|
Actuarial loss
|
(3,683 | ) | (230 | ) | ||||||
|
Benefits paid
|
(944 | ) | (603 | ) | ||||||
|
Benefit obligation at end of year
|
$ | 67,098 | $ | 11,818 | ||||||
|
Change in plan assets:
|
||||||||||
|
Plan assets at fair value at March 10, 2004
|
$ | 27,240 | $ | — | ||||||
|
Actual return on plan assets
|
2,852 | — | ||||||||
|
Company contributions
|
7,828 | 603 | ||||||||
|
Benefits paid
|
(944 | ) | (603 | ) | ||||||
|
Plan assets at fair value at end of year
|
$ | 36,976 | $ | — | ||||||
|
Reconciliation of accrued benefit liability and net amount
recognized:
|
||||||||||
|
Funded status of the plan
|
$ | (30,122 | ) | $ | (11,818 | ) | ||||
|
Unrecognize net loss (gain)
|
(4,609 | ) | (405 | ) | ||||||
|
Net amount recognized
|
$ | (34,731 | ) | $ | (12,223 | ) | ||||
|
Amounts recognized in the consolidated balance sheets consist
of:
|
||||||||||
|
Accrued benefit liability
|
$ | (34,918 | ) | $ | (12,223 | ) | ||||
|
Accumulated other comprehensive income
|
187 | — | ||||||||
|
Net amount recognized
|
$ | (34,731 | ) | $ | (12,223 | ) | ||||
|
Weighted average assumptions used to determine net periodic
benefit expense Projected benefit obligations as of prior
December 31:
|
||||||||||
|
Discount rate
|
6.25 | % | 6.25 | % | ||||||
|
Discount rate beginning March 10, 2004
|
5.75 | % | ||||||||
|
Expected return on plan assets
|
8.00 | % | N/A | |||||||
|
Rate of compensation increase
|
4.50 | % | N/A | |||||||
|
Weighted average assumptions used to determine projected
benefit obligations as of December 31:
|
||||||||||
|
Discount rate
|
6.00 | % | 6.00 | % | ||||||
|
Rate of compensation increase
|
4.00 | % | N/A | |||||||
A-45
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
Plan assets had a fair value of $37 million
December 31, 2004. The allocation of plan assets at
December 31 was as follows:
| 2004 | ||||
|
Equities
|
69 | % | ||
|
U.S. Debt Securities
|
25 | % | ||
|
Other
|
6 | % | ||
|
Total
|
100 | % | ||
Covanta’s expected return on plan assets assumption is
based on historical experience and by evaluating input from the
trustee managing the plans assets. The expected return on the
plan assets is also impacted by the target allocation of assets,
which is based on Covanta’s goal of earning the highest
rate of return while maintaining risk at acceptable levels. The
plans strives to have assets sufficiently diversified so that
adverse or unexpected results from one security class will not
have an unduly detrimental impact on the entire portfolio. The
target ranges of allocation of assets are as follows:
|
Equities
|
40 – 75 | % | ||
|
U.S. Debt Securities
|
25 – 60 | % | ||
|
Other
|
0 – 20 | % |
Covanta anticipates that the long-term asset allocation on
average will approximate the targeted allocation. Actual asset
allocations are reviewed and the pension plans’ investments
are rebalanced to reflect the targeted allocation when
considered appropriate.
For management purposes, an annual rate of increase of 11.0% in
the per capita cost of health care benefits was assumed for 2004
for covered employees. The rate was assumed to decrease
gradually to 5.5% in 2010 and remain at that level.
For the pension plans with accumulated benefit obligations in
excess of plan assets the projected benefit obligation,
accumulated benefit obligation, and fair value of plan assets
were $67.1, million, $46.5 million, and $37 million as
of December 31, 2004.
Covanta estimates that the future benefits payable for the
retirement and post-retirement plans in place are as follows at
December 31, 2004.
| Other Benefits | ||||||||||||
| Pension | Post | Other Benefits | ||||||||||
| Benefits | Medicare | Pre Medicare | ||||||||||
|
2005
|
$ | 594 | $ | 1,744 | $ | 1,744 | ||||||
|
2006
|
635 | 1,699 | 1,826 | |||||||||
|
2007
|
657 | 1,766 | 1,899 | |||||||||
|
2008
|
815 | 1,818 | 1,954 | |||||||||
|
2009
|
942 | 1,830 | 1,967 | |||||||||
|
2010 — 2014
|
10,713 | 9,202 | 9,892 | |||||||||
Contributions and costs for defined contribution plans are
determined by benefit formulas based on percentage of
compensation as well as discretionary contributions and totaled
$3.5 million in 2004. Plan assets at December 31, 2004
primarily consisted of common stocks, United States government
securities, and guaranteed insurance contracts.
A-46
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
Pension costs for Covanta’s defined benefit plans and other
post-retirement benefit plans included the following components:
| Pension | Other | ||||||||
| Benefits | Benefits | ||||||||
| 2004 | 2004 | ||||||||
|
Components of Net Periodic Benefit Cost:
|
|||||||||
|
March 10, 2004 — December 31, 2004
|
|||||||||
|
Service Cost
|
$ | 6,716 | $ | — | |||||
|
Interest Cost
|
2,783 | 546 | |||||||
|
Expected return on plan assets
|
(1,905 | ) | — | ||||||
|
Net periodic benefit cost
|
$ | 7,594 | $ | 546 | |||||
Assumed health care cost trend rates have a significant effect
on the amounts reported for the health care plan. A
one-percentage point change in the assumed health care trend
rate would have the following effects (in thousands of dollars):
| One-Percentage | One-Percentage | |||||||
| Point Increase | Point Decrease | |||||||
|
Effect on total service and interest cost components
|
$ | 59 | $ | (52 | ) | |||
|
Effect on postretirement benefit obligation
|
922 | (804 | ) | |||||
On December 8, 2003, the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (the Act) was signed
into Law. The Act introduces a prescription drug benefit under
Medicare as well as a federal subsidy to sponsors of retiree
health care benefit plans that provide a prescription drug
benefit that is at least actuarially equivalent to Medicare
Part D. In accordance with FASB Staff Position 106-1, the
accumulated post-retirement benefit obligation and net periodic
post-retirement benefit cost in the Company’s Consolidated
Financial Statements and this note reflects the effects of the
Act on the plans.
| Insurance Services |
Under the NAICC 401(k) Plan, employees may elect to contribute
up to 20 percent of the eligible compensation to a maximum
dollar amount allowed by the IRS. In 2002, NAICC suspended its
matching contribution to the 401(k) Plan. In 2003 and 2004 NAICC
reinstated its matching contribution to 50% of the first 6% of
compensation contributed by employees to the 401(k) Plan. In
2004 and 2003, NAICC made matching contributions of $35,000 and
$46,000, respectively.
A non-contributory defined benefit pension plan (the
“Plan”) covers substantially all of the insurance
services employees. Pension benefits are based on an
employee’s years of service and average final compensation.
The funding policy of the Plan is for the Danielson to
contribute the minimum pension costs equivalent to the amount
required under the Employee Retirement Income Security Act of
1974 and the Internal Revenue Code. Effective December 31,
2001, Insurance Services amended the Plan to cease future
service credit for active employees.
A-47
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
The following table sets forth the Plan’s funded status as
of the years ended December 2004 and 2003, valued at
January 1, 2005 and 2004, respectively:
| 2004 | 2003 | |||||||||||
|
Change in benefit obligation:
|
||||||||||||
|
Benefit obligation at beginning of year
|
$ | 2,177 | $ | 1,822 | ||||||||
|
Interest cost
|
94 | 103 | ||||||||||
|
Actuarial (gain) loss
|
(45 | ) | 689 | |||||||||
|
Benefits paid
|
(2 | ) | (437 | ) | ||||||||
|
Settlements
|
(872 | ) | — | |||||||||
|
Benefit obligation, end of year
|
$ | 1,352 | $ | 2,177 | ||||||||
|
Change in plan assets:
|
||||||||||||
|
Plan assets at fair value at beginning of year
|
$ | 1,563 | $ | 1,579 | ||||||||
|
Actual return on plan assets
|
179 | 244 | ||||||||||
|
Employer contributions
|
391 | 177 | ||||||||||
|
Benefits paid
|
(2 | ) | (437 | ) | ||||||||
|
Settlements
|
(1,048 | ) | — | |||||||||
|
Plan assets, end of year
|
$ | 1,083 | $ | 1,563 | ||||||||
|
Reconciliation of accrued benefit liability and net amount
recognized:
|
||||||||||||
|
Unrecognized funded status of the plan unrecognized
|
$ | (269 | ) | $ | (614 | ) | ||||||
|
Prior service costs
|
10 | 14 | ||||||||||
|
Net loss
|
1,052 | 1,298 | ||||||||||
|
Loss recognized due to settlement
|
(793 | ) | — | |||||||||
|
Net amount recognized
|
$ | — | $ | 698 | ||||||||
|
Amounts recognized in the consolidated balance sheets consist
of:
|
||||||||||||
|
Accrued benefit cost
|
$ | (269 | ) | $ | (614 | ) | ||||||
|
Intangible assets
|
10 | 14 | ||||||||||
|
Accumulated other comprehensive income
|
259 | 1,298 | ||||||||||
|
Net amount recognized
|
$ | — | $ | 698 | ||||||||
|
Weighted-average assumptions used to determine net periodic
benefit cost for years ending December 31:
|
||||||||||||
|
Discount rate
|
6.25 | % | 6.75 | % | ||||||||
|
Expected return on plan assets
|
7.00 | % | 7.00 | % | ||||||||
|
Rate of compensation increase
|
N/A | N/A | ||||||||||
|
Weighted-average assumptions used to determine benefit
obligations for the years ending December 31:
|
||||||||||||
|
Discount rate
|
6.00 | % | 6.25 | |||||||||
|
Rate of compensation increase
|
N/A | N/A | ||||||||||
Losses recognized due to settlement charges in the amount of
$0.8 million in 2004 was the result of participants
electing to receive lump sum distributions in 2002, 2003 and
2004. The timing of the elections coincide with the staff
reductions that occurred in 2001, 2002, and 2003.
A-48
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
Pension plan assets had a fair value of $1.1 million and
$1.6 million at December 31, 2004 and 2003. The
allocation of plan assets at December 31 was as follows:
| 2004 | 2003 | |||||||
|
Equities
|
20% | 32% | ||||||
|
U.S. Debt Securities
|
8% | 14% | ||||||
|
Other
|
72% | 54% | ||||||
|
Total
|
100% | 100% | ||||||
The target ranges of allocation of assets are as follows:
|
Equities
|
0 – 50 | % | ||
|
Fixed income
|
0 – 100 | % | ||
|
Cash equivalents
|
0 – 100 | % |
The targeted ranges of asset allocation are intentionally broad
to provide flexibility should the number of participants subject
to staff reductions in 2004 elect to receive lump sum
distributions in 2005. Plan rules allow participants an election
to receive a lump sum distribution in May, following the year of
termination. Actual asset allocations are reviewed and the
pension plans’ investments are rebalanced to reflect the
targeted allocation when considered appropriate.
For the pension plans with accumulated benefit obligations in
excess of plan assets the projected benefit obligation,
accumulated benefit obligation, and fair value of plan assets
were $1.4 million, $1.4 million and $1.1 million,
respectively as of December 31, 2004 and $2.2 million,
$2.2 million and $1.6 million, respectively as of
December 31, 2003.
Pension costs for the defined benefit included the following
components:
| Pension Benefits | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
|
Components of Net Periodic Benefit Cost:
|
||||||||||||
|
Interest Cost
|
$ | 94 | $ | 103 | $ | 149 | ||||||
|
Expected return on plan assets
|
(75 | ) | (98 | ) | (148 | ) | ||||||
|
Net amortization and deferral
|
101 | 56 | 30 | |||||||||
|
Amount recognized due to settlement
|
793 | — | — | |||||||||
|
Net periodic benefit cost
|
$ | 913 | $ | 61 | $ | 31 | ||||||
The overall expected long-term rate of return on plan assets was
based on the performance of the Plan during the past five years
and on the expected performance of the plan assets over the next
five years pursuant to the investment policies and strategies as
described below.
The primary emphasis of the management of the Plan’s
portfolio of assets is to establish sufficient funding for
projected retirement benefits. To this end, the primary
investment management objective is long-term capital
appreciation. A secondary objective is to prevent erosion by
inflation.
It is NAICC’s intent that the portfolio be fully invested
at all times. The allocation between equity securities, debt
securities and cash, including any allocation between registered
investment funds is left to the discretion of the plan trustee
except as required by the plan administrator for pending plan
disbursements.
To ensure adequate diversification, no more than 25% of the
total market value of Plan assets shall be invested in a single
asset other than pooled funds and mutual funds where underlying
diversification shall be considered. The portfolio shall satisfy
the diversification requirements of ERISA at all times as well
as the liquidity requirements of the Plan.
A-49
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
NAICC expects to contribute $0.3 million to the Plan in
2005.
| 25. | Income Taxes |
Danielson files a Federal consolidated income tax return with
its eligible subsidiaries. CPIH and its United States and
foreign subsidiaries do not file as part of the Danielson
federal income tax consolidated return. In addition, Covanta
Lake is not a member of any consolidated return group.
Danielson’s Federal consolidated income tax return includes
the taxable results of certain grantor trusts. These trusts were
established by certain state insurance regulators and the courts
as part of the 1990 reorganization from which the Mission
Insurance Group, Inc. (“Mission”) emerged from Federal
bankruptcy and various state insolvency court proceedings as
Danielson. These trusts were created for the purpose of assuming
various liabilities of their grantors, certain present and
former subsidiaries of Danielson (the “Mission Insurance
Subsidiaries”). This allowed the state regulators to
administer the continuing run-off of Mission’s insurance
business, while Danielson and the Mission Insurance Subsidiaries
were released, discharged and dismissed from the proceedings
free of any claims and liabilities of any kind, including any
obligation to provide further funding to the trusts. The
agreements establishing the trusts provide the grantor of each
trust with a certain “administrative power” which, as
specified in Section 675(4)(c) of the Internal Revenue
Code, requires that Danielson include the income and deductions
of each trust on its consolidated Federal income tax return.
This was to ensure that Danielson’s NOLs would remain
available to offset any post-restructuring taxable income of the
trusts, thereby maximizing the amounts available for
distribution to trust claimants. The Insurance Commissioner of
the State of California and the Director of the Division of
Insurance of the State of Missouri, as the trustees, have sole
management authority over the trusts. Neither Danielson nor any
of its subsidiaries has any power to control or otherwise
influence the management of the trusts nor do they have any
rights with respect to the selection or replacement of the
trustees. At the present time, it is not likely that any of the
Mission Insurance Subsidiaries will receive any distribution
with regard to their residual interests in the existing trusts.
Since Danielson does not have a controlling financial interest
in these trusts nor is the Company the primary beneficiary of
the trusts, they are not consolidated with Danielson for
financial statement purposes.
SFAS No. 109 “Accounting for Income Taxes”
(“SFAS 109”) requires the establishment of a
valuation allowance to reflect the likelihood of realization of
deferred tax assets. Pursuant to SFAS 109, Danielson makes
periodic determinations of whether it is “more likely than
not” that all or a portion of the Danielson’s deferred
tax assets will be realized. In making these determinations,
Danielson considers all of the relevant factors, both positive
and negative, which may impact upon its future taxable income
including the size and operating results of its subsidiaries,
the competitive environment in which these subsidiaries operate
and the impact of the grantor trusts.
Danielson has NOLs estimated to be approximately
$516 million for Federal income tax purposes as of the end
of 2004. The NOLs will expire in various amounts from
December 31, 2005 through December 31, 2023, if not
used. In connection with the purchase of Covanta, the Company
reassessed its valuation allowance on deferred tax benefits
associated with its NOLs. A deferred tax asset of approximately
$121.5 million associated with the reduction in the
valuation allowance is included in the consolidated financial
statements to reflect the estimated future NOL utilization from
the inclusion of Covanta (exclusive of CPIH and Covanta Lake) in
Danielson’s consolidated Federal income tax group.
In connection with ACL’s bankruptcy proceedings and its
emergence from such proceedings under the ACL Plan (as described
in Note 3 above), a portion of Danielson’s NOLs were
utilized in 2004. Danielson estimates that ACL’s ordinary
taxable income recognized in 2004 will be approximately
$120 million. Danielson also estimates it will also have a
capital loss carryforward from ACL 2004 activity of
approximately $50 million.
A-50
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
Danielson’s NOLs will expire, if not used, in the following
amounts in the following years:
| Amount of | ||||
| Carryforward | ||||
| Expiring | ||||
|
2005
|
$ | 12,405 | ||
|
2006
|
92,355 | |||
|
2007
|
89,790 | |||
|
2008
|
31,688 | |||
|
2009
|
39,689 | |||
|
2010
|
23,600 | |||
|
2011
|
19,755 | |||
|
2012
|
38,255 | |||
|
2019
|
33,635 | |||
|
2022
|
26,931 | |||
|
2023
|
108,331 | |||
| $ | 516,434 | |||
Danielson’s ability to utilize its NOLs would be
substantially reduced if Danielson were to undergo an
“ownership change” within the meaning of
Section 382(g)(1) of the Internal Revenue Code. Danielson
will be treated as having had an “ownership change” if
there is more than a 50% increase in stock ownership during a
three year “testing period” by “5%
stockholders”. In an effort to reduce the risk of an
ownership change, Danielson has imposed restrictions on the
ability of holders of five percent or more of its Common Stock,
as well as the ability of others to become five percent
stockholders as a result of transfers of Common Stock. The
transfer restrictions were implemented in 1990, and Danielson
expects that they will remain in force as long as the NOLs are
available to Danielson. Notwithstanding such transfer
restrictions, there could be circumstances under which an
issuance by Danielson of a significant number of new shares of
Common Stock or other new class of equity security having
certain characteristics (for example, the right to vote or
convert into Common Stock) might result in an ownership change
under the Internal Revenue Code.
The components of the provision (benefit) for income taxes for
continuing operations were as follows:
| 2004 | 2003 | 2002 | |||||||||||
|
Current:
|
|||||||||||||
|
Federal
|
$ | 4,320 | $ | — | $ | — | |||||||
|
State
|
5,392 | 18 | 346 | ||||||||||
|
Foreign
|
5,079 | — | — | ||||||||||
|
Total current
|
14,791 | 18 | 346 | ||||||||||
|
Deferred:
|
|||||||||||||
|
Federal
|
(2,030 | ) | — | — | |||||||||
|
State
|
(665 | ) | — | — | |||||||||
|
Foreign
|
(561 | ) | — | — | |||||||||
|
Total deferred
|
(3,256 | ) | — | — | |||||||||
|
Total provision (benefit) for income taxes
|
$ | 11,535 | $ | 18 | $ | 346 | |||||||
The following reflects a reconciliation of income tax expense
computed by applying the applicable Federal income tax rate of
35% to income before provision for income tax for the year ended
December 31,
A-51
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
2004 and 34% to loss before provision for income tax for the
years ended December 2003 and 2002, as compared to the provision
for income taxes:
| 2004 | 2003 | 2002 | |||||||||||
|
Computed “expected” tax benefit
|
$ | 12,416 | $ | (23,530 | ) | $ | (11,087 | ) | |||||
|
State and other tax expense
|
3,072 | 18 | 346 | ||||||||||
|
Change in valuation allowance
|
(15,423 | ) | (1,976 | ) | (49,105 | ) | |||||||
|
Grantor trust income
|
5,810 | 8,500 | 20,188 | ||||||||||
|
Subpart F income and foreign dividends
|
5,153 | — | — | ||||||||||
|
Expiring NOL
|
— | 20,689 | 39,690 | ||||||||||
|
Taxes on foreign earnings
|
(138 | ) | — | — | |||||||||
|
Taxes on equity earnings
|
247 | — | — | ||||||||||
|
Other, net
|
398 | (3,683 | ) | 314 | |||||||||
|
Total income tax expense
|
$ | 11,535 | $ | 18 | $ | 346 | |||||||
The tax effects of temporary differences that give rise to the
deferred tax assets and liabilities as of the years ended
December 2004 and 2003, respectively, are presented as follows:
| 2004 | 2003 | |||||||||
|
Deferred Tax Assets:
|
||||||||||
|
Loss reserve discounting
|
$ | 2,651 | $ | 3,476 | ||||||
|
Unearned premiums
|
88 | 278 | ||||||||
|
Capital loss carryforward
|
17,882 | — | ||||||||
|
Net operating loss carryforwards
|
180,752 | 221,659 | ||||||||
|
Allowance for doubtful accounts
|
697 | 677 | ||||||||
|
Accrued expenses
|
50,799 | — | ||||||||
|
Tax basis in bond and other costs
|
20,350 | — | ||||||||
|
Deferred tax assets of unconsolidated subsidiaries
|
10,169 | — | ||||||||
|
Other
|
1,785 | 67 | ||||||||
|
AMT credit carryforward
|
6,415 | 3,140 | ||||||||
|
Total Gross Deferred Tax Asset
|
291,588 | 229,297 | ||||||||
|
Less: Valuation Allowance
|
(91,186 | ) | (211,535 | ) | ||||||
|
Total deferred tax asset
|
200,402 | 17,762 | ||||||||
|
Deferred Tax Liabilities:
|
||||||||||
|
Unrealized gains on available-for-sale securities
|
323 | 314 | ||||||||
|
Unremitted earnings of foreign subsidiaries
|
8,763 | — | ||||||||
|
Unbilled accounts receivable
|
39,041 | — | ||||||||
|
Property, plant and equipment
|
163,610 | — | ||||||||
|
Intangible assets
|
70,799 | — | ||||||||
|
Deferred acquisition costs
|
292 | 283 | ||||||||
|
Difference in tax basis of bonds
|
65 | 107 | ||||||||
|
Salvage and subrogation discount
|
11 | 23 | ||||||||
|
Losses taken in excess of basis — ACL
|
— | 17,035 | ||||||||
|
Other, net
|
53 | — | ||||||||
|
Total gross deferred tax liability
|
282,957 | 17,762 | ||||||||
|
Net deferred tax asset (liability)
|
$ | (82,555 | ) | $ | — | |||||
A-52
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
In October 2004, new United States federal income tax
legislation entitled “The American Jobs Creation Act of
2004” was enacted. This legislation includes provisions
that may affect the Company, such as provisions requiring
additional federal income tax disclosure and reporting,
provisions regarding the preferential federal income tax
treatment of certain qualified dividend distributions from
foreign subsidiaries, certain additional federal income tax
deductions based on qualified production income, additional
restrictions on the flexibility of executive deferred
compensation plans, and other matters. Danielson is currently
evaluating the impact of this new federal income tax law.
| 26. | Insurance Regulation, Dividend Restrictions and Statutory Surplus |
Danielson’s insurance subsidiaries are regulated by various
states. For regulatory purposes, separate financial statements
which are prepared in accordance with statutory accounting
principles are filed with these states. Insurance Services
prepares its statutory–basis financial statements in
accordance with accounting practices prescribed or permitted by
the California Department of Insurance (the “CDI”).
Prescribed statutory accounting practices include a variety of
publications of the National Association of Insurance
Commissioners, as well as state laws, regulations and general
administrative rules. Permitted statutory accounting practices
encompass all accounting practices not so prescribed (see below
for discussion of Insurance Services’ permitted practice).
The Association has adopted a comprehensive set of accounting
principles for qualification as an Other Comprehensive Basis of
Accounting which was effective in 2001. As of the years ended
December 2004 and 2003, Danielson’s operating insurance
subsidiaries had statutory capital and surplus of
$16.9 million and $16. million, respectively. The
combined statutory net loss for Danielson’s operating
insurance subsidiaries, as reported to the regulatory
authorities for the years ended December 2004, 2003 and 2002,
was $0.8 million, $10.1 million, and
$22.5 million, respectively.
The CDI completed its examination of the statutory–basis
financial statements of NAICC, excluding Valor, for the four
years ended December 2002. The report was filed January 9,
2004. No restatement of NAICC’s December 31, 2002
statutory financial statements were proposed by CDI as a result
of the examination. The CDI did, however, note an increase in
statutory unpaid loss and LAE by $4.1 million and a
corresponding adjustment to surplus. The adjustment issued by
the Department was in response to NAICC’s recognition of
prior years development in its June 30, 2003 quarterly
filing.
A model for determining the risk–based capital
(“RBC”) requirements for property and casualty
insurance companies was adopted in December 1993 and companies
are required to report their RBC ratios based on their statutory
annual statements. At December 31, 2004, NAICC’s RBC
was 361%, which is $7.6 million in excess of the Company
Action Level.
As discussed in Note 3, ACL filed for protection under
Chapter 11 of the Bankruptcy Code. As a result, for
statutory accounting purposes, it was determined that
NAICC’s investment in ACL was fully impaired. At
December 31, 2002, NAICC recognized a statutory charge to
its surplus of $7.4 million. This charge, when combined
with NAICC’s underwriting results, reduced its statutory
surplus level below the Company action level per NAICC’s
RBC calculation.
In response to the above statutory condition, in 2003, Danielson
repaid a $4 million note due May 2004 to NAICC, and further
contributed $4 million to NAICC to increase its statutory
capital. With permission from the CDI, these transactions were
recorded at December 31, 2002 in NAICC’s
statutory–basis annual statement. After consideration for
the $8 million noted above, NAICC’s reported
statutory–basis capital and surplus as of December 31,
2002 was above the Company action level of the RBC calculation.
On December 30, 2003, Danielson contributed $2 million
to NAICC to increase its statutory capital.
Insurance companies are subject to insurance laws and
regulations established by the states in which they transact
business. The governmental agencies established pursuant to
these state laws have broad administrative and supervisory
powers over insurance company operations. These powers include
granting and revoking of licenses to transact business,
regulating trade practices, establishing guaranty associations,
licensing agents,
A-53
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
approving policy forms, filing premium rates on certain
business, setting reserve requirements, determining the form and
content of required regulatory financial statements, conducting
periodic examination of insurers’ records, determining the
reasonableness and adequacy of capital and surplus, and
prescribing the maximum concentrations of certain classes of
investments. Most states have also enacted legislation
regulating insurance holding company systems, including
acquisitions, extraordinary dividends, the terms of affiliate
transactions and other related matters. Danielson and its
insurance subsidiaries have registered as holding company
systems pursuant to such legislation in California and routinely
report to other jurisdictions.
Under the California Insurance Code, NAICC is prohibited from
paying shareholder dividends, other than from accumulated earned
surplus, exceeding the greater of net income or 10% percent of
the preceding year’s statutory surplus, without prior
approval of the CDI. No dividends were paid in 2004, 2003 or
2002. The overall limit of dividends that can be paid during
2005 is approximately $1.6 million as long as there is
sufficient accumulated earned surplus to pay such. As of the
year ended December 2004, NAICC did not have sufficient
accumulated earned surplus, as defined by the CDI, to pay
further ordinary dividends.
| 27. | Stockholders’ Equity and Stock Option Plans |
| Stockholders Equity |
On December 2, 2003, Danielson issued 5,120,854 shares
of common stock (“Common Stock”) to three existing
shareholders in exchange for providing the bridge financing
necessary for the acquisition of Covanta. See Note 2 for
additional information on the acquisition and bridge financing
agreements.
In connection with a pro rata rights offering to all
stockholders on May 18, 2004, Danielson issued 27,438,118
additional shares of Common Stock for approximately
$42 million of gross proceeds. In addition, Danielson
issued the maximum 8,750,000 shares to Laminar pursuant to
the conversion of approximately $13.4 million in principal
amount of notes, as more fully described in Note 2. As of
December 31, 2004, there were 73,441,202 shares of
Common Stock issued of which 73,430,202 were outstanding; the
remaining 10,796 shares of Common Stock issued but not
outstanding are held as treasury stock.
In connection with efforts to preserve Danielson’s NOLs,
Danielson has imposed restrictions on the ability of holders of
five percent or more of Common Stock to transfer the Common
Stock owned by them and to acquire additional Common Stock, as
well as the ability of other to become five percent stockholders
as a result of transfers of Common stock.
The following represents Shares of Common Stock reserved for
future issuance as of December 31, 2004:
|
2005 rights offering in connection with the acquisition of
Ref-Fuel (Note 36)
|
66,087,000 | |||
|
Estimated stock purchase rights of certain creditors of Covanta
(Note 2)
|
3,000,000 | |||
|
Stock options exercisable in 2005
|
820,124 | |||
| 69,907,124 | ||||
As of December 31, 2003, there were 10,000,000 shares
of preferred stock authorized, with none issued or outstanding.
The preferred stock may be divided into a number of series as
defined by Danielson Board of Directors. The Board of Directors
is authorized to fix the rights, powers, preferences, privileges
and restrictions granted to and imposed upon the preferred stock
upon issuance, with prior approval of the stockholders required
for any series of preferred stock issued to any holder of 1% or
more of the outstanding Common Stock.
A substantial part of Danielson net assets are restricted.
Various state insurance requirements restrict the amounts that
may be transferred to Danielson in the form of dividends or
loans from its Insurance Services subsidiaries without prior
regulatory approval. Various debt covenants and credit
arrangements also restrict the amounts that may be transferred
to Danielson in the form of cash dividends or loans from Energy
Services
A-54
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
subsidiaries. Danielson investment in the net assets of its
Insurance Services subsidiaries and its Energy Services
subsidiaries, amount to approximately $16.8 million and
$85.4 million at December 31, 2004, respectively.
| Stock Option Plans |
Danielson adopted the Danielson Holding Corporation Equity Award
Plan for Employees and Officers (the “Employees Plan”)
and the Danielson Holding Corporation Equity Award Plan for
Directors (the “Directors Plan”), collectively (the
“Award Plans”), effective with stockholder approval on
October 5, 2004. The 1995 Stock and Incentive Plan (the
“1995 Plan”) was terminated with respect to any future
awards under such plan on October 5, 2004 upon stockholder
approval of the Award Plans. The 1995 Plan will remain in effect
until all awards have been satisfied or expired.
| Award Plans |
The purpose of the Award Plans is to promote the interests of
Danielson (including its subsidiaries and affiliates) and its
stockholders by using equity interests in Danielson to attract,
retain and motivate its management, non–employee directors
and other eligible persons and to encourage and reward their
contributions to Danielson’s performance and profitability.
Both Award Plans provide for awards to be made in the form of
(a) incentive stock options, (b) non–qualified
stock options, (c) shares of restricted stock,
(d) stock appreciation rights, (e) performance awards,
or (f) other stock–based awards which relate to or
serve a similar function to the awards described above. Awards
may be made on a stand alone, combination or tandem basis. The
maximum aggregate number of shares of Common Stock available for
issuance is 4,000,000 under the Employees Plan and 400,000 under
the Directors Plan.
On October 5, 2004 Danielson granted options to purchase an
aggregate of 1,020,000 shares of Common Stock and
641,010 shares of restricted stock under the Employees
Plan. The options have an exercise price of $7.43 per share
and expire 10 years from the date of grant and vest over
three years commencing on February 28, 2006. Restrictions
upon 50% of the restricted stock shall lapse on a pro rata basis
over three years commencing on February 28, 2005 and the
restrictions upon the remaining 50% of the restricted stock
shall lapse over the same three year period based upon the
satisfaction of performance–based metrics of operating cash
flow or such other performance measures as may be determined by
the Compensation Committee of the Board of Directors.
On October 5, 2004 Danielson granted options to purchase an
aggregate of 93,338 shares of Common Stock and
15,500 shares of restricted stock under the Directors Plan.
The options have an exercise price of $7.43 per share and
expire 10 years from the date of grant and vest upon the
date of grant. Restrictions on the restricted stock shall lapse
on a pro rata basis over three years commencing on the date of
grant. On December 5, 2004, Danielson granted an additional
11,111 stock options at an exercise price of $7.85 and an
additional 1,250 share of restricted stock under the
Directors Plans with similar term and vesting provisions.
| 1995 Stock Option Plan |
The 1995 Plan is a qualified plan which provides for the grant
of any or all of the following types of awards: stock options,
including incentive stock options and non–qualified stock
options; stock appreciation rights, whether in tandem with stock
options or freestanding; restricted stock; incentive awards; and
performance awards. The purpose of the 1995 Plan is to enable
Danielson to provide incentives to increase the personal
financial identification of key personnel with the
long–term growth of Danielson and the interests of
Danielson’s stockholders through the ownership and
performance of Common Stock, to enhance Danielson’s ability
to retain key personnel, and to attract outstanding prospective
employees and Directors. The 1995 Plan became effective as of
March 21, 1995.
A-55
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
In September 2001, Danielson’s stockholders approved
amendments to the 1995 Plan which increased the aggregate number
of shares available for option grants from 1,700,000 to
2,540,000 and provided for options to be awarded to independent
contractors.
On July 24, 2002, Danielson’s Board amended the 1995
Plan to increase the aggregate number of shares available for
grant from 2,540,000 to 4,976,273. The Board reserved
1,936,273 shares for the grant of stock options to
management of ACL, of which options for 1,560,000 shares of
Danielson common stock were granted. The options have an
exercise price of $5.00 per share and expire 10 years
from the date of grant. One–half of the options time vest
over a four–year period in equal annual installments and
one–half of the options vest over a four–year period
in equal annual installments contingent upon the financial
performance of ACL and compliance with the terms of its senior
bank facility.
In July 2002, options for 918,084 shares previously granted
to employees, directors and contractors of Danielson, which
would have expired upon the termination of the service of these
individuals to Danielson on July 24, 2002, were extended
two years or two years beyond the termination of their service
in a new capacity, but in no event longer than the original term
with vesting accelerated simultaneously with the extension.
On August 7, 2003, Danielson granted options for
50,000 shares of Common Stock to an employee of NAICC. The
options have an exercise price of $1.45 per share and
expire 10 years from the grant date. 20,000 of the options
vest on the first and second anniversary of the grant date and
the remaining 10,000 options vest on the third anniversary of
the grant date.
During 2003, options for 829,375 shares of Common Stock
were forfeited due to terminations and ACL not achieving the
performance targets.
The following table summarizes activity and balance information
of the options under the Awards Plans and 1995 Plan:
| 2004 | 2003 | 2002 | |||||||||||||||||||||||
| Weighted | Weighted | Weighted | |||||||||||||||||||||||
| Average | Average | Average | |||||||||||||||||||||||
| Exercise | Exercise | Exercise | |||||||||||||||||||||||
| Shares | Price | Shares | Price | Shares | Price | ||||||||||||||||||||
|
1995 Stock Option Plan
|
|||||||||||||||||||||||||
|
Outstanding at the Beginning of the Year
|
2,564,543 | $ | 4.79 | 3,343,918 | $ | 4.89 | 1,718,500 | $ | 4.67 | ||||||||||||||||
|
Granted
|
— | 50,000 | 1.45 | 1,890,000 | 4.98 | ||||||||||||||||||||
|
Exercised
|
965,991 | 4.27 | — | — | 264,582 | 4.11 | |||||||||||||||||||
|
Forfeited
|
802,875 | 5.14 | 829,375 | 5.00 | — | — | |||||||||||||||||||
|
Outstanding at the End of the Year
|
795,677 | $ | 4.87 | 2,564,543 | $ | 4.79 | 3,343,918 | $ | 4.89 | ||||||||||||||||
|
Options Exercisable at Year End
|
715,675 | $ | 5.04 | 1,783,708 | $ | 4.84 | 1,412,254 | $ | 4.85 | ||||||||||||||||
|
Options Available for Future Grant
|
— | 2,141,048 | 1,632,355 | ||||||||||||||||||||||
|
2004 Stock Option Plan
|
|||||||||||||||||||||||||
|
Outstanding at the Beginning of the
|
|||||||||||||||||||||||||
|
Year
|
|||||||||||||||||||||||||
|
Granted
|
1,124,449 | $ | 7.43 | ||||||||||||||||||||||
|
Exercised
|
— | ||||||||||||||||||||||||
|
Forfeited Outstanding at the End of the Year
|
1,124,449 | $ | 7.43 | ||||||||||||||||||||||
|
Options Exercisable at Year End
|
104,449 | $ | 7.47 | ||||||||||||||||||||||
|
Options Available for Future Grant
|
1,475,551 | ||||||||||||||||||||||||
A-56
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
As of December 31, 2004, options for shares were
outstanding in the following price ranges:
| Options Outstanding | ||||||||||||||||||||
| Weighted Average | Options Exercisable | |||||||||||||||||||
| Remaining | ||||||||||||||||||||
| Number of | Weighted Average | Contractual Life | Number | Weighted Average | ||||||||||||||||
| Exercise Price Range | Shares | Exercise Price | (Years) | of Shares | Exercise Price | |||||||||||||||
|
$1.45 – $4.26
|
308,502 | $ | 3.48 | 6.6 | 238,500 | $ | 3.60 | |||||||||||||
|
$4.94 – $5.78
|
349,675 | $ | 5.27 | 6.7 | 339,675 | $ | 5.25 | |||||||||||||
|
$6.69 – $7.06
|
137,500 | $ | 6.99 | 2.0 | 137,500 | $ | 6.99 | |||||||||||||
|
$7.43– $7.85
|
1,124,449 | $ | 7.43 | 9.8 | 104,449 | $ | 7.47 | |||||||||||||
| 1,920,126 | 820,124 | |||||||||||||||||||
Danielson applies APB 25, and related interpretations in
accounting for the stock options granted to directors and
employees. Compensation cost of approximately $0.1 million
was recognized in 2002 relating to the modification of stock
options granted to directors and employees. The fair value based
method of accounting prescribed by SFAS No. 123
“Accounting for Stock–Based Compensation”
(“SFAS 123”), is used to measure stock–based
compensation for contractors. Accordingly, compensation costs of
$0.1 million, $0.1 million and $0.8 million were
recognized in 2004, 2003 and 2002, respectively, relating to
stock options granted to contractors. Pro forma net income and
earnings per share are disclosed in Note 1 as if the fair
value based method of accounting for stock–based
compensation under SFAS 123 had been applied to all stock
options. For pro forma calculation purposes, fair value of the
option grants are estimated as of the date of grant using the
Black–Scholes option pricing model with the following
assumptions: dividend yield of 0% per annum; an expected
life of approximately 8 years; expected volatility of
50%–73%; and a risk free interest rate of 4% —
6%. The pro forma effect on net loss may not be representative
of the effects on income for future years.
| 28. | Accumulated Other Comprehensive Income (Loss) |
Accumulated other comprehensive (loss) as of December 31,
2004 and 2003 consists of the following:
| 2004 | 2003 | |||||||
|
Foreign currency translation
|
$ | 549 | $ | — | ||||
|
Unrealized gain on available for sale securities
|
104 | 850 | ||||||
|
Minimum pension liability
|
(70 | ) | (1,295 | ) | ||||
| $ | 583 | $ | (445 | ) | ||||
| 29. | Earnings (Loss) Per Share |
Per share data is based on the weighted average number of shares
of common stock of Danielson’s, par value $0.10 per
share (“Common Stock”), outstanding during the
relevant period. Basic earnings per share are calculated using
only the average number of outstanding shares of Common Stock.
Diluted earnings per share computations, as calculated under the
treasury stock method, include the average number of shares of
additional outstanding Common Stock issuable for unvested
restricted stock, stock options, warrants, rights
A-57
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
and convertible notes whether or not currently exercisable.
Diluted earnings per share for all the periods presented do not
include shares related to stock options and warrants because
their effect was anti–dilutive.
| 2004 | 2003 | 2002 | ||||||||||||||||||||||||||||||||||
| Income | Per | Income | Per | Income | Per | |||||||||||||||||||||||||||||||
| (Loss) | Shares | Share | (Loss) | Shares | Share | (Loss) | Shares | Share | ||||||||||||||||||||||||||||
| (Numerator) | (Denominator) | Amount | (Numerator) | (Denominator) | Amount | (Numerator) | (Denominator) | Amount | ||||||||||||||||||||||||||||
| - | ||||||||||||||||||||||||||||||||||||
|
Basic Earnings (Loss)
|
||||||||||||||||||||||||||||||||||||
|
Per Share:
|
||||||||||||||||||||||||||||||||||||
|
Income (loss) to common stockholders
|
$ | 34,094 | 63,469 | $ | 0.54 | $ | (69,225 | ) | 47,362 | $ | (1.46 | ) | $ | (32,955 | ) | 40,400 | $ | (0.82 | ) | |||||||||||||||||
|
Effect of Diluted Securities:
|
||||||||||||||||||||||||||||||||||||
|
Stock options
|
302 | (A | ) | (A | ) | |||||||||||||||||||||||||||||||
|
Restricted stock
|
187 | (A | ) | (A | ) | |||||||||||||||||||||||||||||||
|
Rights
|
1,784 | |||||||||||||||||||||||||||||||||||
|
Warrants
|
(A | ) | (A | ) | ||||||||||||||||||||||||||||||||
|
Convertible debentures
|
(A | ) | (A | ) | ||||||||||||||||||||||||||||||||
|
Diluted Loss Per Share:
|
||||||||||||||||||||||||||||||||||||
|
Income (loss) to common stockholders
|
$ | 34,094 | 65,742 | $ | 0.52 | $ | (69,225 | ) | 47,362 | $ | ( 1.46 | ) | $ | (32,,955 | ) | 40,400 | $ | (0.82 | ) | |||||||||||||||||
(A) Antidilutive
Basic and diluted earnings per share and the average shares used
in the calculation of basic and diluted earnings per share for
all periods have been adjusted retroactively to reflect the
bonus element contained in the rights offering issued on
May 18, 2004.
On December 2, 2003, pursuant to the note purchase
agreement, 5,120,853 shares of Common Stock were issued and
included in the weighted average outstanding shares calculation
as of March 10, 2004, the date on which certain conditions
upon which the shares were contingently returnable were
satisfied. The shares were not included in the computation of
diluted earnings per share for the year ended December 31,
2003 because their effect would be antidilutive. The weighted
average number of such shares included in the basic and diluted
earnings per share calculation was 4,152,801 for the year ended
December 31, 2004.
Options to purchase 3,393,918 shares of Common Stock
at exercise prices ranging from $1.45 to $7.0625 per share
and options to purchase 3,608,500 shares of Common
Stock at exercise prices ranging from $3.37 to $7.0625 per
share were outstanding during the years ended December 31,
2003, and December 31, 2002, respectively but were not
included in the computation of diluted earnings per share
because the option’s exercise price was greater than the
average market price of Common Stock. 2,564,543 and 3,343,918 of
such options were outstanding as of December 31, 2003 and
2002, respectively.
Warrants to purchase 2,002,558 shares of Common Stock
at an exercise price of $4,74391 per share were outstanding
during the year ended December 31, 2002 but were not
included in the computation of diluted earnings per share
because of the warrants exercise price was greater than the
average market price of the Common Stock. None of these warrants
were outstanding as of December 31, 2002.
A-58
Table of Contents
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| 30. | Financial Instruments |
The following disclosure of the estimated fair value of
financial instruments is made in accordance with the
requirements of SFAS No. 107, “Disclosures About
Fair Value of Financial Instruments.” The estimated
fair-value amounts have been determined using available market
information and appropriate valuation methodologies. However,
considerable judgment is necessarily required in interpreting
market data to develop estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the
amounts that Covanta would realize in a current market exchange.
The following methods and assumptions were used to estimate the
fair value of each class of financial instruments for which it
is practicable to estimate that value.
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 long-term
unbilled receivables is estimated by using a discount rate that
approximates the current rate for comparable notes. The fair
value of non-current receivables is estimated by discounting the
future cash flows using the current rates at which similar loans
would be made to such borrowers based on the remaining
maturities, consideration of credit risks, and other business
issues pertaining to such receivables. The fair value of
restricted funds held in trust is based on quoted market prices
of the investments held by the trustee. Other assets, consisting
primarily of insurance and escrow deposits, and other
miscellaneous financial instruments used in the ordinary course
of business are valued based on quoted market prices or other
appropriate valuation techniques.
Fair values for debt were determined based on interest rates
that are currently available to the Company 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. Other liabilities are valued by
discounting the future stream of payments using the incremental
borrowing rate of the Company. The fair value of the
Company’s interest rate swap agreements is the estimated
amount the Company would receive or pay to terminate the
agreement based on the net present value of the future cash
flows as defined in the agreement.
Energy Services
The fair-value estimates presented herein are based on pertinent
information available to management as of December 31,
2004. However, such amounts have not been comprehensively
revalued for purposes of these financial statements since
December 31, 2004, and current estimates of fair value may
differ significantly from the amounts presented herein.
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
The estimated fair value of financial instruments at
December 31, 2004 is summarized as follows:
| 2004 | ||||||||
| Carrying | Estimated | |||||||
| Amount | Fair Value | |||||||
|
Assets:
|
||||||||
|
Cash and cash equivalents
|
$ | 78,112 | $ | 78,112 | ||||
|
Marketable securities
|
3,100 | 3,100 | ||||||
|
Receivables
|
301,553 | 299,480 | ||||||
|
Restricted funds
|
272,723 | 272,877 | ||||||
|
Interest rate swap receivable
|
14,920 | 14,920 | ||||||
| Liabilities: | ||||||||
|
Debt
|
312,896 | 290,538 | ||||||
|
Project debt
|
944,737 | 936,926 | ||||||
|
Interest rate swap payable
|
14,920 | 14,920 | ||||||
|
Liabilities subject to compromise
|
$ | — | $ | — | ||||
|
Off Balance-Sheet Financial Instruments:
|
||||||||
|
Guarantees(a)
|
||||||||
| (a) | additionally guarantees include approximately $9 million of guarantees related to international energy projects. |
| (b) | see Note 2 to the Notes to the Consolidated Financial Statements | |
Insurance Services
The carrying amounts and fair values of financial instruments
are as follows as of December 31, 2004:
| Carry Amount | Fair Value | |||||||
|
Assets:
|
||||||||
|
Parent investments — fixed maturity securities
|
$ | 3,300 | $ | 3,300 | ||||
|
Insurance services’ investments — fixed maturity
securities
|
57,210 | 57,210 | ||||||
|
Insurance services’ investments — equity
securities
|
1,432 | 1,432 | ||||||
31. Supplemental Cash Flow Disclosures
| 2004 | 2003 | 2002 | ||||||||||
|
Cash Paid for Interest and Income Taxes:
|
||||||||||||
|
Interest (net of amounts capitalized)
|
$ | 66,917 | $ | — | $ | — | ||||||
|
Income taxes paid (refunded)
|
24,207 | — | — | |||||||||
32. Business Segments
Danielson has two reportable business segments —
Energy and Insurance. Energy develops, constructs, owns and
operates for others key infrastructure for the conversion of
waste–to–energy and independent power production in
the United States and abroad. The Insurance segment writes
property and casualty insurance in the western United States,
primarily in California. As described in Note 2 Covanta was
acquired on March 11, 2004 and as described in Note 3,
the investment in ACL was written off during the quarter ended
March 31, 2003.
The accounting policies of the reportable segments are
consistent with those described in the summary of significant
accounting policies, unless otherwise noted.
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
For the years ended December 31, 2004, 2003 and 2002
segment results were as follows:
| 2004 | 2003 | 2002 | |||||||||||||
|
Revenues:
|
|||||||||||||||
|
Energy
|
|||||||||||||||
|
Domestic
|
$ | 452,931 | $ | — | $ | — | |||||||||
|
International
|
104,271 | — | — | ||||||||||||
|
Subtotal Energy
|
557,202 | — | — | ||||||||||||
|
Insurance
|
20,868 | 41,123 | 69,397 | ||||||||||||
|
Marine
|
— | — | 462,104 | ||||||||||||
|
Corporate
|
— | — | — | ||||||||||||
|
Total revenues
|
$ | 578,070 | $ | 41,123 | $ | 531,501 | |||||||||
|
Income (Loss) from operations:
|
|||||||||||||||
|
Energy
|
|||||||||||||||
|
Domestic
|
$ | 65,001 | $ | — | $ | — | |||||||||
|
International
|
15,197 | — | — | ||||||||||||
|
Subtotal Energy
|
80,198 | — | — | ||||||||||||
|
Insurance
|
(811 | ) | (10,172 | ) | (10,492 | ) | |||||||||
|
Marine
|
— | — | 17,658 | ||||||||||||
|
Corporate
|
(2,032 | ) | (2,734 | ) | (3,833 | ) | |||||||||
|
Income (loss) from operations
|
77,355 | (12,906 | ) | 3,333 | |||||||||||
|
Investment income related to ACL Debt
|
— | — | 8,402 | ||||||||||||
|
Interest income
|
1,858 | — | — | ||||||||||||
|
Interest expense
|
(43,739 | ) | (1,424 | ) | (38,735 | ) | |||||||||
|
Other- net
|
— | — | (5,609 | ) | |||||||||||
|
Income (loss) before income tax expense, equity in net income
(loss) from unconsolidated investments and minority interests
|
$ | 35,474 | $ | (14,330 | ) | $ | (32,609 | ) | |||||||
Total revenues by segment reflect sales to unaffiliated
customers. In computing income (loss) from operations none of
the following have been added or deducted: unallocated corporate
expenses, non-operating interest expense, interest income and
income taxes.
For the years ended December 31, 2004 and 2003 segment and
corporate assets and results are as:
| Depreciation | ||||||||||||
| Identifiable | and | Capital | ||||||||||
| Assets | Amortization | Additions | ||||||||||
|
2004
|
||||||||||||
|
Energy Services
|
$ | 1,814,042 | $ | 52,632 | $ | 11,877 | ||||||
|
Insurance Services
|
85,679 | 544 | 121 | |||||||||
|
Parent
|
39,360 | — | — | |||||||||
|
Consolidated
|
$ | 1,939,081 | $ | 53,176 | $ | 11,998 | ||||||
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| Depreciation | ||||||||||||
| Identifiable | and | Capital | ||||||||||
| Assets | Amortization | Additions | ||||||||||
|
2003
|
||||||||||||
|
Insurance Services
|
$ | 110,012 | $ | 339 | $ | 96 | ||||||
|
Parent and Other
|
52,636 | 36 | — | |||||||||
|
Consolidated
|
$ | 162,648 | $ | 375 | $ | 96 | ||||||
|
2002
|
||||||||||||
|
Marine Services
|
$ | 41,785 | $ | 18,126 | ||||||||
|
Insurance Services
|
479 | 26 | ||||||||||
|
Parent
|
95 | — | ||||||||||
|
Consolidated
|
$ | 42,359 | $ | 18,152 | ||||||||
Covanta’s operations are principally in the United States.
Operations outside of the United States are primarily in Asia,
with some projects in Latin America and Europe. A summary of
revenues by geographic area for 2004, 2003 and 2002 is as
follows:
| 2004 | 2003 | 2002 | |||||||||||
|
Revenues:
|
|||||||||||||
|
United States
|
$ | 473,799 | $ | 35,851 | $ | 524,268 | |||||||
|
India
|
69,118 | — | — | ||||||||||
|
Other Asia
|
34,164 | — | — | ||||||||||
|
Other International
|
989 | — | — | ||||||||||
|
Total
|
$ | 578,070 | $ | 35,851 | $ | 524,268 | |||||||
A summary of identifiable assets by geographic area for the
years ended December 31, 2004 and 2003 is as follows:
| 2004 | 2003 | ||||||||
|
Identifiable Assets:
|
|||||||||
|
United States
|
$ | 1,674,636 | $ | 162,648 | |||||
|
India
|
93,462 | — | |||||||
|
Other Asia
|
100,655 | — | |||||||
|
Other International
|
70,328 | — | |||||||
|
Total
|
$ | 1,939,081 | $ | 162,648 | |||||
33. Quarterly Data (Unaudited)
| 2004 | |||||||||||||||||||||
| 1st | 2nd | 3rd | 4th | Total | |||||||||||||||||
|
Operating revenue
|
$ | 45,961 | $ | 185,240 | $ | 172,801 | 174,553 | 578,555 | |||||||||||||
|
Operating income
|
3,885 | 30,942 | 21,763 | 20,765 | 77,355 | ||||||||||||||||
|
Net (Loss) income
|
(2,173 | ) | 15,195 | 12,815 | 8,257 | 34,094 | |||||||||||||||
|
Net income per share:
|
|||||||||||||||||||||
|
Basic
|
(0.04 | ) | 0.26 | 0.18 | 0.11 | 0.54 | |||||||||||||||
|
Diluted
|
(0.04 | ) | 0.24 | 0.17 | 0.11 | 0.52 | |||||||||||||||
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| 2003 | ||||||||||||||||||||
| 1st | 2nd | 3rd | 4th | Total | ||||||||||||||||
|
Operating revenue
|
$ | 11,076 | $ | 11,837 | $ | 8,909 | 9,301 | $ | 41,123 | |||||||||||
|
Operating income
|
(2,650 | ) | (4,578 | ) | (3,546 | ) | (2,132 | ) | (12,906 | ) | ||||||||||
|
Net loss
|
(57,836 | ) | (4,501 | ) | (3,442 | ) | (3,446 | ) | (69,225 | ) | ||||||||||
|
Net loss per basic and diluted share
|
(1.22 | ) | (0.09 | ) | (0.07 | ) | (0.07 | ) | (1.46 | ) | ||||||||||
As discussed in Note 1, Danielson acquired ACL on
May 29, 2002 and, accordingly, the operating results for
2002 include ACL beginning with the date of acquisition. As
discussed in Note 1, Danielson began accounting for its
investment in ACL on the equity method in the first quarter of
2003 and, as discussed in Note 3, wrote off its investment
in ACL in the same quarter. Covanta’s results of operations
are included in Danielson’s consolidated results since its
March 10, 2004 acquisition.
34. Commitments and Contingent Liabilities
Danielson and/or its subsidiaries are party to a number of other
claims, lawsuits and pending actions, most of which are routine
and all of which are incidental to its business. Danielson
assesses the likelihood of potential losses on an ongoing basis
and when losses are considered probable and reasonably
estimable, records as a loss an estimate of the ultimate
outcome. If Danielson can only estimate the range of a possible
loss, an amount representing the low end of the range of
possible outcomes is recorded. The final consequences of these
proceedings are not presently determinable with certainty.
American Commercial Lines, Inc.
The petition with the U.S. Bankruptcy Court to reorganize
under Chapter 11 of the U.S. Bankruptcy Code, that ACL
and many of its subsidiaries and its immediate direct parent
entity, American Commercial Lines Holdings, LLC, filed on
January 31, 2003 has resulted in the confirmation of a plan
of reorganization on December 30, 2004 that was effective
as of January 11, 2005. Pursuant to ACL’s plan of
reorganization ACL is no longer a subsidiary of Danielson as
Danielson’s equity interest in ACL was cancelled and it
received warrants to purchase 3% of ACL’s new common
stock. See Note 3 to the Notes to the Consolidated
Financial Statements.
Covanta Energy Corporation
Generally claims and lawsuits against Covanta and its
subsidiaries that had filed bankruptcy petitions and
subsequently emerged from bankruptcy arising from events
occurring prior to their respective petition dates have been
resolved pursuant to the Covanta Reorganization Plan, and have
been discharged pursuant to the March 5, 2004 order of the
Bankruptcy Court which confirmed the Covanta Reorganization
Plan. However, to the extent that claims are not dischargeable
in bankruptcy, such claims may not be discharged. For example,
the claims of certain persons who were personally injured prior
to the petition date but whose injury only became manifest
thereafter may not be discharged pursuant to the Covanta
Reorganization Plan.
Environmental Matters
Covanta’s operations are subject to environmental
regulatory laws and environmental remediation laws. Although
Covanta’s operations are occasionally subject to
proceedings and orders pertaining to emissions into the
environment and other environmental violations, which may result
in fines, penalties, damages or other sanctions, Covanta
believes that it is in substantial compliance with existing
environmental laws and regulations.
Covanta 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 laws. In certain instances, Covanta may be exposed to joint
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
and several liabilities for remedial action or damages.
Covanta’s ultimate liability in connection with such
environmental claims will depend on many factors, including its
volumetric share of waste, the total cost of remediation, and
the financial viability of other companies that also sent waste
to a given site and, in the case of divested operations, its
contractual arrangement with the purchaser of such operations.
Generally such claims arising prior to the first petition date
were resolved in and discharged by the Chapter 11 Cases.
The potential costs related to the matters described below and
the possible impact on future operations are uncertain due in
part to the complexity of governmental laws and regulations and
their interpretations, the varying costs and effectiveness of
cleanup technologies, the uncertain level of insurance or other
types of recovery and the questionable level of Covanta’s
responsibility. Although the ultimate outcome and expense of any
litigation, including environmental remediation, is uncertain,
Covanta believes that the following proceedings will not have a
material adverse effect on Covanta’s consolidated financial
position or results of operations.
In June, 2001, the EPA named Covanta’s wholly-owned
subsidiary, Ogden Martin Systems of Haverhill, Inc., now known
as Covanta Haverhill, Inc., as one of 2,000 potentially
responsible parties (“PRPs”) at the Beede Waste Oil
Superfund Site, Plaistow, New Hampshire, a former waste oil
recycling facility. The total quantity of waste oil alleged by
EPA to have been disposed of by PRPs at the Beede site is
approximately 14.3 million gallons, of which Covanta
Haverhill’s contribution is alleged to be approximately
44,000 gallons. On January 9, 2004, the EPA signed its
Record of Decision with respect to the cleanup of the site.
According to the EPA, the costs of response actions incurred as
of January 2004 by the EPA and the State of New Hampshire
Department of Environmental Services (“DES”) total
approximately $19 million, and the estimated cost to
implement the remedial alternative selected in the Record of
Decision is an additional $48 million. Covanta Haverhill,
Inc. is participating in discussions with other PRPs concerning
EPA’s selected remedy for the site, in anticipation of
eventual settlement negotiations with EPA and DES. Covanta
Haverhill, Inc.’s share of liability, if any, cannot be
determined at this time as a result of uncertainties regarding
the source and scope of contamination, the large number of PRPs
and the varying degrees of responsibility among various classes
of PRPs. Covanta believes that based on the amount of waste oil
materials Covanta Haverhill, Inc. is alleged to have sent to the
site, its liability will not be material.
Other Matters
During the course of the Chapter 11 Cases, Covanta and
certain contract counterparties reached agreement with respect
to material restructuring of their mutual obligations in
connection with several waste-to-energy projects. Subsequent to
March 10, 2004 Covanta were also involved in material
disputes and/or litigation with respect to the Warren County,
New Jersey and Lake County, Florida waste-to-energy projects and
the Tampa Bay water project. During 2004, all disputes relating
to the Lake County and Tampa Bay matters were resolved, and the
Company’s subsidiaries involved in these projects emerged
from bankruptcy. As of December 31, 2004 Covanta’s
subsidiaries involved with the Warren County, New Jersey project
remain in Chapter 11 and are not consolidated in the
Company’s consolidated financial statements. Danielson
expects that the outcome of the Warren County, New Jersey
litigation described below will not adversely affect Danielson.
The Covanta subsidiary (“Covanta Warren”) which
operates the waste-to-energy facility in Warren County, New
Jersey (the “Warren Facility”) and the Pollution
Control Financing Authority of Warren County (“Warren
Authority”) have been engaged in negotiations for an
extended time concerning a potential restructuring of the
parties’ rights and obligations under various agreements
related to Covanta Warren’s operation of the Warren
Facility. Those negotiations were in part precipitated by a 1997
federal court of appeals decision invalidating certain of the
State of New Jersey’s waste-flow laws, which resulted in
significantly reduced revenues for the Warren Facility. Since
1999, the State of New Jersey has been voluntarily making all
debt service payments with respect to the project bonds issued
to finance construction of the Warren Facility, and Covanta
Warren has been operating the Warren Facility pursuant to an
agreement
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
with the Warren Authority which modifies the existing service
agreement. Principal on the Warren Facility project debt is due
annually in December of each year, while interest is due
semi-annually in June and December of each year. The State of
New Jersey provided sufficient funds to the project bond trustee
to pay principal and interest to bondholders during 2004.
Although discussions continue, to date Covanta Warren and the
Warren Authority have been unable to reach an agreement to
restructure the contractual arrangements governing Covanta
Warren’s operation of the Warren Facility.
Also as part of Covanta’s emergence from bankruptcy,
Covanta and Covanta Warren entered into several agreements
approved by the Bankruptcy Court that permit Covanta Warren to
reimburse Covanta for employees and employee-related expenses,
provide for payment of a monthly allocated overhead expense
reimbursement in a fixed amount, and permit Covanta to advance
up to $1 million in super-priority debtor-in-possession
loans to Covanta Warren in order to meet any liquidity needs. As
of December 31, 2004, Covanta Warren owed Covanta
$1.9 million.
In the event the parties are unable to timely reach agreement
upon and consummate a restructuring of the contractual
arrangements governing Covanta Warren’s operation of the
Warren Facility, the Debtors may, among other things, elect to
litigate with counterparties to certain agreements with Covanta
Warren, assume or reject one or more executory contracts related
to the Warren Facility, attempt to file a plan of reorganization
on a non-consensual basis, or liquidate Covanta Warren. In such
an event, creditors of Covanta Warren may receive little or no
recovery on account of their claims.
35. Related Party
Transactions
With respect to Covanta’s predecessor entity, one member of
Covanta’s previous Board of Directors was a partner in a
major law firm, and another member is an employee of another
major law firm. From time to time, Covanta sought legal services
and advice from those two law firms. During 2004 (prior to
March 10, 2004), 2003 and 2002, Covanta paid those two law
firms approximately $0.4 million, $0.5 million and
$1.4 million, and zero, zero and $2.7 million,
respectively, for services rendered. One member of Danielson
current Board of Directors is a counsel to a major law firm
which Covanta has used for several years. Such member of the
Board of Directors did not have any direct or indirect
involvement in the procurement or provision of such services and
does not directly or indirectly benefit from associated fees.
Covanta has sought legal services and advice from this firm
after March 10, 2004 and since that date has paid this law
firm approximately $0.1 million.
| 1. As part of the investment and purchase agreement with Covanta, Danielson was obligated to arrange the Second Lien Facility. Covanta paid a fee shared by the Bridge Lenders, among others, to the agent bank for the Second Lien Facility. In order to finance its acquisition of Covanta and to arrange the Second Lien Facility, Danielson entered into a note purchase agreement with SZ Investments, L.L.C., a Danielson stockholder, TAVF, a Danielson stockholder, and D.E. Shaw Laminar Portfolios, L.L.C., a creditor of Covanta and a Danielson stockholder. In addition, in connection with such note purchase agreement, Laminar arranged for a $10 million revolving loan facility for CPIH secured by CPIH’s assets. Subsequent to the signing of the investment and purchase agreement, each of TAVF, Laminar and SZ Investments assigned approximately 30% of their participation in the second lien letter of credit facility to Goldman Sachs Credit Partners, L.P. and Laminar assigned the remainder of its participation in the second lien letter of credit facility to TRS Elara, LLC. | |
| 2. Danielson and Covanta have entered into a corporate services agreement, pursuant to which Danielson provides to Covanta, at Covanta’s expense, certain administrative and professional services and Covanta pays most of Danielson’s expenses, which totaled $3 million for the period March 11, 2004 through December 31, 2004. In addition, Danielson and Covanta have entered into an agreement pursuant to which Covanta provides, at Danielson’s expense, payroll and benefit services for Danielson | |
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
| employees which totaled $0.5 million for the period March 11, 2004 through December 31, 2004. The amounts accrued but not paid under these arrangements totaled $0.9 million for the period March 11, 2004 through December 31, 2004. |
36. Subsequent
Events — Proposed American Ref-Fuel Corp.
Acquisition
On January 31, 2005, Danielson entered into a stock
purchase agreement (the “Purchase Agreement”) with
Ref-Fuel , an owner and operator of waste-to-energy facilities
in the northeast United States, and Ref-Fuel’s stockholders
(the “Selling Stockholders”) to purchase 100% of
the issued and outstanding shares of Ref-Fuel capital stock.
Under the terms of the Purchase Agreement, Danielson will pay
$740 million in cash for the stock of Ref-Fuel and will
assume the consolidated net debt of Ref-Fuel, which as of
December 31, 2004 was approximately $1.2 billion.
After the transaction is completed, Ref-Fuel will be a
wholly-owned subsidiary of Covanta.
The acquisition is expected to close when all of the closing
conditions to the Purchase Agreement have been satisfied or
waived. These closing conditions include the receipt of
approvals, clearances and the satisfaction of all waiting
periods as required under the Hart-Scott-Rodino Antitrust Act of
1976 (“HSR Approval”) and as required by certain
governmental authorities such as the Federal Energy Regulatory
Commission (“FERC Approval”) and other applicable
regulatory authorities. Other closing conditions of the
transaction include the Company’s completion of debt
financing and an equity rights offering, as further described
below, Danielson arranging letters of credit or other financial
accommodations in the aggregate amount of $100 million to
replace two currently outstanding letters of credit that have
been entered into by two respective subsidiaries of Ref-Fuel and
issued in favor of a third subsidiary of Ref-Fuel, and other
customary closing conditions. While it is anticipated that all
of the applicable conditions will be satisfied, there can be no
assurance as to whether or when all of those conditions will be
satisfied or, where permissible, waived.
Either Danielson or the Selling Stockholders may terminate the
Purchase Agreement if the acquisition does not occur on or
before June 30, 2005, but if a required governmental or
regulatory approval has not been received by such date then
either party may extend the closing to a date that is no later
than the later of August 31, 2005 or the date 25 days
after which Ref-Fuel has provided to Danielson certain financial
statements described in the Purchase Agreement.
If the Purchase Agreement is terminated because of
Danielson’s failure to complete the rights offering and
financing as described below, and all other closing conditions
are capable of being satisfied, Danielson must pay to the
Selling Stockholders a termination fee of $25 million, of
which no less than $10 million shall be paid in cash and of
which up to $15 million may be paid in shares of
Danielson’s common stock, at its election, calculated based
on $8.13 per share. As of the date of the Purchase
Agreement, Danielson entered into a registration rights
agreement granting registration rights to the Selling
Stockholders with respect to such termination fee stock and
Danielson has deposited $10 million in cash in an escrow
account pursuant to the terms of an escrow agreement.
The Company intends to finance this transaction through a
combination of debt and equity financing. The equity component
of the financing is expected to consist of an approximately
$400 million offering of warrants or other rights to
purchase Danielson’s common stock to all of
Danielson’s existing stockholders at $6.00 per share
(the “Rights Offering”). In the Rights Offering
Danielson’s existing stockholders will be issued rights to
purchase Danielson’s stock on a pro rata basis, with each
holder entitled to purchase approximately 0.9 shares of
Danielson’s common stock at an exercise price of
$6.00 per full share for each share of Danielson’s
common stock then held.
Four of Danielson’s largest stockholders, SZ Investments
L.L.C. and EGI-Fund (05-07) Investors, L.L.C. (collectively,
“SZI”), Third Avenue Business Trust, on behalf of
Third Avenue Value Fund Series (“TAVF”), D. E.
Shaw Laminar Portfolios, L.L.C. (“Laminar”),
representing ownership of approximately
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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
40% of Danielson’s outstanding common stock, have committed
to participate in the Rights Offering and acquire their pro rata
portion of the shares. As consideration for their commitments,
Danielson will pay each of these four stockholders an amount
equal to 1.5% to 2.25% of their respective equity commitments,
depending on the timing of the transaction. Danielson agreed to
amend an existing registration rights agreement to provide these
stockholders with the right to demand that Danielson undertake
an underwritten offering within twelve months of the closing of
the acquisition of Ref-Fuel in order to provide such
stockholders with liquidity.
Danielson also expects to complete its previously announced
rights offering for up to three million shares of its common
stock to certain holders of 9.25% debentures issued by
Covanta at a purchase price of $1.53 per share (the
“9.25% Offering”). Danielson has executed a letter
agreement with Laminar pursuant to which Danielson agreed to
restructure the 9.25% Offering if that offering has not closed
prior to the record date for the Rights Offering so that the
holders that participate in the 9.25% Offering are offered
additional shares of Danielson common stock at the same purchase
price as in the Rights Offering and in an amount equal to the
number of shares of common stock that such holders would have
been entitled to purchase in the Rights Offering if the 9.25%
Offering was consummated on or prior to the record date for the
Rights Offering.
Assuming exercise of all rights in the Rights Offering and the
purchase of three million shares in the 9.25% Offering, the
Company estimates that it will have approximately
144 million shares outstanding following the consummation
of both rights offerings.
The Company has received a commitment from Goldman Sachs Credit
Partners, L.P. and Credit Suisse First Boston for a debt
financing package for Covanta necessary to finance the
acquisition, as well as to refinance the existing recourse debt
of Covanta and provide additional liquidity for the Company.
This financing shall consist of two tranches, each of which is
secured by pledges of the stock of Covanta’s subsidiaries
that has not otherwise been pledged, guarantees from certain of
Covanta’s subsidiaries and all other available assets of
Covanta’s subsidiaries. The first tranche, a first priority
senior secured bank facility, shall be made up of a
$250 million term loan facility, a $100 million
revolving credit facility and a $340 million letter of
credit facility. The second tranche, a second priority senior
secured term loan facility, shall consist of a $450 million
term loan facility.
The closing of the financing and receipt of proceeds under the
Rights Offering are closing conditions under the Purchase
Agreement. The proceeds that must be received by the Company in
the Rights Offering will be equal to the difference between
$399 million and the sum of (1) the cash contributed
as common equity to Covanta by the Company from its unrestricted
cash, and (2) not more than $25 million of cash from
Covanta.
The Company estimates that there will be approximately
$45 million in aggregate transaction expenses (including
customary underwriting and commitment fees relating to the
financing).
Immediately upon closing of the acquisition, Ref-Fuel will
become a wholly-owned subsidiary of Covanta, and Covanta will
control the management and operations of the Ref-Fuel
facilities. The current project and other debt of Ref-Fuel
subsidiaries will be unaffected by the acquisition, except that
the revolving credit and letter of credit facility of Ref-Fuel
Company LLC (the direct parent of each Ref-Fuel project company)
will be cancelled and replaced with new facilities at the
Covanta level. For additional information concerning the
combined capital structure of Covanta and Ref-Fuel following the
acquisition, see Par II, Item 7, Management’s
Discussion and Analysis of Financial Condition and Results of
Operation.
There can be no assurance that Danielson will be able to
complete the acquisition of Ref-Fuel.
A-67
Table of Contents
SCHEDULE I
DANIELSON HOLDING CORPORATION
CONDENSED STATEMENT OF OPERATIONS
PARENT COMPANY ONLY
| For the Year Ended | |||||||||||||
| December, 31 | December 31, | December 27, | |||||||||||
| 2004 | 2003 | 2002 | |||||||||||
| (Dollars in thousands) | |||||||||||||
|
Operating revenues
|
|||||||||||||
|
Net investment income
|
$ | 233 | $ | 344 | $ | 826 | |||||||
|
Net realized investment gains
|
252 | 1,090 | 438 | ||||||||||
|
Parent company investment income related to ACL debt
|
— | — | 8,402 | ||||||||||
|
Total operating revenues
|
485 | 1,434 | 9,666 | ||||||||||
|
Operating expenses
|
|||||||||||||
|
Employee compensation and benefits
|
306 | 611 | 2,828 | ||||||||||
|
Director fees
|
99 | 163 | 248 | ||||||||||
|
Professional fees
|
1,664 | 1,044 | 567 | ||||||||||
|
Insurance expense
|
296 | 978 | 778 | ||||||||||
|
Intercompany interest expense
|
— | — | 237 | ||||||||||
|
Other general and administrative expenses
|
152 | 1,372 | 787 | ||||||||||
|
Total parent company administrative expenses
|
2,517 | 4,168 | 5,445 | ||||||||||
|
Operating (loss) income before income taxes
|
(2,032 | ) | (2,734 | ) | 4,221 | ||||||||
|
Interest expense
|
(9,033 | ) | (1,424 | ) | — | ||||||||
|
Income tax benefit
|
13,273 | 1 | 77 | ||||||||||
|
Net income (loss) before equity in net income (loss) of
subsidiaries
|
2,208 | (4,157 | ) | 4,298 | |||||||||
|
Equity in net income of Energy Services subsidiaries including
Covanta Lake
|
33,276 | — | — | ||||||||||
|
Equity in net loss of Insurance Services subsidiaries excluding
gain on ACL bonds
|
(879 | ) | (10,191 | ) | (15,432 | ) | |||||||
|
Insurance subsidiary gain on ACL bonds
|
— | — | 5,212 | ||||||||||
|
Equity in net income of Marine Services subsidiaries net of
impairments of equity method investees
|
(511 | ) | (54,877 | ) | (27,033 | ) | |||||||
|
Total equity in net income (loss) of subsidiaries
|
31,886 | (65,068 | ) | (37,253 | ) | ||||||||
|
Net income (loss)
|
$ | 34,094 | $ | (69,225 | ) | $ | (32,955 | ) | |||||
|
Parent company expenses from above
|
$ | 2,517 | $ | 4,168 | $ | 5,445 | |||||||
|
Elimination of amortization of unearned compensation
|
— | (297 | ) | ||||||||||
|
Intercompany interest expense — NAICC
|
— | — | (237 | ) | |||||||||
|
Parent company expenses report on Consolidated Statement of
Operations
|
$ | 2,517 | $ | 4,168 | $ | 4,911 | |||||||
A-68
Table of Contents
SCHEDULE I — Continued
DANIELSON HOLDING CORPORATION
CONDENSED STATEMENT OF FINANCIAL POSITION
PARENT COMPANY ONLY
| December 31, | December 31, | ||||||||||
| 2004 | 2003 | ||||||||||
| (Dollars in thousands) | |||||||||||
| ASSETS | |||||||||||
|
Cash
|
$ | 12,912 | $ | 3,529 | |||||||
|
Restricted cash, Covanta escrow
|
— | 37,026 | |||||||||
|
Fixed maturities, available for sale at fair value (cost: $3,300
and $453)
|
3,300 | 488 | |||||||||
|
Total cash and investments
|
16,212 | 41,043 | |||||||||
|
Investment in Energy Services subsidiaries
|
81,765 | — | |||||||||
|
Investment in Insurance Services subsidiaries
|
16,842 | 17,314 | |||||||||
|
Investment in Marine Services subsidiaries
|
2,500 | 4,425 | |||||||||
|
Accrued investment income
|
6 | 45 | |||||||||
|
Intercompany receivable
|
2,016 | — | |||||||||
|
Deferred financing costs (net of amortization $1,024)
|
— | 6,145 | |||||||||
|
Deferred tax asset
|
18,042 | — | |||||||||
|
Other assets
|
2,600 | 978 | |||||||||
|
Total assets
|
$ | 139,983 | $ | 69,950 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
|
Liabilities:
|
|||||||||||
|
Interest payable
|
$ | — | $ | 400 | |||||||
|
Income taxes payable
|
3,421 | — | |||||||||
|
Debt payable to related parties
|
— | 40,000 | |||||||||
|
Other liabilities
|
1,747 | 1,759 | |||||||||
|
Total liabilities
|
5,168 | 42,159 | |||||||||
|
Stockholders’ equity:
|
|||||||||||
|
Preferred stock ($0.10 par value; authorized
10,000 shares; none issued and outstanding)
|
— | — | |||||||||
|
Common stock ($0.10 par value; authorized
150,000 shares; issued 73,441 shares and
35,793 shares; outstanding 73,430 shares and
35,782 shares)
|
7,344 | 3,579 | |||||||||
|
Additional paid-in capital
|
194,783 | 123,446 | |||||||||
|
Unearned compensation
|
(3,489 | ) | (289 | ) | |||||||
|
Accumulated other comprehensive loss
|
583 | (445 | ) | ||||||||
|
Accumulated deficit
|
(64,340 | ) | (98,434 | ) | |||||||
|
Treasury stock (cost of 11 shares)
|
(66 | ) | (66 | ) | |||||||
|
Total stockholders’ equity
|
134,815 | 27,791 | |||||||||
|
Total liabilities and stockholders’ equity
|
$ | 139,983 | $ | 69,950 | |||||||
A-69
Table of Contents
SCHEDULE I — Continued
DANIELSON HOLDING CORPORATION
CONDENSED STATEMENT CASH FLOWS
PARENT COMPANY ONLY
| For the Year Ended | |||||||||||||||
| December, 31 | December 31, | December 27, | |||||||||||||
| 2004 | 2003 | 2002 | |||||||||||||
| (Dollars in thousands) | |||||||||||||||
|
Operating activities
|
|||||||||||||||
|
Net loss
|
$ | 34,094 | $ | (69,225 | ) | $ | (32,955 | ) | |||||||
|
Adjustments to reconcile net loss to net cash provided by (used
in) operating activities:
|
|||||||||||||||
|
Gain related to ACL debt contributed in acquisition of ACL
|
— | — | (8,402 | ) | |||||||||||
|
Net realized gain on the sale of investment securities
|
(159 | ) | (1,090 | ) | (438 | ) | |||||||||
|
Depreciation and amortization
|
— | 36 | 95 | ||||||||||||
|
Amortization of deferred financing costs
|
7,045 | 1,024 | — | ||||||||||||
|
Change in accrued investment income
|
39 | 18 | 3 | ||||||||||||
|
Stock option and unearned compensation expense
|
1,425 | 521 | 920 | ||||||||||||
|
Interest payable
|
(400 | ) | — | — | |||||||||||
|
Deferred tax asset
|
(16,693 | ) | — | — | |||||||||||
|
Receivable from Energy Services
|
(2,016 | ) | — | — | |||||||||||
|
Equity in net income of Energy Services subsidiaries
|
(33,276 | ) | — | — | |||||||||||
|
Equity in net loss of Marine Services subsidiaries
|
511 | 44,898 | 27,033 | ||||||||||||
|
Equity in net loss of Insurance Services subsidiaries
|
879 | 20,198 | 10,220 | ||||||||||||
|
Other operating activities
|
— | — | 289 | ||||||||||||
|
Changes in other assets and liabilities:
|
|||||||||||||||
|
Other assets
|
(1,723 | ) | 1,730 | (1,413 | ) | ||||||||||
|
Other liabilities
|
3,224 | 1,926 | (195 | ) | |||||||||||
|
Net cash provided by (used in) operating activities
|
(7,050 | ) | 36 | (4,843 | ) | ||||||||||
|
Investing activities
|
|||||||||||||||
|
Collection of note receivable from affiliate
|
— | 6,035 | — | ||||||||||||
|
Distribution received from unconsolidated Marine Services
subsidiary
|
— | 58 | — | ||||||||||||
|
Purchase of Energy and Marine Services
|
(36,400 | ) | — | (42,665 | ) | ||||||||||
|
Proceeds from sale of GMS
|
1,512 | — | — | ||||||||||||
|
Proceeds from the sale of investment securities
|
612 | 4,110 | 1,100 | ||||||||||||
|
Restricted cash, Covanta escrow
|
37,026 | (37,026 | ) | — | |||||||||||
|
Purchase of investment securities, net
|
(3,300 | ) | — | (2,163 | ) | ||||||||||
|
Other investing activities, net
|
— | (978 | ) | (6,035 | ) | ||||||||||
|
Capital contributions to NAICC
|
— | (6,000 | ) | — | |||||||||||
|
Net cash used in investing activities
|
(550 | ) | (33,801 | ) | (49,763 | ) | |||||||||
|
Financing activities
|
|||||||||||||||
|
Repayment of debt from NAICC
|
— | (4,000 | ) | — | |||||||||||
|
Borrowings under Bridge Financing
|
— | 40,000 | — | ||||||||||||
|
Parent company debt issue costs
|
(900 | ) | — | — | |||||||||||
|
Repayment of Bridge Financing
|
(26,612 | ) | — | — | |||||||||||
|
Proceeds from Rights Offering, net of expenses
|
41,021 | — | 42,228 | ||||||||||||
|
Proceeds from exercise of warrants and options for common stock
|
3,474 | — | 10,588 | ||||||||||||
|
Cash received from restricted stock
|
— | 14 | — | ||||||||||||
|
Net cash provided by financing activities
|
16,983 | 36,014 | 52,816 | ||||||||||||
|
Net increase (decrease) in cash and cash equivalents
|
9,383 | 2,249 | (1,790 | ) | |||||||||||
|
Cash and cash equivalents at beginning of year
|
3,529 | 1,280 | 3,070 | ||||||||||||
|
Cash and cash equivalents at end of year
|
$ | 12,912 | 3,529 | 1,280 | |||||||||||
A-70
Table of Contents
Schedule II — Valuation and Qualifying
Accounts
Receivables Valuation and Qualifying Accounts
| Additions | |||||||||||||||||||||
| Balance at | Charged to | Charged to | Balance At | ||||||||||||||||||
| Beginning | Costs and | Other | End of | ||||||||||||||||||
| of Period | Expense | Accounts | Deductions | Period | |||||||||||||||||
| (Dollars in thousands) | |||||||||||||||||||||
|
INSURANCE SERVICES
|
|||||||||||||||||||||
|
Allowance for premiums and fees receivable
|
|||||||||||||||||||||
|
2004
|
$ | 462 | $ | (40 | ) | $ | — | $ | (294 | ) | $ | 128 | |||||||||
|
2003
|
1,623 | 228 | — | (1,389 | ) | 462 | |||||||||||||||
|
2002
|
1,431 | 734 | — | (542 | ) | 1,623 | |||||||||||||||
|
Allowance for uncollectible reinsurance on paid losses
|
|||||||||||||||||||||
|
2004
|
$ | 1,328 | $ | (103 | ) | $ | — | $ | (332 | ) | $ | 893 | |||||||||
|
2003
|
— | 1,328 | — | — | 1,328 | ||||||||||||||||
|
2002
|
— | — | — | — | — | ||||||||||||||||
|
Allowance for uncollectible reinsurance on unpaid losses
|
|||||||||||||||||||||
|
2004
|
$ | 176 | $ | 60 | $ | — | $ | — | $ | 236 | |||||||||||
|
2003
|
116 | 60 | — | — | 176 | ||||||||||||||||
|
2002
|
20 | 96 | — | — | 116 | ||||||||||||||||
|
ENERGY SERVICES
|
|||||||||||||||||||||
|
March 11, through December 31, 2004
|
|||||||||||||||||||||
|
Allowances deducted in the balance sheet from the assets to
which they apply:
|
|||||||||||||||||||||
|
Doubtful receivables — current
|
$ | — | $ | 733 | $ | — | $ | 299 | $ | 434 | |||||||||||
|
Retention receivables — current
|
— | — | — | — | — | ||||||||||||||||
|
Doubtful receivables — non-current
|
— | — | — | (170 | ) | 170 | |||||||||||||||
|
Total
|
$ | — | $ | 733 | $ | — | $ | 129 | $ | 604 | |||||||||||
|
MARINE SERVICES
|
|||||||||||||||||||||
|
Allowance for uncollectible accounts in 2002
|
$ | — | $ | 1,070 | $ | 2,037 | (1) | $ | (761 | ) | $ | 2,346 | |||||||||
| (1) | Acquired with purchase of ACL and GMS |
Deferred Tax Valuation Allowance
| Subtractions | ||||||||||||||||||||
| Credits | ||||||||||||||||||||
| Balance at | (Charges) | Charged to | Balance At | |||||||||||||||||
| Beginning | to Tax | Other | End of | |||||||||||||||||
| of Period | Expense | Accounts | Deductions | Period | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
|
Tax valuation allowance
|
||||||||||||||||||||
|
2004
|
$ | 211,535 | $ | 15,423 | $ | 104,926 | (1) | $ | — | $ | 91,186 | |||||||||
|
2003
|
213,511 | 1,976 | — | — | 211,535 | |||||||||||||||
|
2002
|
260,727 | 49,105 | (1,889 | ) | — | 213,511 | ||||||||||||||
| (1) | Primarily attributable to purchase accounting adjustments related to the Covanta acquisition. |
A-71
Table of Contents
Schedule V — Supplemental Information
Concerning Property–Casualty Insurance Operations
| Reserves for | Discount | ||||||||||||||||||||||||||||
| Unpaid Claims | from | Other Policy | |||||||||||||||||||||||||||
| Deferred | and Claim | Reserves | Claims and | Net | |||||||||||||||||||||||||
| Acquisition | Adjustment | for Unpaid | Unearned | Benefits | Earned | Investment | |||||||||||||||||||||||
| Affiliation with Registrant | Costs | Expenses | Claims | Premiums | Payable | Premiums | Income | ||||||||||||||||||||||
|
Consolidated Property–Casualty Entities:
|
|||||||||||||||||||||||||||||
|
As of and for the year ended 12/31/2004
|
$ | 256 | $ | 64,270 | $ | — | $ | 1,254 | $ | — | $ | 17,998 | $ | 2,405 | |||||||||||||||
|
As of and for the year ended 12/31/2003
|
833 | 83,380 | — | 4,595 | — | 35,851 | 3,999 | ||||||||||||||||||||||
|
As of and for the year ended 12/31/2002
|
1,612 | 101,249 | — | 10,622 | — | 62,164 | 5,603 | ||||||||||||||||||||||
| Claims and Claim | |||||||||||||||||||||||||
| Adjustment Expenses | Amortization | Paid Claims | |||||||||||||||||||||||
| Incurred Related to | of Deferred | Other | and Claim | Net | |||||||||||||||||||||
| Acquisition | Operating | Adjustment | Written | ||||||||||||||||||||||
| Affiliation with Registrant | Current Year | Prior Years | Costs | Expenses | Expenses | Premiums | |||||||||||||||||||
|
Consolidated Property–Casualty Entities:
|
|||||||||||||||||||||||||
|
As of and for the year ended 12/31/2004
|
$ | 10,343 | $ | 2,518 | $ | 4,255 | $ | 165 | $ | 31,775 | $ | 15,165 | |||||||||||||
|
As of and for the year ended 12/31/2003
|
23,199 | 13,485 | 6,610 | 1,337 | 50,734 | 30,408 | |||||||||||||||||||
|
As of and for the year ended 12/31/2002
|
49,474 | 10,407 | 11,437 | 2,678 | 68,701 | 52,655 | |||||||||||||||||||
A-72
Table of Contents
Quezon Power,
Inc.
Consolidated Financial Statements
December 31, 2004 and 2003
and the Years Ended
December 31, 2004, 2003 and 2002
(In United States Dollars)
and
Report of Independent Auditors
A-73
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Management Committee of Quezon Power, Inc.
We have audited the accompanying consolidated balance sheets of
Quezon Power, Inc. (incorporated in the Cayman Islands, British
West Indies) and subsidiary as of December 31, 2004 and
2003, and the related consolidated statements of operations,
changes in stockholders’ equity and cash flows for each of
the three years ended December 31, 2004. These financial
statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
financial statements 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. We were not engaged to perform an
audit of the Company’s internal control over financial
reporting. Our audits included consideration of internal control
over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of
the Company’s internal control over financial reporting.
Accordingly, we express no such opinion. 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 financial position
of Quezon Power, Inc. and subsidiary as of December 31,
2004 and 2003, and the results of their operations and their
cash flows for each of the three years ended December 31, 2004
in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial
statements, the Company changed its method of accounting for
asset retirement obligation in 2003.
| /s/ Sycip Gorres Velayo & Co. | |
| A Member Practice of Ernst & Young Global | |
Makati City, Philippines
February 14, 2005
A-74
Table of Contents
QUEZON POWER, INC.
CONSOLIDATED BALANCE SHEETS
| December 31 | ||||||||||
| 2004 | 2003 | |||||||||
| ASSETS | ||||||||||
|
Current Assets
|
||||||||||
|
Cash
|
$ | 39,404,181 | $ | 92,034,651 | ||||||
|
Accounts receivable — net of allowance for bad debts
of $8,485,146 in 2004 and $7,908,586 in 2003 (Note 8)
|
33,283,177 | 30,219,419 | ||||||||
|
Fuel inventories
|
7,740,902 | 2,813,418 | ||||||||
|
Spare parts
|
11,997,603 | 7,862,712 | ||||||||
|
Due from affiliated companies (Note 6)
|
697,470 | 671,632 | ||||||||
|
Prepaid expenses and other current assets
|
7,016,139 | 5,993,842 | ||||||||
|
Total Current Assets
|
100,139,472 | 139,595,674 | ||||||||
|
Property, Plant and Equipment — net (Notes 3, 5
and 8)
|
685,735,745 | 701,661,466 | ||||||||
|
Deferred Financing Costs — net (Note 5)
|
27,376,966 | 33,739,900 | ||||||||
|
Deferred Income Taxes (Note 4)
|
9,340,567 | 9,805,585 | ||||||||
|
Prepaid Input Value-Added Taxes — net
|
9,611,838 | 6,025,658 | ||||||||
| $ | 832,204,588 | $ | 890,828,283 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||
|
Current Liabilities
|
||||||||||
|
Accounts payable and accrued expenses (Note 8)
|
$ | 38,331,623 | $ | 27,866,072 | ||||||
|
Due to affiliated companies (Note 6)
|
352,462 | 2,315,331 | ||||||||
|
Current portion of (Note 5):
|
||||||||||
|
Long-term loans payable
|
40,002,310 | 38,598,480 | ||||||||
|
Bonds payable
|
6,450,000 | 6,450,000 | ||||||||
|
Income taxes payable
|
70,824 | 54,465 | ||||||||
|
Total Current Liabilities
|
85,207,219 | 75,284,348 | ||||||||
|
Long-term Loans Payable — net of current portion
(Note 5)
|
256,752,703 | 296,755,016 | ||||||||
|
Bonds Payable — net of current portion (Note 5)
|
190,275,000 | 196,725,000 | ||||||||
|
Asset Retirement Obligation (Note 2)
|
3,481,098 | 3,298,498 | ||||||||
|
Minority Interest
|
6,371,565 | 6,626,965 | ||||||||
|
Stockholders’ Equity (Note 7)
|
290,117,003 | 312,138,456 | ||||||||
| $ | 832,204,588 | $ | 890,828,283 | |||||||
See accompanying Notes to Consolidated Financial
Statements.
A-75
Table of Contents
QUEZON POWER, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
| Years Ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
|
OPERATING REVENUES(Note 8)
|
$ | 214,865,088 | $ | 217,869,232 | $ | 208,132,957 | ||||||
|
OPERATING EXPENSES
|
||||||||||||
|
Fuel costs
|
40,822,798 | 36,002,310 | 35,800,748 | |||||||||
|
Operations and maintenance
|
36,770,262 | 29,479,164 | 35,559,352 | |||||||||
|
Depreciation and amortization
|
19,263,376 | 18,776,557 | 18,750,151 | |||||||||
|
General and administrative
|
16,768,912 | 18,095,761 | 15,414,227 | |||||||||
| 113,625,348 | 102,353,792 | 105,524,478 | ||||||||||
|
INCOME FROM OPERATIONS
|
101,239,740 | 115,515,440 | 102,608,479 | |||||||||
|
OTHER INCOME (CHARGES)
|
||||||||||||
|
Interest income
|
731,751 | 702,954 | 937,337 | |||||||||
|
Foreign exchange gain — net
|
105,899 | 94,789 | 384,772 | |||||||||
|
Interest expense (Note 5)
|
(39,502,726 | ) | (42,321,405 | ) | (45,180,633 | ) | ||||||
|
Amortization of deferred financing costs
|
(6,362,934 | ) | (6,995,001 | ) | (7,705,161 | ) | ||||||
|
Other income (charges) — net (Note 5)
|
(409,779 | ) | (281,928 | ) | 3,903,685 | |||||||
| (45,437,789 | ) | (48,800,591 | ) | (47,660,000 | ) | |||||||
|
INCOME BEFORE INCOME TAX, MINORITY INTEREST AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
|
55,801,951 | 66,714,849 | 54,948,479 | |||||||||
|
BENEFIT FROM (PROVISION FOR) INCOME TAX (Note 4)
|
||||||||||||
|
Current
|
(216,786 | ) | (220,889 | ) | — | |||||||
|
Deferred
|
(465,018 | ) | 2,005,684 | 2,864,359 | ||||||||
| (681,804 | ) | 1,784,795 | 2,864,359 | |||||||||
|
INCOME BEFORE MINORITY INTEREST AND CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE
|
55,120,147 | 68,499,644 | 57,812,838 | |||||||||
|
MINORITY INTEREST
|
(1,292,540 | ) | (1,606,129 | ) | (1,355,518 | ) | ||||||
|
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE
|
53,827,607 | 66,893,515 | 56,457,320 | |||||||||
|
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE — net of benefit from income
tax — deferred, branch profits remittance tax and
minority interest amounting to $166,657, $52,060 and $7,083,
respectively (Note 2)
|
— | (295,004 | ) | — | ||||||||
|
NET INCOME
|
$ | 53,827,607 | $ | 66,598,511 | $ | 56,457,320 | ||||||
See accompanying Notes to Consolidated Financial Statements.
A-76
Table of Contents
QUEZON POWER, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Years Ended December 31 | |||||||||||||||
| 2004 | 2003 | 2002 | |||||||||||||
|
CASH FLOWS FROM OPERATING ACTIVITIES
|
|||||||||||||||
|
Net income
|
$ | 53,827,607 | $ | 66,598,511 | $ | 56,457,320 | |||||||||
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|||||||||||||||
|
Depreciation and amortization
|
19,263,376 | 18,776,557 | 18,750,151 | ||||||||||||
|
Amortization of deferred financing costs
|
6,362,934 | 6,995,001 | 7,705,161 | ||||||||||||
|
Minority interest
|
1,292,540 | 1,606,129 | 1,355,518 | ||||||||||||
|
Deferred income taxes
|
465,018 | (2,005,684 | ) | (2,864,359 | ) | ||||||||||
|
Accretion on asset retirement obligation
|
182,600 | 167,508 | — | ||||||||||||
|
Unrealized foreign exchange loss (gain) — net
|
(182,117 | ) | 88,480 | (317,254 | ) | ||||||||||
|
Cumulative effect of change in accounting principle
|
— | 295,004 | — | ||||||||||||
|
Gain on sale of property, plant and equipment
|
— | (16,793 | ) | — | |||||||||||
|
Noncash gain from reversal of inventory allowance
|
— | — | (1,130,000 | ) | |||||||||||
|
Changes in operating assets and liabilities:
|
|||||||||||||||
|
Decrease (increase) in:
|
|||||||||||||||
|
Accounts receivable
|
(3,233,753 | ) | (4,319,426 | ) | (4,549,548 | ) | |||||||||
|
Fuel inventories
|
(4,927,484 | ) | 3,860,655 | 3,858,559 | |||||||||||
|
Spare parts
|
(4,134,891 | ) | (615,794 | ) | (836,189 | ) | |||||||||
|
Prepaid expenses and other current assets
|
(1,275,504 | ) | 2,230 | (281,766 | ) | ||||||||||
|
Prepaid input value-added taxes
|
(3,586,180 | ) | (2,577,989 | ) | (2,506,902 | ) | |||||||||
|
Increase in:
|
|||||||||||||||
|
Accounts payable and accrued expenses
|
10,996,927 | 2,716,764 | 13,214,673 | ||||||||||||
|
Income taxes payable
|
16,359 | 54,465 | — | ||||||||||||
|
Net cash from operating activities
|
75,067,432 | 91,625,618 | 88,855,364 | ||||||||||||
|
CASH FLOWS FROM INVESTING ACTIVITIES
|
|||||||||||||||
|
Additions to property, plant and equipment
|
(3,337,655 | ) | (1,124,883 | ) | (933,912 | ) | |||||||||
|
Proceeds from sale of property, plant and equipment
|
— | 16,806 | — | ||||||||||||
|
Net cash used in investing activities
|
(3,337,655 | ) | (1,108,077 | ) | (933,912 | ) | |||||||||
|
CASH FLOWS FROM FINANCING ACTIVITIES
|
|||||||||||||||
|
Cash dividends
|
(75,849,060 | ) | (20,658,400 | ) | (26,789,000 | ) | |||||||||
|
Payments of:
|
|||||||||||||||
|
Term loan
|
(35,389,726 | ) | (35,389,726 | ) | (35,389,726 | ) | |||||||||
|
Bonds payable
|
(6,450,000 | ) | (5,375,000 | ) | (4,300,000 | ) | |||||||||
|
Long-term loans payable
|
(3,208,757 | ) | (2,206,018 | ) | (601,642 | ) | |||||||||
|
Net changes in accounts with affiliated companies
|
(1,979,103 | ) | 1,298,863 | 1,459,967 | |||||||||||
|
Minority interest
|
(1,547,940 | ) | (496,000 | ) | (660,000 | ) | |||||||||
|
Net cash used in financing activities
|
(124,424,586 | ) | (62 ,826,281 | ) | (66,280,401 | ) | |||||||||
|
EFFECT OF EXCHANGE RATE CHANGES ON CASH
|
64,339 | 30,916 | 71,672 | ||||||||||||
|
NET INCREASE (DECREASE) IN CASH
|
(52,630,470 | ) | 27,722,176 | 21,712,723 | |||||||||||
|
CASH AT BEGINNING OF YEAR
|
92,034,651 | 64,312,475 | 42,599,752 | ||||||||||||
|
CASH AT END OF YEAR
|
39,404,181 | $ | 92,034,651 | $ | 64,312,475 | ||||||||||
|
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
|
|||||||||||||||
|
Cash paid during the year for:
|
|||||||||||||||
|
Interest
|
39,694,095 | $ | 40,819,139 | $ | 43,585,195 | ||||||||||
|
Income taxes
|
200,427 | 166,424 | — | ||||||||||||
|
Noncash investing and financing activity:
|
|||||||||||||||
|
Recognition of asset retirement obligation
|
— | 2,747,564 | — | ||||||||||||
See accompanying Notes to Consolidated Financial
Statements.
A-77
Table of Contents
QUEZON POWER, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’
EQUITY
For the Years Ended December 31, 2004, 2003 and 2002
| Additional | ||||||||||||||||
| Capital Stock | Paid-in | Retained | ||||||||||||||
| (Note 7) | Capital | Earnings | Total | |||||||||||||
|
Balance at December 31, 2001
|
$ | 1,001 | $ | 207,641,266 | $ | 28,887,758 | $ | 236,530,025 | ||||||||
|
Cash dividends
|
— | — | (26,789,000 | ) | (26,789,000 | ) | ||||||||||
|
Net income for the year
|
— | — | 56,457,320 | 56,457,320 | ||||||||||||
|
Balance at December 31, 2002
|
1,001 | 207,641,266 | 58,556,078 | 266,198,345 | ||||||||||||
|
Cash dividends
|
— | — | (20,658,400 | ) | (20,658,400 | ) | ||||||||||
|
Net income for the year
|
— | — | 66,598,511 | 66,598,511 | ||||||||||||
|
Balance at December 31, 2003
|
1,001 | 207,641,266 | 104,496,189 | 312,138,456 | ||||||||||||
|
Cash dividends
|
— | — | (75,849,060 | ) | (75,849,060 | ) | ||||||||||
|
Net income for the year
|
— | — | 53,827,607 | 53,827,607 | ||||||||||||
|
Balance at December 31, 2004
|
$ | 1,001 | $ | 207,641,266 | $ | 82,474,736 | $ | 290,117,003 | ||||||||
See accompanying Notes to Consolidated Financial
Statements.
A-78
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 1. | Organization and Business |
(a) Organization
Quezon Power, Inc. (the Company; formerly Ogden Quezon Power,
Inc.), an exempted company with limited liability, was
incorporated in the Cayman Islands, British West Indies on
August 4, 1995 primarily: (i) to be a promoter, a
general or limited partner, member, associate, or manager of any
general or limited partnership, joint venture, trust or other
entity, whether established in the Republic of the Philippines
or elsewhere and (ii) to engage in the business of power
generation and transmission and in any development or other
activity related thereto; provided that the Company shall only
carry on the business for which a license is required under the
laws of the Cayman Islands when so licensed under the terms of
such laws. The Philippine Branch (the Branch) was registered
with the Philippine Securities and Exchange Commission on
March 15, 1996 to carry out the Company’s business in
the Republic of the Philippines to the extent allowed by law
including, but not limited to, developing, designing and
arranging financing for a 470-megawatt (net) base load
pulverized coal-fired power plant and related electricity
transmission line (the Project) located in Quezon Province,
Republic of the Philippines. In addition, the Branch is
responsible for the organization and is the sole general partner
of Quezon Power (Philippines), Limited Co. (the Partnership), a
limited partnership in the Philippines. The Partnership is
responsible for financing, constructing, owning and operating
the Project.
The Branch is the legal and beneficial owner of (i) the
entire general partnership interest in the Partnership
representing 21% of the economic interest in the Partnership and
(ii) a limited partnership interest representing 77% of the
economic interest in the Partnership. The remaining 2% economic
interest in the Partnership is in the form of a limited
partnership interest held by PMR Limited Co. (PMRL). The
accompanying financial statements include the consolidated
results of the Company and the Partnership.
Ultimately, 100% of the aggregate capital contributions of the
Company to the Partnership were indirectly made by Quezon
Generating Company, Ltd. (QGC), a Cayman Islands limited
liability company, and Covanta Power Development —
Cayman, Inc. (CPD; formerly Ogden Power Development —
Cayman, Inc.), an indirect wholly owned subsidiary of Covanta
Energy Group, Inc. (formerly Ogden Energy Group, Inc.), a
Delaware corporation. The shareholders of QGC are QGC Holdings,
Ltd. and Global Power Investment, L.P. (GPI), both Cayman
Islands companies. QGC Holdings, Ltd. is a wholly owned
subsidiary of InterGen N.V. (formerly InterGen), a joint venture
between Bechtel Enterprises, Inc. (Bechtel) and Shell Generating
Limited (Shell). The ultimate economic ownership percentages
among QGC, CPD and PMRL in the Partnership are 71.875%, 26.125%
and 2%, respectively.
The equity commitment of the Company, up to $207.7 million,
was made pursuant to an equity contribution agreement and is
supported by letters of credit provided by ABN AMRO. These
letters of credit were obtained with the financial backing of
InterGen N.V. and Covanta Corporation (formerly Ogden
Corporation). PMRL does not have any equity funding obligation.
| (b) Allocation of Earnings |
Each item of income and loss of the Partnership for each fiscal
year (or portion thereof) shall be allocated 21% to the Company,
as a general partner; 77% to the Company, as a limited partner;
and 2% to PMRL, as a limited partner.
| (c) The Project |
The Project is a 470-megawatt (net) base load pulverized
coal-fired electricity generation facility and related
transmission line. The Project receives substantially all of its
revenue from a 25-year take-or-pay Power Purchase Agreement
(PPA) and a Transmission Line Agreement (TLA) with the Manila
Electric Company (Meralco). Construction of the Project
commenced in December 1996 and the Project started commercial
operations on May 30, 2000. The total cost of the Project
was $895.4 million.
A-79
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| (d) Principal Business Risks |
The principal risks associated with the Project include
operating risks, dependence on one customer (Meralco),
environmental matters, permits, political and economic factors
and fluctuations in currency.
The risks associated with operating the Project include the
breakdown or failure of equipment or processes and the
performance of the Project below expected levels of output or
efficiency due to operator fault and/or equipment failure.
Meralco is subject to regulation by the Energy Regulatory
Commission (ERC) with respect to sales charged to consumers. In
addition, pursuant to the Philippine Constitution, the
Philippine government at any time may purchase Meralco’s
property upon payment of just compensation. If the Philippine
government were to purchase Meralco’s property or the ERC
ordered any substantial disallowance of costs, Meralco would
remain obligated under the PPA to make the firm payments to the
Partnership. Such purchase or disallowance, however, could
result in Meralco being unable to fulfill its obligations under
the PPA, which would have material adverse effect on the ability
of the Partnership to meet its obligations under the credit
facilities [see Notes 5, 8(a), 8(b) and 10(f)].
| 2. | Summary of Significant Accounting Policies |
| Basis of Presentation |
The consolidated financial statements of the Company include the
financial position and results of operations of the Partnership
and have been prepared in conformity with accounting principles
generally accepted in the United States (U.S.).
| Principles of Consolidation |
The consolidated financial statements include the accounts of
the Company and the Partnership, a 98%-owned and controlled
limited partnership. All significant intercompany transactions
have been eliminated.
| Use of Estimates |
The preparation of financial statements in conformity with
accounting principles generally accepted in the
U.S. requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could
differ from those estimates.
| Inventories |
Fuel inventories and spare parts are valued at the lower of cost
or market value, net of any provision for inventory losses. Cost
is determined using the moving average cost method.
| Property, Plant and Equipment |
Property, plant and equipment are carried at cost less
accumulated depreciation and amortization. Cost includes the
fair value of asset retirement obligation, capitalized interest
and amortized deferred financing costs incurred in connection
with the construction of the Project. Capitalization of interest
and amortization of deferred financing costs ceased upon
completion of the Project.
A-80
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of the
assets. The estimated useful lives of the assets are as follows:
| Category | Number of Years | |||
|
Power plant
|
50 | |||
|
Transmission lines
|
25 | |||
|
Others
|
3 to 5 | |||
The cost of routine maintenance and repairs is charged to income
as incurred; significant renewals and betterments are
capitalized. When assets are retired or otherwise disposed of,
both the cost and related accumulated depreciation and
amortization are removed from the accounts and any resulting
gain or loss is credited or charged to current operations.
| Deferred Financing Costs |
Deferred financing costs represent the costs incurred to obtain
project financing and are amortized, using the effective
interest rate method, over the lives of the related loans.
| Derivative Instruments and Hedging Activities |
The Company accounts for derivative instruments and hedging
activities under Statement of Financial Accounting Standards
(SFAS) No. 133 (subsequently amended by
SFAS No. 138 and No. 149), Accounting for
Derivative Instruments and Hedging Activities. This
statement, as amended, establishes certain accounting and
reporting standards requiring all derivative instruments to be
recorded as either assets or liabilities measured at fair value.
Changes in derivative fair values are recognized currently in
earnings unless specific hedge accounting criteria are met.
Special accounting treatment for qualifying hedges allows a
derivative’s gains and losses to offset related results on
the hedged item in the statement of operations and requires the
Company to formally document, designate and assess the
effectiveness of transactions that receive hedge accounting. The
Company periodically reviews its existing contracts to determine
the existence of any embedded derivatives. As of
December 31, 2004, there are no significant embedded
derivatives that exist.
| Prepaid Input Value-Added Taxes |
Prepaid input value-added taxes (VAT) represent VAT imposed
on the Partnership by its suppliers for the acquisition of goods
and services required under Philippine taxation laws and
regulations.
The input VAT is recognized as an asset and will be used to
offset the Partnership’s current VAT liabilities [see
Note 10(a)] and any excess will be claimed as tax credits.
Input taxes are stated at their estimated net realizable values.
| Revenue Recognition |
Revenue is recognized when electric capacity and energy is
delivered to Meralco [see Note 8(a)]. Commencing on the
Commercial Operations Date and continuing throughout the term of
the PPA, the Partnership receives payment, net of penalty
obligation for each kilowatt hour (kWh) of shortfall deliveries,
consisting of a Monthly Capacity Payment, Monthly Operating
Payment and Monthly Energy Payment as defined in the PPA.
Revenue from transmission lines consists of Capital Cost
Recovery Payment (CCRP) and the Transmission Line Monthly
Operating Payment as defined in the TLA. Transmission Line
Monthly Operating Payment is recognized as revenue in the period
it is intended for.
A-81
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Income Taxes |
The Partnership is registered with the Philippine Board of
Investments as a pioneer enterprise under a statutory scheme
designed to promote investments in certain industries (including
power generation). As such, the Partnership benefits from a
six-year income tax holiday starting on January 1, 2000.
During 2004, the Partnership was able to move the effective date
of its income tax holiday period to May 30, 2000,
coinciding with the start of commercial operations. Under
Philippine taxation laws, a corporate tax rate of 32% is levied
against Philippine taxable income. Net operating losses, on the
other hand, can be carried forward for three immediately
succeeding years.
The Partnership accounts for corporate income taxes in
accordance with SFAS No. 109, Accounting for Income
Taxes, which requires an asset and liability approach in
determining income tax liabilities. The standard recognizes
deferred tax assets and liabilities for the future tax
consequences attributable to differences between the financial
reporting bases of assets and liabilities and their related tax
bases. Deferred tax assets and liabilities are measured using
the tax rates expected to apply to taxable income in the years
in which those temporary differences are expected to be
recovered or settled. Deferred tax assets and deferred tax
liabilities that will reverse during the income tax holiday
period are not recognized.
The Company is not subject to income taxes as a result of the
Company’s being incorporated in the Cayman Islands.
However, the Philippine branch profit remittance tax of 15% will
be levied against the total profit applied or earmarked for
remittance by the Branch to the Company.
| Functional Currency |
The functional currency of the Company and the Partnership has
been designated as the U.S. dollar because borrowings under
the credit facilities are made and repaid in U.S. dollars.
In addition, all major agreements are primarily denominated in
U.S. dollars or are U.S. dollar linked. Consequently,
the consolidated financial statements and transactions of the
Company and the Partnership have been recorded in
U.S. dollars.
| Valuation of Long-lived Assets |
Long-lived assets are accounted for in accordance with
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-lived Assets. The Partnership periodically
evaluates its long-lived assets for events or changes in
circumstances that might indicate that the carrying amount of
the assets may not be recoverable. The Partnership assesses the
recoverability of the assets by determining whether the
amortization of such long-lived assets over their estimated
lives can be recovered through projected undiscounted future
cash flows. The amount of impairment, if any, is measured based
on the fair value of the assets. For the years ended
December 31, 2004, 2003 and 2002, no such impairment was
recorded in the accompanying consolidated statements of
operations.
| Asset Retirement Obligation |
Effective January 1, 2003, the Partnership adopted
SFAS No. 143, Accounting for Asset Retirement
Obligations. Previous to this date, the Partnership had not
been recognizing amounts related to asset retirement
obligations. The Partnership recognizes asset retirement
obligations in the period in which they are incurred if a
reasonable estimate of a fair value can be made. In estimating
fair value, the Partnership did not use a market risk premium
since a reliable estimate of the premium is not obtainable given
that the retirement activities will be performed many years into
the future and the Partnership has insufficient information on
how much a third party contractor would charge to assume the
risk that the actual costs will change in the future. The
associated asset retirement costs are capitalized as part of the
carrying amount of the Power plant.
A-82
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The cumulative effect of the change in the years prior to 2003
resulted in a charge to income of $295,004 (net of benefit from
income tax — deferred, branch profits remittance tax
and minority interest amounting to $166,657, $52,060 and $7,083,
respectively), which is included in net income for the year
ended December 31, 2003. The effect of the accounting
change on the year ended December 31, 2003 was to decrease
income before cumulative effect of a change in accounting
principle by $126,010. Assuming the effect of
SFAS No. 143 is applied retroactively, the pro forma
net income for the years ended December 31, 2003 and 2002
is $66,893,515 and $56,336,129, respectively.
On May 30, 2000, the Project started commercial operations.
The Partnership recognized the fair value of decommissioning and
dismantlement cost of the Power plant and the corresponding
liability for asset retirement in 2003. The cost was capitalized
as part of the cost basis of the Power plant and the Partnership
depreciates it on a straight-line basis over 50 years.
The following table describes all changes to the
Partnership’s asset retirement obligation liability as of
December 31, 2004:
| 2004 | 2003 | |||||||
|
Asset retirement obligation at beginning of year
|
$ | 3,298,498 | $ | — | ||||
|
Liability recognized in transition
|
— | 3,130,990 | ||||||
|
Accretion expense for the year
|
182,600 | 167,508 | ||||||
|
Asset retirement obligation at end of year
|
$ | 3,481,098 | $ | 3,298,498 | ||||
No payments of asset retirement obligation were made in 2004 and
2003. Assuming the effect of SFAS No. 143 is applied
retroactively, the pro forma amount of asset retirement
obligation at the beginning of 2003 is $3,130,990.
| Impact of Recently Issued Accounting Standards |
On December 16, 2004, the Financial Accounting Standards
Board (FASB) issued SFAS No. 123 (revised 2004),
Share-Based Payment, which is a revision of
SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS No. 123 (revised 2004)
supersedes Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees,
and amends SFAS No. 95, Statement of Cash
Flows. Generally, the approach in SFAS No. 123
(revised 2004) is similar to the approach described in
SFAS No. 123. However, SFAS No. 123 (revised
2004) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the
consolidated statements of operations based on their fair
values. Pro forma disclosure is no longer an alternative.
SFAS No. 123 (revised 2004) must be adopted no later
than July 1, 2005. Early adoption will be permitted in
periods in which financial statements have not yet been issued.
SFAS No. 123 (revised 2004) permits public companies
to adopt its requirements using one of two methods:
| (a) A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123 (revised 2004) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123 (revised 2004) that remain unvested on the effective date. | |
| (b) A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously | |
A-83
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| recognized under SFAS No. 123 for purposes of pro forma disclosures either (i) all prior periods presented or (ii) prior interim periods of the year of adoption. |
Since the Company and the Partnership have no stock option plan
in existence, they do not expect the adoption of
SFAS No. 123 (revised 2004) to have a material effect
on their results of operations or financial condition.
In November 2004, the FASB issued SFAS No. 151,
Inventory Costs — An Amendment of ARB No. 43,
Chapter 4, Inventory Pricing. SFAS No. 151
amends the guidance in Accounting Research Bulletin
(ARB) No. 43, Chapter 4, Inventory
Pricing, to clarify the accounting for abnormal amounts of
idle facility expense, freight, handling costs and wasted
material (spoilage). Among other provisions, the new rule
requires that items such as idle facility expense, excessive
spoilage, double freight and rehandling costs be recognized as
current-period charges regardless of whether they meet the
criterion of “so abnormal” as stated in ARB
No. 43. Additionally, SFAS No. 151 requires that
the allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production
facilities. SFAS No. 151 is effective for fiscal years
beginning after June 15, 2005. The Company and the
Partnership do not expect the adoption of SFAS No. 151
to have a material effect on their results of operations or
financial condition.
In December 2004, the FASB issued SFAS No. 153,
Exchanges of Nonmonetary Assets — An Amendment of
APB Opinion No. 29, Accounting for Nonmonetary
Transactions. SFAS No. 153 eliminates the
exception from fair value measurement for nonmonetary exchanges
of similar productive assets in paragraph 21(b) of APB
Opinion No. 29, Accounting for Nonmonetary Transactions,
and replaces it with an exception for exchanges that do not
have commercial substance. SFAS No. 153 specifies that
a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as
a result of the exchange. SFAS No. 153 is effective
for the fiscal periods beginning after June 15, 2005. The
Company and the Partnership do not expect the adoption of
SFAS No. 153 to have a material effect on their
results of operations or financial condition.
| 3. | Property, Plant and Equipment |
| 2004 | 2003 | |||||||
|
Power plant
|
$ | 680,241,476 | $ | 676,929,577 | ||||
|
Transmission lines
|
86,593,717 | 86,593,717 | ||||||
|
Furniture and fixtures
|
4,061,433 | 4,035,677 | ||||||
|
Transportation equipment
|
336,602 | 336,602 | ||||||
|
Leasehold improvements
|
184,033 | 184,033 | ||||||
| 771,417,261 | 768,079,606 | |||||||
|
Less accumulated depreciation and amortization
|
85,681,516 | 66,418,140 | ||||||
| $ | 685,735,745 | $ | 701,661,466 | |||||
Approximately $99.0 million of interest on borrowings and
$11.8 million of amortization of deferred financing costs
have been capitalized as part of the cost of property, plant and
equipment and depreciated over the estimated useful life of the
Power plant. No interest on borrowings and amortization of
deferred financing costs were capitalized to property, plant and
equipment in 2004 and 2003 since the Project started commercial
operations on May 30, 2000.
Total depreciation and amortization related to property, plant
and equipment charged to operations amounted to $19,263,376,
$18,776,557 and $18,750,151 in 2004, 2003 and 2002, respectively.
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QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| 4. | Income Taxes |
The significant components of the Company’s deferred tax
assets at December 31, 2004 and 2003 are as follows:
| 2004 | 2003 | ||||||||
|
Noncurrent:
|
|||||||||
|
Deferred financing cost
|
$ | 9,027,394 | $ | 7,376,376 | |||||
|
Capitalized unrealized foreign exchange losses
|
3,081,554 | 2,191,365 | |||||||
|
Asset retirement obligation
|
313,173 | 237,844 | |||||||
| 12,422,121 | 9,805,585 | ||||||||
|
Less valuation allowance
|
3,081,554 | — | |||||||
| $ | 9,340,567 | $ | 9,805,585 | ||||||
Deferred income tax provision is provided for the temporary
differences of financial reporting on deferred financing costs,
capitalized unrealized foreign exchange losses, and accretion
and depreciation expenses related to asset retirement
obligation. Under accounting principles generally accepted in
the U.S., the deferred financing costs were treated as a
deferred asset and amortized, using the effective interest rate
method, over the lives of the related loans. Under accounting
principles generally accepted in the Philippines, asset
retirement obligation is not being recognized but deferred
financing costs and foreign exchange losses are capitalized and
depreciated as part of the cost of property, plant and equipment
consistent with the Philippine tax base except for depreciation
of capitalized unrealized foreign exchange losses which is not
deductible under the Philippine tax base.
Income from nonregistered operations of the Partnership is not
covered by its income tax holiday incentives. The current
provision for income tax in 2004 and 2003 pertains to income tax
due on interest income from offshore bank deposits and certain
other income. There was no current provision for income tax in
2002 because of the Partnership’s net taxable loss position
from its unregistered activities.
During 2004, the Partnership provided for a full valuation
allowance on deferred tax assets pertaining to capitalized
unrealized foreign exchange losses in view of a pending revenue
regulation of the Philippine Bureau of Internal Revenue
(BIR) on the use of functional currency other than the
Philippine peso which may result in the write-off of these
amounts. The revenue regulation has not yet been finalized as of
February 14, 2005. There was no valuation allowance as of
December 31, 2003.
A reconciliation of the statutory income tax rate to the
effective income tax rates as a percentage of income before
income taxes is as follows:
| 2004 | 2003 | 2002 | |||||||||||
|
Statutory income tax rate
|
32 | % | 32 | % | 32 | % | |||||||
|
Tax effects of:
|
|||||||||||||
|
Change in valuation allowance
|
6 | — | — | ||||||||||
|
The Company’s operations
|
5 | 5 | 6 | ||||||||||
|
Partnership’s operations under income tax holiday
|
(42 | ) | (40 | ) | (44 | ) | |||||||
|
Others
|
— | — | 1 | ||||||||||
|
Effective tax rates
|
1 | % | (3 | )% | (5 | )% | |||||||
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Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| 5. | Debt Financing Agreements |
The Partnership was financed through the collective arrangement
of the Common Agreement, Eximbank-Supported Construction Credit
Facility, Trust Agreement, Uninsured Alternative Credit
Agreement, Indenture, Bank Notes, Bank Letters of Credit, Bonds,
Interest Hedge Contracts, Eximbank Political Risk Guarantee,
OPIC Political Risk Insurance Policy, Eximbank Term Loan
Agreement, Intercreditor Agreement, Side Letter Agreements,
Security Documents and Equity Documents.
The Common Agreement contains affirmative and negative covenants
including, among other items, restrictions on the sale of
assets, modifications to agreements, certain transactions with
affiliates, incurrence of additional indebtedness, capital
expenditures and distributions and collateralization of the
Project’s assets. The debt is collateralized by
substantially all of the assets of the Partnership and a pledge
of the Company’s and certain affiliated companies’
shares of stock. The Partnership has complied with the
provisions of the debt financing agreements, in all material
respects, or has obtained a waiver for noncompliance from the
lenders [see Notes 10(d) and (e)].
| (a) Term Loan Agreement |
The debt financing agreements contemplated that the outstanding
principal amount of the Eximbank-Supported Construction Loans
will be repaid on the Eximbank Conversion Date with the proceeds
of a loan from Eximbank under the Eximbank Term Loan.
Under the Eximbank Term Loan Agreement, Eximbank was to provide
for a $442.1 million direct term loan, the proceeds of
which could only be used to refinance the outstanding
Eximbank-Supported Construction Credit Facility and to pay the
Eximbank Construction Exposure Fee to Eximbank. This term loan,
which would have had interest at a fixed rate of 7.10% per
annum, would have had a 12-year term and would have been
amortized in 24 approximately equal semi-annual payments during
such term.
In April 2001, in lieu of the Eximbank Term Loan, the
Partnership availed the alternative refinancing of the
Eximbank-Supported Construction Loans allowed under the Eximbank
Option Agreement through an Export Credit Facility guaranteed by
Eximbank and financed by Private Export Funding Corporation
(PEFCO). Under the terms of the agreement, PEFCO established
credit in an aggregate amount of $424.7 million which bears
interest at a fixed rate of 6.20% per annum and payable
under the payment terms identical with the Eximbank Term Loan.
Upon compliance of the conditions precedent as set forth in the
Term Loan Agreement, the PEFCO Term Loan was drawn and the
proceeds were applied to the Eximbank-Supported Construction
Loans.
Amendments to the Omnibus Agreement were made to include, among
other things, PEFCO as a party to the Agreement in the capacity
of a lender.
Annual future amortization payments for the next five years
ending December 31 are as follows:
|
2005
|
$ | 35,389,726 | ||
|
2006
|
35,389,726 | |||
|
2007
|
35,389,726 | |||
|
2008
|
35,389,726 | |||
|
2009
|
35,389,726 | |||
|
and thereafter
|
106,169,178 |
| (b) Uninsured Alternative Credit Agreement |
The Uninsured Alternative Credit Agreement provides for the
arrangement of Construction Loans, Refunding Loans and Cost
Overrun Loans (collectively, the Uninsured Alternative Credit
Facility Loans) as
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QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
well as the issuance of the PPA Letter of Credit and the Coal
Supply Letter of Credit. In July 1997, the Partnership
terminated commitments in excess of $30 million in respect
of the Construction Loans in connection with the issuance of the
bonds. Interest will accrue on (i) the Construction Loans
at a rate equal to LIBOR plus a margin of 2.75% to 3.25%;
(ii) the Refunding Loans at a rate equal to LIBOR plus
2.50%; and (iii) the Cost Overrun Loans at a rate equal to
LIBOR plus a margin of 2.75% to 3.25%.
The Construction Loans will have a seven-year term and will be
amortized in 14 semi-annual payments during such term commencing
on January 15, 2001. Repayment of principal in respect of
each Refunding Loan will be made in four equal semi-annual
installments. Repayment of the Cost Overrun Loans will be made
in ten equal semi-annual installments.
There were no outstanding balances at December 31, 2004 and
2003 for the Refunding Loans and Cost Overrun Loans. As of
December 31, 2004 and 2003, approximately
$13.6 million and $16.8 million, respectively, were
outstanding with respect to the Construction Loans.
Annual future amortization payments of the Construction Loans
for the next three years ending December 31 are as follows:
|
2005
|
$ | 4,612,584 | ||
|
2006
|
5,615,320 | |||
|
2007
|
3,409,301 |
| (c) Trust and Retention Agreement |
The Trust and Retention Agreement provides, among others, for
(i) the establishment, maintenance and operation of one or
more U.S. dollar and Philippine peso accounts into which
power sales revenues and other project-related cash receipts of
the Partnership will be deposited and from which all operating
and maintenance disbursements, debt service payments and equity
distributions will be made; and (ii) the sharing by the
lenders on a pari passu basis of the benefit of certain security.
| (d) Bonds Payable |
Bonds payable represents the proceeds from the issuance of the
$215.0 million in aggregate principal amount of the
Partnership’s 8.86% Senior Secured Bonds Due 2017 (the
Series 1997 Bonds). The interest rate is 8.86% per
annum and is payable quarterly on March 15, June 15,
September 15 and December 15 of each year (each, a Bond Payment
Date), with the first Bond Payment Date being September 15,
1997. The principal amount of the Series 1997 Bonds is
payable in quarterly installments on each Bond Payment Date
occurring on or after September 15, 2001 with the Final
Maturity Date on June 15, 2017. The proceeds of the
Series 1997 Bonds were applied primarily by the Partnership
to the payment of a portion of the development, construction and
certain initial operating costs of the Project.
The Series 1997 Bonds are treated as senior secured
obligations of the Partnership and rank pari passu in right of
payment with all other credit facilities, as well as all other
existing and future senior indebtedness of the Partnership
(other than a working capital facility of up to
$15.0 million), and senior in right of payment to all
existing and future indebtedness of the Partnership that is
designated as subordinate or junior in right of payment to the
Series 1997 Bonds. The Series 1997 Bonds are subject
to redemption by the Partnership in whole or in part, beginning
five years from the date of issuance, at par plus a make-whole
premium, calculated using a discount rate equal to the
applicable U.S. Treasury rate plus 0.75%.
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Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Annual future amortization payments for the next five years
ending December 31 are as follows:
|
2005
|
$ | 6,450,000 | ||
|
2006
|
7,525,000 | |||
|
2007
|
10,750,000 | |||
|
2008
|
12,900,000 | |||
|
2009
|
12,900,000 | |||
|
and thereafter
|
146,200,000 |
| 6. | Related Party Transactions |
Due to the nature of the ownership structure, the majority of
the transactions were among the Company, the Partnership and the
Partners, their affiliates or related entities.
The following approximate amounts were paid to affiliates of the
Partners for the operation and maintenance and management of the
Project under the agreements discussed in Note 8:
| 2004 | 2003 | 2002 | ||||||||||
|
Covanta
|
$ | 40,564,370 | $ | 18,483,011 | $ | 20,266,893 | ||||||
|
InterGen
|
2,400,924 | 1,731,011 | 3,216,152 | |||||||||
As of December 31, 2004 and 2003, the net amounts of cash
advanced to affiliated companies pertaining to and due to
affiliated companies related to costs and expenses incurred by
the Project were $345,008 and $1,643,699, respectively.
| 7. | Capital Stock |
| 2004 | 2003 | ||||||||||||||||
| Number of | Number of | ||||||||||||||||
| Shares | Amount | Shares | Amount | ||||||||||||||
|
Class A, $0.01 par value:
|
|||||||||||||||||
|
Authorized
|
1,000,000 | 1,000,000 | |||||||||||||||
|
Issued
|
26,151 | $ | 262 | 26,151 | $ | 262 | |||||||||||
|
Class B, $0.01 par value:
|
|||||||||||||||||
|
Authorized
|
1,000,000 | 1,000,000 | |||||||||||||||
|
Issued
|
2,002 | 20 | 2,002 | 20 | |||||||||||||
|
Class C, $0.01 par value:
|
|||||||||||||||||
|
Authorized
|
1,000,000 | 1,000,000 | |||||||||||||||
|
Issued
|
71,947 | 719 | 71,947 | 719 | |||||||||||||
|
Class D, $0.01 par value:
|
|||||||||||||||||
|
Authorized
|
10 | — | |||||||||||||||
|
Issued
|
10 | — | — | — | |||||||||||||
| $ | 1,001 | $ | 1,001 | ||||||||||||||
Class A and Class C shares have an aggregate 100%
beneficial economic interest and 98% voting interest in the
Company divided among the holders of the Class A and
Class C shares. Class B shares have a 2% voting
interest in the Company. On October 18, 2004, the
shareholders of the Company entered into a Third Amended and
Restated Development and Shareholders Agreement (D&S
Agreement) to, among others, add GPI as party to the D&S
Agreement as a shareholder and holder of newly issued
Class D shares. Class D
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Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
shares have no economic interest, no right to dividends and
other distributions and no voting rights other than the power to
appoint a director and an alternate director.
| 8. | Commitments and Contingencies |
The Partnership has entered into separate site lease,
construction, energy sales, electric transmission, coal supply
and transportation, operations and maintenance and project
management agreements.
In connection with the construction and operation of the
Project, the Partnership is obligated under the following key
agreements:
(a) PPA
The Partnership and Meralco are parties to the PPA, as amended
on June 9, 1995, and on December 1, 1996. The PPA
provides for the sale of electricity from the Partnership’s
Generation Facility to Meralco. The term extends 25 years
from the Commercial Operations Date, defined in the PPA as the
date designated in writing by the Partnership to Meralco as the
date on which the Project has been completed, inspected, tested
and is ready to commence operations. As disclosed in
Note 1(c), the Commercial Operations Date occurred on
May 30, 2000.
The PPA provides that commencing on the Commercial Operations
Date, the Partnership is required to deliver to Meralco, and
Meralco is required to take and pay for, in each year commencing
on the Commercial Operations Date and ending on each anniversary
thereof (each such year, a Contract Year), a minimum number of
kWhs of net electrical output (NEO).
The PPA provides that commencing on the Commercial Operations
Date and continuing throughout the term of the PPA, Meralco will
pay to the Partnership on each calendar month a monthly payment
consisting of the following: (i) a Monthly Capacity
Payment, (ii) a fixed Monthly Operating Payment,
(iii) a variable Monthly Operating Payment and (iv) a
Monthly Energy Payment. Under the PPA, Meralco is allowed to
make all of its payments to the Partnership in Philippine pesos.
However, the Monthly Capacity Payment, the Monthly Energy
Payment, and portions of the Monthly Operating Payments are
denominated in U.S. dollars and the Philippine peso amounts
are adjusted to reflect changes in the foreign exchange rates.
Under the terms of the PPA, the Partnership is obligated to
provide Meralco with the PPA Letter of Credit for
$6.5 million. The PPA Letter of Credit serves as security
for the performance of the Partnership’s obligation to
Meralco pursuant to the PPA.
The Plant failed to meet its monthly delivery obligations to
Meralco from May 2000 through the third quarter of 2001. Under
the existing PPA, Meralco is obligated to make full Monthly
Capacity Payments and Monthly Fixed Operating Payments,
notwithstanding plant availability. However, in the event of a
shortfall, the Partnership is required to make a payment to
Meralco for each kWh of shortfall that is less than the per kWh
tariff of the Monthly Capacity Payment and Monthly Fixed
Operating Payment.
In mid-2001, Meralco requested that the Partnership renegotiate
certain terms of the PPA and increase the amount of shortfall
payments made to Meralco when the Project is unable to meet
certain performance standards. Meralco was also seeking
compensation for prior Project performance shortfalls. The
Partnership rejected the payment of any compensation related to
past performance. However, the Partnership agreed in principle
to give Meralco a rebate over the next six years. During this
period, Meralco withheld payments of approximately
$10.8 million during 2001 ($2.3 million of which was
otherwise payable to Meralco as shortfall penalties). A
provision had already been provided in the December 31,
2001 financial statements for $7.9 million representing the
amount management believes is adequate to cover any possible
losses while the negotiations were ongoing.
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Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
On February 22, 2002, the Partnership and Meralco signed
Amendment No. 3 to the PPA (Original Amendment) that was to
become effective following approval of the ERC and the
Partnership’s lenders but with retroactive effect. The
Original Amendment primarily relates to the reallocation of
risks relating to the performance and dispatch of the Plant.
Under the amended terms of the PPA, Meralco would, in general,
bear risks relating to the dispatch of the Plant while the
Partnership, in general, would bear risks relating to the
technical performance of the Plant. To accomplish this risk
reallocation, the Original Amendment provided for, among other
things, the following:
| (i) Payment by the Partnership of higher shortfall penalties in the event the Partnership fails to meet the minimum guaranteed electrical quantity (MGEQ) due to the fault or negligence of the Partnership; | |
| (ii) Recovery from and payment by Meralco to the Partnership of certain variable operating, maintenance and fuel costs incurred by the Partnership due to the Plant being dispatched at less than the nominated capacity; | |
| (iii) Payment of rebates by the Partnership to Meralco over a six year period subject to the satisfaction of certain conditions; | |
| (iv) Sharing with Meralco revenues earned for deliveries in excess of the MGEQ; | |
| (v) Payment by Meralco of U.S. dollar-denominated portions of fixed and variable payments in U.S. dollars; and | |
| (vi) The Partnership will be deemed to have delivered electricity under circumstances where the Plant is declared available but is not dispatched at the load declared as available. | |
In addition to the Original Amendment, on February 22,
2002, Meralco and the Partnership signed a Settlement and
Release Agreement (SRA) to become effective at the same
time as the Original Amendment. The SRA was to cover, among
others, the payment to Meralco of an amount equal to
$8.5 million in consideration of Meralco’s agreement
to execute and perform the SRA. Such amount was to be settled
with an offset against the payments which had been withheld by
Meralco.
As a result, the Partnership recorded the lower of the income
that would have been recognized under the existing PPA and the
Original Amendment together with the SRA for the year ended
December 31, 2002. The net effect of the provisions of the
Original Amendment and the SRA was to decrease the revenues that
would have been recognized under the existing PPA by
$3.2 million in 2002.
In 2003, Meralco indicated to the Partnership that Meralco
intended to negotiate certain “refinements” to the
terms of the Original Amendment. Meralco formally withdrew its
petition for the approval of the Original Amendment from the ERC
on March 5, 2003.
The Partnership and Meralco have agreed in principle on the
major terms of the refinements to the Original Amendment
(Refined Amendment). However, after the Partnership prepared and
submitted a draft of the Refined Amendment to Meralco for
Meralco’s review and comments, the Partnership and Meralco
agreed to defer further action on the Refined Amendment pending
the ERC’s decision on the Transmission Line issue [see
Note 8(b)]. The Partnership and Meralco agreed in principle
in late 2003 that the Refined Amendment would not have a
retroactive date of effectiveness that is earlier than
December 26, 2003. As a result, during 2003, management
reversed the liability recognized as of December 31, 2002,
amounting to about $4.7 million, that recognized the lower
income in accordance with the Original Amendment.
During the course of discussions with Meralco, the Partnership
and Meralco agreed to remove the rebate from the PPA and instead
administer a rebate through the TLA resulting in a combined
amendment agreement (Amendment Agreement). This Amendment
Agreement contains the proposed amendments to the PPA and the
TLA and incorporates the terms of the SRA.
A-90
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
In summary, the Refined Amendment supplanted the Original
Amendment and the Amendment Agreement supplanted the Refined
Amendment, each such document (and various drafts thereto)
dealing with similar issues albeit reflecting different
commercial terms and transaction details. Except for the rebate
provisions, the incorporation of the terms of the SRA and other
commercial matters, the proposed amendments in the Amendment
Agreement are the same as those of the Refined Amendment.
The Amendment Agreement currently provides for changes in the
Original Amendment in the following areas:
| (i) Deemed generation; | |
| (ii) Excess generation; | |
| (iii) Credits against excess generation; | |
| (iv) Generation shortfall recovery mechanisms; | |
| (v) Forced outage allowance; | |
| (v) Variable operating payments; | |
| (vii) Rebate program; | |
| (viii) Deferred transmission line CCRP; | |
| (ix) Third party delivery; | |
| (x) Fuel inventory; | |
| (xi) Local business taxes; | |
| (xii) Community development; and | |
| (xiii) Effectivity date of the amendment. | |
Under the Amendment Agreement, in lieu of rebates over a
six-year period as prescribed in the Original Amendment, the
Partnership agreed in principle to provide a rebate program
under the TLA from December 26, 2003 through its remaining
term [see Note 8(b)].
The Partnership currently intends to agree to a retroactive
effective date of the Amendment Agreement of December 26,
2003, following satisfaction of conditions precedent and
completion requirements, including approval by the ERC and the
Partnership’s lenders. Accordingly, the Partnership
recorded the lower of income that would have been recognized
under the Amendment Agreement for the year ended
December 31, 2004. The net effect of the provisions of the
Amendment Agreement pertaining to rebates and other adjustments
pertaining to energy and variable operating fees was to decrease
the revenues that would have been recognized under the existing
PPA by $5.6 million.
The Partnership also does not intend to become bound by the
Original Amendment or the SRA. To that end, the Amendment
Agreement provides that the parties will formally terminate the
Original Amendment and the SRA on the date that the Amendment
Agreement becomes effective. The Partnership currently expects
to reach an agreement with Meralco on the language of the
Amendment Agreement in 2005.
The existing PPA remains effective until the execution and
delivery, satisfaction of conditions precedent and completion of
closing steps in accordance with the terms of any amendment
agreement. The effectiveness of the Amendment Agreement is
subject to the approval of the lenders, the board of directors
(BOD) of each of the respective parties and the ERC. In the
event that these approvals are not obtained, the Amendment
Agreement will not become effective. Consequently, the existing
PPA would remain effective.
A-91
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
(b) TLA
Pursuant to the PPA and the TLA dated as of June 13, 1996
(as amended on December 1, 1996; the TLA) between the
Partnership and Meralco, the Partnership accepted responsibility
for obtaining all necessary rights-of-way for, and the siting,
design, construction, operation and maintenance of, the
Transmission Line. The construction of the Transmission Line was
part of the Engineering, Procurement and Construction Management
(EPCM) Contractor’s scope of work under the EPCM Contracts.
Meralco is obligated to pay all costs and expenses incurred by
the Partnership in connection with the siting, design,
construction, operation and maintenance of the Transmission Line
(including unforeseen cost increases, such as those due to new
regulations or taxes) through the payment of periodic
transmission charges.
The term of the TLA will extend for the duration of the term of
the PPA, commencing on the date of execution of the TLA and
expiring on the 25th anniversary of the Commercial Operations
Date. The term of the TLA is subject to renewal on mutually
acceptable terms in conjunction with the renewal of the term of
the PPA. Under the TLA, Meralco is obligated to make a Monthly
CCRP and a Monthly Operating Payment to the Partnership.
In its order dated March 20, 2003, the ERC disallowed
Meralco from collecting from its consumers a portion of the
Partnership’s CCRP amounting to approximately
$646,000 per month pending the ERC’s thorough review
of these charges. Consequently, at Meralco’s request, the
Partnership agreed to defer the collection of this portion of
the CCRP until the ERC resolved the issue or until the
Partnership notified Meralco otherwise. As of December 31,
2003, the portion of the CCRP deferred for collection amounted
to $5.8 million.
In its order dated September 20, 2004, the ERC has rendered
a decision with regard to Meralco’s application to collect
from its consumers, transmission line costs charged by the
Partnership in accordance with the TLA. The order contained,
among others, the following:
| (1) Recovery of $60.7 million of transmission line costs out of the total $88.8 million actual costs incurred by the Partnership. The portion disallowed by ERC amounting to $28.1 million is composed mainly of schedule extension costs. | |
| (2) Reduction of annual CCRP to be recovered by Meralco from its consumers. Annual recoverable payments were reduced from $13.2 million to $9.0 million to reflect the amount disallowed by the ERC. | |
As a result, recoverable payments billed by Meralco to its
consumers were reduced to reflect the amount disallowed by the
ERC.
On its letter dated November 5, 2004, Meralco agreed to the
Partnership’s proposal dated October 22, 2004 where
the Partnership agreed to continue to defer collection from
Meralco of the amounts finally disallowed by the ERC, which
amounted to about $6.7 million as of September 30,
2004. Meralco, on the other hand, will reduce the amounts
deferred on each monthly CCRP from $646,000 to $350,000 and make
catch-up payments on the $5.6 million representing the
difference between the previously deferred amounts and the final
disallowance. Of the $5.6 million, $2.0 million has
been paid by Meralco as of December 31, 2004.
The adjusted deferral amount will be applied in the calculation
of the rebates discussed under the Amendment Agreement. As of
December 31, 2004, the adjusted deferral amount totaled
$7.4 million.
| (c) Coal Supply Agreements |
In order to ensure that there is an adequate supply of coal to
operate the Generation Facility, the Partnership has entered
into two coal supply agreements (CSA) with the intent to
purchase approximately
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Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
70% of its coal requirements from PT Adaro Indonesia (Adaro) and
the remainder of its coal requirements from PT Kaltim Prima Coal
(Kaltim Prima, and together with Adaro, the Coal Suppliers). The
agreement with Adaro (the Adaro CSA) will continue to be in
effect until October 1, 2022. If the term of the Coal
Cooperation Agreement between Adaro and the Ministry of Mines
and Energy of the Government of the Republic of Indonesia is
extended beyond October 1, 2022, the Partnership may elect
to extend the Adaro CSA until the earlier of the expiration of
the PPA or the expiration of the extended Coal Cooperation
Agreement, subject to certain conditions. The agreement with
Kaltim Prima (the Kaltim Prima CSA) has a scheduled termination
date 15 years after the Commercial Operations Date. The
Partnership may renew the Kaltim Prima CSA for two additional
five-year periods by giving not less than one year prior written
notice. The second renewal period will be subject to the parties
agreeing to the total base price to be applied during that
period.
Under the CSA, the Partnership is subject to minimum take
obligations of 900,000 Metric Tonnes (MT) for Adaro and
360,000 MT for Kaltim Prima. The Partnership was not able to
meet the minimum take obligations for Adaro by 336,000 MT in
2004 and by 335,000 MT in 2003. However, the Partnership was
able to secure waivers from Adaro for these shortfalls.
In 2003, the Partnership and its coal suppliers started
discussions on the use of an alternative to the
Australian-Japanese benchmark price, which is the basis for
adjusting the energy-base price under the Partnership’s
CSA. During 2003, the Partnership and Adaro agreed in principle
to use the six-month rolling average of the ACR Asia Index with
a certain discount as the new benchmark price applied
retroactively to April 1, 2003. Accordingly, adjustments to
effect the change in energy-base price were recorded in 2003. On
November 18, 2004, the Adaro CSA has been amended to
reflect the change in the benchmark price.
With respect to Kaltim Prima, the Partnership and Kaltim Prima
agreed in principle to retain the Australian-Japanese benchmark
price and is currently in discussions for the possible reduction
in the Partnership’s minimum take obligation from 360,000
MT to 280,000 MT.
During 2004, Adaro charged the Partnership $789,000 for
applicable demurrage charges pertaining to certain shipments
from 1999 to 2004 as provided under the CSA. Of this amount, the
Partnership recorded $286,000 which management has verified, as
of February 14, 2005, based on their records. The remaining
$503,000 is still being reconciled with Adaro since management
believes some of these charges may not qualify for demurrage
under the CSA.
| (d) Operations and Maintenance Agreement |
The Partnership and Covanta Philippines Operating, Inc. (the
Operator; formerly Ogden Philippines Operating, Inc.), a Cayman
Islands corporation and a wholly owned subsidiary of Covanta
Projects, Inc. (CPI; formerly Ogden Projects, Inc.), a
subsidiary of Covanta Energy Group, Inc. (formerly Ogden Energy
Group, Inc.), have entered into the Plant Operation and
Maintenance Agreement dated December 1, 1995 (as amended,
the O&M Agreement) under which the Operator has assumed
responsibility for the operation and maintenance of the Project
pursuant to a cost-reimbursable contract. CPI, pursuant to an
O&M Agreement Guarantee, guarantees the obligations of the
Operator. The initial term of the O&M Agreement extends
25 years from the Commercial Operations Date. Two automatic
renewals for successive five year periods are available to the
Operator, provided that (i) the PPA has been extended;
(ii) no default by the Operator exists; and (iii) the
O&M Agreement has not been previously terminated by either
party.
The Partnership is obligated to compensate the Operator for
services under the O&M Agreement, to reimburse the Operator
for all reimbursable costs one month in advance of the
incurrence of such costs and to pay the Operator a base fee and
certain bonuses. In certain circumstances, the Operator could be
required to pay liquidated damages depending on the operating
performance of the Project, subject to contractual
A-93
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
limitations. Beginning on Provisional Acceptance, as defined,
the Partnership is obligated to pay the Operator a monthly fee
of $160,000, subject to escalation.
Under the O&M Agreement, the Operator may earn a bonus as a
result of: (i) higher than expected NEO generated during
the year, (ii) the Operator’s contributions to the
community, and (iii) reductions in operating costs below
budget. The target NEO is defined as the lesser of (a) MGEQ
and (b) the average NEO achieved over the immediately
preceding two contract years and adjusted to consider
significant non-recurring events and significant maintenance
activities undertaken other than the annual major maintenance.
In late 2003, operational issues were noted in an operations and
maintenance audit of the Generation Facility by R.W. Beck, the
independent engineer, commissioned by Eximbank. These issues
triggered requests from lenders that the issues be addressed and
that certain governance adjustments be made to the O&M
Agreement and charter documents of the Company. Following
negotiations among various project participants, in October
2004, the O&M Agreement was amended, with the concurrence of
required lenders.
Significant changes to the amended O&M Agreement include,
among others, changes in the terms concerning material breach of
the O&M Agreement; introduction of Surviving Service Fees to
the Operator in case the agreement is pre-terminated; and
changes in the methodology of computing additions or reduction
in fees when NEO is greater or less than the MGEQ of each
contract year; and introduction of Banked Hours that can be
applied to future reductions in fees or exchanged for cash
subject to a 5 year expiration period. The adjustments in
Operator’s fee, including the cash value of all Banked
Hours accrued during a contract year, shall not exceed
$1 million, adjusted pursuant to an escalation index.
Amendments in the O&M Agreement have a retroactive effect
beginning December 26, 2003. On October 18, 2004, the
Partnership received all the necessary approvals including that
of the lenders and implemented the amended O&M Agreement.
Accordingly, the Partnership provided for about $269,000
representing the cash exchange value of Banked Hours estimated
to be earned by the Operator during 2004.
Further to those amendments and pre-amendment efforts, the
Partnership and its partners have taken proactive steps to
address the issues raised by the independent engineer and as a
result, remedial efforts to address these issues have been
applied and are currently being applied by the Operator. A
recent audit by the independent engineer has indicated that most
of the operating issues have been resolved.
In connection with the amendment of the O&M Agreement and
resolution of issues between the Partnership and the Operator,
on behalf of the Partnership, the BOD of the Company approved,
on March 18, 2004, the payment to the Operator of
$1.3 million in fees that were not paid during the 2002 and
2003 calendar years, and on June 9, 2004, a payment in lieu
of a bonus, amounting to $1.8 million.
| (e) Management Services Agreement |
The Partnership has entered into the Project Management Services
Agreement, dated as of September 20, 1996 (as amended, the
Management Services Agreement), with InterGen Management
Services (Philippines), Ltd. (as assignee of International
Generating Company, Inc.), an affiliate of InterGen N.V., (the
Manager), pursuant to which, the Manager is providing management
services for the Project. Pursuant to the Management Services
Agreement, the Manager nominates a person to act as a General
Manager of the Partnership, and, acting on behalf of the
Partnership, to be responsible for the day-to-day management of
the Project. The initial term of the Management Services
Agreement extends for a period ending 25 years after the
Commercial Operations Date, unless terminated earlier, with
provisions for extension upon mutually acceptable terms and
conditions. InterGen N.V., pursuant to a Project Management
Services Agreement Guarantee dated as of December 10, 1996,
guarantees the obligations of the Manager.
The Partnership is obligated to pay the Manager an annual fee
equal to $400,000 subject to escalation after the first year
relative to an agreed-upon index payable in 12 equal monthly
installments.
A-94
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Similar to the O&M Agreement, amendments to the Management
Services Agreement were made. Significant changes to the
Management Services Agreement include, among others, amendments
to the duties of the Manager, General Manager, rights of the
Partnership, acting through the BOD of the Company, to audit the
Manager’s procedures and past practices, changes in
termination provisions and the introduction of a Surviving
Management Fee in case the agreement is pre-terminated. Similar
to the O&M Agreement, the amendments to the Management
Services Agreement have a retroactive effect beginning
December 26, 2003. These amendments were likewise approved
on October 18, 2004.
| (f) Project Site Lease, Transmission Line Site Lease and Foreshore Lease Agreements |
Due to Philippine legal requirements that limit the ownership
interests in real properties and foreshore piers and utilities
to Philippine nationals and in order to facilitate the exercise
by Meralco of its power of condemnation should it be obligated
to exercise such powers on the Partnership’s behalf,
Meralco owns the Project Site and leases the Project Site to the
Partnership. Meralco has also agreed in the Foreshore Lease
Agreement dated January 1, 1997, as amended, to lease from
the Philippine government the foreshore property on which the
Project piers were constructed, to apply for and maintain in
effect the permits necessary for the construction and operation
of the Project piers and to accept ownership of the piers.
The Company has obtained rights-of-way for the Transmission line
for a majority of the sites necessary to build, operate and
maintain the Transmission line. Meralco has agreed, pursuant to
a letter agreement dated December 19, 1996, that
notwithstanding the provisions of the TLA that anticipates that
Meralco would be the lessor of the entire Transmission Line
Site, Meralco will only be the Transmission Line Site Lessor
with respect to rights-of-way acquired through the exercise of
its condemnation powers.
The Company, as lessor, and the Partnership, as lessee, have
entered into the Transmission Line Site Leases, dated as of
December 20, 1996, with respect to real property required
for the construction, operation and maintenance of the
Transmission line other than rights-of-way to be acquired
through the exercise of Meralco’s condemnation powers.
The initial term of each of the Project Site Leases and each of
the Transmission Line Site Leases (collectively, the Site
Leases) extends for the duration of the PPA, commencing on the
date of execution of such Site Lease and expiring 25 years
following the Commercial Operations Date. The Partnership has
the right to extend the term of any Site Lease for consecutive
periods of five years each, provided that the extended term of
such Site Lease may not exceed 50 years in the aggregate.
| (g) Community Memorandum of Agreement |
The Partnership has entered into a Community Memorandum of
Agreement (MOA) with the Province of Quezon, the
Municipality of Mauban, the Barangay of Cagsiay and the
Department of Environmental and Natural Resources (DENR) of
the Philippines. Under the MOA, the Partnership is obligated to
consult with local officials and residents of the Municipality
and Barangay and other affected parties about Project related
matters and to provide for relocation and compensation of
affected families, employment and community assistance funds.
The funds include an electrification fund, development and
livelihood fund and reforestation, watershed, management health
and/or environmental enhancement fund. Total estimated amount to
be contributed by the Partnership over the 25-year life and
during the construction period is approximately
$16 million. In accordance with the MOA, a certain portion
of this amount will be in the form of advance financial
assistance to be given during the construction period.
In addition, the Partnership is obligated to design, construct,
maintain and decommission the Project in accordance with
existing rules and regulations. The Partnership deposited the
amount of P5.0 million (about $89,000) to an Environmental
Guarantee Fund for rehabilitation of areas affected by damage in
the environment, monitoring compensation for parties affected
and education activities.
A-95
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| 9. | Fair Value of Financial Instruments |
The required disclosures under SFAS No. 107,
Disclosure about Fair Value of Financial Instruments,
follow:
The financial instruments recorded in the consolidated balance
sheets include cash, accounts receivable, accounts payable and
accrued expenses, due from (to) affiliated companies and
debt. Because of their short maturity, the carrying amounts of
cash, accounts receivable and accounts payable and accrued
expenses approximate fair value. It is not practical to
determine the fair value of the amounts due from
(to) affiliated companies.
Long-term debt — Fair value was based on the following:
| Debt Type | Fair Value Assumptions | |
|
Term loan
|
Estimated fair value is based on the discounted value of future cash flows using the applicable risk free rates for similar types of loans plus a certain margin. | |
|
Bonds payable
|
Estimated fair value is based on the discounted value of future cash flows using the latest available yield percentage of the Partnership’s bonds prior to balance sheet dates. | |
|
Other variable rate loans
|
The carrying value approximates fair value because of recent and frequent repricing based on market conditions. |
Following is a summary of the estimated fair value (in millions)
as of December 31, 2004 and 2003 of the Partnership’s
financial instruments other than those whose carrying amounts
approximate their fair values:
| 2004 | 2003 | |||||||
|
Term loan — $283.1 in 2004 and $318.5 in 2003
|
$ | 251.2 | $ | 262.5 | ||||
|
Bonds payable — $196.7 in 2004 and $203.2 in 2003
|
183.2 | 169.3 | ||||||
| 10. | Other Matters |
| (a) | Electric Power Industry Reform Act (EPIRA) |
Republic Act No. 9136, the EPIRA, and the covering
Implementing Rules and Regulations (IRR) provides for
significant changes in the power sector, which include among
others:
| (i) The unbundling of the generation, transmission, distribution and supply and other disposable assets of a company, including its contracts with independent power producers and electricity rates; | |
| (ii) Creation of a Wholesale Electricity Spot Market; and | |
| (iii) Open and non-discriminatory access to transmission and distribution systems. | |
The law also requires public listing of not less than 15% of
common shares of generation and distribution companies within
5 years from the effectivity date of the EPIRA. It provides
cross ownership restrictions between transmission and generation
companies and between transmission and distribution companies
and a cap of 50% of its demand that a distribution utility is
allowed to source from an associated company engaged in
generation except for contracts entered into prior to the
effectivity of the EPIRA.
A-96
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
There are also certain sections of the EPIRA, specifically
relating to generation companies, which provide for:
| (i) a cap on the concentration of ownership to only 30% of the installed capacity of the grid and/or 25% of the national installed generating capacity; and | |
| (ii) VAT zero-rating of sale of generated power. | |
Based on the assessment of the Partnership, it is in the process
of complying with the applicable provisions of the EPIRA and its
IRR.
| (b) Clean Air Act |
The Clean Air Act and the related IRR contain provisions that
have an impact on the industry as a whole, and to the
Partnership in particular, that need to be complied with within
44 months from the effectivity date or by July 2004. Based
on the assessment made on the Partnership’s existing
facilities, the Partnership believes it complies with the
provisions of the Clean Air Act and the related IRR.
| (c) Claims and Litigation |
The Partnership had a dispute with the Province of Quezon
regarding the start of the commercial operations, the correct
valuation of the fair market value of the Plant and the amount
of property tax it owed for years 2000 and 2001. Management
believes that the assessment had no legal basis. Consequently,
the Partnership had initiated legal action against the relevant
provincial and municipal government departments and officers
challenging the validity of the assessment and had elevated the
dispute to the Department of Finance (DOF) and the Regional
Trial Court (RTC) for resolution.
The DOF, which agreed to arbitrate the dispute between the
Partnership and the Province of Quezon, issued two resolutions
that are favorable to the Partnership in all material respects.
However, the RTC examining the suit for consignation filed by
the Partnership against the provincial government related to the
real property tax dispute dismissed the suit citing the trial
court’s alleged lack of jurisdiction over the issue.
The Provincial Government of Quezon accepted the
Partnership’s real property tax payments for the third and
fourth quarters of 2002. However, prior to the third quarter of
2002, the Partnership had been paying real property taxes it
believed to be the correct tax by way of consignation with a
local court. With the RTC’s dismissal of the suit for
consignation, the RTC ordered the consigned payments to be
remitted to the Provincial Government.
During 2003, the Provincial Government eventually accepted the
consigned payment and the Partnership received the revised Tax
Declaration and Notice of Assessment from the Provincial
Assessor and Municipal Treasurer, which are consistent with the
DOF’s resolution and did not include surcharge or interest
on late payments. In accordance with the revised assessment, the
Partnership paid the Provincial Government of Quezon an
additional P26.0 million ($0.5 million) in taxes in
2003.
| (d) Insurance Coverage Waiver |
The Partnership was able to improve insurance coverage for the
November 2004 to March 2005 insurance coverage period. However,
the insurance coverage amounts required by the lenders under the
debt financing agreements still have not been met due to market
unavailability on commercially reasonable terms, based on
determinations of the Partnership’s insurance advisor and
the lenders’ insurance advisor. On October 15, 2004,
the Partnership requested for a waiver of certain insurance
requirements which was granted by the required lender
representatives on November 10, 2004, effective until
March 31, 2005, the end of the insurance coverage period.
A-97
Table of Contents
QUEZON POWER, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| (e) PPA Default Waiver |
Section 5.1(d) of the Common Agreement provides for, among
others, the prompt billing and collection from Meralco for
energy sold and services rendered by the Project pursuant to the
PPA and the TLA. In this regard, the Partnership was in default
under the financing documents as a result of the withholding by
Meralco of its payment obligations under the PPA amounting to
$8.5 million [see Note 8(a)]. To address this default,
the Partnership sought, and successfully obtained, a consent
from its lenders to permit the Partnership to waive, on an
interim basis, the timely payment by Meralco of the withheld
amount. The lenders granted the consent, subject to conditions,
and the Partnership issued an interim waiver to Meralco in
November 2002. The waiver is in effect until the amendment to
the PPA becomes effective. The key condition to that consent
required that the Partnership hold back from distributions cash
in excess of the reserve requirements of the financing
agreements, originally equal to approximately
$20.5 million. In October 2004, the Partnership sought, and
successfully obtained, lender consent to reduce the hold back
amount to $10.5 million.
| (f) Impact of the Decision of the Supreme Court (SC) of the Philippines |
On November 15, 2002, the Third Division of the SC rendered
a decision ordering Meralco, the largest power distribution
company in the country, to refund to its customers $0.003/kWh
(P0.167/kWh) starting with Meralco’s billing cycles
beginning February 1994 or correspondingly credit this in their
favor for future consumption. The SC sustained the then Energy
Regulatory Board’s (now known as the ERC) disallowance of
income tax as an operating expense, which resulted in
Meralco’s rate of return exceeding 12%, the maximum allowed.
On December 5, 2002, Meralco filed a Motion for
Reconsideration with the SC. The motion is based mainly on the
following grounds: (i) the disallowance of income tax is
contrary to jurisprudence; (ii) the decision modifies SC
decisions recognizing 12% as the reasonable return a utility is
entitled to (if income tax is disallowed for rate making, the
return is reduced to about 8%); and (iii) the ERC adheres
to the principle that income tax is part of operating expenses
as set forth in the Uniform Rate Filing Requirements, which
embody the detailed guidelines to be followed with respect to
the rate unbundling applications of distribution companies.
On January 27, 2003, Meralco filed with the SC a motion
seeking the referral of the case to the SC en banc. The
motion was denied by the SC in a resolution which Meralco
received on March 17, 2003. On April 1, 2003, Meralco
filed a Motion for Reconsideration of this resolution.
On April 9, 2003, the SC denied with finality the Motion
for Reconsideration filed by Meralco with the SC ordering
Meralco to refund to its consumers the excess charges in
electricity billings from 1994 to 1998 amounting to about
P30 billion (about $536 million). As of
December 31, 2004, the amounts processed for refund stand
at approximately P12 billion (about $214 million).
Meralco is currently preparing for the last phase of the refund
amounting to about P18 billion (about $322 million).
If Meralco is unable to generate resources to satisfy its refund
obligations, it may not meet its obligations under the PPA [see
Note 1(d)].
| (g) Tax Assessments |
During 2004, the BIR issued and the Partnership settled a formal
assessment pertaining to deficiency income tax on the 2001 and
2000 taxable years. Accordingly, management accrued
P16.1 million ($287,000) for probable losses on other
taxable years that may arise based on the findings contained in
these assessments.
A-98
Table of Contents
APPENDIX B
Unaudited Interim Financial Statements of Covanta Holding
Corporation
|
Interim Financial Statements as of September 30, 2005
(Unaudited) and December 31, 2004 and for the three and
nine-month periods ended September 30, 2005 and 2004
(Unaudited):
|
|||||
|
Condensed Consolidated Statements of Operations for the Three
and Nine Months Ended September 30, 2005 and 2004
(Unaudited)
|
B-2 | ||||
|
Condensed Consolidated Balance Sheets as of September 30,
2005 (Unaudited) and December 31, 2004
|
B-3 | ||||
|
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 2005 and 2004 (Unaudited)
|
B-4 | ||||
|
Condensed Consolidated Statement of Stockholders’ Equity
for the Nine Months Ended September 30, 2005 (Unaudited)
|
B-5 | ||||
|
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
|
B-6 | ||||
B-1
Table of Contents
PART I. FINANCIAL INFORMATION
| ITEM 1. | FINANCIAL STATEMENTS |
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
| Three Months Ended | Nine Months Ended | |||||||||||||||||
| September 30, | September 30, | |||||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||||
| (Unaudited) | ||||||||||||||||||
| (In thousands, except per share amounts) | ||||||||||||||||||
|
Operating revenues
|
||||||||||||||||||
|
Waste and service revenues
|
$ | 194,176 | $ | 111,314 | $ | 436,624 | $ | 260,563 | ||||||||||
|
Electricity and steam sales
|
103,316 | 54,892 | 225,541 | 124,153 | ||||||||||||||
|
Other operating revenues
|
3,998 | 5,416 | 13,236 | 17,659 | ||||||||||||||
|
Total operating revenues
|
301,490 | 171,622 | 675,401 | 402,375 | ||||||||||||||
|
Operating expenses
|
||||||||||||||||||
|
Plant operating expenses
|
151,984 | 106,053 | 393,343 | 241,149 | ||||||||||||||
|
Depreciation and amortization expense
|
44,551 | 17,177 | 78,027 | 36,784 | ||||||||||||||
|
Net interest expense on project debt
|
16,988 | 10,218 | 36,700 | 23,194 | ||||||||||||||
|
Other operating expenses
|
2,378 | 3,197 | 7,736 | 12,603 | ||||||||||||||
|
General and administrative expenses
|
19,615 | 13,269 | 46,313 | 32,381 | ||||||||||||||
|
Restructuring charges
|
— | — | 2,655 | — | ||||||||||||||
|
Acquisition-related charges
|
983 | — | 2,963 | — | ||||||||||||||
|
Total operating expenses
|
236,499 | 149,914 | 567,737 | 346,111 | ||||||||||||||
|
Operating income
|
64,991 | 21,708 | 107,664 | 56,264 | ||||||||||||||
|
Other income (expenses)
|
||||||||||||||||||
|
Investment income
|
1,657 | 836 | 3,530 | 2,002 | ||||||||||||||
|
Interest expense
|
(30,701 | ) | (10,541 | ) | (59,053 | ) | (33,267 | ) | ||||||||||
|
Gain on derivative instrument, unexercised ACL warrants
|
10,578 | — | 14,796 | — | ||||||||||||||
|
Total other expenses
|
(18,466 | ) | (9,705 | ) | (40,727 | ) | (31,265 | ) | ||||||||||
|
Income before income tax provision, minority interests and
equity in net income from unconsolidated investments
|
46,525 | 12,003 | 66,937 | 24,999 | ||||||||||||||
|
Income tax expense
|
(16,391 | ) | (5,165 | ) | (24,008 | ) | (8,436 | ) | ||||||||||
|
Minority interest expense
|
(2,172 | ) | (1,632 | ) | (9,311 | ) | (3,922 | ) | ||||||||||
|
Equity in net income from unconsolidated investments
|
9,439 | 7,609 | 20,003 | 13,196 | ||||||||||||||
|
Net Income
|
$ | 37,401 | $ | 12,815 | $ | 53,621 | $ | 25,837 | ||||||||||
|
Earnings Per Share of Common Stock:
|
||||||||||||||||||
|
Basic
|
$ | 0.27 | $ | 0.13 | $ | 0.46 | $ | 0.31 | ||||||||||
|
Diluted
|
$ | 0.26 | $ | 0.12 | $ | 0.44 | $ | 0.30 | ||||||||||
The accompanying notes are an integral part of the condensed
consolidated financial statements.
B-2
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
| September 30, | December 31, | |||||||
| 2005 | 2004 | |||||||
| (Unaudited) | ||||||||
| (In thousands, except per | ||||||||
| share amounts) | ||||||||
| ASSETS | ||||||||
|
Current:
|
||||||||
|
Cash and cash equivalents
|
$ | 165,732 | $ | 96,148 | ||||
|
Marketable securities available for sale
|
7,400 | 6,400 | ||||||
|
Investments in securities and derivatives (securities at cost:
$1,326 and $1,324)
|
17,096 | 1,432 | ||||||
|
Restricted funds held in trust
|
213,520 | 116,092 | ||||||
|
Restricted funds, other
|
30,634 | 32,805 | ||||||
|
Receivables (less allowances of $3,738 and $2,460)
|
188,463 | 133,994 | ||||||
|
Unbilled service receivables
|
55,499 | 58,206 | ||||||
|
Deferred income taxes
|
21,058 | 8,868 | ||||||
|
Prepaid expenses and other assets
|
66,650 | 64,452 | ||||||
|
Total Current Assets
|
766,052 | 518,397 | ||||||
|
Property, plant and equipment, net
|
2,675,799 | 819,400 | ||||||
|
Investments in fixed maturities at market (cost: $47,004 and
$57,264)
|
46,084 | 57,210 | ||||||
|
Restricted funds held in trust
|
215,218 | 123,826 | ||||||
|
Unbilled service receivables
|
90,424 | 98,248 | ||||||
|
Other noncurrent receivables (less allowances of $449 and $406)
|
32,261 | 31,840 | ||||||
|
Intangible assets, net
|
426,197 | 177,290 | ||||||
|
Goodwill
|
292,810 | — | ||||||
|
Investments in and advances to investees and joint ventures
|
68,945 | 64,156 | ||||||
|
Deferred financing costs
|
26,912 | 4,747 | ||||||
|
Deferred income taxes
|
18,525 | 18,042 | ||||||
|
Other assets
|
47,067 | 25,925 | ||||||
|
Total Assets
|
$ | 4,706,294 | $ | 1,939,081 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
|
Current:
|
||||||||
|
Current portion of long-term debt
|
$ | 27,983 | $ | 112 | ||||
|
Current portion of project debt
|
174,382 | 109,701 | ||||||
|
Accounts payable
|
22,689 | 16,243 | ||||||
|
Accrued expenses
|
189,026 | 120,701 | ||||||
|
Accrued emergence costs
|
24,152 | 32,805 | ||||||
|
Deferred revenue
|
13,528 | 15,219 | ||||||
|
Other liabilities
|
3,538 | 5,546 | ||||||
|
Total Current Liabilities
|
455,298 | 300,327 | ||||||
|
Long-term debt
|
1,315,032 | 312,784 | ||||||
|
Project debt
|
1,458,299 | 835,036 | ||||||
|
Deferred income taxes
|
488,118 | 109,465 | ||||||
|
Other liabilities
|
314,640 | 163,304 | ||||||
|
Total Liabilities
|
4,031,387 | 1,720,916 | ||||||
|
Minority Interests
|
83,410 | 83,350 | ||||||
|
Stockholders’ Equity:
|
||||||||
|
Preferred stock ($0.10 par value; authorized
10,000 shares; none issued and outstanding)
|
— | — | ||||||
|
Common stock ($0.10 par value; authorized 250,000 and
150,000 shares; issued 141,244 and 73,441 shares;
outstanding 141,175 and 73,430 shares)
|
14,124 | 7,344 | ||||||
|
Additional paid-in capital
|
594,341 | 194,783 | ||||||
|
Unearned compensation
|
(7,074 | ) | (3,489 | ) | ||||
|
Accumulated other comprehensive gain
|
832 | 583 | ||||||
|
Accumulated deficit
|
(10,719 | ) | (64,340 | ) | ||||
|
Treasury stock
|
(7 | ) | (66 | ) | ||||
|
Total Stockholders’ Equity
|
591,497 | 134,815 | ||||||
|
Total Liabilities and Stockholders’ Equity
|
$ | 4,706,294 | $ | 1,939,081 | ||||
The accompanying notes are an integral part of the condensed
consolidated financial statements.
B-3
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
| Nine Months Ended | ||||||||||
| September 30, | ||||||||||
| 2005 | 2004 | |||||||||
| (Unaudited) | ||||||||||
| (In thousands) | ||||||||||
|
OPERATING ACTIVITIES
|
||||||||||
|
Net income
|
$ | 53,621 | $ | 25,837 | ||||||
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
||||||||||
|
Depreciation and amortization
|
78,259 | 36,874 | ||||||||
|
Revenue contract levelization
|
1,007 | — | ||||||||
|
Amortization of deferred financing costs
|
5,584 | 7,045 | ||||||||
|
Amortization of project debt premium and discount
|
(11,359 | ) | (7,370 | ) | ||||||
|
Accretion on principal of Senior Secured Notes
|
872 | 1,884 | ||||||||
|
Provision for doubtful accounts
|
1,107 | 975 | ||||||||
|
Stock option and unearned compensation expense
|
1,642 | 308 | ||||||||
|
Equity in net income from unconsolidated Waste and Energy
Services investments
|
(20,003 | ) | (12,792 | ) | ||||||
|
Dividends from unconsolidated Waste and Energy Services
investments
|
12,124 | 6,986 | ||||||||
|
Minority interests
|
9,310 | 3,922 | ||||||||
|
Unrealized gain on derivative instruments, unexercised ACL
warrants
|
(14,796 | ) | — | |||||||
|
Deferred income taxes
|
7,057 | (226 | ) | |||||||
|
Other, net
|
5,397 | (413 | ) | |||||||
|
Change in operating assets and liabilities, net of effects of
acquisition:
|
||||||||||
|
Restricted funds for emergence costs
|
8,655 | 58,896 | ||||||||
|
Receivables
|
21,859 | 30,456 | ||||||||
|
Unbilled service receivables
|
10,444 | 6,638 | ||||||||
|
Other assets
|
2,506 | 16,930 | ||||||||
|
Accounts payable
|
8,729 | (2,294 | ) | |||||||
|
Accrued expenses
|
(5,630 | ) | (3,531 | ) | ||||||
|
Accrued emergence costs
|
(8,653 | ) | (58,896 | ) | ||||||
|
Deferred revenue
|
(1,691 | ) | (5,219 | ) | ||||||
|
Unpaid losses and loss adjustment expenses
|
(12,713 | ) | (16,640 | ) | ||||||
|
Other liabilities
|
(5,476 | ) | (1,475 | ) | ||||||
|
Other, net
|
— | 1,388 | ||||||||
|
Net cash provided by operating activities
|
147,852 | 89,283 | ||||||||
|
INVESTING ACTIVITIES
|
||||||||||
|
Decrease in restricted cash, Covanta Energy escrow
|
— | 37,026 | ||||||||
|
Purchase of Ref-Fuel and Covanta Energy, respectively
|
(747,217 | ) | (36,400 | ) | ||||||
|
Cash acquired of Ref-Fuel and Covanta Energy, respectively
|
62,358 | 57,795 | ||||||||
|
Matured or called investment securities
|
11,542 | 24,048 | ||||||||
|
Purchase of investment securities
|
(2,605 | ) | (16,052 | ) | ||||||
|
Purchase of property, plant and equipment
|
(14,127 | ) | (6,916 | ) | ||||||
|
Other
|
1,839 | 2,526 | ||||||||
|
Net cash provided by (used in) investing activities
|
(688,210 | ) | 62,027 | |||||||
|
FINANCING ACTIVITIES
|
||||||||||
|
Bank overdrafts
|
— | (1,436 | ) | |||||||
|
Proceeds from rights offerings, net
|
395,871 | 41,020 | ||||||||
|
Proceeds from the exercise of options for common stock, net
|
2,984 | 3,330 | ||||||||
|
Borrowings of recourse debt
|
675,000 | — | ||||||||
|
Premium received on refinancing
|
1,862 | — | ||||||||
|
Payment of deferred financing costs
|
(34,574 | ) | (900 | ) | ||||||
|
Repayment of bridge financing
|
— | (26,612 | ) | |||||||
|
Borrowings for facilities
|
42,447 | 1,208 | ||||||||
|
Payment of recourse debt
|
(336,492 | ) | (12,604 | ) | ||||||
|
Payment of project debt
|
(96,127 | ) | (14,932 | ) | ||||||
|
Increase in restricted funds held in trust
|
(24,926 | ) | (37,778 | ) | ||||||
|
Increase in parent restricted funds
|
(6,471 | ) | — | |||||||
|
Distribution to minority partners
|
(9,632 | ) | (6,368 | ) | ||||||
|
Net cash provided by (used in) financing activities
|
609,942 | (55,072 | ) | |||||||
|
Net increase in cash and cash equivalents
|
69,584 | 96,238 | ||||||||
|
Cash and cash equivalents at beginning of period
|
96,148 | 17,952 | ||||||||
|
Cash and cash equivalents at end of period
|
$ | 165,732 | $ | 114,190 | ||||||
The accompanying notes are an integral part of the condensed
consolidated financial statements.
B-4
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’
EQUITY
For The Nine Months Ended September 30, 2005
| Accumulated | ||||||||||||||||||||||||||||||||||||||
| Common Stock | Additional | Other | Treasury Stock | |||||||||||||||||||||||||||||||||||
| Paid-In | Unearned | Comprehensive | Accumulated | |||||||||||||||||||||||||||||||||||
| Shares | Amount | Capital | Compensation | Loss | Deficit | Shares | Amount | Total | ||||||||||||||||||||||||||||||
| (Unaudited) | ||||||||||||||||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||||||||||||
|
Balance at December 31, 2004
|
73,441 | $ | 7,344 | $ | 194,783 | $ | (3,489 | ) | $ | 583 | $ | (64,340 | ) | 11 | $ | (66 | ) | $ | 134,815 | |||||||||||||||||||
|
Stock option compensation expense
|
(30 | ) | (30 | ) | ||||||||||||||||||||||||||||||||||
|
Amortization of unearned compensation
|
1,672 | 1,672 | ||||||||||||||||||||||||||||||||||||
|
Adjustment of unearned compensation for terminated employees
|
(20 | ) | (2 | ) | (87 | ) | 89 | — | ||||||||||||||||||||||||||||||
|
Exercise of options to purchase common stock
|
724 | 72 | 4,935 | 5,007 | ||||||||||||||||||||||||||||||||||
|
Shares cancelled in exercise of options
|
(21 | ) | (2 | ) | (290 | ) | 58 | 59 | (233 | ) | ||||||||||||||||||||||||||||
|
Shares issued in restricted stock award
|
447 | 45 | 5,317 | (5,346 | ) | 16 | ||||||||||||||||||||||||||||||||
|
Shares issued in rights offering, net of expenses
|
66,673 | 6,667 | 389,204 | 395,871 | ||||||||||||||||||||||||||||||||||
|
ACL gift of warrants upon emergence from bankruptcy, net of
income taxes
|
509 | 509 | ||||||||||||||||||||||||||||||||||||
|
Comprehensive income, net of income taxes:
|
||||||||||||||||||||||||||||||||||||||
|
Net income
|
53,621 | 53,621 | ||||||||||||||||||||||||||||||||||||
|
Foreign currency translation
|
(51 | ) | (51 | ) | ||||||||||||||||||||||||||||||||||
|
Net unrealized loss on available for sale securities
|
(727 | ) | (727 | ) | ||||||||||||||||||||||||||||||||||
|
Net unrealized gain on derivative instruments
|
1,027 | 1,027 | ||||||||||||||||||||||||||||||||||||
|
Total comprehensive income
|
249 | 53,870 | ||||||||||||||||||||||||||||||||||||
|
Balance at September 30, 2005
|
141,244 | $ | 14,124 | $ | 594,341 | $ | (7,074 | ) | $ | 832 | $ | (10,719 | ) | 69 | $ | (7 | ) | $ | 591,497 | |||||||||||||||||||
The accompanying notes are an integral part of the condensed
consolidated financial statements.
B-5
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
| Note 1. | Organization and Basis of Presentation |
| Organization |
On September 20, 2005, Danielson Holding Corporation
changed its name to Covanta Holding Corporation
(“Covanta” or the “Company”). Covanta’s
common stock was traded on the American Stock Exchange under the
symbol “DHC” until close of trading on October 4,
2005. Since that date, Covanta’s stock has been traded on
the New York Stock Exchange under the symbol “CVA”.
Covanta is a holding company that owns subsidiaries currently
engaged in the businesses of waste and energy services, and
insurance services. The more significant business is the waste
and energy business which is comprised of Covanta Energy
Corporation and its subsidiaries (“Covanta Energy”),
which Covanta acquired on March 10, 2004. Covanta
Energy’s subsidiaries also include Covanta ARC Holdings
Corp., formerly known as American Ref-Fuel Holdings Corp., and
its subsidiaries (“Ref-Fuel”), which Covanta Energy
acquired on June 24, 2005 (the “Acquisition
Date”). See Note 3. Acquisitions and Dispositions of
the Notes to the Condensed Consolidated Financial Statements
(“Notes”) for a description of these acquisitions.
Covanta has changed the names of the Ref-Fuel subsidiaries such
that they will conduct business under the Covanta name.
Covanta Energy and its domestic subsidiaries, including
Ref-Fuel, engage in the waste-to-energy, waste disposal, water
and independent power production businesses in the United
States. Covanta Energy’s subsidiary Covanta Power
International Holdings, Inc. and its subsidiaries
(“CPIH”) engage in the independent power production
business outside the United States. Covanta’s business
segments are comprised of Waste and Energy Services, which is
comprised of Covanta Energy’s domestic and international
operations, and Other Services, which is comprised of the
holding company and insurance subsidiaries operations.
On March 10, 2004, Covanta Energy consummated a plan of
reorganization and emerged from its reorganization proceeding
under Chapter 11 of the United States Bankruptcy Code
(“Chapter 11”). Pursuant to the plan of
reorganization (“Reorganization Plan”), Covanta
acquired 100% of the equity in Covanta Energy. Three of Covanta
Energy’s subsidiaries, which relate to Covanta
Energy’s Warren County, New Jersey project, did not
reorganize with Covanta Energy but have since filed a plan of
reorganization and expect to emerge from bankruptcy in December
2005. Accordingly, Covanta does not include these subsidiaries
as consolidated subsidiaries in these Condensed Consolidated
Financial Statements. Covanta Energy’s investment in these
subsidiaries is recorded using the cost method effective from
March 10, 2004. For additional information regarding these
three Covanta Energy subsidiaries, see Note 17. Commitments
and Contingent Liabilities of the Notes.
Covanta also has investments in subsidiaries engaged in
insurance operations in California. Covanta holds all of the
voting stock of Danielson Indemnity Company (“DIND”).
DIND owns 100% of the common stock of National American
Insurance Company of California, Covanta’s principal
operating insurance subsidiary. National American Insurance
Company of California and its subsidiaries are collectively
referred to herein as “NAICC.” The operations of NAICC
are in property and casualty insurance. NAICC writes
non-standard private automobile insurance in California.
| Basis of Presentation |
The accompanying unaudited condensed consolidated financial
statements of Covanta have been prepared in accordance with the
instructions to Form 10-Q. As permitted by the rules and
regulations of the Securities and Exchange Commission (the
“SEC”), the financial statements contain certain
condensed financial information and exclude certain footnote
disclosures normally included in audited consolidated financial
statements prepared in accordance with United States generally
accepted accounting principles (“GAAP”). In the
opinion of management, the accompanying financial statements
contain all adjustments, including normal recurring accruals,
necessary to fairly present the accompanying financial
statements. For
B-6
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
further information, refer to the consolidated financial
statements and footnotes thereto included in Covanta’s
Annual Report on Form 10-K, as amended, for the year ended
December 31, 2004. Operating results for the interim period
are not necessarily indicative of the results that may be
expected for the fiscal year ending December 31, 2005.
The condensed consolidated financial statements include the
accounts of Covanta. Companies in which Covanta has significant
influence are accounted for using the equity method. Those
companies in which Covanta owns less than 20% are accounted for
using the cost method. Certain prior period amounts, including
various revenues and expenses, have been reclassified in the
condensed consolidated financial statements to conform to the
current period presentation. All intercompany transactions and
balances have been eliminated.
| Note 2. | New Accounting Pronouncements |
In December 2004, the Financial Accounting Standards Board
(“FASB”) issued Statement of Financial Accounting
Standards (“SFAS”) No. 123 (revised 2004),
“Share-Based Payment”
(“SFAS No. 123R”), which replaces
SFAS No. 123 “Accounting for Stock-Based
Compensation” (“SFAS No. 123”) and
supersedes Accounting Principles Board Opinion (“APB”)
No. 25, “Accounting for Stock Issued to
Employees” (“APB No. 25”).
SFAS No. 123R, as modified, requires all share-based
payments to employees, including grants of employee stock
options, to be recognized in the financial statements based on
their fair values. The pro forma disclosures previously
permitted under SFAS No. 123, will no longer be an
alternative to financial statement recognition.
Under SFAS No. 123R, Covanta must determine the
appropriate fair value model to be used for valuing share-based
payments, the amortization method for compensation cost and the
transition method to be used at date of adoption. The transition
methods include prospective and retroactive adoption methods.
Under the retroactive method, prior periods may be restated
either as of the beginning of the year of adoption or for all
periods presented. The prospective method requires that
compensation expense be recorded for all unvested stock options
and restricted stock at the beginning of the first quarter of
adoption of SFAS No. 123R, while the retroactive
method would record compensation expense for all unvested stock
options and restricted stock beginning with the first period
restated.
In March 2005, the SEC issued Staff Accounting
Bulletin No. 107 (“SAB No. 107”)
regarding the SEC’s interpretation of
SFAS No. 123R and the valuation of share-based
payments for public companies. In April 2005, the SEC modified
the initial dates for mandatory adoption to the first annual
period beginning on or after June 15, 2005. The extended
adoption dates are optional and registrants are permitted to
adopt SFAS No. 123R earlier. Covanta is required to
adopt SFAS No. 123R beginning on January 1, 2006.
Covanta is evaluating the requirements of
SFAS No. 123R and SAB No. 107. Covanta has
not yet determined the method of adoption or the effect of
adopting SFAS No. 123R, and it has not determined
whether the adoption will result in amounts that are similar to
the current pro forma disclosures required by
SFAS No. 123.
In March 2005, the FASB issued FIN No. 47,
“Accounting for Conditional Asset Retirement Obligations,
an interpretation of FASB Statement No. 143”
(“FIN No. 47”), which requires an entity to
recognize a liability for the fair value of a conditional asset
retirement obligation when incurred if the liability’s fair
value can be reasonably estimated. FIN No. 47 is
effective for fiscal years ending after December 15, 2005.
Covanta is currently evaluating the effect that the adoption of
FIN No. 47 will have on its consolidated results of
operations and financial condition but does not expect the
adoption to have a material impact on Covanta condensed
consolidated financial statements.
B-7
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Note 3. | Acquisitions and Dispositions |
| Acquisitions |
| Ref-Fuel |
On January 31, 2005, Covanta entered into a stock purchase
agreement with Ref-Fuel, the owner and operator of six
waste-to-energy facilities in the northeastern United States,
and Ref-Fuel’s stockholders. On June 24, 2005,
Covanta, through its wholly-owned subsidiary Covanta Energy,
purchased 100% of the issued and outstanding shares of Ref-Fuel
capital stock. Under the terms of the stock purchase agreement,
Covanta paid $747 million in cash and transaction costs for
the stock of Ref-Fuel and assumed the consolidated net debt of
Ref-Fuel of $1.3 billion at June 24, 2005
($1.5 billion of consolidated indebtedness and
$0.2 billion of cash and restricted cash). The acquisition
of Ref-Fuel was financed by a combination of debt and equity as
described below. Immediately after the transaction was
completed, Ref-Fuel became a wholly-owned subsidiary of Covanta
Energy.
Covanta’s acquisition of Ref-Fuel markedly increased the
size and scale of Covanta Energy’s waste-to-energy
business, and thus Covanta’s business. The acquisition also
provided Covanta Energy with the opportunity to achieve cost
savings by combining the businesses of Covanta Energy and
Ref-Fuel. Furthermore, Covanta Energy lowered its cost of
capital and obtained less restrictive covenants than under its
previous financing arrangements when it refinanced its existing
recourse debt concurrent with the acquisition of Ref-Fuel.
| Financing the Ref-Fuel Acquisition |
As part of the Ref-Fuel acquisition, Covanta Energy entered into
new credit arrangements which totaled approximately
$1.1 billion and are guaranteed by Covanta and certain
domestic subsidiaries of Covanta Energy. These credit
arrangements consisted of a first priority senior secured credit
facility and a second priority senior secured credit facility.
The first priority senior secured credit facility is comprised
of a $275 million first lien term loan, a $100 million
revolving credit facility, and a $340 million letter of
credit facility. The second priority senior secured credit
facility is a $400 million second lien term loan facility.
See Note 11. Credit Arrangements and Long-Term Debt of the
Notes for a detailed description of these credit arrangements.
The proceeds from the new credit arrangements were used to fund
the acquisition of Ref-Fuel, to refinance approximately
$479 million of Covanta Energy’s existing recourse
debt and letters of credit, and to pay related fees and
expenses. The revolving credit and letter of credit facilities
are further available for ongoing permitted expenditures and for
general corporate purposes.
The equity component of the financing consisted of a
$400 million offering of warrants to purchase
Covanta’s common stock (the “Ref-Fuel Rights
Offering”). Such warrants entitled Covanta’s existing
stockholders to purchase Covanta’s stock on a pro rata
basis, with each holder entitled to purchase 0.9 shares of
Covanta’s common stock at an exercise price of $6.00 for
each share of Covanta’s common stock held as of
May 27, 2005, the record date. Covanta received net
proceeds of approximately $395.9 million ($400 million
gross proceeds, net of $4.1 million of expenses) and issued
66,673,004 shares of common stock.
Three of Covanta’s largest stockholders, SZ Investments
L.L.C. (together with its affiliate EGI-Fund (05-07)
Investors, L.L.C. to which it transferred a portion of its
shares, “SZ Investments”), Third Avenue Business
Trust, on behalf of Third Avenue Value Fund Series
(“TAVF”), and D. E. Shaw Laminar Portfolios, L.L.C.
(“Laminar”), representing ownership, at the time of
the Ref-Fuel Rights Offering, of approximately 40.4% of
Covanta’s outstanding common stock, committed to
participate in the Ref-Fuel Rights Offering and acquired at
least their pro rata portion of the shares. As consideration for
their commitments, Covanta paid each of these stockholders, an
amount equal to 1.75% of their respective equity
B-8
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
commitments, which in the aggregate was $2.8 million.
Covanta agreed to amend an existing registration rights
agreement to provide these stockholders with the right to demand
that Covanta undertake an underwritten offering within twelve
months of the closing of the acquisition of Ref-Fuel in order to
provide such stockholders with liquidity.
The $2.2 billion preliminary purchase price was comprised
of the following (in millions of dollars):
|
Cash
|
$ | 740.0 | ||
|
Debt assumed
|
1,455.0 | |||
|
Direct transaction costs
|
7.2 | |||
|
Restructuring liability
|
9.1 | |||
| $ | 2,211.3 | |||
The preliminary purchase price included acquisition related
restructuring charges of $9.1 million which were recorded
as a liability and assumed in the Ref-Fuel acquisition, and
consisted primarily of severance and related benefits, and the
costs of vacating duplicate facilities. As of September 30,
2005, the restructuring liability was $8.5 million.
B-9
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following table summarizes the preliminary allocation of
values to the assets acquired and liabilities assumed at the
Acquisition Date in conformity with SFAS No. 141,
“Business Combinations” and SFAS No. 109,
“Accounting for Income Taxes.” The allocation of
purchase price to Ref-Fuel is preliminary and subject to change
as additional information and analysis is obtained. Management
is in the process of performing the valuation studies necessary
to finalize the fair values of the assets and liabilities of
Ref-Fuel and the related allocation of purchase price, and
expects adjustments to the preliminary fair values which may
include those related to:
| • | property, plant and equipment, intangibles, goodwill and debt, all of which may change based on consideration of additional analysis by Covanta and its valuation consultants; | |
| • | accrued expenses for transaction costs and restructuring efforts which may change based on identification of final fees and costs; and | |
| • | tax liabilities and deferred taxes, which may be adjusted based upon additional information to be received from taxing authorities and which result from changes in the allocated book basis of items for which deferred taxes are provided. | |
| Purchase Price Allocation as of | ||||||||
| June 24, 2005 | September 30, 2005 | |||||||
| (In thousands of dollars) | ||||||||
|
Current assets
|
$ | 233,885 | $ | 233,885 | ||||
|
Property, plant and equipment
|
1,901,786 | 1,901,786 | ||||||
|
Intangible assets (excluding goodwill)
|
269,436 | 269,436 | ||||||
|
Goodwill
|
298,089 | 292,810 | ||||||
|
Other assets
|
111,458 | 108,869 | ||||||
|
Total assets acquired
|
$ | 2,814,654 | $ | 2,806,786 | ||||
|
Current liabilities
|
$ | 156,610 | $ | 156,610 | ||||
|
Long-term debt
|
655,270 | 655,270 | ||||||
|
Project debt
|
718,805 | 706,732 | ||||||
|
Deferred income taxes
|
368,907 | 372,684 | ||||||
|
Other liabilities
|
164,787 | 165,215 | ||||||
|
Total liabilities assumed
|
2,064,379 | 2,056,511 | ||||||
|
Minority interest acquired
|
3,058 | 3,058 | ||||||
|
Net assets acquired
|
$ | 747,217 | $ | 747,217 | ||||
The acquired intangible assets of $269.4 million relate to
favorable energy and waste contracts, and a favorable leasehold
interest with an approximate 10 year average useful life.
In its initial purchase price allocation as of June 24,
2005, goodwill of $298.1 million was recorded to reflect
the excess of cost over the preliminary fair value of acquired
net assets. As of September 30, 2005, goodwill was
$292.8 million which reflected adjustments to the carrying
value of project debt by $12.1 million, a fair value
adjustment related to a service agreement of $2.5 million,
a deferred tax adjustment of $3.8 million and various other
liability adjustments of $0.5 million as part of
Covanta’s ongoing purchase accounting true-up.
B-10
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Covanta Energy |
On December 2, 2003, Covanta executed a definitive
investment and purchase agreement to acquire Covanta Energy in
connection with Covanta Energy’s emergence from
Chapter 11 proceedings after the non-core and geothermal
assets of Covanta Energy were divested. The primary components
of the transaction were: (1) the purchase by Covanta of
100% of the equity of Covanta Energy in consideration for a cash
purchase price of approximately $30 million, and
(2) agreement as to new letter of credit and revolving
credit facilities for Covanta Energy’s domestic and
international operations, provided by some of the existing
Covanta Energy lenders and a group of additional lenders
organized by Covanta. Covanta’s acquisition of Covanta
Energy was consummated on March 10, 2004.
The aggregate purchase price was $47.5 million which
included the cash purchase price of $30 million,
$6.4 million for professional fees and other estimated
costs incurred in connection with the acquisition, and an
estimated fair value of $11.3 million for Covanta’s
commitment to sell up to 3.0 million shares of its common
stock at $1.53 per share to certain creditors of Covanta
Energy, subject to certain limitations.
In addition to the purchase price allocation adjustments,
Covanta Energy’s emergence from Chapter 11 proceedings
on March 10, 2004 resulted in Covanta Energy becoming a new
reporting entity and adoption of fresh start accounting as of
that date, in accordance with AICPA Statement of Position
(“SOP”) 90-7, “Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code”. The following
table summarizes the final allocation of values to the assets
acquired and liabilities assumed at March 10, 2004 in
conformity with SFAS No. 141 and
SFAS No. 109 (in thousands of dollars):
|
Current assets
|
$ | 522,659 | |||
|
Property, plant and equipment
|
814,369 | ||||
|
Intangible assets
|
191,943 | ||||
|
Other assets
|
327,065 | ||||
|
Total assets acquired
|
$ | 1,856,036 | |||
|
Current liabilities
|
$ | 364,480 | |||
|
Long-term debt
|
328,053 | ||||
|
Project debt
|
850,591 | ||||
|
Deferred income taxes
|
88,405 | ||||
|
Other liabilities
|
176,982 | ||||
|
Total liabilities assumed
|
1,808,511 | ||||
|
Net assets acquired
|
$ | 47,525 | |||
The acquired intangible assets of $191.9 million primarily
relate to service and energy agreements on publicly-owned
waste-to-energy projects with an approximate 17 year
weighted average useful life. However, many such contracts have
remaining lives that are significantly shorter.
B-11
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Pro Forma Results of Operations |
The results of operations from Covanta Energy and Ref-Fuel are
included in Covanta’s consolidated results of operations
from March 11, 2004 and June 25, 2005, respectively.
The following table sets forth certain unaudited consolidated
operating results for the three and nine months ended
September 30, 2005 and 2004, as if the acquisitions of
Covanta Energy and Ref-Fuel were consummated on the same terms
at January 1, 2004 (in thousands, except per share amounts):
| Three Months Ended | Nine Months Ended | ||||||||||||||||
| September 30, | September 30, | ||||||||||||||||
| Pro Forma | Pro Forma | ||||||||||||||||
| 2005 | 2004 | 2005 | 2004 | ||||||||||||||
|
Total operating revenues
|
$ | 301,490 | $ | 296,294 | $ | 903,853 | $ | 901,449 | |||||||||
|
Net income
|
$ | 38,199 | $ | 21,010 | $ | 58,117 | $ | 40,285 | |||||||||
|
Basic earnings per share:
|
|||||||||||||||||
|
Weighted average shares outstanding
|
140,086 | 139,522 | 140,207 | 139,135 | |||||||||||||
|
Earnings per share
|
$ | 0.27 | $ | 0.15 | $ | 0.41 | $ | 0.29 | |||||||||
|
Diluted earnings per share:
|
|||||||||||||||||
|
Weighted average shares outstanding
|
145,737 | 143,799 | 145,907 | 143,814 | |||||||||||||
|
Earnings per share
|
$ | 0.26 | $ | 0.15 | $ | 0.40 | $ | 0.28 | |||||||||
| Restructuring and Acquisition-Related Charges |
In connection with the acquisition of Ref-Fuel, Covanta Energy
incurred integration costs of $1.0 million and
$3.0 million for the quarter and nine months ended
September 30, 2005, respectively, primarily related to
professional fees and employee incentive costs. These charges
were included as part of the operating costs of the Waste and
Energy Services business.
Covanta Energy also incurred restructuring costs in 2005 of
$2.7 million. The restructuring costs resulted from a
$2.1 million severance payment to CPIH executives in
connection with overhead reductions made possible by the
elimination of CPIH’s separate capital structure during the
second quarter of 2005. An additional $0.6 million was paid
to remaining CPIH executives, in the second quarter of 2005, as
incentive payments from existing contractual obligations
relating to CPIH debt repayment in connection with the Ref-Fuel
acquisition.
| Dispositions |
| Marine Services |
Covanta had investments in the marine services business, the
largest of which was American Commercial Lines LLC
(“ACL”), an integrated marine transportation and
service company which, throughout 2004 was in bankruptcy
proceedings under Chapter 11. ACL is no longer a subsidiary
of Covanta. On December 30, 2004, ACL’s plan of
reorganization was confirmed and ACL has since emerged from
bankruptcy. As part of ACL’s plan of reorganization, the
ACL stock owned by Covanta was cancelled, and its ownership
interest terminated. Covanta received no cash distributions
under the ACL plan of reorganization but, through a subsidiary,
received from ACL’s former creditors warrants to
purchase 672,920 shares of ACL stock at an exercise
price of $3.00 per share after ACL’s emergence in
January 2005. See Note 16. Financial Instruments of the
Notes for a discussion of these warrants.
Covanta’s other investees in the marine services business
consisted of Global Materials Services, LLC (“GMS”)
and Vessel Leasing, LLC (“Vessel Leasing”). GMS was a
joint venture of ACL, a third party and Covanta, in which
Covanta held a 5.4% interest. Covanta sold its interests in GMS
to the third party member
B-12
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
of the joint venture as of October 6, 2004. Vessel Leasing
was a joint venture of ACL and Covanta. Covanta sold its
interest in Vessel Leasing to ACL on January 13, 2005.
| Note 4. | Incentive Stock-Based Compensation Plans |
Stock-based compensation cost is measured using the intrinsic
value based method of accounting prescribed by APB No. 25
for the directors and employees of Covanta and its subsidiaries.
Pro forma net income and earnings per share are disclosed below
as if the fair value based method of accounting under
SFAS No. 123 had been applied to all stock-based
compensation awards (in thousands of dollars, except per share
amounts).
| Three Months Ended | Nine Months Ended | ||||||||||||||||
| September 30, | September 30, | ||||||||||||||||
| 2005 | 2004 | 2005 | 2004 | ||||||||||||||
|
Net income, as reported
|
$ | 37,401 | $ | 12,815 | $ | 53,621 | $ | 25,837 | |||||||||
|
Pro forma compensation expense
|
(1,007 | ) | (111 | ) | (2,413 | ) | (133 | ) | |||||||||
|
Pro forma net income
|
$ | 36,394 | $ | 12,704 | $ | 51,208 | $ | 25,704 | |||||||||
|
Basic earnings per share:
|
|||||||||||||||||
|
As reported
|
$ | 0.27 | $ | 0.13 | $ | 0.46 | $ | 0.31 | |||||||||
|
Pro forma
|
$ | 0.26 | $ | 0.13 | $ | 0.44 | $ | 0.31 | |||||||||
|
Diluted earnings per share:
|
|||||||||||||||||
|
As reported
|
$ | 0.26 | $ | 0.12 | $ | 0.44 | $ | 0.30 | |||||||||
|
Pro forma
|
$ | 0.25 | $ | 0.12 | $ | 0.42 | $ | 0.30 | |||||||||
Covanta accelerated the vesting period for 330,000 options from
February 28, 2006 to March 21, 2005. The average of
the high and low trading price for Covanta’s common stock
on March 18, 2005, the new measurement date, was
$16.48 per share. The exercise price is $7.43 per
share. At the time the options were granted, they had a fair
value per option of $5.68 per share using the Black-Scholes
valuation model. The 2004 pro forma after-tax compensation
expense under SFAS No. 123 related to the options for
which the vesting period was accelerated was $0.2 million.
The pro forma after-tax compensation expense related to the
options for which vesting was accelerated, which would otherwise
have not been included in the first nine months of 2005 was
$0.8 million. The purpose of the acceleration was to permit
officers and employees who held the options to exercise their
options and participate in the Ref-Fuel Rights Offering to
ensure that those participants’ rights with respect to this
subset of options were not diluted by the issuance of the new
shares.
Under APB No. 25 and authoritative interpretations, when
the vesting provisions are modified, Covanta is only required to
recognize compensation expense for the estimated portion of the
award that, absent the modification, would have expired
unexercisable. Accordingly, Covanta estimated the number of
employees who might cease to be employees prior to the original
vesting date of February 28, 2006. Covanta anticipates that
all participating employees will remain employees through the
original vesting date, based upon the compensation structure of
the employees holding these options, including the vesting
provisions of other awards, and the diminutive period of time
remaining until February 28, 2006. Covanta would be
required to recognize compensation expense of up to
$2.9 million if all employees holding the subset of options
were to cease being employees of Covanta prior to the original
vesting date. If one or more participating employees were to
cease being employed, Covanta would be required to revise its
estimate quarterly and recognize compensation expense in an
amount equal to that employee’s vested options divided by
330,000 and applying that ratio to $2.9 million.
B-13
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
On July 7, 2005, the Compensation Committee of the Board of
Directors, under the equity award plan for employees, awarded
certain key employees 404,000 shares of restricted stock.
The terms of the restricted stock awards include vesting
provisions based on two financial performance factors (66%) and
continued service over the passage of time (34%). The awards
vest over approximately 31 months, with 134,636 shares
(33.33%) vesting on February 28, 2006, 134,636 shares
(33.33%) vesting on February 28, 2007 and the remaining
134,728 shares (33.34%) vesting on February 29, 2008.
On September 19, 2005, in accordance with its existing
program for annual director compensation, Covanta granted
options to purchase an aggregate of 120,006 shares of
common stock and 13,500 shares of restricted stock under
the equity award plan for directors. The options have an
exercise price of $12.90 per share and expire 10 years
from the date of grant and vest upon the date of grant (but are
not exercisable for six months following such date).
Restrictions on the restricted stock shall lapse on a pro rata
basis over three years commencing on the date of grant.
| Note 5. | Earnings Per Share |
Per share data is based on the weighted average number of
Covanta’s par value $0.10 per share common stock
outstanding during the relevant period. Basic earnings per share
are calculated using only the average number of outstanding
shares of common stock. Diluted earnings per share computations,
as calculated under the treasury stock method, include the
average number of shares of additional outstanding common stock
issuable for stock options, restricted stock, rights and
convertible notes whether or not currently exercisable. Prior
periods were restated to reflect the impact of the Ref-Fuel
Rights Offering and the 9.25% Offering described in
Note 13. Stockholders Equity of the Notes.
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
| (In thousands of dollars, except share and per share | ||||||||||||||||
| amounts) | ||||||||||||||||
|
Net income
|
$ | 37,401 | $ | 12,815 | $ | 53,621 | $ | 25,837 | ||||||||
|
Basic earnings per share:
|
||||||||||||||||
|
Weighted average basic common shares outstanding
|
140,086 | 101,503 | 116,181 | 84,174 | ||||||||||||
|
Basic earnings per share
|
$ | 0.27 | $ | 0.13 | $ | 0.46 | $ | 0.31 | ||||||||
|
Diluted earnings per share:
|
||||||||||||||||
|
Weighted average basic common shares outstanding
|
140,086 | 101,503 | 116,181 | 84,174 | ||||||||||||
|
Stock options
|
545 | 220 | 733 | 513 | ||||||||||||
|
Restricted stock
|
1,049 | 36 | 801 | 62 | ||||||||||||
|
Rights
|
4,057 | 2,314 | 4,166 | 1,883 | ||||||||||||
|
Weighted average diluted common shares outstanding
|
145,737 | 104,073 | 121,881 | 86,632 | ||||||||||||
|
Diluted earnings per share
|
$ | 0.26 | $ | 0.12 | $ | 0.44 | $ | 0.30 | ||||||||
B-14
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Note 6. | Pass Through Costs |
Pass through costs are costs for which Covanta Energy receives a
direct contractually committed reimbursement from the municipal
client which sponsors a waste-to-energy project. These costs
generally include utility charges, insurance premiums, ash
residue transportation and disposal and certain chemical costs.
These costs are recorded net of municipal client reimbursements
in Covanta’s condensed consolidated financial statements.
Total pass through costs for three and nine months ended
September 30, 2005 were $12.3 million and
$41.9 million, respectively. Total pass through costs for
the three month period ended September 30, 2004 and for the
period March 11, 2004 through September 30, 2004 were
$11.9 million and $24.8 million, respectively.
| Note 7. | Revenues and Unbilled Service Receivables |
The following table summarizes the components of waste and
service revenues for the periods presented below (in thousands
of dollars):
| For the Period | ||||||||||||||||
| Three Months Ended | Nine Month | March 11, | ||||||||||||||
| September 30, | Ended | through | ||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
|
Waste and service revenues unrelated to project debt
|
$ | 166,830 | $ | 92,557 | $ | 365,910 | $ | 218,487 | ||||||||
|
Revenue earned explicitly to service project debt-principal
|
16,491 | 11,117 | 44,478 | 24,745 | ||||||||||||
|
Revenue earned explicitly to service project debt-interest
|
10,855 | 7,640 | 26,236 | 17,331 | ||||||||||||
|
Total waste and service revenues
|
$ | 194,176 | $ | 111,314 | $ | 436,624 | $ | 260,563 | ||||||||
Unbilled service receivables include fees related to the
principal portion of debt service earned to service project debt
principal where such fees are expressly included as a component
of the service fee paid by the municipality pursuant to
applicable waste-to-energy service agreements. Regardless of the
timing of amounts paid by municipalities relating to project
debt principal, Covanta Energy records service revenue with
respect to this principal component on a levelized basis over
the term of the service agreement. Long-term unbilled service
receivables related to waste-to-energy operations are recorded
at their discounted amounts.
Electricity and steam sales included lease income from the
international business of $23.3 million and
$20.7 million for the three months ended September 30,
2005 and 2004, respectively and $74.4 million and
$48.3 million for the nine months ended September 30,
2005 and for the period March 11, 2004 through
September 30, 2004, respectively.
| Note 8. | Equity in Net Income from Unconsolidated Investments |
Equity in net income from unconsolidated investments was
$9.4 million and $20.0 million for the three and nine
months ended September 30, 2005. Equity in net income from
unconsolidated investments was $7.6 million and
$13.2 million for the three and nine months ended
September 30, 2004.
See Note 3. Acquisitions and Dispositions of the Notes for
information regarding Covanta’s investment in Marine
Services.
B-15
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Equity in net income from unconsolidated investments primarily
relates to Covanta Energy’s 26.7% investment in Quezon
Power, Inc. in the Philippines (“Quezon”). The
unaudited results of operations from Quezon was as follows (in
thousands of dollars):
| Quezon | ||||||||||||||||
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
|
Revenue
|
$ | 74,307 | $ | 55,446 | $ | 184,614 | $ | 157,687 | ||||||||
|
Operating income
|
35,614 | 27,366 | 79,384 | 70,143 | ||||||||||||
|
Net income
|
26,859 | 18,162 | 52,806 | 41,995 | ||||||||||||
| Note 9. | Intangible Assets and Goodwill |
| Intangible Assets |
As of March 10, 2004, Covanta Energy’s waste and
energy contracts were recorded at their fair market values, in
accordance with SFAS No. 141, based upon discounted
cash flows from the service contracts and the “above
market” portion of the energy contracts using currently
available information. Amortization was calculated by the
straight-line method over the remaining contract lives. The
remaining weighted-average life of the agreements is
approximately 17 years. However, many of such contracts
have remaining lives that are significantly shorter.
As of June 25, 2005, Ref-Fuel’s waste and energy
contracts, lease interest, renewable energy credits and other
indefinite-lived assets were recorded at their preliminary fair
value, in accordance with SFAS No. 141, based upon
discounted cash flows attributable to the “above
market” portion of these contracts and assets using
currently available information. Amortization was calculated by
the straight-line method over the remaining contract lives which
range from four to fifteen years for waste and energy contracts
and twenty four years for the lease interest.
Intangible assets consisted of the following (in thousands of
dollars):
| September 30, | December 31, | |||||||||||
| Useful Life | 2005 | 2004 | ||||||||||
|
Waste and energy contracts
|
4 — 23 years | $ | 386,205 | $ | 192,058 | |||||||
|
Lease interest and other
|
5 — 24 years | 74,614 | 442 | |||||||||
|
Other intangibles
|
Not subject to amortization | 3,029 | — | |||||||||
| 463,848 | 192,500 | |||||||||||
|
Accumulated amortization
|
(37,651 | ) | (15,210 | ) | ||||||||
|
Intangible assets, net
|
$ | 426,197 | $ | 177,290 | ||||||||
B-16
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The following table details the amount of the actual/estimated
amortization expense associated with intangible assets included
or expected to be included in Covanta’s statement of
operations for each of the years indicated (in thousands of
dollars):
| Lease | ||||||||||||
| Waste and | Interest | |||||||||||
| Energy | and Other | |||||||||||
| Contracts | Contracts | Totals | ||||||||||
|
Nine months ended September 30, 2005
|
$ | 20,953 | $ | 793 | $ | 21,746 | ||||||
|
2005 remaining
|
$ | 11,305 | $ | 862 | $ | 12,167 | ||||||
|
2006
|
44,084 | 3,449 | 47,533 | |||||||||
|
2007
|
43,751 | 3,449 | 47,200 | |||||||||
|
2008
|
42,079 | 3,449 | 45,528 | |||||||||
|
2009
|
38,532 | 3,449 | 41,981 | |||||||||
|
Thereafter
|
169,726 | 59,033 | 228,759 | |||||||||
|
Total
|
$ | 349,477 | $ | 73,691 | $ | 423,168 | ||||||
Goodwill
In connection with the Ref-Fuel acquisition, Covanta Energy
recorded $292.8 million of goodwill as of
September 30, 2005. Goodwill represents the total
consideration paid in excess of the fair value of the net
tangible and identifiable intangible assets acquired and the
liabilities assumed in the Ref-Fuel acquisition in accordance
with the provisions of SFAS No. 142. Goodwill has an
indefinite life and is not amortized but will be reviewed under
the provisions of SFAS No. 142 for impairment. Covanta
will perform an annual fair value test of its recorded goodwill
for its reporting units using a discounted cash flow approach.
Goodwill is not deductible for federal income tax purposes.
| Note 10. | Other Noncurrent Liabilities |
Other noncurrent liabilities consisted of the following (in
thousands of dollars):
| September 30, | December 31, | |||||||
| 2005 | 2004 | |||||||
|
Waste and service contracts
|
$ | 118,883 | $ | — | ||||
|
Interest rate swap
|
12,874 | 14,920 | ||||||
|
Pension benefit obligation
|
47,631 | 45,430 | ||||||
|
Landfill remediation obligation
|
31,537 | 18,912 | ||||||
|
Duke liability
|
25,074 | — | ||||||
|
Insurance loss and loss adjustment reserves
|
51,557 | 64,270 | ||||||
|
Service contract obligations
|
10,856 | 7,873 | ||||||
|
Other
|
16,228 | 11,899 | ||||||
| $ | 314,640 | $ | 163,304 | |||||
As of June 25, 2005, Ref-Fuel’s waste and service
contracts were recorded at their fair market values, in
accordance with SFAS No. 141, based upon discounted
cash flows attributable to the “below market” portion
of the waste and service contracts using currently available
information. Amortization was calculated by the straight-line
method over the remaining weighted-average contract life which
is approximately 14 years.
B-17
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Note 11. | Credit Arrangements and Long-Term Debt |
Credit Facilities
Long-term debt is presented below (in thousands of dollars):
| September 30, | ||||||
| 2005 | ||||||
|
Senior Secured Credit Facilities
|
||||||
|
First Lien Term Loan Facility
|
$ | 274,313 | ||||
|
Second Lien Term Loan Facility
|
400,000 | |||||
| 674,313 | ||||||
|
Intermediate Subsidiary Debt
|
||||||
|
6.26% Senior Notes due 2015
|
234,000 | |||||
|
8.5% Senior Secured Notes due 2010
|
195,785 | |||||
|
7.375% Senior Secured Notes due 2010
|
224,100 | |||||
| 653,885 | ||||||
|
Unamortized debt premium
|
14,592 | |||||
|
Total intermediate subsidiary debt
|
668,477 | |||||
|
Other long-term debt
|
225 | |||||
|
Total long-term debt
|
1,343,015 | |||||
|
Less: current portion
|
(27,983 | ) | ||||
|
Total long-term debt
|
$ | 1,315,032 | ||||
As part of the Ref-Fuel acquisition, Covanta Energy entered into
new financing arrangements which are guaranteed by Covanta and
certain subsidiaries of Covanta Energy described more fully
below. The proceeds of the new financing arrangements were used
to fund the acquisition of Ref-Fuel, to refinance approximately
$479 million of Covanta Energy’s and CPIH’s
recourse debt and letter of credit facilities, and to pay
related fees and expenses. The new credit facilities are further
available for ongoing permitted expenditures and for general
corporate purposes.
Covanta Energy’s new financing arrangements are comprised
of the following:
| • | a first priority secured term loan facility in the amount of $275 million that will mature in 2012 and is repayable in scheduled quarterly installments that began September 30, 2005 (the “First Lien Term Loan Facility”); | |
| • | a first priority secured revolving credit facility in the amount of $100 million that will mature in 2011 and is available for revolving loans, up to $75 million of which may be utilized for letters of credit (the “Revolving Credit Facility”); | |
| • | a first priority secured letter of credit facility in the amount of $340 (of which $304.3 million of letters of credit have been issued as of September 30, 2005) million that will mature in 2012 (the “Funded L/C Facility” and collectively with the First Lien Term Loan Facility and the Revolving Loan Facility the “First Lien Facilities”); and | |
| • | a second priority secured term loan facility in the amount of $400 million that matures and is repayable in full in 2013 (the “Second Lien Term Loan Facility” and collectively with the First Lien Facilities the “Credit Facilities”). | |
B-18
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Material Terms of Senior Secured Credit Facilities |
| Amortization Terms |
The First Lien Term Loan Facility has a mandatory annual
amortization, paid in equal quarterly installments beginning
September 30, 2005, through the date of maturity in annual
amounts set forth in the following schedule (in thousands of
dollars):
| Remaining | ||||
| First Lien Term Loan Facility | Amortization | |||
|
2005
|
$ | 688 | ||
|
2006
|
2,750 | |||
|
2007
|
2,750 | |||
|
2008
|
2,750 | |||
|
2009
|
2,750 | |||
|
2010
|
2,750 | |||
|
2011
|
130,625 | |||
|
2012
|
129,250 | |||
The Second Lien Term Loan Facility has no mandatory
amortization requirements and is required to be repaid in full
on its maturity date.
| Interest and Fee Terms |
Interest on loans under the Credit Facilities varies, depending
upon interest rate periods and designation of such loans, each
selected by Covanta Energy. Loans are designated as Eurodollar
rate loans or base rate loans. Eurodollar loans bear interest at
a reserve adjusted British Bankers Association Interest
Settlement Rate, commonly referred to as “LIBOR,” for
deposits in dollars plus a borrowing margin as described below.
Interest on Eurodollar rate loans is payable at the end of the
applicable interest period of one, two, three or six months (and
at the end of every three months in the case of six month
Eurodollar loans). Base rate loans bear interest at (a) a
rate per annum equal to the greater of (i) the “prime
rate” designated in the relevant facility or (ii) the
federal funds rate plus 0.50% per annum, plus (b) a
borrowing margin as described below.
Letters of credit issued under the Revolving Credit Facility
will accrue fees at the then effective borrowing margins on
Eurodollar rate loans, plus a fee on each issued letter of
credit payable to the issuing bank. Letter of credit
availability under the Funded L/C Facility accrues fees (whether
or not letters of credit are issued thereunder) at the
then-effective borrowing margin for Eurodollar rate loans
described below times the total funded letter of credit
availability (whether or not then utilized), plus a fee on each
issued letter of credit payable to the issuing bank. In
addition, Covanta Energy has agreed to pay to the participants
under the Funded L/C Facility any shortfall between the
Eurodollar rate applicable to the relevant Funded L/C Facility
interest period and the investment income earned on the
pre-agreed investments made by the relevant issuing banks with
the purchase price paid by such participants for their
participations under the Funded L/C Facility. Covanta Energy is
required to enter into certain hedging obligations designed to
mitigate its exposure to the risk of interest rate changes with
respect to $337.5 million of its borrowings under the
Credit Facilities, less any second lien notes to the extent
issued. See Note 16. Financial Instruments of the Notes.
B-19
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The borrowing margins referred to above for the Revolving Credit
Facility are as follows:
| Borrowing | Borrowing | |||||||
| Margin for | Margin for | |||||||
| Revolving | Revolving | |||||||
| Eurodollar | Base Rate | |||||||
| Company Leverage Ratio | Loans | Loan | ||||||
|
³4.25:1.00
|
3.00 | % | 2.00 | % | ||||
|
<4.25:1.00
|
||||||||
|
³3.50:1:00
|
2.75 | % | 1.75 | % | ||||
|
<3.50:1:00
|
2.50 | % | 1.50 | % | ||||
The borrowing margin for the First Lien Term Loan Facility
and the Funded L/ C Facility are 3.00% for Eurodollar rate loans
and 2.00% for base rate loans. The borrowing margins under the
Second Lien Term Loan Facility are 5.50% for Eurodollar
rate loans and 4.50% for base rate loans.
Fees payable under the Credit Facilities are as follows:
| • | Revolving Credit Facility — A commitment fee of 0.50% of the unfunded portion of the facility and a fronting fee of 0.125% of the average aggregate daily maximum available to be drawn under the facility per annum; and | |
| • | Funded L/ C Facility — A funded letter of credit fee as defined in the credit agreement and a fronting fee of 0.125% of the average aggregate daily maximum available to be drawn under the facility per annum. | |
| Guarantees and Securitization |
The Credit Facilities are guaranteed by Covanta and by certain
Covanta Energy subsidiaries. Covanta Energy agreed to secure all
of its obligations under the First and Second Lien Facilities by
granting, for the benefit of secured parties, a first and second
priority lien on substantially all of its assets, to the extent
permitted by existing contractual obligations, a pledge of all
of the capital stock of each of its domestic subsidiaries owned
by it and 65% of all the capital stock of each of its foreign
subsidiaries directly owned by it, in each case to the extent
not otherwise pledged.
The Credit Facilities provide for the mandatory prepayments of
all or a portion of the amounts funded by the lenders under the
First Lien Facilities from specified sources, including the sale
of assets, incurrence of additional debt, net insurance or
condemnation proceeds received and fifty percent of Covanta
Energy’s excess annual cash flow as calculated pursuant to
the credit agreement.
| Debt Covenants and Defaults |
The Credit Facilities require Covanta Energy to furnish the
lenders with periodic financial, operating and other
information. In addition, these facilities further restrict,
without consent of its lenders, Covanta Energy’s ability
to, among other things:
| • | incur indebtedness, or incur liens on its property, subject to specific exemptions; | |
| • | pay any dividends or distributions, subject to specific exceptions; | |
| • | make new investments, subject to specific exceptions; | |
| • | sell or dispose of assets, enter into a merger transaction, liquidate or dissolve itself subject to specific exceptions; | |
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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| • | enter into any transactions with affiliates, subject to specific exceptions; and | |
| • | engage in new lines of business. | |
In addition, the Credit Facilities require Covanta Energy to
maintain a minimum interest coverage ratio, a maximum leverage
ratio and minimum adjusted EBITDA and to comply with maximum
capital expenditure limitations.
Events of default under the Credit Facilities include any of the
following:
| • | a failure by Covanta Energy to pay amounts when due under the First Lien Term Loan Facility or other debt instruments; | |
| • | material breaches of representations and warranties; | |
| • | breaches of covenants; | |
| • | involuntary or voluntary bankruptcy; | |
| • | a judgment in excess of specified amounts is rendered against Covanta Energy and is unstayed, to the extent not covered by insurance; | |
| • | any event that would cause a material adverse effect on Covanta Energy; | |
| • | a change in control; or | |
| • | as a result of the occurrence of certain events, the net operating losses available to Covanta or Covanta Energy to offset taxable income are less than $315 million (as reduced by amounts used by Covanta after December 31, 2004). | |
The priority of the security interests and related creditor
rights among the Credit Facilities are set forth in the
intercreditor agreement among Covanta Energy and its lenders
(the “Intercreditor Agreement”). The Intercreditor
Agreement provides, among other things, that for as long as any
of the First Lien Facilities are outstanding:
| • | any proceeds of collateral received in connection with the sale or disposition of such collateral by the collateral agent for the holders of the First Lien Facilities will be applied to the First Lien Facilities in the order specified by the Intercreditor Agreement and the applicable First Lien Facilities documents. Upon discharge of the First Lien Facilities, any proceeds of collateral held by the collateral agent for the First Lien Facilities will be delivered to the collateral agent for the Second Lien Term Loan Facility to be applied in the order specified by the Intercreditor Agreement and the applicable Second Lien Term Loan Facility; and | |
| • | except as permitted under the Credit Facilities, Covanta Energy will not make prepayments of the Second Lien Term Loan Facility prior to any voluntary or mandatory prepayment of any amounts outstanding under the First Lien Facilities. | |
| Intermediate Subsidiary Debt |
Upon the consummation of the Ref-Fuel acquisition, Covanta
Energy assumed the existing consolidated debt of Ref-Fuel and
its subsidiaries. This assumed debt included certain notes
issued by non-project subsidiaries of Ref-Fuel described below,
as of the Acquisition Date.
| • | 6.26% senior notes outstanding in the amount of $240 million ($234 million as of September 30, 2005) maturing in 2015. Interest is payable June 30 and December 31 each year through maturity; |
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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| • | 8.5% senior secured notes in the amount of $200 million ($196 million as of September 30, 2005) maturing September 1, 2010. Interest is payable on March 1 and September 1 each year through maturity; and | |
| • | 7.375% senior secured notes in the amount of $225 million ($224 million as of September 30, 2005) maturing September 1, 2010. Interest is payable on March 1 and September 1 each year through maturity. | |
The 6.26% senior notes and the 8.5% and 7.375% senior
secured notes have indentures that provide for certain
restrictive covenants, including among other things,
restrictions on the incurrence of indebtedness, certain payments
to related and unrelated parties, acquisitions and asset sales.
In addition, the indentures, pursuant to which such notes are
issued, provide that distributions of cash to parent entities
(including Covanta Energy) may occur quarterly and only if
certain financial covenants are satisfied. Holders of 8.5% and
7.375% senior secured notes are entitled to receive from
the issuer an offer to repurchase such notes upon a change of
control, (a “Change of Control Offer”), such as was
caused by Covanta Energy’s purchase of Ref-Fuel. These
issuers are MSW Energy Holdings LLC (“MSW I”) issuer
of the 8.5% senior secured notes, and MSW Energy
Holdings II LLC (“MSW II”), issuer of the
7.375% senior secured notes. On June 24, 2005, Change
of Control Offers were issued by both MSW I and MSW II.
Holders of approximately $4.2 million of MSW I notes
properly tendered their notes for repurchase, and holders of
approximately $0.9 million of MSW II notes properly
tendered their notes for repurchase. All such notes were
repurchased on July 26, 2005. MSW I and MSW II paid
the purchase price of such notes, which was $5.1 million in
the aggregate with cash made available by Covanta Energy.
| Financing Costs |
Deferred financing costs on the condensed consolidated balance
sheet represent capitalizable costs incurred by Covanta in
connection with the acquisition of Ref-Fuel and refinancing of
Covanta Energy’s recourse debt. All deferred financing
costs are amortized to interest expense over the life of the
related debt using the straight-line method, which approximates
the effective interest method.
| Note 12. | Income Taxes |
Covanta records its interim tax provision based upon its
estimated effective tax rates for the full year.
Covanta files a Federal consolidated income tax return with its
eligible subsidiaries. Covanta’s Federal consolidated
income tax return also includes the taxable results of certain
grantor trusts. The trusts were established pursuant to a prior
court approved reorganization of certain present and former
insurance subsidiaries of Covanta. These trusts are not
consolidated with Covanta for financial statement purposes.
Covanta’s 2004 Federal consolidated income tax return
excluded the results of CPIH since its operations did not
qualify for consolidation under the applicable tax laws.
Effective July 31, 2005, CPIH is includable in the
Covanta’s Federal consolidated return. Covanta’s
Federal consolidated tax return will include the results of
Ref-Fuel after June 24, 2005 (the date of acquisition).
Covanta had net operating losses (“NOLs”) estimated to
be $516 million for Federal income tax purposes as of the
end of 2004. The NOLs will expire in various amounts from
December 31, 2005 through December 31, 2023, if not
used. The Internal Revenue Service (“IRS”) has not
audited any of Covanta’s tax returns. There can be no
assurance that Covanta would prevail if the IRS were to
challenge the use of the NOLs.
If Covanta were to undergo an “ownership change,” as
such term is used in Section 382 of the Internal Revenue
Code, the use of its NOLs would be limited. Covanta will be
treated as having had an “ownership change” if there
is a more than 50% increase in stock ownership during a 3-year
“testing period” by “5%
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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
stockholders”. Covanta’s Certificate of Incorporation
contains stock transfer restrictions that were designed to help
preserve Covanta’s NOLs by avoiding an ownership change.
The transfer restrictions were implemented in 1990, and Covanta
expects that they will remain in-force as long as Covanta has
NOLs. Covanta cannot be certain, however, that these
restrictions will prevent an ownership change.
Reductions in Covanta’s NOLs could occur in connection with
the administration and wind-up of the grantor trusts discussed
above. During or at the conclusion of the administration of
these grantor trusts, material taxable income could result which
could utilize a substantial portion of Covanta’s NOLs which
in turn could materially reduce Covanta’s cash flow and
ability to service its debt. The impact of a material reduction
in Covanta’s NOLs could cause an event of default under the
Credit Facilities, and/or a reduction of a substantial portion
of Covanta’s deferred tax assets relating to such NOLs.
Covanta has received preliminary information which raises the
possibility that it may recognize taxable income in connection
with the conclusion of the administration of the grantor trusts.
However, after reviewing the preliminary information, Covanta
determined that it was insufficient to warrant inclusion of
taxable income in its 2004 tax filing based on such preliminary
information. Covanta is in discussions with the representatives
of the grantor trusts in order to obtain additional information
regarding the potential amount of includible taxable income and
to clarify the treatment of certain liabilities and the manner
of distributions to claimsholders in insolvency proceedings.
If Covanta’s existing insurance business were to require
capital infusions in order to meet certain regulatory capital
requirements, and were Covanta to fail to provide such capital,
some or all of its subsidiaries comprising the insurance
business could enter insurance insolvency or bankruptcy
proceedings. In such event, such subsidiaries may no longer be
included in Covanta’s consolidated tax return and a
portion, which could constitute a significant portion, of
Covanta’s remaining NOLs may no longer be available to it.
There may also be a significant inclusion of taxable income in
Covanta’s Federal consolidated tax return.
Covanta’s provision for income taxes in the condensed
consolidated statements of operations also includes certain
state and other taxes. Tax filings for these jurisdictions do
not consolidate the activity of the grantor trusts referred to
above and reflect preparation on a separate company basis. For
further information, reference is made to Note 25 of the
Notes to the Consolidated Financial Statements included in
Covanta’s Annual Report on Form 10-K, as amended, for
the year ended December 31, 2004.
| Note 13. | Stockholders’ Equity |
In connection with a pro rata rights offering to all
stockholders on May 27, 2005, Covanta issued approximately
66.7 million additional shares of common stock for
approximately $400 million of gross proceeds, as more fully
described in Note 3. Acquisitions and Dispositions of the
Notes. As of September 30, 2005, there were approximately
141.2 million shares of common stock issued and outstanding.
Covanta is expected to complete its previously announced rights
offering for up to 3.0 million shares of its common stock
to certain holders of 9.25% debentures issued by Covanta
Energy prior to its reorganization, at a purchase price of
$1.53 per share which Covanta is required to complete in
order to satisfy its obligations as the sponsor of Covanta
Energy’s Reorganization Plan (the “9.25%
Offering”). This 9.25% Offering will be made solely to
holders of the $100 million of principal amount of
9.25% debentures due 2022 issued by Covanta Energy who
voted in favor of the Reorganization Plan on January 12,
2004 or were authorized to participate by the Bankruptcy Court.
Covanta executed a letter agreement with Laminar on
January 31, 2005 pursuant to which Covanta agreed that if
the 9.25% Offering did not close prior to commencement of the
Ref-Fuel Rights Offering, that it would revise the terms of the
9.25% Offering so that participants in the 9.25% Offering are
offered up to 2.7 million additional shares of
Covanta’s common stock at the same $6.00 per share
purchase price as in the Ref-Fuel Rights Offering. Covanta filed
a registration statement with the SEC to register the 9.25%
Offering, which registration statement has not been declared
effective. Since the 9.25%
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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Offering was not commenced prior to the Ref-Fuel Rights
Offering, Covanta will amend and restructure the 9.25% Offering
in accordance with its agreement.
| Note 14. | Business Segments |
Given the significance of the Covanta Energy and Ref-Fuel
acquisitions to Covanta’s business results of operations
and financial condition, Covanta decided, during the third
quarter of 2005, to combine the previously separate business
segments of Insurance Services and Parent into one reportable
segment called Other Services. Covanta currently has two
reportable business segments — Waste and Energy
Services and Other Services.
Waste and Energy Services develops, constructs, owns and
operates for others key infrastructure for the disposal of waste
(primarily waste-to-energy) and independent power production
facilities in the United States and abroad. Covanta also has one
water facility in this segment. The Other Services segment is
comprised of Covanta’s insurance business, which writes
property and casualty insurance in California, and the parent
company which primarily receives income from its investments and
incurred general and administrative expenses prior to the
acquisition of Covanta Energy.
The accounting policies of the reportable segments are
consistent with those described in Covanta’s Annual Report
on Form 10-K, as amended, for the year ended
December 31, 2004. Segment results are shown below (in
thousands of dollars):
| Three Months Ended | Nine Months Ended | ||||||||||||||||||
| September 30, | September 30, | ||||||||||||||||||
| 2005 | 2004 | 2005 | 2004 | ||||||||||||||||
|
Operating Revenues:
|
|||||||||||||||||||
|
Waste and Energy Services
|
|||||||||||||||||||
|
Domestic
|
$ | 265,558 | $ | 135,869 | $ | 559,339 | $ | 311,636 | |||||||||||
|
International
|
32,312 | 31,158 | 104,605 | 74,189 | |||||||||||||||
|
Subtotal Waste and Energy Services
|
297,870 | 167,027 | 663,944 | 385,825 | |||||||||||||||
|
Other Services
|
3,620 | 4,595 | 11,457 | 16,550 | |||||||||||||||
|
Total operating revenues
|
$ | 301,490 | $ | 171,622 | $ | 675,401 | $ | 402,375 | |||||||||||
|
Income (loss) from segment operations:
|
|||||||||||||||||||
|
Waste and Energy Services
|
|||||||||||||||||||
|
Domestic
|
$ | 61,325 | $ | 19,763 | $ | 95,487 | $ | 48,249 | |||||||||||
|
International
|
3,558 | 2,569 | 11,704 | 10,216 | |||||||||||||||
|
Subtotal Waste and Energy Services
|
64,883 | 22,332 | 107,191 | 58,465 | |||||||||||||||
|
Other Services
|
108 | (624 | ) | 473 | (2,201 | ) | |||||||||||||
|
Total operating income
|
64,991 | 21,708 | 107,664 | 56,264 | |||||||||||||||
|
Other income (expense):
|
|||||||||||||||||||
|
Interest income
|
1,657 | 836 | 3,530 | 2,002 | |||||||||||||||
|
Interest expense
|
(30,701 | ) | (10,541 | ) | (59,053 | ) | (33,267 | ) | |||||||||||
|
Gain on derivative instrument, unexercised ACL warrants
|
10,578 | — | 14,796 | — | |||||||||||||||
|
Income before income taxes, minority interests and equity in net
income from unconsolidated investments
|
$ | 46,525 | $ | 12,003 | $ | 66,937 | $ | 24,999 | |||||||||||
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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The acquisition of Ref-Fuel substantially increased the assets
in the Waste and Energy Services segment. Identifiable assets
were as follows (in thousands of dollars).
| September 30, | December 31, | |||||||
| 2005 | 2004 | |||||||
|
Waste and Energy Services
|
$ | 4,567,299 | $ | 1,814,042 | ||||
|
Other Services
|
138,995 | 125,039 | ||||||
|
Consolidated assets
|
$ | 4,706,294 | $ | 1,939,081 | ||||
| Note 15. | Pension and Other Postretirement Benefits |
Net periodic defined pension benefit expense for Covanta Energy
were as follows (in thousands of dollars):
| Pension Benefits | ||||||||||||||||
| For the Three | For the Period | |||||||||||||||
| Months Ended | For the Nine | March 11, | ||||||||||||||
| September 30, | Months Ended | through | ||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
|
Service cost
|
$ | 1,805 | $ | 2,077 | $ | 5,417 | $ | 4,638 | ||||||||
|
Interest cost
|
997 | 861 | 2,992 | 1,922 | ||||||||||||
|
Expected return on plan assets
|
(753 | ) | (588 | ) | (2,261 | ) | (1,313 | ) | ||||||||
|
Net periodic benefit cost
|
$ | 2,049 | $ | 2,350 | $ | 6,148 | $ | 5,247 | ||||||||
| Other Postretirement Benefits | ||||||||||||||||
| For the Three | For the Period | |||||||||||||||
| Months Ended | For the Nine | March 11, | ||||||||||||||
| September 30, | Months Ended | through | ||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
|
Interest cost
|
$ | 165 | $ | 169 | $ | 493 | $ | 377 | ||||||||
|
Net periodic benefit cost
|
$ | 165 | $ | 169 | $ | 493 | $ | 377 | ||||||||
Covanta Energy has recorded a pension plan liability equal to
the amount that the present value of projected benefit
obligations (using a discount rate of 5.75%) exceeded the fair
value of pension plan assets at March 10, 2004 in
accordance with the provisions of SFAS No. 141.
Covanta Energy made contributions of $3.2 million and
$6.2 million to the plan in the nine months ended
September 30, 2005 and for the period of March 11,
through September 30, 2004, respectively.
Net periodic defined pension benefit expense was not significant
for Covanta’s insurance business for the nine months ended
September 30, 2005 and 2004.
During the third quarter of 2005, Covanta announced it would
freeze the Covanta Energy pension plan effective
December 31, 2005. All active employees who are eligible
participants in the Covanta Energy Pension Plan as of
December 31, 2005 will be 100% vested, and have a
nonforfeitable right to this benefit as of such date. Beginning
January 1, 2006, all eligible employees will receive a
company contribution into a new defined contribution retirement
plan.
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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Note 16. | Financial Instruments |
| ACL Warrants |
On January 12, 2005, two subsidiaries of Covanta received
warrants to purchase 168,230 shares of common stock of
ACL at $12.00 per share. The number of shares and exercise
price subject to the warrants were subsequently adjusted to
672,920 shares at an exercise price of $3.00 per
share, as a result of a four for one stock split effective as of
August 2005. The warrants were given by certain of the former
creditors of ACL under the ACL plan of reorganization.
Covanta’s investment in ACL was written down to zero in
2003.
Covanta recorded the warrants as a derivative security in
accordance with SFAS No. 133 “Accounting for
Derivative Instruments and Hedging Activities”
(“SFAS No. 133”). Covanta recorded the
warrants at their aggregate fair value of $0.8 million on
the grant date and marked the warrants to their fair value of
$5.0 million as of June 30, 2005. On October 7,
2005, ACL issued 7.5 million shares in an initial public
offering. Based on market quotes as of September 30, 2005,
Covanta recorded a mark-to-market adjustment for the period
ended September 30, 2005 which increased the value of its
investment in ACL warrants to $15.6 million in the
condensed consolidated balance sheet and recorded a
corresponding pre-tax gain on derivative instruments of
$10.6 million in the condensed consolidated statements of
operations for the three months ended September 30, 2005.
See Note 19. Subsequent Events of the Notes for a
discussion related to the ACL shares sold in October 2005.
| Interest Rate Swaps |
As described in Note 11. Credit Arrangements and Long-Term
Debt of the Notes, Covanta Energy is required to enter into
hedging arrangements with respect to a portion of its exposure
to interest rate changes with respect to its borrowing under the
Credit Facilities. On July 8, 2005, Covanta Energy entered
into two pay fixed, receive floating interest rate swap
agreements with a total notional amount of $300 million.
These swaps were designated as cash flow hedges in accordance
with SFAS No. 133, accordingly, unrealized gains or
losses will be deferred in other comprehensive income until the
hedged cash flows affect earnings. The impact of the swaps was
to increase interest expense for the three months ended
September 30, 2005 by $0.5 million. As of
September 30, 2005, the net after-tax deferred gain in
other comprehensive income was $1.0 million
($1.5 million before income taxes, which is recorded in
other assets).
| Note 17. | Commitments and Contingent Liabilities |
Covanta and/or its subsidiaries are party to a number of claims,
lawsuits and pending actions, most of which are routine and all
of which are incidental to its business. Covanta assesses the
likelihood of potential losses on an ongoing basis and when
losses are considered probable and reasonably estimable, records
as a loss an estimate of the ultimate outcome. If Covanta can
only estimate the range of a possible loss, an amount
representing the low end of the range of possible outcomes is
recorded. The final consequences of these proceedings are not
presently determinable with certainty.
| Covanta Energy Corporation |
Generally, claims and lawsuits against Covanta Energy and its
subsidiaries that had filed bankruptcy petitions and
subsequently emerged from bankruptcy arising from events
occurring prior to their respective petition dates, have been
resolved pursuant to the Covanta Energy Reorganization Plan, and
have been discharged pursuant to the March 5, 2004 order of
the Bankruptcy Court which confirmed the Covanta Energy
Reorganization Plan. However, to the extent that claims are not
dischargeable in bankruptcy, such claims may not be discharged.
For example, the claims of certain persons who were personally
injured prior to the petition date but whose injury only became
manifest thereafter may not be discharged pursuant to the
Covanta Energy Reorganization Plan.
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COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Environmental Matters |
Covanta Energy’s operations are subject to environmental
regulatory laws and environmental remediation laws. Although
Covanta Energy’s operations are occasionally subject to
proceedings and orders pertaining to emissions into the
environment and other environmental violations, which may result
in fines, penalties, damages or other sanctions, Covanta Energy
believes that it is in substantial compliance with existing
environmental laws and regulations.
Covanta Energy may be identified, along with other entities, as
being among parties potentially responsible for contribution to
costs associated with the correction and remediation of
environmental conditions at disposal sites subject to the
Comprehensive Environmental Response Compensation and Liability
Act (“CERCLA”) and/or analogous state laws. In certain
instances, Covanta Energy may be exposed to joint and several
liabilities for remedial action or damages. Covanta
Energy’s ultimate liability in connection with such
environmental claims will depend on many factors, including its
volumetric share of waste, the total cost of remediation, and
the financial viability of other companies that also sent waste
to a given site and, in the case of divested operations, its
contractual arrangement with the purchaser of such operations.
Generally such claims arising prior to the first petition date
were resolved in and discharged by Covanta Energy’s
Chapter 11 cases.
The potential costs related to the matters described below and
the possible impact on future operations are uncertain due in
part to the complexity of governmental laws and regulations and
their interpretations, the varying costs and effectiveness of
cleanup technologies, the uncertain level of insurance or other
types of recovery and the questionable level of Covanta
Energy’s responsibility. Although the ultimate outcome and
expense of any litigation, including environmental remediation,
is uncertain, Covanta Energy believes that the following
proceedings will not have a material adverse effect on Covanta
Energy’s consolidated financial position or results of
operations.
| 1. | In June 2001, the EPA named Covanta Energy’s wholly-owned subsidiary, Ogden Martin Systems of Haverhill, Inc., now known as Covanta Haverhill, Inc., as one of 2,000 potentially responsible parties (“PRPs”) at Beede Waste Oil Superfund Site, Plaistow, New Hampshire, a former waste oil recycling facility. The total quantity of waste oil alleged by the EPA to have been disposed of by PRPs at the Beede site is approximately 14.3 million gallons, of which Covanta Haverhill’s contribution is alleged to be approximately 44,000 gallons. On January 9, 2004, the EPA signed its Record of Decision with respect to the cleanup of the site. The estimated cost to implement the remedial alternative selected in the Record of Decision is $48 million. By letter dated September 28, 2005, the EPA invited Covanta Haverhill and 94 other PRPs including, among others, those PRPs that are alleged to have contributed more than 20,000 gallons of waste oil to the Beede site, to negotiate the voluntary performance and/or financing of the site cleanup, including reimbursement of past costs incurred to date by the EPA and the State of New Hampshire Department of Environmental Services (“DES”). Covanta Haverhill, Inc. is a member of a PRP group at the Beede site and expects to participate in settlement negotiations with the EPA and DES as part of that PRP group. Covanta Haverhill, Inc.’s share of liability, if any, cannot be determined at this time as a result of uncertainties regarding the source and scope of contamination, the large number of PRPs and the varying degrees of responsibility among various classes of PRPs. Covanta Energy believes that based on the amount of waste oil materials Covanta Energy Haverhill, Inc. is alleged to have sent to the site, its liability will not be material to Covanta Energy’s results of operation and financial position. | |
| 2. | By letters dated August 13, 2004 and May 3, 2005, EPA notified Covanta Essex Company (“Essex”), formerly named American Ref-Fuel Company of Essex County, that it was potentially liable under CERCLA Section 107(a) for response actions in the Lower Passaic River Study Area (“LPRSA”), a 17 mile stretch of river in northern New Jersey. Essex is one of at least 52 PRPs named thus far. EPA alleges that hazardous substances found in the LPRSA were being released from the Essex site, which abuts the river. EPA’s notice letters state that Essex may be liable for costs related to a proposed | |
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Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| $10 million study of the Lower Passaic River, for certain past costs incurred by EPA totaling approximately $2.8 million, and for unspecified natural resource damages. Considering the history of industrial and other discharges into the LPRSA from other sources, including named PRPs, Essex believes any releases from its site to be de minimus; however, it is not possible at this time to predict that outcome with certainty or to estimate Essex’ ultimate liability in the matter, including for natural resource damage. Given the uncertainty, Essex has entered an arrangement with USEPA and the cooperating PRP group to settle the potential liability Essex might have for the $2.8 million in past costs incurred by EPA, by contributing $250,000 to the cost of the study and by sharing in certain past and ongoing legal fees and other costs of the cooperating PRP group. |
| Other Matters |
The Covanta Energy subsidiaries (collectively “Covanta
Warren”) which operate the waste-to-energy facility in
Warren County, New Jersey (the “Warren Facility”) and
the Pollution Control Financing Authority of Warren County
(“Warren Authority”) have been engaged in negotiations
for an extended time concerning a potential restructuring of the
parties’ rights and obligations under various agreements
related to Covanta Warren’s operation of the Warren
Facility. Those negotiations were in part precipitated by a 1997
Federal court of appeals decision invalidating certain of the
State of New Jersey’s waste-flow laws, which resulted in
significantly reduced revenues for the Warren Facility. Since
1999, the State of New Jersey has been voluntarily making all
debt service payments with respect to the project bonds issued
to finance construction of the Warren Facility, and Covanta
Warren has been operating the Warren Facility pursuant to an
agreement with the Warren Authority which modifies the existing
service agreement. Principal on the Warren Facility project debt
is due annually in December of each year, while interest is due
semi-annually in June and December of each year. The State of
New Jersey has provided sufficient funds to the project bond
trustee to pay principal and interest to bondholders when due
during 2004 and 2005.
Also as part of Covanta Energy’s emergence from bankruptcy,
Covanta Energy and Covanta Warren entered into several
agreements approved by the Bankruptcy Court that permit Covanta
Warren to reimburse Covanta Energy for employees and
employee-related expenses, provide for payment of a monthly
allocated overhead expense reimbursement in a fixed amount, and
permit Covanta Energy to advance up to $2 million in
super-priority debtor-in-possession loans to Covanta Warren in
order to meet any liquidity needs. As of September 30,
2005, Covanta Warren owed Covanta Energy $1.4 million.
In September 2005, Covanta Warren facility filed a
reorganization plan after they reached agreements with the
Warren Authority and various contract counterparties. Covanta
Energy expects Covanta Warren will emerge from bankruptcy prior
to December 31, 2005 and that after such emergence they
will be consolidated in Covanta’s financial statements. As
a condition to the consummation of the reorganization plan,
Covanta Warren expects to pay approximately $15 million to
satisfy all amounts then due with respect to the outstanding
project debt, and to pay certain amounts to project creditors
and the Warren Authority. The reorganization plan also
contemplates that Covanta Warren and the Warren Authority will
enter into certain agreements pursuant to which Covanta Warren
will own and operate the Warren Facility for its own account,
without a committed supply of waste from the Warren Authority or
other municipal entities, and that the Warren Authority will
provide ash disposal services to Covanta Warren at its landfill
adjacent to the Warren facility. Under the reorganization plan,
Covanta Warren’s creditors filed claims are expected to be
paid in full, in cash. A hearing is scheduled to be held on
December 1, 2005 at which time the Bankruptcy Court will
consider confirmation of the reorganization plan.
In the event the parties are unable to timely reach agreement
and/or Covanta Warren is unable to consummate such
reorganization plan, the debtors may, among other things, elect
to litigate with counterparties to certain agreements with
Covanta Warren, assume or reject one or more executory contracts
related to the Warren Facility, attempt to file a plan of
reorganization on a non-consensual basis, or liquidate Covanta
Warren. In such an event, creditors of Covanta Warren may
receive little or no recovery on account of their claims.
B-28
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
| Other Commitments |
Covanta Energy’s other commitments as of September 30,
2005 were as follows (in thousands of dollars):
| Commitments Expiring by Period | ||||||||||||
| Less Than | More Than | |||||||||||
| Total | One Year | One Year | ||||||||||
|
Letters of credit issued
|
$ | 306,329 | $ | 19,275 | $ | 287,054 | ||||||
|
Surety bonds
|
44,948 | — | 44,948 | |||||||||
|
Total other commitments — net
|
$ | 351,277 | $ | 19,275 | $ | 332,002 | ||||||
The letters of credit were issued pursuant to the facilities
described in Note 11. Credit Arrangements and Long-Term
Debt of the Notes to secure Covanta Energy’s performance
under various contractual undertakings related to its domestic
and international projects, or to secure obligations under its
insurance program. Each letter of credit relating to a project
is required to be maintained in effect for the period specified
in related project contracts, and generally may be drawn if it
is not renewed prior to expiration of that period.
Some of these letters of credit reduce over time as well, and
one of such reducing letters of credit may be cancelled if
Covanta Energy receives an investment grade rating from both
Moody’s Investors Service and Standard &
Poor’s. As of September 30, 2005, Covanta Energy had
approximately $35.7 million in available capacity for
additional letters of credit under its Funded L/C Facility.
Covanta Energy believes that it will be able to fully perform
its contracts to which these existing letters of credit relate,
and that it is unlikely that letters of credit would be drawn
because of a default of its performance obligations. If any of
Covanta Energy’s letters of credit were to be drawn under
its current debt facilities, the amount drawn would be
immediately repayable to the issuing bank. If Covanta Energy
were unable to immediately repay such amounts drawn under
letters of credit, unreimbursed amounts would be treated under
the Credit Facilities as additional term loans issued under the
First Lien Facilities.
The surety bonds listed on the table above relate primarily to
assumed contracts from Ref-Fuel ($35.3 million) and
possible closure costs for various energy projects when such
projects cease operating ($9.6 million). Were these bonds
to be drawn upon, Covanta Energy would have a contractual
obligation to indemnify the surety company.
Covanta Energy and certain of its subsidiaries have issued or
are party to performance guarantees and related contractual
support obligations undertaken mainly pursuant to agreements to
construct and operate certain waste-to-energy and a water
facility. With respect to its domestic businesses, Covanta
Energy and certain of its subsidiaries have issued guarantees to
municipal clients and other parties that Covanta Energy’s
subsidiaries will perform in accordance with contractual terms,
including, where required, the payment of damages or other
obligations. Such contractual damages or other obligations could
be material, and in circumstances where one or more
subsidiary’s contract has been terminated for its default,
such damages could include amounts sufficient to repay project
debt. For facilities owned by municipal clients and operated by
Covanta Energy, Covanta Energy’s potential maximum
liability as of September 30, 2005 associated with the
repayment of the municipalities’ project debt on such
facilities was in excess of $1 billion. This amount was not
recorded as a liability in Covanta Energy’s condensed
consolidated balance sheet as of September 30, 2005 as
Covanta Energy believes that it had not incurred such liability
at the date of the financial statements. Additionally, damages
payable under such guarantees on Covanta Energy-owned
waste-to-energy facilities could expose Covanta Energy to
recourse liability on project debt. Covanta Energy also believes
that it has not incurred such damages at the date of the
financial statements. If Covanta Energy is asked to perform
under one or more of such guarantees, its liability for damages
upon contract termination would be reduced by funds held in
trust and proceeds from sales of the facilities securing the
project debt, which is presently not estimable.
B-29
Table of Contents
COVANTA HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Concluded)
With respect to its international businesses, Covanta Energy has
issued guarantees of certain of CPIH’s operating
subsidiaries contractual obligations to operate power projects.
The potential damages owed under such arrangements for
international projects may be material.
Depending upon the circumstances giving rise to such domestic
and international damages, the contractual terms of the
applicable contracts, and the contract 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 Covanta Energy’s
then-available sources of funds. To date, Covanta Energy has not
incurred material liabilities under its guarantees, either on
domestic or international projects.
| Note 18. | Related-Party Transactions |
ACL was an indirect, wholly-owned subsidiary of Covanta prior to
ACL’s bankruptcy proceedings. At that same time, SZ
Investments, LLC’s equity ownership in Covanta was
approximately 18%. SZ Investments, LLC is affiliated with Samuel
Zell, Covanta’s current Chairman of the Board of Directors.
Another affiliate of Mr. Zell, HY I Investments, LLC,
was a holder of approximately 42% of ACL’s Senior Notes and
PIK Notes. The holders of ACL’s Senior Notes were among the
class of grantors of the warrants to subsidiaries of Covanta.
SZ Investments, TAVF and Laminar, representing ownership of
approximately 40.4% of Covanta’s outstanding common stock,
each participated in Ref-Fuel Rights Offering and acquired at
least their respective pro rata portion of the shares. As
consideration for their commitments, Covanta paid each of these
stockholders an amount equal to 1.75% of their respective equity
commitments, which in the aggregate was $2.8 million.
Covanta also agreed to amend an existing registration rights
agreement to provide these stockholders with the right to demand
that Covanta undertake an underwritten offering within twelve
months of the closing of the acquisition of Ref-Fuel in order to
provide such stockholders with liquidity.
Covanta executed a letter of agreement with Laminar on
January 31, 2005 pursuant to which Covanta agreed that if
the 9.25% Offering did not close prior to the Ref-Fuel Rights
Offering, that it would revise the terms of the 9.25% Offering
so that participants in the 9.25% Offering are offered up to
2.7 million additional shares of Covanta’s common
stock at the same $6.00 per share purchase price as in the
Ref-Fuel Rights Offering. Covanta filed a registration statement
with the SEC to register the 9.25% Offering, which registration
statement has not been declared effective. Since the 9.25%
Offering was not commenced prior to the Ref-Fuel Rights
Offering, Covanta will amend and restructure the 9.25% Offering
in accordance with its agreement.
| Note 19. | Subsequent Events |
During October 2005, Covanta monetized its investment in the
672,920 ACL warrants it owned and converted into shares of
ACL’s common stock. The average gross selling price was
$26.79 per share and resulted in net cash proceeds of
$18 million and a realized gain of $16 million. As of
September 30, 2005, Covanta had recognized approximately
$15.6 million in unrealized gains related to these shares.
As a result, Covanta will recognize an additional
$0.4 million realized gain in the fourth quarter of 2005.
In the corporate rehabilitation proceedings of Magellan
Cogeneration, Inc. (“MCI”) in the Philippines, on
October 20, 2005, the Court approved a Rehabilitation Plan
involving a debt-to-equity swap and debt restructuring. Under
the approved Rehabilitation Plan, Covanta’s present 100%
equity interest in MCI will be reduced to approximately 30% and
various creditors will hold the remaining 70% of the equity.
MCI’s remaining debt will be restructured into several
tranches with quarterly amortization over 15 years. The
restructured debt will be Peso denominated and the interest
rates on the several tranches will range from 0% to 3% per
annum. Covanta is to retain “management control” of
MCI and will receive an annual management fee. Project
disbursements will remain subject to approval of the
Court-appointed Receiver during the 15 year pay-down of the
restructured debt.
B-30
Table of Contents
APPENDIX C
Consolidated Financial Statements of Covanta ARC Holdings,
Inc. and Subsidiaries
|
Consolidated Financial Statements for Covanta ARC Holdings,
Inc. and Subsidiaries as of December 31, 2004 and 2003 and
for the year ended December 31, 2004, the period from
December 12, 2003 through December 31, 2003 and the
period from January 1, 2003 through December 12, 2003
and the year ended December 31, 2002:
|
|||||
|
Reports of Independent Registered Public Accounting Firms
|
C-2 | ||||
|
Consolidated Balance Sheets
|
C-5 | ||||
|
Consolidated Statements of Operations and Comprehensive Income
|
C-6 | ||||
|
Consolidated Statements of Stockholders’ Equity
|
C-7 | ||||
|
Consolidated Statements of Cash Flows
|
C-8 | ||||
|
Notes to Consolidated Financial Statements
|
C-9 | ||||
|
Consolidated Financial Statements of Covanta Ref-Fuel
Holdings LLC and Subsidiaries as of December 31, 2004 and
2003 and the year ended December 31, 2004 and the period
from December 12, 2003 through December 31, 2003 and
the period from January 1, 2003 through December 12,
2003 and the year ended December 31, 2002:
|
|||||
|
Reports of Independent Registered Public Accounting Firm
|
C-38 | ||||
|
Consolidated Balance Sheets
|
C-40 | ||||
|
Consolidated Statements of Operations and Comprehensive Income
|
C-41 | ||||
|
Consolidated Statements of Members’ Equity
|
C-42 | ||||
|
Consolidated Statements of Cash Flows
|
C-43 | ||||
|
Notes to Consolidated Financial Statements
|
C-44 | ||||
C-1
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
American Ref-Fuel Holdings Corp. and Subsidiaries:
In our opinion, the accompanying consolidated balance sheets and
the related consolidated statements of operations and
comprehensive income, stockholders’ equity and cash flows
present fairly, in all material respects, the financial position
of American Ref-Fuel Holdings Corp. and Subsidiaries (the
“Company”) at December 31, 2004 and 2003, and the
results of their operations and their cash flows for the year
ended December 31, 2004 and the period from
December 12, 2003 through December 31, 2003 in
conformity with accounting principles generally accepted in the
United States of America. These financial statements are the
responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these
statements 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, assessing the accounting principles
used and significant estimates made by management, and
evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our
opinion.
| /s/ PricewaterhouseCoopers LLP |
Florham Park, NJ
March 15, 2005
C-2
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
American Ref-Fuel Holdings Corp. and Subsidiaries:
In our opinion, the accompanying consolidated statement of
operations and comprehensive income, of stockholders’
equity and of cash flows for the period January 1, 2003
through December 12, 2003 present fairly, in all material
respects, the results of operations and cash flows of American
Ref-Fuel Holdings Corp. and Subsidiaries (the
“Company”), in conformity with accounting principles
generally accepted in the United States of America. These
financial statements are the responsibility of the
Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audit. We
conducted our audit of these statements 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,
assessing the accounting principles used and significant
estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
| /s/ PricewaterhouseCoopers LLP |
Florham Park, NJ
June 30, 2004
C-3
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
American Ref-Fuel Holdings Corp.:
We have audited the accompanying consolidated statements of
operations and comprehensive income, stockholders’ equity
and cash flows of American Ref-Fuel Holdings Corp. and
subsidiaries for the year ended December 31, 2002. These
consolidated financial statements are the responsibility of the
Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audit. We did not audit the consolidated financial statements of
Ref-Fuel Holdings LLC (a 50-percent owned investee company). The
Company’s equity in earnings of Ref-Fuel Holdings LLC was
approximately $52.9 million for the year ended
December 31, 2002. The consolidated financial statements of
Ref-Fuel Holdings LLC were audited by other auditors whose
report has been furnished to us, and our opinion, insofar as it
relates to the amounts included for Ref-Fuel Holdings LLC, is
based solely on the report of the other auditors.
We conducted our audit 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 audit and the report
of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audit and the report of the other
auditors, the consolidated financial statements referred to
above present fairly, in all material respects, the results of
operations and cash flows of American Ref-Fuel Holdings Corp.
and subsidiaries for the year ended December 31, 2002, in
conformity with U.S. generally accepted accounting
principles.
| /s/ KPMG LLP |
Short Hills, New Jersey
April 11, 2003, except for the reclassifications
described in the second and sixth
paragraphs of
Note 4, which are as of
June 24, 2004
C-4
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Consolidated Balance Sheets
| December 31, | ||||||||||
| 2004 | 2003 | |||||||||
| (Dollars in thousands) | ||||||||||
| ASSETS | ||||||||||
|
Current assets:
|
||||||||||
|
Cash and cash equivalents
|
$ | 88,945 | $ | 17,537 | ||||||
|
Restricted cash and cash equivalents
|
73,103 | — | ||||||||
|
Receivables, net of allowance of $1,491 and $954
|
72,027 | 94 | ||||||||
|
Income tax receivable
|
4,338 | 3,760 | ||||||||
|
Prepaid expenses and other current assets
|
12,846 | 907 | ||||||||
|
Assets of business held for sale
|
— | 184,521 | ||||||||
|
Total current assets
|
251,259 | 206,819 | ||||||||
|
Restricted cash and cash equivalents
|
90,971 | — | ||||||||
|
Property, plant and equipment, net
|
1,187,178 | — | ||||||||
|
Intangible assets, net
|
542,877 | 10,383 | ||||||||
|
Goodwill
|
123,984 | — | ||||||||
|
Equity investments
|
— | 488,002 | ||||||||
|
Other assets
|
4,806 | 237 | ||||||||
|
Total assets
|
$ | 2,201,075 | $ | 705,441 | ||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||
|
Current liabilities:
|
||||||||||
|
Accounts payable and accrued liabilities
|
$ | 48,879 | $ | 7,539 | ||||||
|
Deferred income taxes
|
— | 4,012 | ||||||||
|
Current portion of long-term debt
|
87,184 | — | ||||||||
|
Accrued interest
|
22,115 | 2,527 | ||||||||
|
Liabilities of businesses held for sale
|
— | 141,273 | ||||||||
|
Total current liabilities
|
158,178 | 155,351 | ||||||||
|
Long-term debt, less current portion
|
1,383,829 | 308,179 | ||||||||
|
Deferred income taxes
|
149,419 | 116,875 | ||||||||
|
Other liabilities
|
224,649 | 133 | ||||||||
|
Total liabilities
|
1,916,075 | 580,538 | ||||||||
|
Commitments and contingencies (Note 19 )
|
||||||||||
|
Minority interest in consolidated subsidiary
|
742 | — | ||||||||
|
Stockholders’ equity:
|
||||||||||
|
Common stock, Class A, 263,987 of $0.001 par value
issued in 2004 and 1,000 of $0.01 issued in 2003
|
1 | 1 | ||||||||
|
Additional paid-in capital
|
300,306 | 123,908 | ||||||||
|
Retained earnings
|
(16,049 | ) | 994 | |||||||
|
Total stockholders’ equity
|
284,258 | 124,903 | ||||||||
|
Total liabilities and stockholders’ equity
|
$ | 2,201,075 | $ | 705,441 | ||||||
The accompanying notes are an integral part of these
consolidated financial statements.
C-5
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Consolidated Statements of Operations and Comprehensive
Income
| December 12, | January 1, | ||||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | ||||||||||||||||
| December 31, | December 31, | December 12, | December 31, | ||||||||||||||||
| 2004 | 2003 | 2003 | 2002 | ||||||||||||||||
| (In thousands) | |||||||||||||||||||
|
Revenues
|
|||||||||||||||||||
|
Waste disposal and related services
|
$ | 194,950 | $ | — | $ | — | $ | — | |||||||||||
|
Energy
|
93,188 | — | — | — | |||||||||||||||
|
Other
|
10,506 | — | — | — | |||||||||||||||
|
Total net revenues
|
298,644 | — | — | — | |||||||||||||||
|
Expenses
|
|||||||||||||||||||
|
Operating
|
116,089 | — | — | — | |||||||||||||||
|
Depreciation and amortization
|
45,154 | 4 | 258 | 281 | |||||||||||||||
|
General and administrative
|
30,216 | 358 | 4,634 | 7,548 | |||||||||||||||
|
Transaction costs related to MSW Merger
|
— | — | 16,600 | — | |||||||||||||||
|
Loss on asset retirements
|
1,765 | — | — | — | |||||||||||||||
|
Total operating costs and expenses
|
193,224 | 362 | 21,492 | 7,829 | |||||||||||||||
|
Operating income
|
105,420 | (362 | ) | (21,492 | ) | (7,829 | ) | ||||||||||||
|
Interest income
|
2,967 | 133 | 519 | 616 | |||||||||||||||
|
Interest expense
|
(69,219 | ) | (2,677 | ) | (10,651 | ) | (12,202 | ) | |||||||||||
|
Loss on extinguishment of debt
|
— | — | (1,655 | ) | — | ||||||||||||||
|
Equity in net earnings of unconsolidated subsidiaries
|
6,148 | 3,969 | 50,204 | 52,898 | |||||||||||||||
|
Minority interest in net income of subsidiaries
|
(12,283 | ) | — | — | — | ||||||||||||||
|
Other, net
|
303 | — | 3,278 | 2,020 | |||||||||||||||
|
Income before income taxes
|
33,336 | 1,063 | 20,203 | 35,503 | |||||||||||||||
|
Provision for income taxes
|
17,818 | 498 | 12,362 | 15,639 | |||||||||||||||
|
Income from continuing operations
|
15,518 | 565 | 7,841 | 19,864 | |||||||||||||||
|
Discontinued operations:
|
|||||||||||||||||||
|
Income from discontinued operations net of income tax expense of
$5,373, $382, $3,310 and $418, respectively
|
5,589 | 429 | 2,888 | 2,612 | |||||||||||||||
|
Loss on disposal of discontinued operations, net of income tax
benefit of $0, $0, $0, $(3,238), respectively
|
— | — | — | (10,427 | ) | ||||||||||||||
|
Income (loss) from discontinued operations
|
5,589 | 429 | 2,888 | (7,815 | ) | ||||||||||||||
|
Net income
|
21,107 | 994 | 10,729 | 12,049 | |||||||||||||||
|
Other comprehensive (loss) income
|
(211 | ) | — | — | 502 | ||||||||||||||
|
Comprehensive income
|
$ | 20,896 | $ | 994 | $ | 10,729 | $ | 12,551 | |||||||||||
The accompanying notes are an integral part of these
consolidated financial statements.
C-6
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
| Participating | Accumulated | ||||||||||||||||||||||||||||||||
| Convertible | Common | Additional | Comprehensive | Deferred | Total | ||||||||||||||||||||||||||||
| Preferred | Stock — | Paid-In | Retained | Income | Treasury | Compensation | Stockholders’ | ||||||||||||||||||||||||||
| Stock | Class A | Capital | Earnings | (Loss) | Stock | Plan | Equity | ||||||||||||||||||||||||||
| (In thousands) | |||||||||||||||||||||||||||||||||
|
Balance at January 1, 2002 (Predecessor)
|
$ | 70,955 | $ | 18 | $ | 3,982 | $ | 36,123 | $ | (502 | ) | $ | — | $ | — | $ | 110,576 | ||||||||||||||||
|
Modification of stock options
|
— | — | 2,589 | — | — | — | — | 2,589 | |||||||||||||||||||||||||
|
Exercise of stock options
|
— | — | 194 | — | — | (194 | ) | — | — | ||||||||||||||||||||||||
|
Shares received for taxes on stock options
|
— | — | — | — | — | (32 | ) | — | (32 | ) | |||||||||||||||||||||||
|
Stock contributed to deferred compensation plan
|
— | — | 2,160 | — | — | — | (2,160 | ) | — | ||||||||||||||||||||||||
|
Comprehensive income
|
— | — | — | 12,049 | 502 | — | — | 12,551 | |||||||||||||||||||||||||
|
Balance at December 31, 2002
|
70,955 | 18 | 8,925 | 48,172 | — | (226 | ) | (2,160 | ) | 125,684 | |||||||||||||||||||||||
|
Acceleration of stock option vesting
|
— | — | 713 | — | — | — | — | 713 | |||||||||||||||||||||||||
|
Exercise of stock options
|
— | 4 | 2,389 | — | — | (726 | ) | — | 1,667 | ||||||||||||||||||||||||
|
Shares received for taxes on stock options
|
— | — | — | — | — | (108 | ) | — | (108 | ) | |||||||||||||||||||||||
|
Stock contributed to deferred compensation plan
|
— | — | 6,976 | — | — | — | (6,976 | ) | — | ||||||||||||||||||||||||
|
Comprehensive income
|
— | — | — | 10,729 | — | — | — | 10,729 | |||||||||||||||||||||||||
|
Equity prior to the MSW Transaction (Predecessor)
|
$ | 70,955 | $ | 22 | $ | 19,003 | $ | 58,901 | $ | — | $ | (1,060 | ) | $ | (9,136 | ) | $ | 138,685 | |||||||||||||||
|
Balance at December 12, 2003
|
$ | — | $ | 1 | $ | 123,908 | $ | — | $ | — | $ | — | $ | — | $ | 123,909 | |||||||||||||||||
|
Comprehensive income
|
— | — | — | 994 | — | — | — | 994 | |||||||||||||||||||||||||
|
Balance at December 31, 2003
|
— | 1 | 123,908 | 994 | — | — | — | 124,903 | |||||||||||||||||||||||||
|
Unrealized gain on investment from the consolidation of Ref-Fuel
Holdings
|
— | — | — | — | 211 | — | — | 211 | |||||||||||||||||||||||||
|
Contribution of Senior Notes
|
— | — | 40,000 | — | — | — | — | 40,000 | |||||||||||||||||||||||||
|
Equity contributed in the August 31 Transactions
|
— | — | 136,398 | — | — | — | — | 136,398 | |||||||||||||||||||||||||
|
Comprehensive income
|
— | — | — | 21,107 | (211 | ) | — | — | 20,896 | ||||||||||||||||||||||||
|
Dividends paid
|
— | — | — | (38,150 | ) | — | — | — | (38,150 | ) | |||||||||||||||||||||||
|
Balance at December 31,2004
|
$ | — | $ | 1 | $ | 300,306 | $ | (16,049 | ) | $ | — | $ | — | $ | — | $ | 284,258 | ||||||||||||||||
The accompanying notes are an integral part of these
consolidated financial statements.
C-7
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Consolidated Statements of Cash Flows
| December 12, | January 1, | |||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | |||||||||||||||
| December 31, | December 31, | December 12, | December 31, | |||||||||||||||
| 2004 | 2003 | 2003 | 2002 | |||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||
|
Cash flows from operating activities
|
||||||||||||||||||
|
Net income
|
$ | 21,107 | $ | 994 | $ | 10,729 | $ | 12,049 | ||||||||||
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
||||||||||||||||||
|
Depreciation and amortization
|
69,239 | 174 | 17,329 | 21,254 | ||||||||||||||
|
Deferred income taxes
|
18,895 | 712 | 11,932 | 8,834 | ||||||||||||||
|
Revenue contract levelization
|
15,163 | — | — | — | ||||||||||||||
|
Interest on loss contracts
|
1,410 | — | — | — | ||||||||||||||
|
Reversal of provision for accounts receivable
|
— | — | (664 | ) | (5,028 | ) | ||||||||||||
|
Noncash compensation charge for altering options
|
— | — | 713 | 2,192 | ||||||||||||||
|
Accrued interest added to principal on note
|
— | — | 5,350 | 4,800 | ||||||||||||||
|
Loss (gain) on asset retirements
|
1,765 | — | (414 | ) | 369 | |||||||||||||
|
Loss on sale of subsidiary
|
— | — | — | 13,665 | ||||||||||||||
|
Earnings from equity investments
|
(6,148 | ) | (3,969 | ) | (50,802 | ) | (53,347 | ) | ||||||||||
|
Distributions from equity investments
|
31,500 | — | 36,791 | 47,555 | ||||||||||||||
|
Loss on refinancing and extinguishment of debt
|
— | — | 1,655 | 19,050 | ||||||||||||||
|
Minority interests in net income (loss) of subsidiaries
|
12,283 | (454 | ) | 3,043 | 4,683 | |||||||||||||
|
Changes in assets and liabilities:
|
||||||||||||||||||
|
Receivables
|
901 | (3,204 | ) | 6,997 | (401 | ) | ||||||||||||
|
Prepaid expenses and other current assets
|
(1,844 | ) | 83 | 374 | 249 | |||||||||||||
|
Other long-term assets
|
4,466 | — | — | — | ||||||||||||||
|
Accounts payable, and other current liabilities
|
(3,561 | ) | (1,310 | ) | 2,693 | 1,660 | ||||||||||||
|
Income taxes payable
|
(10,017 | ) | 880 | 3,132 | (352 | ) | ||||||||||||
|
Accrued interest
|
(3,659 | ) | 2,983 | (135 | ) | (1,863 | ) | |||||||||||
|
Other accrued liabilities
|
2,730 | 16 | (3,942 | ) | 306 | |||||||||||||
|
Net cash provided by (used in) operating activities
|
154,230 | (3,095 | ) | 44,781 | 75,675 | |||||||||||||
|
Cash flows from investing activities:
|
||||||||||||||||||
|
Capital expenditures
|
(13,047 | ) | — | (1,049 | ) | (4,381 | ) | |||||||||||
|
Payments (to) from restricted cash investments
|
(18,308 | ) | 6,046 | (5,327 | ) | 328 | ||||||||||||
|
Proceeds from sale of subsidiaries
|
42,508 | (5,498 | ) | — | (19,046 | ) | ||||||||||||
|
Proceeds from sale of interest in note receivable
|
— | — | 425 | — | ||||||||||||||
|
Proceeds from sale of equipment
|
50 | — | 68 | 249 | ||||||||||||||
|
Payments for intangible assets
|
(2,055 | ) | — | (26 | ) | (5,158 | ) | |||||||||||
|
Cash from the consolidation of unconsolidated subsidiary
|
40,238 | — | — | — | ||||||||||||||
|
Acquisitions, net of cash acquired
|
7,678 | — | — | (12,617 | ) | |||||||||||||
|
Net cash provided by (used in) investing activities
|
57,064 | 548 | (5,909 | ) | (40,625 | ) | ||||||||||||
|
Cash flows from financing activities:
|
||||||||||||||||||
|
Proceeds from long-term debt
|
— | 310,000 | — | 162,300 | ||||||||||||||
|
Payments on long-term debt
|
(100,244 | ) | (1,821 | ) | (143,132 | ) | (138,212 | ) | ||||||||||
|
Payment of debt issuance costs
|
— | (9,216 | ) | (363 | ) | (3,927 | ) | |||||||||||
|
Distributions to minority shareholders in consolidated
subsidiaries
|
(1,492 | ) | — | (955 | ) | (1,575 | ) | |||||||||||
|
Dividends paid
|
(38,150 | ) | — | — | — | |||||||||||||
|
Capital contributions
|
— | 123,909 | — | — | ||||||||||||||
|
Exercise of stock options and warrants
|
— | — | 1,667 | — | ||||||||||||||
|
Advance from MSW Merger
|
— | — | 32,686 | — | ||||||||||||||
|
Payments pursuant to MSW Merger
|
— | (408,657 | ) | — | — | |||||||||||||
|
Net cash (used in) provided by financing activities
|
(139,886 | ) | 14,215 | (110,097 | ) | 18,586 | ||||||||||||
|
Net change in cash and cash equivalents
|
71,408 | 11,668 | (71,225 | ) | 53,636 | |||||||||||||
|
Cash and cash equivalents at beginning of period
|
17,537 | 5,869 | 77,094 | 23,458 | ||||||||||||||
|
Cash and cash equivalents at end of period
|
$ | 88,945 | $ | 17,537 | $ | 5,869 | $ | 77,094 | ||||||||||
The accompanying notes are an integral part of these
consolidated financial statements.
C-8
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial Statements
| 1. | Organization and Basis of Presentation |
American Ref-Fuel Holdings Corp. (Holdings Corp.), formerly
known as United American Energy Holdings Corp., and subsidiaries
(collectively, the Company) is engaged in the business of
acquiring, developing, owning and managing waste and
energy-related businesses in the United States. The Company has
had investments in and/or manages waste-to-energy facilities,
transfer stations, landfills, electric-generating facilities and
steam cogeneration facilities.
Prior to the MSW Transaction on December 12, 2003, as
defined and described in Note 3, the Company primarily
derived its revenue from: (i) the sale of electrical energy
and capacity, thermal energy and waste disposal services;
(ii) earnings on equity investments; and
(iii) providing operation and management services to
various energy businesses for fixed and variable fees. Following
the MSW Transaction, the Company sold several of its operating
subsidiaries to a wholly-owned subsidiary of Delta Power
Company, LLC (Delta) on December 15, 2003. As of
December 31, 2003, the Company had a 50% equity ownership
in Ref-Fuel Holdings LLC (Ref-Fuel Holdings), through its
ownership of MSW Energy Holdings II LLC (MSW Energy
Holdings II), and 100% ownership of UAE Mecklenburg
Cogeneration LP, a coal-fired facility in Clarksville, VA
(the Mecklenburg Facility). The Company sold the Mecklenburg
Facility on August 18, 2004 (see Note 4). As a result
of these transactions, the Company’s primary business is
the ownership, operation and development of waste-to-energy
facilities.
On April 30, 2004, the Company entered into a series of
transactions (Equalization Transactions) which changed its
ownership structure. As a result, Holdings Corp. is now owned
60% by affiliates of Credit Suisse First Boston Private Equity,
Inc. (CSFB Private Equity), and 40% by entities managed by AIG
Global Investment Corp. (AIGGIC) (collectively, the Control
Group).
Also as a result of the Equalization Transactions, the Company
acquired a 0.01% ownership interest in and was named the
managing member of MSW Energy Holdings LLC (MSW Energy
Holdings), which holds a 49.8% membership interest in Ref-Fuel
Holdings. After the Equalization Transactions, MSW Energy
Holdings was owned 60% by MSW Acquisition LLC, an affiliate of
CSFB Private Equity, and 39.99% by entities managed by AIGGIC.
As a result of the Equalization Transactions, the Company gained
effective control of the operations of Ref-Fuel Holdings, as
99.8% of the interests in Ref-Fuel Holdings were owned by the
Control Group as of April 30, 2004. Accordingly, the
Company began consolidating Ref-Fuel Holdings and MSW Energy
Holdings results of operations, cash flows and balance sheets as
of April 30, 2004.
On August 31, 2004, the Company and certain investment
funds affiliated with CSFB Private Equity and certain funds
managed by AIGGIC effected a series of transactions that
resulted in Holdings Corp. becoming the direct and indirect
parent of MSW Energy Holdings (the August 31 Transactions)
(see Note 6).
American Ref-Fuel Company LLC (American Ref-Fuel, ARC, or ARC
LLC), a wholly-owned subsidiary of Ref-Fuel Holdings, owns
partnerships that develop, own and operate waste-to-energy
facilities, which combust municipal solid waste and produce
energy in the form of electricity and steam. Through such
partnerships, American Ref-Fuel owns or controls six
waste-to-energy facilities located in the northeastern United
States (the ARC operating facilities). The subsidiaries of
American Ref-Fuel that operate the ARC operating facilities (the
ARC operating companies) derive revenue principally from
disposal or tipping fees received for accepting waste and from
the sale of electricity and steam produced by those facilities.
ARC subsidiaries include: (a) American Ref-Fuel Company
(Ref-Fuel Management); (b) TransRiver Marketing Company,
L.P. (TransRiver); (c) American Ref-Fuel Company of
Hempstead (Hempstead); (d) American Ref-Fuel Company of
Essex County (Essex); (e) American Ref-Fuel Company of
Southeastern Connecticut (Seconn); (f) American Ref-Fuel
Company of Niagara, L.P. (Niagara); (g) American Ref-Fuel
Company of Semass, L.P. (Ref-Fuel Semass); (h) American
Ref-Fuel Operations of Semass, L.P. (Semass Operator);
C-9
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
and (i) American Ref-Fuel Company of Delaware Valley, L.P.
(Delaware Valley) (collectively referred to as the American
Ref-Fuel Partnerships).
| 2. | Summary of significant accounting policies |
| Principles of consolidation |
The accompanying consolidated financial statements include the
accounts of Holdings Corp., its wholly-owned subsidiaries
including MSW Energy Holdings LLC and MSW Energy
Holdings II LLC, and Ref-Fuel Holdings. Prior to the
Equalization Transactions, the Company’s investment in
Ref-Fuel Holdings was accounted for using the equity method of
accounting. As a result of the Equalization Transactions and the
associated acquisition of MSW Energy Holdings, the Company has
effective control of Ref-Fuel Holdings and MSW Energy Holdings
and as of April 30, 2004, is consolidating their results of
operations, cash flows, and balance sheets. All significant
intercompany transactions and balances have been eliminated in
consolidation. The minority interests shown relate to
Duke’s 0.2% interest in Ref-Fuel Holdings and, for the
period from April 30, 2004 through August 31, 2004,
the 99.99% nonmanaging interests in MSW Energy Holdings.
| Reclassifications |
Certain reclassifications have been made to the prior years to
conform to the current years’ presentation.
| Use of estimates |
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management of the Company to make estimates and
assumptions that affect the (a) reported amounts of assets
and liabilities at the date of the financial statements;
(b) disclosures of contingent assets and liabilities at the
date of the financial statements; and (c) the reported
amounts of revenues and expenses recognized during the reporting
period. Significant estimates include the estimated lives of
long-lived assets, allowances for doubtful accounts receivable,
estimated useful lives and fair value adjustments of net
tangible and intangible assets, liabilities for self-insurance
and certain landfill liabilities. Such estimates may be
subsequently revised as necessary when additional information
becomes available. Actual results could differ from those
estimates.
| Cash and cash equivalents |
Cash and cash equivalents include cash balances and unrestricted
short-term investments with original maturities of three months
or less.
| Restricted cash and cash equivalents |
The Company is required to maintain cash and investment balances
that are restricted by provisions of its debt, operational or
lease agreements, and obligations under the Duke Agreement, as
described below. These amounts are held by financial
institutions in order to comply with contractual provisions
requiring such reserves.
Restricted cash and investments are invested in accounts earning
market rates; therefore, the carrying value approximates fair
value. Restricted cash and investments are excluded from cash
and cash equivalents in the accompanying financial statements,
and changes in these assets are characterized as investing
activities in the consolidated statements of cash flows.
Restricted cash and investments include certain investments
stated at amortized cost, which approximates market, including
debt securities that are classified as
“held-to-maturity” as the Company has the intent and
ability to hold the securities to maturity. The Company accounts
for marketable securities in accordance with Statement of
Financial Accounting Standards (SFAS) No. 115,
Accounting for Certain Investments in Debt and Equity
Securities. Under the provisions of this statement,
C-10
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
investments that are classified as available-for-sale are marked
to market with unrealized gains and losses reported as a
component of other comprehensive income. The Company’s only
investment classified as available-for-sale was sold during 2004.
| Fair value of financial instruments |
Unless disclosed otherwise, all other financial instruments of
the Company are stated at cost, which management believes
approximates fair market value.
| Property, plant and equipment |
Property, plant and equipment are stated at cost. The Company
provides for depreciation of its assets using the straight-line
method over the estimated useful lives.
Routine repairs and maintenance are charged against current
operations. Expenditures that increase value, increase capacity
or extend useful lives are capitalized.
When property and equipment are retired, sold, or otherwise
disposed of, the cost, net of accumulated depreciation, is
removed from the accounts and any resulting gain or loss is
included in operating income for the period.
The Company maintains a supply of various spare parts integral
to its operations. Certain spare parts that are not expected to
be used within the upcoming year have been classified as
long-term spare parts inventory within property, plant and
equipment.
Landfill costs, including original acquisition cost and incurred
construction costs, are amortized over the estimated capacity of
the landfill based on a per-unit basis as landfill space is
consumed.
In accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, management
periodically reviews long-lived assets and intangibles whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. If factors indicate
that an asset should be evaluated for possible impairment,
management compares estimated undiscounted future operating cash
flows associated with the asset to its carrying amount. If the
carrying amount of the asset is greater than undiscounted future
operating cash flows, an impairment loss is calculated and
recognized. The effect of any impairment would be to expense the
difference between the fair value of such asset and its carrying
value.
| Goodwill |
Goodwill represents the total consideration paid in excess of
the fair value of the net tangible and identifiable intangible
assets acquired and the liabilities assumed. In accordance with
the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets, the Company performs an annual fair value
test of its recorded goodwill for its reporting units using a
discounted cash flows approach. As of December 31, 2004,
the Company’s estimate of the fair value indicated no
impairment of goodwill in its annual assessment.
| Intangible assets |
Energy contract intangibles represent the amount by which the
contract rates in long-term energy sales contracts held by
certain subsidiaries of the Company exceeded fair value on the
dates that these subsidiaries were acquired. These
contract-related intangibles are amortized into income as a
reduction of energy revenues on a straight-line basis over the
remaining terms of the applicable contracts, which range from
five to fifteen years.
Waste contract intangibles represent the amount by which the
contract rates in long-term waste sales contracts held by
Hempstead exceeded fair value on the dates that the partnership
was acquired. These
C-11
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
contract-related intangibles are being amortized into income as
a reduction of waste revenues on a straight-line basis through
2009, the term of the applicable contracts.
The Company has intangible assets relating to Nitrous Oxide
(NOx) emission allowances. These assets have indefinite lives
and, as such, are not amortized. Consistent with all the
Company’s intangible assets, these are reviewed under the
provisions of SFAS No. 142 for potential impairment on
an annual basis.
Deferred financing costs represent certain capitalizable costs
incurred by the Company to finance its long-term debt
obligations. These costs are amortized to interest expense over
the life of the related debt using the effective interest method.
| Equity method investment |
Investments are accounted for using the equity method of
accounting if the investment gives the Company the ability to
exercise significant influence, but not control, over an
investee. Significant influence is generally deemed to exist if
the Company has an ownership interest in the voting stock of the
investee of between 20% and 50%, although other factors, such as
representation on the investee’s board of directors, are
considered in determining whether the equity method of
accounting is appropriate.
The Company’s investment in Ref-Fuel Holdings was accounted
for using the equity method of accounting prior to the
Equalization Transactions. As a result, the accompanying
consolidated results of operations include the Company’s
share of net earnings in “Equity in net earnings of
Ref-Fuel Holdings” for the period up to April 30,
2004, the periods from December 12, 2003 through
December 31, 2003 and January 1, 2003 through
December 12, 2003, and the year ended December 31,
2002.
| Income Taxes |
The Company accounts for income taxes under the assets and
liability method. The provision for income taxes includes
deferred income taxes resulting from items reported in different
periods for income tax and financial statement purposes.
Deferred income tax assets and liabilities represent the
expected future tax consequences of the differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. The effects of
changes in tax rates on deferred income tax assets and
liabilities are recognized in the period that includes the
enactment date. A valuation allowance is provided when necessary
to reduce deferred tax assets to amounts expected to be realized.
| Other liabilities |
Other current and other long-term liabilities primarily consist
of (a) fair value adjustments related to certain operating
leases and long-term waste contracts acquired by the Company;
(b) deferred revenue; (c) accruals for certain
long-term incentive plans; (d) energy contract levelization
(see Notes 10 and 14); and (e) the Duke Agreement, as
defined below.
The fair value adjustment related to the operating lease
represents the amount by which future rent payments on the
Delaware Valley facility lease exceeded the fair market value of
that facility as of the acquisition dates. This amount is being
amortized as a decrease in facility rent expense on a
straight-line basis through 2016, the end of the associated
lease.
The fair value adjustment related to the acquired long-term
waste contracts represents the amount by which the fair value of
long-term waste sales contracts held by Ref-Fuel Semass and
Essex exceeded the contract rates on the dates that the
partnerships were acquired. These costs are being amortized as
an increase to waste disposal revenues using the straight-line
method over the term of the applicable contracts.
Landfill closure and postclosure costs are also included in
other long-term liabilities. The Company accrues landfill
closure and postclosure costs as the remaining permitted space
of the landfill is consumed over
C-12
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
the expected life cycle of the landfill. Landfill retirement
costs arising from post-closure obligations, are capitalized as
part of the landfill asset, are being amortized consistent with
the landfill’s current estimated life.
Landfill retirement costs arising from final capping obligations
are being amortized on a units-of-consumption basis over the
estimated number of tons of waste that each final capping event
covers.
The Company is accounting for the long-term power contracts at
Ref-Fuel Semass in accordance with Emerging Issues Task Force
(EITF) Issues 91-6, Revenue Recognition of Long-Term
Power Sales Contracts, and 96-17, Revenue Recognition
under Long-Term Power Sales Contracts That Contain both Fixed
and Variable Pricing Terms, which require the Company to
recognize power revenues under these contracts as the lesser of
(a) amounts billable under the respective contracts; or
(b) an amount determinable by the kilowatt hours made
available during the period multiplied by the estimated average
revenue per kilowatt hour over the term of the contract. The
determination of the lesser amount is to be made annually based
on the cumulative amounts that would have been recognized had
each method been applied consistently from the beginning of the
contract. The difference between the amount billed and the
amount recognized is included in other long-term liabilities.
In June, 2003, MSW Energy Holdings acquired their 49.8% interest
from an affiliate of Duke Energy Corporation (Duke). In
conjunction with the acquisition, they entered into an agreement
with Duke Capital Corporation (Duke Capital), an affiliate of
Duke (the Duke Agreement) under which MSW Energy Holdings agreed
to pay Duke Capital certain future fees in exchange for Duke
Capital’s agreement to remain obligated under an existing
support agreement related to Ref-Fuel Holdings. The fees payable
to Duke Capital escalate over time and a portion of such fees
are to be deposited into a restricted account for the benefit of
Duke Capital. The Company is in compliance with all of its
obligations under this agreement. The present value of the
obligation under the Duke Agreement is included in other current
and long-term liabilities.
| Revenue Recognition |
The Company recognizes revenue from two major sources: waste
disposal services and energy production. Revenue from waste
disposal services is recognized as waste is received, and
revenue from energy production is recognized as the energy is
delivered.
| Concentration of Credit Risk |
The Company invests excess cash and funds held in trust in bank
deposit accounts, government securities, commercial paper,
certificates of deposit and money market investments with a
limited number of financial institutions.
The Company has exposure to credit risk in accounts receivable
as the Company disposes of waste for and sells energy to a
limited number of customers. The Company maintains adequate
reserves for potential credit losses. Furthermore, these and
other customers are primarily located in the northeastern region
of the United States of America.
| Unamortized Debt Premium |
Unamortized debt premium represents the amount by which the fair
value of the Company’s debt exceeded par value on the dates
that the debt was acquired. These amounts are amortized to
interest expense over the life of the related debt using the
effective interest method.
| Stock-Based Compensation |
The Company has adopted the disclosure-only provisions of
SFAS No. 123, Accounting for Stock-Based
Compensation, (FAS 123) as amended by
SFAS No. 148, Accounting for Stock-Based
Compensation —
C-13
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
Transition and Disclosure — an Amendment of
FAS No. 123, concerning certain transition and
disclosure provisions, but applies the intrinsic value
recognition provisions of Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees,
and related interpretations in accounting for stock-based
compensation plans of the Company.
| Interest Rate Risk Management and Derivatives |
The Company has limited involvement with derivative financial
instruments and does not use them for trading or speculative
purposes. The Company had a derivative financial instrument,
designated a cash flow hedge, outstanding from January 2001
through December 2002, which was marked to market through other
comprehensive income. There were no derivative instruments
outstanding as of December 31, 2003 and December 31,
2004.
| Push-Down Accounting |
On December 12, 2003, MSW Merger LLC (MSW Merger), an
affiliate of CSFB Private Equity, merged with and into Holdings
Corp. which continues as the surviving company in the merger
(Merger). As a result of this transaction, the Company’s
assets and liabilities, including the investment in Ref-Fuel
Holdings, were revalued to reflect their fair value on the date
of acquisition. The value of the assets sold to Delta were
determined based on the actual sale price of those assets on
December 15, 2003, and the value of the Mecklenburg Project
was determined based upon the expected proceeds from its sale.
Upon consummation of the Merger and taking into account the
June 30, 2003 acquisition of membership interest in
Ref-Fuel Holdings, the Control Group owns, directly and
indirectly, 99.8% of the membership interests in Ref-Fuel
Holdings (and exercises voting power with respect to the
remaining 0.2% interest). EITF Topic D-97, Push-Down
Accounting, requires that Ref-Fuel Holdings’ financial
statements reflect this change in ownership. Accordingly, the
aggregate excess of purchase price over the net assets acquired
by the MSW Energy Holdings on June 30, 2003 was pushed-down
to Ref-Fuel Holdings and its subsidiaries on December 12,
2003 as a result of the Merger. The value assigned reflects the
excess of the purchase price paid over the equity of Ref-Fuel
Holdings on the acquisition date which has been allocated to the
Company’s proportionate share of the fair value of the
assets acquired and liabilities assumed, based on an independent
valuation of Ref-Fuel Holdings (see Note 5).
| Risks and Uncertainties |
The Company’s operations involve a number of significant
risks and uncertainties. Factors that could affect its future
operating results and cause actual results to vary materially
from expectations and adversely affect the Company’s
financial condition and prevent it from fulfilling its
obligations, include but are not limited to, the Company’s
dependency on the operations of the ARC operating companies and
the Company’s substantial indebtedness.
| 3. | Business Combinations |
| Merger with MSW Merger LLC |
On December 12, 2003, Holdings Corp. completed a merger
with MSW Merger, a Delaware limited liability company, pursuant
to an agreement and plan of merger dated August 22, 2003
with Holdings Corp. becoming the surviving entity (the MSW
Transaction). MSW Merger was owned by several investment funds
affiliated with CSFB Private Equity. MSW Merger paid
approximately $392 million to acquire the outstanding
capital stock of the Company and to extinguish certain Company
level debt. Additionally, MSW Merger incurred various costs
associated with the merger with the Company and retained certain
funded amounts to be retained as working capital by the Company.
C-14
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
MSW Merger funded the merger with Holdings Corp. through the net
proceeds from $225 million in Senior Secured Notes due 2010
issued by MSW Energy Holdings II prior to the Merger,
together with loans and capital contributions from the members
of MSW Merger of $209 million (see Note 11).
The accompanying consolidated financial statements include the
assets, liabilities and results of operations of MSW Merger and
its wholly-owned subsidiaries since their inception, on
December 12, 2003. The accompanying consolidated financial
statements beginning on December 12, 2003 reflect the
acquisition basis of MSW Merger in acquiring the outstanding
equity of the Company on such date. The purchase price for MSW
Merger’s acquisition of the Company was assigned to the
fair value of the underlying assets and liabilities of the
Company. Financial statements for periods before
December 12, 2003 are referred to as Predecessor.
The stockholders’ equity of the Company acquired by the
members of MSW Merger through consummation of the merger was
approximately $138.7 million. The excess purchase price has
been allocated to the Company’s proportionate share of the
fair value of the assets acquired and liabilities assumed, based
on an independent valuation of Ref-Fuel Holdings, the purchase
price for the assets sold to Delta, and the expected purchase
price of the Mecklenburg Facility. The amounts allocated to
fixed and intangible assets are amortized using the
straight-line method over the estimated useful lives of the
underlying assets or obligations ranging from ten to twenty
years.
A summary of the allocation of purchase price to the fair value
of the assets acquired and liabilities assumed by the Company
was as follows (in thousands):
|
Equity of the Company acquired
|
$ | 138,685 | |||
|
Investment in Ref-fuel Holdings
|
308,627 | ||||
|
Advance from MSW Merger
|
32,686 | ||||
|
Fixed assets and other adjustments, net
|
(12,281 | ) | |||
|
Identifiable intangible assets
|
20,785 | ||||
|
Other long-term assets
|
(2,817 | ) | |||
|
Deferred income taxes
|
(70,592 | ) | |||
|
Other liabilities
|
(6,436 | ) | |||
|
Purchase price subject to allocation
|
$ | 408,657 | |||
During 2004, the Company finalized the purchase accounting that
was applied to this transaction. As a result, the following
details the changes to the allocated purchase price during 2004
(in thousands):
|
Intangible Assets
|
$ | (4,009 | ) | ||
|
Investment in Ref-fuel Holdings
|
5,018 | ||||
|
Deferred Taxes
|
919 | ||||
|
Finalization of purchase accounting
|
$ | 1,928 | |||
| 4. | Discontinued Operations |
Mecklenburg Transaction. MSW Merger entered into a Stock
Purchase Agreement with an affiliate of Delta on
September 24, 2003 that would have resulted in the sale of
the Company’s interest in the Mecklenburg Facility to
Delta’s affiliate for approximately $42.5 million.
Upon the MSW Transaction, the Company’s investment in the
Mecklenburg Facility was increased to its fair value reflecting
the proposed sale to an affiliate of Delta. Consistent with the
guidance in SFAS No. 144, the Company is accounting
for the sale of its interests in the Mecklenburg Facility as a
disposal of a
C-15
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
component of the business and has reclassified its consolidated
statements of operations to reflect the Mecklenburg Facility as
discontinued operations for all periods presented. The assets
and liabilities of the Mecklenburg Facility included in the
accompanying consolidated balance sheets as of December 31,
2003 as assets and liabilities of discontinued operations were
as follows (in thousands):
|
Restricted cash and cash equivalents
|
$ | 11,997 | |||
|
Accounts receivable, net
|
8,975 | ||||
|
Materials and supplies
|
3,015 | ||||
|
Other current assets
|
554 | ||||
|
Property, plant & equipment, net
|
43,533 | ||||
|
Intangible assets, net
|
114,842 | ||||
|
Deferred charges and other noncurrent assets
|
1,605 | ||||
|
Assets of discontinued operations
|
$ | 184,521 | |||
|
Accounts payable and accrued expenses
|
$ | 2,256 | |||
|
Accrued interest
|
2,057 | ||||
|
Long-term debt
|
136,900 | ||||
|
Other noncurrent liabilities
|
60 | ||||
|
Liabilities of discontinued operations
|
$ | 141,273 | |||
The Company did not sell its interest in the Mecklenburg
Facility to Delta, but instead entered into an agreement to sell
the Mecklenburg Facility to Virginia Electric and Power Company
(Virginia Power). On August 18, 2004, the Company
consummated the sale of the Mecklenburg Facility to Virginia
Power. The cash received as a result of the sale was
$42.5 million (with cash on the balance sheet as of the
date of sale of $14.5 million) and the Company recorded
this sale which resulted in no gain or loss.
The following divestitures occurred during the periods from
December 12, 2003 through December 31, 2003,
January 1, 2003 through December 12, 2003, and the
year ended December 31, 2002, and have been presented as
disposals of a component of an entity in accordance with
SFAS No. 144:
| Delta Power Transactions. On December 15, 2003, the Company sold its interests in several operating power plants (the Delta Projects) for aggregate cash consideration of approximately $1.8 million to a wholly-owned subsidiary of Delta. The Company and its management have no continuing involvement in the ownership, operation or management of the Delta Projects. | |
| Consistent with the guidance in SFAS No. 144, the Company has accounted for its sale of interests in the Delta Projects as a disposal of a component of the business and has therefore reclassified its consolidated statements of operations to reflect the Delta Projects as discontinued operations for all periods presented. Upon the completion of the MSW Transaction, the Company’s investment in the Delta Projects was adjusted to its fair value reflecting the proposed sale to Delta. As a result, the Company did not record a gain or loss on its disposal of its interests in the Delta Projects. | |
| WBU Transactions. On December 27, 2002, the Company sold its stock interests in several subsidiaries that hold interests in power plants (the WBU Projects) located in California and a subsidiary that provides operation and management services to the same Projects in California and third parties for consideration of $0.5 million. All such subsidiaries and WBU Projects are collectively referred to as the Western Business Unit (WBU). The Company retained certain notes receivable due from the WBU Projects aggregating $2.6 million, after half of these notes were contributed to a subsidiary of WBU in connection with the transaction. The Company and its management have no continuing involvement in the operation of the WBU or any of the WBU Projects. | |
C-16
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
Consistent with the guidance in SFAS No. 144, the
Company accounted for its sale of the WBU as a disposal of a
component of the business and has therefore reclassified its
consolidated statements of operations to reflect the WBU
operations as discontinued operations for the applicable periods
presented. The Company recorded a loss on disposal of its
interests in the WBU in 2002 of $10.4 million, net of
$3.2 million in income tax benefit, after reserves for
potentially uncollectible notes receivable of $2.6 million.
| Summarized results of operations: |
Operating results of discontinued operations for the year ended
December 31, 2004, the periods December 12, 2003 to
December 31, 2003, January 1, 2003 to
December 12, 2003, and the year ended December 31,
2002 (Predecessor), respectively, related to the sale of the
Mecklenburg Facility, the Delta Projects, and the WBU Projects,
were as follows (in thousands):
| December 12, | January 1, | ||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | ||||||||||||||
| December 31, | December 31, | December 12, | December 31, | ||||||||||||||
| 2004 | 2003 | 2003 | 2002 | ||||||||||||||
|
Revenue
|
$ | 34,554 | $ | 2,779 | $ | 75,372 | $ | 114,993 | |||||||||
|
Income before income taxes
|
$ | 10,962 | $ | 811 | $ | 8,778 | $ | 7,713 | |||||||||
|
Income tax expense
|
(5,373 | ) | (382 | ) | (3,310 | ) | (418 | ) | |||||||||
|
Minority interests
|
— | — | (2,580 | ) | (4,683 | ) | |||||||||||
|
Income from discontinued operations
|
$ | 5,589 | $ | 429 | $ | 2,888 | $ | 2,612 | |||||||||
| 5. | Acquisitions and Investments |
The following acquisitions occurred during the three-year period
ended December 31, 2004:
| Kennebec Transactions. On November 27, 2002, the Company acquired limited partner interests in the Hydro-Kennebec Limited Partnership (Kennebec) for consideration of $11.4 million, plus transaction costs. This investment was included in the Delta projects and sold in December 2003. | |
| MSW Energy Holdings. On April 30, 2004, the Company acquired a 0.01% ownership interest and was named the managing member in MSW Energy Holdings for $15,000. This acquisition, which was a component of the Equalization Transactions, was accounted for using the purchase method of accounting and, accordingly, the consolidated statements of operations include the results of MSW Energy Holdings beginning as of the date of acquisition. The income and distributions allocable to the 99.99% nonmanaging members of MSW Energy Holdings is accounted for as minority interests in consolidated subsidiaries. The assets and liabilities assumed were recorded at fair values, which approximated book values, as of the acquisition date. A summary of the assets acquired and liabilities assumed in the acquisition is as follows (in thousands): | |
|
Investment in Ref-Fuel Holdings
|
$ | 347,843 | |||
|
Other assets acquired
|
14,079 | ||||
|
Liabilities assumed
|
(228,697 | ) | |||
|
Minority interest in MSW Energy Holdings
|
(140,903 | ) | |||
|
Cash paid, net of cash acquired of $7,693
|
$ | 7,678 | |||
As a result of the Equalization Transactions, the Company gained
effective control of the operations of Ref-Fuel Holdings, as
99.98% of the interests in Ref-Fuel Holdings were owned by the
Company and MSW Energy Holdings. Accordingly, the Company began
consolidating Ref-Fuel Holdings as of April 30, 2004, and
the 0.02% interest in the income and distributions allocable to
the other owner of Ref-Fuel Holdings is
C-17
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
accounted for as minority interests. Ref-Fuel Holdings had
$40.2 million of cash and cash equivalents as of
April 30, 2004, which is shown as cash from the
consolidation of unconsolidated subsidiary on the accompanying
Statement of Cash Flows.
On August 31, 2004, the 99.99% nonmanaging interests in MSW
Energy Holdings were contributed to the Company is conjunction
with the August 31 Transaction, at which time the Control
Group contributed $40 million and repaid the Company’s
Senior Note due November 30, 2013 (see Note 11).
| Pro Forma Information (unaudited) |
The following represents the results of Holdings Corp.
operations on a pro forma basis as if the Equalization
Transactions and the August 31 Transactions had occurred on
January 1, 2004 (in thousands):
| Year Ended | |||||||||||||
| December 31, | Pro Forma | Pro Forma | |||||||||||
| 2004 | Adjustments | Total | |||||||||||
|
Waste disposal and related services
|
$ | 194,950 | $ | 89,496 | (a) | $ | 284,446 | ||||||
|
Energy
|
93,188 | 41,566 | (a) | 134,754 | |||||||||
|
Other
|
10,506 | 6,475 | (a) | 16,981 | |||||||||
|
Total net revenues
|
298,644 | 137,537 | 436,181 | ||||||||||
|
Operating
|
(116,089 | ) | (73,322 | )(a) | (189,411 | ) | |||||||
|
Depreciation and amortization
|
(45,154 | ) | (22,842 | )(a) | (67,996 | ) | |||||||
|
General and administrative
|
(30,216 | ) | (15,031 | )(b) | (45,247 | ) | |||||||
|
Loss on asset retirements
|
(1,765 | ) | (342 | )(a) | (2,107 | ) | |||||||
|
Operating income
|
105,420 | 26,000 | 131,920 | ||||||||||
|
Interest income
|
2,967 | 1,022 | (b) | 3,989 | |||||||||
|
Interest expense
|
(69,219 | ) | (21,626 | )(b) | (90,845 | ) | |||||||
|
Equity in net income of subsidiaries
|
6,148 | (6,148 | )(c) | — | |||||||||
|
Minority interest in net income of subsidiaries
|
(12,283 | ) | 11,372 | (d) | (911 | ) | |||||||
|
Other, net
|
303 | 122 | (a) | 425 | |||||||||
|
Income from continuing operations before income taxes
|
$ | 33,336 | $ | 10,742 | $ | 44,578 | |||||||
| (a) | Represents January 1, 2004 through April 30, 2004 activity for Ref-Fuel Holdings. | |
| (b) | Represents January 1, 2004 through April 30, 2004 activity for Ref-Fuel Holdings and MSW Energy Holdings. | |
| (c) | Represents the Company’s equity in earnings for the period from January 1, 2004 through April 30, 2004 related to Ref-Fuel Holdings. | |
| (d) | Represents the interests allocable to the owners of MSW Energy Holdings for the period from April 30, 2004 through August 31, 2004. | |
| 6. | Equity Investments |
Prior to the Equalization Transactions, the Company recorded its
50% investment in Ref-Fuel Holdings as an equity investment. As
a result of the Equalization Transaction, the Company gained
effective control of its investment in Ref-Fuel Holdings, as it
was named managing member of MSW Energy Holdings (the owner of
the additional 49.8% interest in Ref-Fuel Holdings). Ref-Fuel
Holdings condensed consolidated financial information prior to
April 30, 2004 is included for informational purposes. As
of December 31, 2003,
C-18
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
the Company’s investment in Ref-Fuel Holdings represented
approximately 66% of the Company’s total assets.
The following is a summary of aggregate financial information
for the Company’s investment in Ref-Fuel Holdings accounted
for using the equity method for the four months ended
April 30, 2004, for the period of December 12, 2003
through December 31, 2003, the period of January 1,
2003 through December 12, 2003, and the year ended
December 31, 2002 (in thousands):
| January 1, | December 12, | January 1, | ||||||||||||||
| 2004 to | 2003 to | 2003 to | Year Ended | |||||||||||||
| April 30, | December 31, | December 12, | December 31, | |||||||||||||
| 2004 | 2003 | 2003 | 2002 | |||||||||||||
|
Condensed consolidated statement of operations data
|
||||||||||||||||
|
Revenues
|
$ | 137,537 | $ | 24,847 | $ | 444,461 | $ | 438,542 | ||||||||
|
Net income
|
12,573 | 8,082 | 103,071 | 108,604 | ||||||||||||
|
Company’s share of net earnings
|
6,148 | 3,969 | 50,204 | 52,898 | ||||||||||||
|
Distributions received from equity investees
|
31,500 | — | 36,275 | 47,250 | ||||||||||||
|
Condensed consolidated balance sheet data at period end
|
||||||||||||||||
|
Assets
|
$ | 2,056,595 | $ | 2,127,908 | ||||||||||||
|
Liabilities
|
1,365,848 | 1,386,608 | ||||||||||||||
|
Equity
|
690,747 | 741,300 | ||||||||||||||
|
Company’s investment in equity investee
|
463,170 | 488,002 | ||||||||||||||
The Company’s investment in Ref-Fuel Holdings was greater
than its share of the underlying equity in net assets of the
American Ref-Fuel partnerships by approximately
$14.1 million at December 31, 2002. Such difference
was being amortized using the straight-line method over the
estimated economic lives of the related assets ranging from 12
to 23 years. Differences between the earnings of equity
investee reported by the Company and the Company’s
proportionate share of the combined income of the related equity
investee result principally from purchase accounting.
The Company received $1.5 million and $2 million in
fees, classified as other income on the statement of operations
in 2003 and 2002, respectively, related to an agreement with its
then partner in Ref-Fuel Holdings.
C-19
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| 7. | Property, Plant and Equipment |
A summary of property, plant and equipment is as follows (in
thousands):
| December 31, | ||||||||||||
| Useful Life | 2004 | 2003 | ||||||||||
|
Plant and equipment
|
2-50 years | $ | 1,206,558 | $ | — | |||||||
|
Land
|
3,813 | — | ||||||||||
|
Leasehold improvements
|
Up to 17 years | 5,575 | — | |||||||||
|
Landfill
|
13 years | 17,768 | — | |||||||||
|
Spare parts
|
12,282 | — | ||||||||||
|
Construction in progress
|
6,244 | — | ||||||||||
|
Total property, plant and equipment
|
1,252,240 | — | ||||||||||
|
Accumulated depreciation
|
(65,062 | ) | — | |||||||||
|
Property, plant and equipment, net
|
$ | 1,187,178 | $ | — | ||||||||
| 8. | Intangible Assets |
A summary of intangible assets is as follows (in thousands):
| December 31, | ||||||||||||
| Useful Life | 2004 | 2003 | ||||||||||
|
Energy contracts
|
6-18 years | $ | 525,125 | $ | — | |||||||
|
Waste contracts
|
6 years | 23,600 | — | |||||||||
|
Financing costs
|
6 years | 17,652 | 10,716 | |||||||||
|
Emissions credits
|
Indefinite | 43,377 | — | |||||||||
|
Other intangibles
|
Indefinite | 3,579 | — | |||||||||
| 612,772 | 10,716 | |||||||||||
|
Accumulated amortization
|
(70,456 | ) | (333 | ) | ||||||||
|
Intangible assets, net
|
$ | 542,877 | $ | 10,383 | ||||||||
Amortization expense related to intangible assets for the year
ended December 31, 2004, and the projected amortizations is
as follows (in thousands):
| Energy | Waste | |||||||||||
| Contracts | Contracts | Totals | ||||||||||
|
The year ended December 31, 2004
|
$ | 38,687 | $ | 2,736 | $ | 41,423 | ||||||
|
2005
|
$ | 58,306 | $ | 4,256 | $ | 62,562 | ||||||
|
2006
|
58,306 | 4,256 | 62,562 | |||||||||
|
2007
|
58,305 | 4,256 | 62,561 | |||||||||
|
2008
|
58,206 | 4,256 | 62,462 | |||||||||
|
2009
|
36,907 | 2,130 | 39,037 | |||||||||
|
Thereafter
|
192,381 | — | 192,381 | |||||||||
|
Total
|
$ | 462,411 | $ | 19,154 | $ | 481,565 | ||||||
C-20
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
Amortization expense related to intangible assets for the period
January 1, 2003 through December 12, 2003 and for the
year ended December 31, 2002 which is reported in
discontinued operations in the accompanying statements of
operations is as follows (in thousands):
| January 1, | ||||||||
| 2003 to | Year Ended | |||||||
| December 12, | December 31, | |||||||
| 2003 | 2002 | |||||||
|
Power contracts
|
$ | 8,371 | $ | 6,796 | ||||
|
Management contracts
|
77 | 80 | ||||||
|
Other
|
37 | 37 | ||||||
|
Total
|
$ | 8,485 | $ | 6,913 | ||||
| 9. | Goodwill |
Goodwill consists of the following (in thousands):
| December 31, | December 31, | |||||||
| 2004 | 2003 | |||||||
|
Beginning Balance
|
$ | — | $ | — | ||||
|
Goodwill from the consolidation of Ref-Fuel Holdings
|
123,984 | — | ||||||
|
Total
|
$ | 123,984 | $ | — | ||||
| 10. | Accounts payable and other accrued liabilities |
Accounts payable and accrued liabilities consist of the
following (in thousands):
| December 31, | December 31, | |||||||
| 2004 | 2003 | |||||||
|
Accounts payable
|
$ | 25,933 | $ | 62 | ||||
|
Compensation liabilities
|
11,237 | 6,231 | ||||||
|
Incentive plan accruals
|
3,569 | — | ||||||
|
Current amount due under Duke Agreement
|
2,500 | — | ||||||
|
Other
|
5,640 | 1,246 | ||||||
|
Total
|
$ | 48,879 | $ | 7,539 | ||||
C-21
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| 11. | Debt |
The following is a summary of long-term debt by obligor (in
thousands):
| December 31, | |||||||||||||||||
| Final | |||||||||||||||||
| Interest Rate | Maturity | 2004 | 2003 | ||||||||||||||
|
Senior Note
|
10% increasing to 12 | % | 2006 | $ | — | $ | 43,179 | ||||||||||
|
Senior Note
|
9.00 | % | 2013 | — | 40,000 | ||||||||||||
|
MSW Energy Holdings Senior Note
|
8.50 | % | 2010 | 200,000 | — | ||||||||||||
|
MSW Energy Holdings II Senior Note
|
7.38 | % | 2010 | 225,000 | 225,000 | ||||||||||||
| 425,000 | 308,179 | ||||||||||||||||
|
ARC LLC-supported debt
|
|||||||||||||||||
|
Senior Notes
|
6.26 | % | 2015 | 240,000 | — | ||||||||||||
|
Niagara Series 2001A
|
5.45%-5.625 | % | 2015 | 165,010 | — | ||||||||||||
|
Seconn Corporate Credit Bonds
|
5.50%-6.45 | % | 2022 | 43,500 | — | ||||||||||||
|
Hempstead Corporate Credit Bonds
|
5.00 | % | 2010 | 42,670 | — | ||||||||||||
|
ARC LLC-supported debt
|
491,180 | — | |||||||||||||||
|
Other debt
|
|||||||||||||||||
|
Hempstead project debt
|
4.625%-5.00 | % | 2009 | 114,543 | — | ||||||||||||
|
Essex project debt
|
5.248%-7.375 | % | 2020 | 96,496 | — | ||||||||||||
|
Seconn project debt
|
5.125%-5.50 | % | 2015 | 50,602 | — | ||||||||||||
|
Semass Series 2001A
|
5.50%-5.625 | % | 2016 | 134,345 | — | ||||||||||||
|
Semass Series 2001B
|
5.00%-5.50 | % | 2010 | 104,385 | — | ||||||||||||
|
Semass Series 2001C
|
2.90%-4.00 | % | 2004 | — | — | ||||||||||||
| 500,371 | — | ||||||||||||||||
|
Other obligations
|
273 | — | |||||||||||||||
|
Total debt at par value
|
1,416,824 | 308,179 | |||||||||||||||
|
Unamortized debt premium, net
|
54,189 | — | |||||||||||||||
|
Current portion
|
(87,184 | ) | — | ||||||||||||||
|
Total long-term debt obligations
|
$ | 1,383,829 | $ | 308,179 | |||||||||||||
| Company Financing: |
| Senior Notes |
MSW Merger issued two series of Senior Notes on
November 21, 2003 in the aggregate amount of
$85 million to the members of MSW Merger. The proceeds of
such Senior Notes, along with the net proceeds of the issuance
of the MSW Energy Holdings II Senior Secured Notes and
capital contributions from the members of MSW Merger, were used
to finance the consideration paid in the MSW Transaction. One
Senior Note in the amount of $45 million was due
September 30, 2006 and had an initial interest rate of 10%
through March 31, 2004, increasing by one-half of a percent
each subsequent quarter until January 1, 2005, when the
maximum rate of 12% per annum would have been reached. The
Company was required to repay principal under this Senior Note
with any distributions from or the sale proceeds resulting from
the Company’s sale of its interest in certain assets,
including the assets sold to Delta on December 15, 2003 and
any sale of the Company’s interest in the Mecklenburg
Facility. This note was repaid during 2004.
C-22
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
The other Senior Note in the amount of $40 million was due
November 30, 2013 with a fixed interest rate of 9%, payable
semi-annually. This note was contributed by the Company’s
members as a capital contribution as a result of the
August 31 Transactions.
| MSW Energy Holdings and MSW Energy Holdings II Senior Notes |
In November 2003, MSW Energy Holdings II sold
$225 million of Senior Notes due September 1, 2010,
which have an interest rate of 7.375% payable semi-annually. The
net proceeds of the Senior Notes were used to partially fund the
Merger consideration paid in the MSW Transaction.
In June 2003, MSW Energy Holdings sold $200 million of
Senior Notes due September 1, 2010, which have an interest
rate of 8.5% payable semi-annually.
These notes contain certain restrictions which will, among other
things, limit the wholly-owned subsidiary from incurring
additional indebtedness, paying dividends, making investments,
selling assets or merging with other companies, subject to
certain exceptions. The notes are redeemable by the
Company’s wholly-owned subsidiaries with the payment of
certain stated make-whole amounts before September 1, 2007
and, thereafter, at the face amount of the notes, plus accrued
interest.
MSW Energy Holdings and MSW Energy Holdings II have pledged
their membership interests in Ref-Fuel Holdings under the notes.
In the event of any bankruptcy or liquidation the Ref-Fuel
Holdings debt would be repaid prior to the repayment of the MSW
Energy Holdings and MSW Energy Holdings II Senior Notes.
| ARC LLC Supported Debt and Other Debt |
ARC LLC supported debt includes obligations of subsidiary
companies for which ARC has issued a guarantee. Other debt
obligations mainly consist of indebtedness supported by the
facility to which the indebtedness belongs and certain
contingent credit support obligations of ARC LLC.
| Note Payable |
On April 30, 2001, in connection with the Recapitalization,
the Company repurchased 1.963 million shares of
Series B preferred stock for a note of $40 million. In
connection with the MSW Transaction, the outstanding principal
amount of the note and accrued interest, aggregating
$53.2 million was paid in full satisfaction of the
obligation on December 12, 2003. The note had a term of ten
years; during the first five years, interest at 11% per
annum was accrued and added to principal at the election of the
Company and paid monthly thereafter. Provisions of the note
limited Holdings Corp. from making certain restricted payments,
including dividends, repurchases of capital stock and payments
to certain stockholders, without making a commensurate
prepayment of the note for 25% of the restricted payment.
| Revolving Credit/ Term Loan Facility |
ARC LLC has a credit facility for up to $75 million (the
ARC Credit Facility), including $45 million of which can be
used for letters of credit. Under the terms of the ARC Credit
Facility, ARC is subject to certain financial covenants, as
defined, with respect to leverage and adjusted cash flow
coverage ratios. As of December 31, 2004, there were no
borrowings and $10.2 million of letters of credit
outstanding under the ARC Credit Facility. Pursuant to the terms
of certain guarantee agreements, as of December 31, 2004,
ARC was contingently obligated to issue $29 million in
letters of credit in the event that the ratings of the ARC LLC
Senior Notes are reduced to below investment grade.
C-23
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
The Company had a $150 million revolving credit/term loan
facility with a syndicate of banks available to American
Ref-Fuel Corp., formerly United American Energy Corp., a
wholly-owned subsidiary, which was repaid in full and terminated
in connection with the MSW Transaction on December 12, 2003.
The annual contractual principal maturities of the debt
outstanding at December 31, 2004 are as follows (in
thousands):
|
2005
|
$ | 87,184 | |||
|
2006
|
79,331 | ||||
|
2007
|
90,466 | ||||
|
2008
|
98,472 | ||||
|
2009
|
78,463 | ||||
|
Thereafter
|
982,908 | ||||
| $ | 1,416,824 | ||||
Certain of the debt agreements held by the Company contain
restrictions on cash distributions, new borrowings and require
certain defined leverage ratios and adjusted cash flow coverage
ratios. Substantially all of the assets and revenues of the
facilities owned or controlled and operated by subsidiaries of
the Company are pledged to trustees under the terms of the debt
agreements. In addition, the terms of the documents governing
these obligations limit the business activities and the
circumstances and timing of distributions.
| Fair Value of Financial Instruments |
Considerable judgment is required in developing the
methodologies and in interpreting available market data and,
accordingly, the estimates presented herein are not necessarily
indicative of the values of such financial instruments in a
current market exchange. The fair value of the Company’s
debt as of December 31, 2004 was approximately
$1.5 billion.
| 12. | Other liabilities |
Other liabilities consist of the following (in thousands):
| December 31, | ||||||||||||
| Amortization Period | 2004 | 2003 | ||||||||||
|
Waste contracts acquired
|
9-17 years | $ | 116,635 | $ | — | |||||||
|
Operating lease acquired
|
14 years | 42,094 | — | |||||||||
|
Duke liability
|
16 years | 22,622 | — | |||||||||
|
Energy contract levelization
|
12 years | 24,123 | — | |||||||||
|
Landfill liabilities
|
13 years | 10,699 | — | |||||||||
|
Deferred revenue
|
8-20 years | 5,113 | — | |||||||||
|
Incentive plan accruals
|
3,333 | — | ||||||||||
|
Other
|
30 | 133 | ||||||||||
| $ | 224,649 | $ | 133 | |||||||||
C-24
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| 13. | Income Taxes |
The provision for income taxes and the effect of income taxes on
discontinued operations consist of the following for the year
ended December 31, 2004, the period from December 12,
2003 through December 31, 2003, the periods from
January 1, 2003 through December 12, 2003, and the
year ended December 31, 2002 (in thousands):
| December 12, | January 1, | ||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | ||||||||||||||
| December 31, | December 31, | December 12, | December 31, | ||||||||||||||
| 2004 | 2003 | 2003 | 2002 | ||||||||||||||
|
Current (benefit) expense
|
$ | (1,077 | ) | $ | — | $ | (380 | ) | $ | 8,156 | |||||||
|
Deferred expense
|
18,895 | 498 | 12,742 | 7,483 | |||||||||||||
| 17,818 | 498 | 12,362 | 15,639 | ||||||||||||||
|
Tax expense (benefit) related to discontinued operations
|
5,373 | 382 | 3,310 | (2,820 | ) | ||||||||||||
|
Total
|
$ | 23,191 | $ | 880 | $ | 15,672 | $ | 12,819 | |||||||||
A reconciliation of the statutory federal income tax expense
with the Company’s actual effective combined federal and
state income tax expense based on income from continuing
operations is as follows for the year ended December 31,
2004, the period from December 12, 2003 through
December 31, 2003, the period from January 1, 2003
through December 12, 2003, and the year ended
December 31, 2002 (in thousands):
| December 12, | January 1, | |||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | |||||||||||||||
| December 31, | December 31, | December 12, | December 31, | |||||||||||||||
| 2004 | 2003 | 2003 | 2002 | |||||||||||||||
|
Statutory federal income tax expense
|
$ | 11,736 | $ | 372 | $ | 7,071 | $ | 12,426 | ||||||||||
|
State tax expense, net of federal benefit
|
5,368 | 121 | 3,059 | 2,451 | ||||||||||||||
|
Corporate sale transaction expenses, net
|
— | — | 1,832 | — | ||||||||||||||
|
Other, net
|
714 | 5 | 400 | 762 | ||||||||||||||
|
Total income tax expense
|
$ | 17,818 | $ | 498 | $ | 12,362 | $ | 15,639 | ||||||||||
|
Effective tax rate
|
53.4 | % | 46.9 | % | 61.2 | % | 44.1 | % | ||||||||||
Deferred income taxes reflect the net tax effects of
(a) temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes and (b) net operating
loss and tax credit carryforwards.
C-25
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
The tax effects of temporary differences, which give rise to
deferred tax assets and liabilities, are as follows (in
thousands):
| December 31, | ||||||||
| 2004 | 2003 | |||||||
|
Accrued liabilities
|
$ | 1,289 | $ | 3,256 | ||||
|
Deferred revenue
|
13 | 12 | ||||||
|
Tax credit carryforwards
|
— | 2,132 | ||||||
|
Net operating loss carryforwards
|
893 | 9,016 | ||||||
|
Capital loss carryforward
|
9,280 | 8,559 | ||||||
|
Gross deferred tax assets
|
11,475 | 22,975 | ||||||
|
Valuation allowance
|
(9,280 | ) | (9,567 | ) | ||||
|
Net deferred tax asset
|
2,195 | 13,408 | ||||||
|
The Company’s respective share of depreciation,
amortization, accrued liabilities and other of Ref-Fuel Holdings
LLC
|
(152,071 | ) | (120,073 | ) | ||||
|
Depreciation and amortization
|
457 | (8,534 | ) | |||||
|
Deferred charges and intangibles
|
— | (5,688 | ) | |||||
|
Net deferred tax liability
|
$ | (149,419 | ) | $ | (120,887 | ) | ||
A valuation allowance is provided when it is more likely than
not that some portion or all of the deferred tax assets will not
be realized. Management believes that it is more likely than not
that the remaining net deferred tax assets at December 31,
2004 will be realized based on the future reversals of existing
deferred tax liabilities and the continuation of earnings.
Future earnings may be affected by factors outside the
Company’s control.
The Company had federal capital loss carryforwards of
approximately $22.4 million and $20.9 million at
December 31, 2004 and December 31, 2003, respectively,
related to the disposal of certain subsidiaries, which have been
offset by a valuation allowance. Such capital losses can only be
offset by future capital gains. The capital loss carryforwards
expire beginning in the year 2008. The Company also has Federal
net operating loss carryforwards of approximately
$1.3 million as of December 31, 2004, which expire
between 2021 and 2024, and $19.7 million as of
December 31, 2003, and state net operating loss
carryforwards of approximately $22.7 million and
$40.4 million as of December 31, 2004 and
December 31, 2003, respectively, which have various
expiration dates.
At December 31, 2003, the Company had alternative minimum
tax credit carryforwards of $1.4 million, which were fully
utilized in 2004.
| 14. | Operational and other agreements |
The ARC operating facilities operate under various long-term
service agreements, the terms of which extend from 2009 through
2020. These service agreements require the projects to provide
disposal services for waste delivered by counterparties to these
agreements at prices determined by various formulas contained in
such agreements.
Hempstead, Essex, Seconn, Ref-Fuel Semass and Delaware Valley
operate under various long-term service agreements, the terms of
which extend from 2009 through 2020. These service agreements
require the projects to provide disposal services for waste
delivered by counterparties to these agreements at prices
determined by various formulas contained in such agreements.
Duke and Allied Waste Industries, Inc. (Allied) are each
obligated to fund one-half of certain cash shortfalls and other
liabilities of Essex arising out
C-26
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
of operating the project, including certain environmental
claims. Essex and ARC LLC entered into agreements with Duke and
Allied requiring Essex and ARC LLC to reimburse, indemnify and
defend Duke and Allied from any liability in respect to these
obligations.
With respect to the Delaware Valley facility, ARC LLC has
guaranteed amounts payable by Delaware Valley pursuant to
certain agreements. ARC LLC guarantees through 2006 the
obligations of Delaware Valley under its service agreement with
the Delaware County Solid Waste Authority. In conjunction with
the acquisition of the facility, ARC LLC also provides an
indemnity to the sellers of the facility from post-acquisition
environmental damages as a result of remedial action for
releases or threatened releases of hazardous substances at the
facility.
In order to provide ARC LLC with an additional source of funds
to meet calls on its project support obligations, MSW Energy
Holdings II and the Company entered into the Equity
Contribution Agreement pursuant to which each of them have
agreed to provide up to $50 million in equity capital to
ARC LLC.
Significant Customers
The following customers represented more than 10% of the
Company’s net revenues for the year ended December 31,
2004 (dollars in thousands):
| Percentage | ||||||||||||||||
| ARC Facility that | Revenues from | of Total Net | ||||||||||||||
| Customer | Services Customer | Revenue Type | Customer | Revenues | ||||||||||||
|
Commonwealth Electric
|
Ref-Fuel Semass | Energy | $ | 38,308 | 12.9% | |||||||||||
|
Long Island Power Authority
|
Hempstead | Energy | 35,286 | 11.8% | ||||||||||||
|
Town of Hempstead and Brookhaven
|
Hempstead | Waste disposal and | ||||||||||||||
| related services | 34,595 | 11.6% | ||||||||||||||
One customer, the Port Authority of New York and New Jersey (the
Port), represented more than 10% of the Company’s accounts
receivable with a total receivable balance of $8.4 million,
or 11.7% of total accounts receivable at of December 31,
2004. The Port receives waste disposal and related services from
Essex.
| 15. | Related Party Transactions |
The Company had been engaged to perform certain management
services related to unconsolidated equity investees and other
affiliated entities. The Company received $0.2 million and
$0.4 million from Ref-Fuel Holdings for the period from
January 1, 2003 through December 12, 2003, and the
year ended December 31, 2002, respectively, which are
included in “Other, net” in the accompanying statement
of operations. In addition, the Company received
$0.5 million and $0.5 million from a subsidiary sold
to Delta for the period from January 1, 2003 through
December 12, 2003, and the year ended December 31,
2002, respectively; these service revenues are included in
discontinued operations in the accompanying statements of
operations for all periods presented.
In connection with the MSW Transaction, the Company paid a
transaction advisory fee of $8.0 million to Credit Suisse
First Boston, an affiliate of CSFB Private Equity, on
December 12, 2003. This fee was approved by the
Company’s Board of Directors.
The entire board is composed of representatives of the
shareholders. In addition, the shareholders control the
appointment of the Company’s management, authorizing
mergers, sales of substantially all of the Company’s assets
and other extraordinary transactions.
C-27
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
From time to time, CSFB or its affiliates may engage in
investment banking and other services with the Company or
Ref-Fuel Holdings or its subsidiaries, for which CSFB or its
affiliates will receive customary compensation.
Subsidiaries of AIG have issued existing insurance policies to
the Company, for which the AIG insurance company subsidiaries
receive customary annual premiums. The Insurance Company of
Pennsylvania, an AIG subsidiary, entered into an indemnity
agreement with American Ref-Fuel, to support the issuance of
surety bonds on behalf of several American Ref-Fuel affiliates,
for which The Insurance Company of Pennsylvania receives
customary annual premiums. In addition, insurance company
subsidiaries of AIG may in the future provide insurance and
surety bonds to the Company. Total fees paid in 2004 related to
these policies were approximately $2.8 million. AIG was not
a related party prior to the MSW Transactions.
| 16. | Employee Compensation and Benefit Plans |
| Retirement Savings Plan |
ARC LLC is the sponsor of the American Ref-Fuel Company
Retirement Savings Plan (the ARC Savings Plan), which
covers substantially all employees of ARC LLC. The Savings Plan,
adopted July 1, 1988, as amended, incorporates a defined
contribution account for each employee with deferred savings
features permitted under Internal Revenue Code
Section 401(k). Employees may make voluntary contributions
to one or more of various investment funds through payroll
deductions. ARC LLC’s matching contribution is defined as
50 percent of the first five percent of covered
compensation contributed by the employee. In addition, ARC LLC
makes a basic contribution on an employee’s behalf in an
amount equal to three percent of an employee’s regular
earnings which are less than the Social Security Wage Base, plus
six percent of an employee’s regular earnings in excess of
the Social Security Wage Base. ARC LLC contributions are
directed to the investment funds in the same proportion as the
employees have directed their voluntary contributions. Amounts
contributed to the ARC Savings Plan were $1.8 million for
the year ended December 31, 2004.
The Company had a qualified 401(k) incentive savings plan (the
Terminated Plan), which is a defined contribution plan, covering
all full-time employees that was terminated on December 15,
2003. Under the Terminated Plan, participating employees elected
to contribute up to 15% of their compensation. During 2003 and
2002, the Company made matching contributions equal to 50% of
the first six percent of the employee contributions subject to
certain IRS limitations.
| Long-Term Compensation Plans |
Ref-Fuel Holdings has granted certain appreciation rights and/or
performance awards to its officers and certain key employees
that were issued under two separate long-term incentive plans;
the Long-Term Incentive Plan (dated as of January 2001) and the
Management Incentive Plan (dated as of January 2004). The
incentive plans are administered by the Compensation Committee
of the Board of Directors of Ref-Fuel Holdings. Awards under
long-term incentive plans are based on the achievement of
certain management objectives during each plan year. Awards
under the long-term incentive plans mature in equal amounts of
25% in the four years following the awards.
The Company recognized long-term incentive compensation expense
of approximately $2.7 million during the year ended
December 31, 2004. The Ref-Fuel Holdings’ obligation
under the long-term incentive plans is approximately
$6.0 million at December 31, 2004, of which
approximately $2.7 million is included in other long-term
liabilities with the remainder in current liabilities. Ref-Fuel
Holdings paid out approximately $3.4 million under these
plans for the year ended December 31, 2004.
C-28
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| Employment Agreements |
Ref-Fuel Holdings has employment agreements with its seven
officers. The agreements, which expire on December 31,
2006, provide for annual base salaries, subject to annual review
by the Board of Directors of Ref-Fuel Holdings. Each officer is
also eligible to participate in cash-based short-term and
long-term bonus and incentive compensation arrangements,
retirement plans and other arrangements that are generally
provided to senior officers. If an officer’s employment is
terminated by Ref-Fuel Holdings “without cause” or by
the officer for “good reason” (each as defined in the
agreement), such officer is entitled to an amount equal to the
sum of two times the annual base salary, two times the average
annual bonus for the three preceding years and prorated target
cash bonus for the calendar year which includes the date of
termination.
As a result of the MSW Transaction, substantially all the
employees of American Ref-Fuel Holdings Corp. were terminated.
Other employees remained employed by operating companies that
were sold to Delta. Employees of the Company, including certain
executives of the Company who had employment agreements and who
were terminated, were entitled to receive certain bonus and
severance payments. Severance payments to former executives with
employment agreements as a result of the change in control of
the Company were paid based upon prior salary, bonus and
benefits. The aggregate severance obligation was approximately
$6.2 million of which approximately $4.5 million was
related to the former executives with employment contracts that
is to be paid in equal bi-weekly payments over three years. The
Company recorded the full severance obligation at its net
present value. The Company included this obligation in its
determination of MSW Merger’s purchase price for the stock
of the Company. As of December 31, 2004 and 2003, the
Company has a remaining obligation of $3.0 million and
$5.9 million, respectively, which is reflected in accrued
liabilities in the accompanying consolidated balance sheet.
| 17. | Stockholders’ Equity |
MSW Merger was a limited liability company formed pursuant to a
limited liability company agreement in August 2003 for the
purpose of completing the merger with the Company.
To partially fund the merger, the members of MSW Merger made
capital contributions aggregating approximately
$124 million and loans aggregating approximately
$85 million and, together with debt proceeds of certain of
MSW Merger’s wholly-owned subsidiaries, acquired all of the
outstanding capital stock of Holdings Corp. and completed the
merger whereby Holdings Corp. was the surviving legal entity.
The members of MSW Merger thereby became the sole owners of
Holdings Corp. and their interest in 1,000 shares of issued
and outstanding common stock of the Company was equal to each
member’s percentage interest of MSW Merger immediately
prior to the merger. All other preferred stock and common stock
of Holdings Corp., including shares held in treasury, were
cancelled in connection with the merger.
In connection with the merger, the authorized capital stock of
Holdings Corp. was reduced to 5,000 shares of common shares
from 9 million shares of authorized common stock and
7 million shares of authorized preferred stock.
On April 30, 2004, in conjunction with the Equalization,
the Company shareholders associated with CSFB Private Equity
sold 40% of the common stock of the Company to affiliates of
AIGGIC.
On May 26, 2004, the stockholders voted to effectuate a 100
for one stock split, reduce the par value of the common stock to
$0.001 per share, and increase the number of common
authorized shares to 300,000.
On August 31, 2004, the stockholders completed the
August 31 Transactions, as previously described. As part of
the August 31 Transactions, the Stockholder issuers of the
$40 million of 9.0% Senior Notes contributed their
interests in those notes in exchange for 32,258 shares of
common stock of the Company. Additionally, the shareholders of
MSW Energy Holdings contributed their 99.99% nonmanaging
interests in MSW Energy Holdings to the Company in exchange for
131,729 shares of common stock of the Company.
C-29
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
A summary of changes in issued and outstanding shares of
preferred stock, common stock and treasury stock of Holdings
Corp. follows for the year ended December 31, 2004, periods
of December 12, 2003 through December 31, 2003,
January 1, 2003 through December 12, 2003, and the
year ended December 2002:
| December 12, | January 1, | |||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | |||||||||||||||
| December 31, | December 31, | December 12, | December 31, | |||||||||||||||
| 2004 | 2003 | 2003 | 2002 | |||||||||||||||
|
Changes in participating convertible preferred stock:
|
||||||||||||||||||
|
Number of shares issued, beginning of period
|
— | — | 3,488,372 | 3,488,372 | ||||||||||||||
|
Shares purchased by MSW Merger and Cancelled
|
— | — | (3,488,372 | ) | — | |||||||||||||
|
Number of shares issued, end of period
|
— | — | — | 3,488,372 | ||||||||||||||
|
Changes in Class A common stock:
|
||||||||||||||||||
|
Number of shares issued, beginning of period
|
1,000 | 1,000 | 1,867,233 | 1,830,233 | ||||||||||||||
|
100 for one stock split
|
99,000 | — | — | — | ||||||||||||||
|
Shares issued for contribution of Senior Notes
|
32,258 | — | — | — | ||||||||||||||
|
Shares issued in conjunction with the acquisition of MSW Energy
Holdings
|
131,729 | — | — | — | ||||||||||||||
|
Exercise of stock options
|
— | — | 472,100 | 37,000 | ||||||||||||||
|
Shares purchased by MSW Merger and Cancelled
|
— | — | (2,338,333 | ) | — | |||||||||||||
|
Number of shares issued, end of period
|
263,987 | 1,000 | 1,000 | 1,867,233 | ||||||||||||||
|
Changes in treasury stock, Class A common:
|
||||||||||||||||||
|
Number of shares held, beginning of period
|
— | — | 3,504 | — | ||||||||||||||
|
Shares received for exercise of stock options and related income
taxes
|
— | — | 12,938 | 3,504 | ||||||||||||||
|
Shares of treasury stock cancelled
|
— | — | (16,442 | ) | — | |||||||||||||
|
Number of shares held, end of period
|
— | — | — | 3,504 | ||||||||||||||
|
Shares of common stock outstanding, end of period
|
263,987 | 1,000 | 1,000 | 1,863,729 | ||||||||||||||
| 18. | Stock Option Plans |
On August 11, 2004, the Board of Directors of the Company,
adopted the 2004 Stock Option Plan (the SOP), effective
January 1, 2004, as further modified on September 16,
2004. The SOP was designed to link the interests of officers of
the Company and other senior management of Ref-Fuel Holdings to
the interests of the Company’s shareholders through the
granting of options to purchase stock. During 2004, the Company
granted 13,199 options to the executive officers of Ref-Fuel
Holdings under the SOP. Options awarded under the SOP vest over
a period of four years and expire ten years from the date of
grant, unless a triggering event (as defined in the agreement)
has not occurred during the option period.
On January 31, 2005, in conjunction with the Sale, as
discussed in Note 20, the Board of Directors and optionees
under the SOP adopted an Option Modification Agreement (OMA).
Under the terms of the OMA, at the completion of the Sale, the
SOP plan will be canceled in exchange for a cash payment. The
cash payment is calculated as the value of all outstanding
options granted or ungranted but authorized under the terms of
the SOP, together with certain amounts due and anticipated under
other long term compensation plans.
C-30
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
Prior to the MSW Transactions, the Company had a stock option
plan that authorized the granting of incentive and nonqualified
stock options to certain key employees and/or directors of the
Company; 900,000 shares of Class A common stock had
been reserved for issuance pursuant to the terms of such plan.
Subject to the occurrence of certain events and/or the passage
of time, which trigger their vesting, options issued under the
stock option plan vest and could have been exercised over a four
to ten year period from the initial grant date.
As a result of the MSW Transaction and pursuant to the plan of
merger between MSW Merger and Holdings Corp., all previous
unvested options of the Company with an exercise price of less
than $63.00 became fully vested and exercisable. Options greater
than $63.00 were cancelled for a nominal payment to each option
holder. The Board of Directors approved the acceleration of the
vesting of options in connection with the MSW Transaction, which
was not provided for in the Company’s stock option plan.
The accelerated vesting by the Board of Directors resulted in
the Company recording a charge of approximately
$0.7 million, representing the difference between the fair
value of the underlying stock and the stock option exercise
price at the date of the acceleration. This charge is reflected
in general and administrative expense in the accompanying
statement of operations for the period from January 1, 2003
through December 12, 2003.
During 2002, the Board authorized the extension of 37,000
options held by a key executive for a one-year period. Such
extension at the discretion of the Board of Directors resulted
in a new measurement date for the options extended. The Company
recorded a charge for $2.2 million, reflecting the
difference between the fair value of the underlying stock on the
date of the extension and the exercise price of the option. Such
charge is included in general and administrative expense in the
accompanying 2002 statement of operations. Pursuant to a
provision in the Company’s stock option plan, in December
2002, this executive exercised these 37,000 options through the
surrender of 3,504 shares of common stock of the Company.
The Company adopted a deferred compensation plan during 2002.
The Company’s obligation under the deferred compensation
plan up until December 12, 2003, the date of the merger and
as of December 31, 2002 was $9.1 million and
$2.2 million, respectively, and is included as a reduction
of stockholders’ equity. All of the stock in the deferred
compensation plan was purchased by MSW Merger in connection with
the merger and the executive received the benefit of those
shares.
In addition, in connection with the sale of WBU in December 2002
(see Note 4), the Company accelerated the vesting of
certain options held by an executive, otherwise such options
would have been cancelled as a result of his terminating
employment with the Company. The Company recorded a charge of
$0.4 million as a result of accelerated vesting of certain
options for executives. Such charge is included in the loss on
disposal of the WBU in discontinued operations in the
accompanying 2002 statement of operations.
During 2003, pursuant to a provision in the Company’s stock
option plan, an executive involved with WBU exercised 121,100
options through the surrender of a net 11,261 shares of
common stock of the Company. All of the stock in the deferred
compensation plan was purchased by MSW Merger in connection with
the MSW Transaction and the executive received the benefit of
those shares.
C-31
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
A summary of the Company’s stock options for the year ended
December 31, 2004, periods from December 12, 2003
through December 31, 2003 and January 1, 2003 through
December 12, 2003 and the year ended December 31, 2002
is as follows:
| December 12, | January 1, | ||||||||||||||||||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | ||||||||||||||||||||||||||||||
| December 31, | December 31, | December 12, | December 31, | ||||||||||||||||||||||||||||||
| 2004 | 2003 | 2003 | 2002 | ||||||||||||||||||||||||||||||
| Weighted | Weighted | Weighted | Weighted | ||||||||||||||||||||||||||||||
| Average | Average | Average | Average | ||||||||||||||||||||||||||||||
| Exercise | Exercise | Exercise | Exercise | ||||||||||||||||||||||||||||||
| Shares | Price | Shares | Price | Shares | Price | Shares | Price | ||||||||||||||||||||||||||
|
Options outstanding:
|
|||||||||||||||||||||||||||||||||
|
Beginning of year
|
— | $ | — | — | $ | — | 681,566 | $ | 18.13 | 674,517 | $ | 13.96 | |||||||||||||||||||||
|
Granted
|
13,199 | 1,189.51 | — | — | 40,800 | 64.50 | 74,450 | 64.50 | |||||||||||||||||||||||||
|
Exercised
|
— | — | — | — | (472,100 | ) | 5.07 | (37,000 | ) | 5.25 | |||||||||||||||||||||||
|
Forfeited or terminated
|
— | — | — | — | (107,466 | ) | 62.45 | (30,401 | ) | 26.91 | |||||||||||||||||||||||
|
Purchased by MSW Merger
|
— | — | — | — | (142,800 | ) | 41.21 | — | — | ||||||||||||||||||||||||
|
End of year
|
13,199 | $ | 1,189.51 | — | $ | — | — | $ | — | 681,566 | $ | 18.13 | |||||||||||||||||||||
|
Options exercisable at year end
|
— | — | — | — | — | $ | — | 499,626 | $ | 6.64 | |||||||||||||||||||||||
|
Weighted average fair value of options granted during the year
|
$ | 132.30 | $ | — | $ | 13.29 | $ | 18.01 | |||||||||||||||||||||||||
The fair value of each stock option granted during the year
ended December 31, 2004, the periods from January 1,
2003 through December 12, 2003 and the year ended
December 31, 2002 is an estimate on the date of grant that
is calculated using the minimum value option pricing model with
the following assumptions:
| December 12, | January 1, | ||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | ||||||||||||||
| December 31, | December 31, | December 12, | December 31, | ||||||||||||||
| 2004 | 2003 | 2003 | 2002 | ||||||||||||||
|
Expected life (years)
|
3 | — | 7 | 7 | |||||||||||||
|
Expected dividend
|
— | — | — | — | |||||||||||||
|
Risk free interest rate
|
3.9 | % | — | 3.4 | % | 4.8 | % | ||||||||||
C-32
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
The Company applies the recognition provisions of Accounting
Principles Board Opinion No. 25 and related interpretations
in accounting for its stock-based compensation plans. No
compensation cost has been recognized for the stock option plan.
Set forth as follows are the Company’s net income presented
both as reported and pro forma, as if compensation cost had been
determined consistent with the provisions of
SFAS No. 123 for the year ended December 31,
2004, the periods of December 12, 2003 through
December 31, 2003, January 1, 2003 through
December 12, 2003, and the year ended December 31,
2002 (in thousands):
| December 12, | January 1, | ||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | ||||||||||||||
| December 31, | December 31, | December 12, | December 31, | ||||||||||||||
| 2004 | 2003 | 2003 | 2002 | ||||||||||||||
|
Net income, as reported
|
$ | 21,107 | $ | 994 | $ | 10,729 | $ | 12,049 | |||||||||
|
Add: stock-based compensation expense included in reported net
income, net of taxes
|
— | — | 428 | 1,528 | |||||||||||||
|
Less: stock-based compensation expense included using fair value
method, net of taxes
|
(1,746 | ) | — | (858 | ) | (1,988 | ) | ||||||||||
|
Pro forma net earnings
|
$ | 19,361 | $ | 994 | $ | 10,299 | $ | 11,589 | |||||||||
The effects of applying SFAS No. 123 in this pro forma
disclosure are not necessarily indicative of future amounts.
| 19. | Commitments and Contingencies |
| Environmental and Regulatory Risk |
The Company operates in an environmentally sensitive industry
and is subject to extensive federal, state and local laws and
regulations adopted for the protection of the environment. The
laws and regulations primarily applicable to the Company are
those related to discharge of emissions into the air and
management of solid waste but can also include those related to
water use, discharges to water, wetlands preservation and
hazardous waste management. Certain of these laws have extensive
and complicated requirements relating to obtaining construction
and operating permits, monitoring, record keeping and reporting.
While management believes that it is in material compliance with
permits and other applicable environmental laws relating to the
Company, its facilities, from time to time, may not be in full
compliance with all such laws.
Noncompliance with environmental laws and regulations can result
in the imposition of civil or criminal fines or penalties. In
some instances, environmental laws also may impose clean-up or
other remedial obligations in the event of a release of
pollutants or contaminants into the environment. The Company
incurs operating costs and capital expenditures related to
various environmental protection and monitoring programs. Such
expenditures have not had a material adverse effect on the
Company’s consolidated financial position or results of
operations. However, federal, state and local regulatory
authorities may consider proposals to restrict or tax certain
emissions, which proposals, if adopted, could impose additional
costs on the operation of the Company.
Future Mercury Regulation at the Essex Facility. On
December 6, 2004 the New Jersey Department of Environmental
Protection (NJDEP) promulgated regulations applicable
to the Essex facility that will make mercury emission
requirements more stringent. Specifically, the new regulations
increase the required removal efficiency to 85% removal on
January 3, 2006 and 95% removal on January 3, 2012
versus the current 80% removal, while retaining the alternative
limit of 28 micrograms per cubic meter. As a result of the new
regulations, there is an increased risk that emission
exceedances will occur and therefore an increased
C-33
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
probability that additional controls will ultimately be required
to prevent such exceedances. The Company believes that the new
requirements may at a minimum result in increased operating
costs due to increased use of activated carbon in the current
control equipment. It is also possible that the regulations will
require the installation of additional pollution control
equipment such as compact hybrid particulate collector units, a
device similar to a baghouse. Management estimates that the cost
of the installation of such additional pollution control
equipment, if required, would be approximately $38 million.
The Essex service agreement provides a mechanism for a
pass-through to the Port Authority of New York and New Jersey of
the majority of any additional capital and operating costs that
may be required. The Company cannot currently determine the
likelihood of additional operating and capital costs being
incurred in connection with these changes in regulation, or the
total of any such costs.
Lower Passaic River Study. In August 2004, USEPA notified
American Ref-Fuel Company of Essex County (Essex) that it was
potentially liable under CERCLA Section 107(a) for response
actions in the Lower Passaic River Study Area (LPRSA), a
17 mile stretch of river in northern New Jersey. Essex is
one of at least 52 Potentially Responsible Parties (PRPs) named
thus far. USEPA alleges that hazardous substances found in the
LPRSA were being released from the Essex site, which abuts the
river. USEPA’s notice letter states that Essex may be
liable for costs related to a proposed $10 million study of
the Lower Passaic River and for unspecified natural resource
damages. Considering the history of industrial and other
discharges into the LPRSA from other sources, including named
PRPs, Essex believes that its contribution will be determined to
be de minimus; however, it is not possible at this time to
predict that outcome with certainty or to estimate the
Company’s liability for the study or any eventual natural
resource damage.
| Landfill Agreements |
Semass Partnership has a waste management agreement (the WMA)
dated May 25, 1982, as amended, with the Carver, Marion,
Wareham Regional Refuse Disposal District (CMW). The WMA allows
Semass Partnership to utilize a portion of a landfill (the CMW
Landfill), which CMW leases from Wankinco River, Inc.
(Wankinco).
Beginning in May 1997, Wankinco provided several notices
purportedly terminating the lease on the CMW Landfill based upon
an allegation that the lease term automatically expired due to
alleged failures to strictly comply with the terms of the lease.
In June 1997, Semass Partnership and CMW filed suit against
Wankinco and A. D. Makepeace Company, Inc., Wankinco’s
parent company, seeking a declaratory judgment that Semass
Partnership and CMW may continue to operate the CMW Landfill.
Trial of the matter before the court was completed in 2001 and a
decision was received by the Company in December 2002, which
decided virtually all issues in favor of the Semass Partnership.
The Semass Partnership avoided both forfeiture of possession and
any liability for damages due to landfill operations. Wankinco
appealed in January 2003, and on August 19, 2004, the
Appellate Court upheld the Trial Court’s decision in
respect of all decisions related to the alleged lease
violations. One ruling unrelated to lease forfeiture or damages
for unlawful possession was remanded because the Judge’s
ruling that Semass had not engaged in “an unfair and
deceptive act or practice” applied the law conjunctively
rather than disjunctively (as required by the law). The
Appellate Court affirmed the Judge’s ruling that there was
no unfairness, but remanded the question of deception for
further findings since the Appellate Court, due to the use of
the conjunctive rather than disjunctive, was unable to infer
that the Judge did not find a compensable deceptive act.
Management believes that the Judge’s ruling on remand will
clarify this issue in favor of the Company. In addition,
Wankinco appealed the Appellate Court’s decision on the
lease issues to the Supreme Judicial Court of Massachusetts and,
on September 30, 2004, the Supreme Judicial Court denied
Wankinco’s Application for Further Appellate Review.
Accordingly, except for the remand discussed above, the
favorable decisions received by Semass have become final and
nonappealable. Apart from this decision, the Semass Partnership
and Wankinco continue litigating several other actions involving
regulatory issues at the landfill.
C-34
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
In March 1990, the Semass Partnership, CMW and Wankinco entered
into an agreement related to the CMW Landfill, as amended (the
Settlement Agreement), which requires, among other things, the
Semass Partnership to make annual deposits into an
environmental protection trust fund (the Fund) in lieu of
obtaining environmental impairment liability insurance for the
CMW Landfill. The Semass Partnership is required under the
Settlement Agreement to deposit $500,000 annually into the Fund,
payable in equal quarterly installments. Certain additional
deposits are required subject to the availability of cash in
accordance with the Loan Agreement. The Semass
Partnership’s obligation to make deposits into the Fund
ceases when the Fund reaches a balance of $20.0 million,
unless the fund limit is increased by agreement of the parties,
or absent such agreement, arbitration, wherein it is determined
the fund limit needs to be increased to adequately protect
against environmental damage. Management believes that the
$20.0 million fund limit is adequate for this purpose.
Proceeds from the Fund are to be used primarily for remediation
of the CMW Landfill in the event of any environmental damages.
The Semass Partnership and Wankinco are each entitled to receive
one-half of the balance of the Fund upon final closure of the
CMW Landfill and receipt of required governmental approvals.
During the year ended December 31, 2004, the Semass
Partnership made the required quarterly deposits into the Fund
and charged operations for one-half of the deposits into the
Fund, representing one-half of the balance of the Fund which
will be disbursed to Wankinco upon final closure of the CMW
Landfill. Additional charges to operations may be required in
future years if any disbursements are required from the Fund to
remediate any environmental damages. To date, management is not
aware of any such environmental damages. As of December 31,
2004, the balance in the Fund is approximately
$14.0 million, and is included in restricted cash and
long-term investments. A corresponding liability of
approximately $7.0 million, representing approximately
one-half of the deposits and related earnings in the Fund, is
included in other long-term liabilities as of December 31,
2004.
| Future Minimum Payments Under Operating Leases |
The Company has an obligation for a lease of office space which
was vacated as a result of terminating all the employees of
American Ref-Fuel Holdings Corp. The Company has accrued the
remaining lease obligation and expected operating costs, less an
estimate of expected sublease rental income and reimbursements
of operating costs, amounting to $0.4 million, which is
included in accrued liabilities. The Company included this
obligation in its determination of MSW Merger’s purchase
price for the stock of the Company.
Delaware Valley leases the Delaware Valley Project pursuant to
an operating lease that expires in July 2019. The Company leases
office space for its Montvale, New Jersey headquarters pursuant
to an operating lease expiring in August 2007. As of
December 31, 2004, total minimum net rental payments on
these leases are as follows (in thousands):
|
2005
|
$ | 15,031 | ||
|
2006
|
14,390 | |||
|
2007
|
14,127 | |||
|
2008
|
12,711 | |||
|
2009
|
28,809 | |||
|
Thereafter
|
70,502 | |||
| $ | 155,570 | |||
The Company is contingently liable for the payment of stipulated
losses, a portion of which is included in the minimum net rental
payments for Delaware Valley reflected in the table above. This
stipulated loss value as of December 31, 2004 is
approximately $170.1 million. Total net rental expense was
$5.5 million for the year ended December 31, 2004.
C-35
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
Prior to the MSW Transaction, the Company was also obligated
under the terms of various leases primarily covering certain
equipment, facilities and land utilized by subsidiaries of the
Company in connection with operating its power plants that have
since been sold. The Company accounted for such leases as
operating leases. Net rental expense which is included in
discontinued operations in the accompanying statements of
operations was $0.9 million and $1.7 million for the
period January 1, 2003 through December 12, 2003, and
the year ended December 31, 2002, respectively.
| Capital Expenditures |
As of December 31, 2004, the Company has commitments for
capital expenditures of approximately $10.8 million, all of
which are expected to be incurred in 2005.
| Other Matters |
The Company is involved in various claims or litigation in the
ordinary course of business. Management believes that the
ultimate resolution of these matters, either individually or in
the aggregate, will not have a material adverse effect on the
future results of operations, cash flows or financial position
of the Company.
The Company is required to provide financial assurance to
government agencies under applicable environmental and
procurement regulations relating to the landfill operations and
waste disposal contract. Performance bonds to secure the
obligations, of which $23.0 million in surety bonds was
outstanding as of December 31, 2004, satisfy these
financial requirements.
| Duke Agreement |
The following table represents the future net minimum payments
to be made under the Duke Agreement as of December 31, 2004
(in thousands):
| Years Ending December 31, | ||||
|
2005
|
$ | 2,500 | ||
|
2006
|
2,500 | |||
|
2007
|
2,500 | |||
|
2008
|
2,500 | |||
|
2009
|
2,500 | |||
|
Thereafter
|
36,500 | |||
|
Total minimum payments
|
49,000 | |||
|
Less: amount representing interest
|
(26,467 | ) | ||
|
Present value of net minimum payments
|
$ | 22,533 | ||
| Equity Contribution Agreement |
In order to provide ARC LLC with an additional source of funds
to meet calls on its guarantees and project support obligations,
two of the Company’s subsidiaries are parties to an equity
contribution agreement, pursuant to which each has agreed to
provide up to $50 million in contingent equity capital to
ACR LLC to meet calls on its guarantees and project support
obligations.
Each party’s obligation to make equity contributions under
the equity contribution agreement is conditioned upon the other
making an equal contribution and will be limited to each making
no more than $50 million of aggregate equity contributions.
Payment obligations under the equity contribution agreement are
triggered by a call by ARC LLC.
C-36
Table of Contents
American Ref-Fuel Holdings Corp. and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
If either party agreeing to provide contingent equity capital is
not rated at least BBB by S&P, such party, as applicable, is
required to provide a letter of credit from a commercial bank
that is rated at least A- by S&P to secure its obligations
under the equity contribution agreement. As of the date hereof,
each of the two subsidiaries have provided letters of credit to
secure their obligations under the equity contribution
agreement. In addition, either or both of the parties to the
Equity Contribution Agreement are obligated to provide such
credit support in order for ARC LLC to retain a credit rating of
at least BBB-.
| 20. | Supplemental Disclosure of Cash Flow Information |
Depreciation and amortization expense included in the Statement
of Cash Flows consists of the following:
| December 12, | January 1, | ||||||||||||||||||
| Year Ended | 2003 to | 2003 to | Year Ended | ||||||||||||||||
| December 31, | December 31, | December 12, | December 31, | ||||||||||||||||
| Asset/ Liability | Statement of Operations | 2004 | 2003 | 2003 | 2002 | ||||||||||||||
|
Property, plant and equipment
|
Depreciation and amortization | $ | 45,154 | $ | 174 | $ | 17,329 | $ | 20,502 | ||||||||||
|
Energy contracts
|
Energy revenues | 38,687 | — | — | — | ||||||||||||||
|
Long-term waste contracts
|
Waste disposal and related services | (5,787 | ) | — | — | — | |||||||||||||
|
Lease
|
Operating expenses (rent expense) | (1,099 | ) | — | — | — | |||||||||||||
|
Debt
|
Interest expense | (7,622 | ) | — | — | 752 | |||||||||||||
|
Deferred revenue
|
Waste disposal and related services revenues and energy revenues | (94 | ) | — | — | — | |||||||||||||
|
Total
|
$ | 69,239 | $ | 174 | $ | 17,329 | $ | 21,254 | |||||||||||
|
Supplemental cash flow information
|
|||||||||||||||||||
|
Cash paid for interest
|
$ | 80,254 | $ | 11 | $ | 11,442 | $ | 21,796 | |||||||||||
|
Income taxes paid (received), net
|
14,074 | (191 | ) | (4,873 | ) | 11,721 | |||||||||||||
|
Noncash investing and financing activities
|
|||||||||||||||||||
|
Noncash contribution from stockholders
|
$ | 40,000 | |||||||||||||||||
|
Equity contributed in the August 31 Transactions
|
136,398 | ||||||||||||||||||
| 21. | Subsequent Events (unaudited) |
DLJ Merchant Banking Partners and AIG Highstar Capital, L.P.,
stockholders of the Company, announced on February 1, 2005
that they have signed a definitive agreement to sell the Company
(the Sale) to Danielson Holding Corporation (Danielson).
Danielson will pay $740 million in cash for the equity of
the Company. Subject to receipt of regulatory approvals and
required financing, the transaction is expected to close in the
second quarter of 2005.
In connection with the Sale, costs relating to transaction
expenses, severance, employment contracts, the OMA, Long-Term
Incentive Plans, housing subsidies, lease termination and other
related items are estimated to be between $50 million and
$70 million.
C-37
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Members and Board of Directors of
Ref-Fuel Holdings LLC and Subsidiaries:
In our opinion, the accompanying consolidated balance sheets and
the related consolidated statements of operations and
comprehensive income, members’ equity and cash flows
present fairly, in all material respects, the financial position
of Ref-fuel Holdings LLC and Subsidiaries (the
“Company”) at December 31, 2004 and 2003, and the
results of their operations and their cash flows for the year
ended December 31, 2004 and the period from
December 12, 2003 through December 31, 2003 in
conformity with accounting principles generally accepted in the
United States of America. These financial statements are the
responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these
statements 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, assessing the accounting principles
used and significant estimates made by management, and
evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our
opinion.
| /s/ PricewaterhouseCoopers LLP |
Florham Park, NJ
March 15, 2005
C-38
Table of Contents
Report of Independent Registered Public Accounting
Firm
To the Members and Board of Directors of
Ref-Fuel Holdings LLC and Subsidiaries:
In our opinion, the accompanying consolidated statement of
operations and comprehensive income, of members’ equity and
of cash flows for the period January 1, 2003 through
December 12, 2003 and for the year ended December 31,
2002 present fairly, in all material respects, the results of
operations and cash flows of Ref-Fuel Holdings LLC and
Subsidiaries (the “Company”), in conformity with
accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of
the Company’s management. Our responsibility is to express
an opinion on these financial statements based on our audits. We
conducted our audits of these statements 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,
assessing the accounting principles used and significant
estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
| /s/ PricewaterhouseCoopers LLP |
Florham Park, NJ
March 29, 2004
C-39
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Consolidated Balance Sheets
| December 31, | ||||||||
| 2004 | 2003 | |||||||
| (In thousands) | ||||||||
| ASSETS | ||||||||
|
Current assets
|
||||||||
|
Cash and cash equivalents
|
$ | 86,050 | $ | 96,511 | ||||
|
Restricted cash and short-term investments
|
53,636 | 52,753 | ||||||
|
Accounts receivable, net of allowance for doubtful accounts of
$1,491 $1,955, respectively
|
72,027 | 73,989 | ||||||
|
Prepaid expenses and other current assets
|
11,013 | 9,898 | ||||||
|
Total current assets
|
222,726 | 233,151 | ||||||
|
Long-term assets
|
||||||||
|
Property, plant and equipment, net
|
1,187,178 | 1,220,949 | ||||||
|
Intangible assets, net
|
528,486 | 584,275 | ||||||
|
Goodwill
|
2,175 | 2,175 | ||||||
|
Restricted cash and long-term investments
|
85,926 | 84,709 | ||||||
|
Other long-term assets
|
4,806 | 2,649 | ||||||
|
Total long-term assets
|
1,808,571 | 1,894,757 | ||||||
|
Total assets
|
$ | 2,031,297 | $ | 2,127,908 | ||||
| LIABILITIES AND MEMBERS’ EQUITY | ||||||||
|
Current liabilities
|
||||||||
|
Accounts payable and other current liabilities
|
$ | 41,164 | $ | 39,610 | ||||
|
Current portion of long-term debt
|
87,184 | 81,907 | ||||||
|
Accrued interest payable
|
10,917 | 11,841 | ||||||
|
Total current liabilities
|
139,265 | 133,358 | ||||||
|
Long-term liabilities
|
||||||||
|
Long-term debt
|
958,829 | 1,060,780 | ||||||
|
Other long-term liabilities
|
204,817 | 192,470 | ||||||
|
Total long-term liabilities
|
1,163,646 | 1,253,250 | ||||||
|
Total liabilities
|
1,302,911 | 1,386,608 | ||||||
|
Commitments and contingencies (Notes 11, 12, 14 and 16)
|
||||||||
|
Members’ equity
|
||||||||
|
Total members’ equity
|
728,386 | 741,300 | ||||||
|
Total liabilities and members’ equity
|
$ | 2,031,297 | $ | 2,127,908 | ||||
The accompanying notes are an integral part of these
consolidated financial statements.
C-40
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Consolidated Statements of Operations and Comprehensive
Income
| The Period from | ||||||||||||||||||
| The Period from | ||||||||||||||||||
| For the | December 12, 2003 | January 1, 2003 | For the | |||||||||||||||
| Year Ended | through | through | Year Ended | |||||||||||||||
| December 31, | December 31, | December 12, | December 31, | |||||||||||||||
| 2004 | 2003 | 2003 | 2002 | |||||||||||||||
| (In thousands) | ||||||||||||||||||
|
Revenues
|
||||||||||||||||||
|
Waste disposal and related services
|
$ | 284,446 | $ | 15,398 | $ | 269,493 | $ | 260,119 | ||||||||||
|
Waste disposal and related services — affiliate
|
— | — | — | 12,190 | ||||||||||||||
|
Energy
|
134,754 | 8,194 | 160,821 | 160,284 | ||||||||||||||
|
Other
|
16,981 | 1,255 | 14,147 | 5,949 | ||||||||||||||
|
Total net revenues
|
436,181 | 24,847 | 444,461 | 438,542 | ||||||||||||||
|
Expenses
|
||||||||||||||||||
|
Operating
|
189,411 | 8,417 | 181,615 | 169,866 | ||||||||||||||
|
Depreciation and amortization
|
67,996 | 3,391 | 55,838 | 67,249 | ||||||||||||||
|
General and administrative
|
40,591 | 2,184 | 42,118 | 43,642 | ||||||||||||||
|
Loss on asset retirements
|
2,107 | — | 2,207 | 1,886 | ||||||||||||||
|
Operating income
|
136,076 | 10,855 | 162,683 | 155,899 | ||||||||||||||
|
Interest income
|
3,521 | 275 | 2,956 | 3,740 | ||||||||||||||
|
Interest expense
|
(47,251 | ) | (2,954 | ) | (59,189 | ) | (60,893 | ) | ||||||||||
|
Loss on early extinguishment of debt
|
— | — | (3,191 | ) | — | |||||||||||||
|
Equipment leasing entities
|
— | — | — | 15,500 | ||||||||||||||
|
Other income (expenses), net
|
425 | — | 264 | (757 | ) | |||||||||||||
|
Income before minority interest and provision for income taxes
|
92,771 | 8,176 | 103,523 | 113,489 | ||||||||||||||
|
Minority interests in net income of subsidiaries
|
— | — | — | (4,885 | ) | |||||||||||||
|
Income before provision for income taxes
|
92,771 | 8,176 | 103,523 | 108,604 | ||||||||||||||
|
Provision for income taxes
|
(741 | ) | (94 | ) | (452 | ) | — | |||||||||||
|
Net income
|
92,030 | 8,082 | 103,071 | 108,604 | ||||||||||||||
|
Other comprehensive income
|
(517 | ) | 517 | — | — | |||||||||||||
|
Comprehensive income
|
$ | 91,513 | $ | 8,599 | $ | 103,071 | $ | 108,604 | ||||||||||
The accompanying notes are an integral part of these
consolidated financial statements.
C-41
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Consolidated Statements of Members’ Equity
| MSW Energy | ||||||||||||||||||||
| MSW Energy | Holdings II/America | Accumulated | ||||||||||||||||||
| Duke | Holdings | Ref-Fuel Holdings | Comprehensive | |||||||||||||||||
| Interests | Interests | Corp. Interests | Income | Total | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
|
Balance, January 1, 2002
|
$ | 68,079 | $ | — | $ | 68,079 | $ | — | $ | 136,158 | ||||||||||
|
Redemption of Class B minority interests
|
72,097 | — | 144,194 | |||||||||||||||||
|
Net income
|
54,302 | — | 54,302 | — | 108,604 | |||||||||||||||
|
Distributions to members
|
(47,250 | ) | — | (47,250 | ) | — | (94,500 | ) | ||||||||||||
|
Balance, December 31, 2002
|
147,228 | — | 147,228 | — | 294,456 | |||||||||||||||
|
MSW Energy I acquisition of Duke’s interest at cost
|
(144,933 | ) | 144,933 | — | — | — | ||||||||||||||
|
Net income for the period from January 1, 2003 through
December 12, 2003
|
20,910 | 30,626 | 51,535 | — | 103,071 | |||||||||||||||
|
Distributions to members
|
(22,555 | ) | (13,720 | ) | (36,275 | ) | — | (72,550 | ) | |||||||||||
|
Equity prior to MSW Transactions (Predecessor)
|
$ | 650 | $ | 161,839 | $ | 162,488 | $ | — | $ | 324,977 | ||||||||||
|
Balance, December 12, 2003
|
$ | 650 | $ | 367,340 | $ | 364,711 | $ | — | $ | 732,701 | ||||||||||
|
Comprehensive income for the period from December, 12, 2003
through December 31, 2003
|
16 | 4,025 | 4,041 | 517 | 8,599 | |||||||||||||||
|
Balance, December 31, 2003
|
666 | 371,365 | 368,752 | 517 | 741,300 | |||||||||||||||
|
Distributions to member
|
(218 | ) | (54,282 | ) | (54,500 | ) | (109,000 | ) | ||||||||||||
|
Comprehensive income
|
294 | 46,180 | 45,556 | (517 | ) | 91,513 | ||||||||||||||
|
Finalization of purchase accounting
|
— | — | 4,573 | — | 4,573 | |||||||||||||||
|
Balance, December 31, 2004
|
$ | 742 | $ | 363,263 | $ | 364,381 | $ | — | $ | 728,386 | ||||||||||
The accompanying notes are an integral part of these
consolidated financial statements.
C-42
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Consolidated Statements of Cash Flows
| For the Period | The Period from | ||||||||||||||||
| For the | December 12, 2003 | January 1, 2003 | For the | ||||||||||||||
| Year Ended | through | through | Year Ended | ||||||||||||||
| December 31, | December 31, | December 12, | December 31, | ||||||||||||||
| 2004 | 2003 | 2003 | 2002 | ||||||||||||||
| (In thousands) | |||||||||||||||||
|
Cash flows from operating activities
|
|||||||||||||||||
|
Net income
|
$ | 92,030 | $ | 8,082 | $ | 103,071 | $ | 108,604 | |||||||||
|
Adjustments to reconcile net income to net cash provided by
operating activities
|
|||||||||||||||||
|
Depreciation and amortization
|
100,714 | 5,706 | 65,662 | 74,695 | |||||||||||||
|
Revenue contract levelization
|
22,789 | 995 | 14,947 | 14,359 | |||||||||||||
|
Interest on loss contracts
|
— | — | 1,863 | 2,051 | |||||||||||||
|
Equity in earnings of unconsolidated affiliates
|
|||||||||||||||||
|
Equipment leasing entities
|
— | — | — | (15,500 | ) | ||||||||||||
|
Minority interest in net income of subsidiaries, net of
distributions
|
— | — | — | 4,885 | |||||||||||||
|
Loss on asset retirements
|
2,107 | — | 2,207 | 1,886 | |||||||||||||
|
Loss on early extinguishment of debt
|
— | — | 3,191 | — | |||||||||||||
|
Changes in assets and liabilities
|
|||||||||||||||||
|
Accounts receivable, net
|
1,962 | 2,890 | (6,337 | ) | (9,245 | ) | |||||||||||
|
Accounts receivable, affiliates
|
— | — | — | 8,808 | |||||||||||||
|
Prepaid expenses and other current assets
|
(1,165 | ) | 3,255 | (2,731 | ) | (7,933 | ) | ||||||||||
|
Other long-term assets
|
(2,187 | ) | 562 | (2,971 | ) | 3,567 | |||||||||||
|
Accounts payable and other current liabilities
|
1,611 | 1,886 | (21,202 | ) | 19,314 | ||||||||||||
|
Accrued interest payable
|
(924 | ) | (7,775 | ) | 6,762 | 6,138 | |||||||||||
|
Other long-term liabilities
|
2,609 | (731 | ) | 6,572 | (12,978 | ) | |||||||||||
|
Net cash provided by operating activities
|
219,546 | 14,870 | 171,034 | 198,651 | |||||||||||||
|
Cash flows from investing activities
|
|||||||||||||||||
|
Change in restricted cash and investments, net
|
(2,617 | ) | 32,981 | (38,505 | ) | (37,145 | ) | ||||||||||
|
Additions of property, plant and equipment
|
(37,475 | ) | — | (33,780 | ) | (35,727 | ) | ||||||||||
|
Acquisition of intangible assets
|
— | — | — | (548 | ) | ||||||||||||
|
Proceeds from redemption
|
— | — | — | 2,592 | |||||||||||||
|
Proceeds from sale of assets
|
455 | 3,333 | 1,731 | 1,292 | |||||||||||||
|
Net cash provided by (used in) investing activities
|
(39,637 | ) | 36,314 | (70,554 | ) | (69,536 | ) | ||||||||||
|
Cash flows from financing activities
|
|||||||||||||||||
|
Borrowings of long-term debt
|
— | — | 325,318 | 40,000 | |||||||||||||
|
Repayments of long-term debt
|
(81,370 | ) | (16,124 | ) | (356,813 | ) | (56,032 | ) | |||||||||
|
Payment of financing costs
|
— | — | (5,157 | ) | (153 | ) | |||||||||||
|
Distributions paid to members
|
(109,000 | ) | — | (72,550 | ) | (94,500 | ) | ||||||||||
|
Net cash (used in) provided by financing activities
|
(190,370 | ) | (16,124 | ) | (109,202 | ) | (110,685 | ) | |||||||||
|
Net (decrease) increase in cash and cash equivalents
|
(10,461 | ) | 35,060 | (8,722 | ) | 18,430 | |||||||||||
|
Cash and cash equivalents, beginning of year
|
96,511 | 61,451 | 70,173 | 51,743 | |||||||||||||
|
Cash and cash equivalents, end of year
|
$ | 86,050 | $ | 96,511 | $ | 61,451 | $ | 70,173 | |||||||||
The accompanying notes are an integral part of these
consolidated financial statements.
C-43
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial Statements
| 1. | Organization and Basis of Presentation |
Ref-Fuel Holdings LLC (Ref-Fuel Holdings or the Company), is a
Delaware limited liability company formed in 1997. Ref-Fuel
Holdings was formed with the purpose of obtaining
50 percent ownership of the following partnerships:
(a) American Ref-Fuel Company (Ref-Fuel Management), which
owned 98 percent of TransRiver Marketing Company, L.P.
(TransRiver); (b) American Ref-Fuel Company of Hempstead
(Hempstead); (c) American Ref-Fuel Company of Essex County
(Essex); (d) American Ref-Fuel Company of Southeastern
Connecticut (Seconn); (e) American Ref-Fuel Company of
Niagara, L.P. (Niagara); (f) American Ref-Fuel Company of
Semass, L.P. (Ref-Fuel Semass); (g) American Ref-Fuel
Operations of Semass, L.P. (Semass Operator); and
(h) American Ref-Fuel Company of the Capital District, L.P.
These companies, along with American Ref-Fuel Company of
Delaware Valley, L.P. (Delaware Valley), are collectively
referred to as the “American Ref-Fuel Partnerships”.
The American Ref-Fuel Partnerships, except for Delaware Valley,
were a series of general and limited partnerships
50 percent owned by the Company and 50 percent
indirectly owned by wholly-owned subsidiaries of Allied Waste
Industries, Inc. (Allied), who also owned the remaining
2 percent of TransRiver and 100 percent of Delaware
Valley.
The American Ref-Fuel Partnerships were organized to
(a) develop, own and operate waste-to-energy
(WTE) facilities that combust municipal solid waste and
produce energy in the form of steam and electricity; and
(b) procure waste for such facilities.
Prior to June 30, 2003, Ref-Fuel Holdings was indirectly
owned 50 percent by American Ref-Fuel Holdings Corp.,
formerly known as United American Energy Holdings Corp.
(Holdings Corp.) and 50 percent by Duke Energy Corporation
(Duke). Effective June 30, 2003, Duke sold membership
interests representing 49.8% of Ref-Fuel Holdings to MSW Energy
Holdings LLC (MSW Energy Holdings), which is jointly owned by
entities managed by AIG Global Asset Management Holdings Corp.
(AIGGIC), a subsidiary of American International Group, Inc.
(AIG), and affiliates of Credit Suisse First Boston Private
Equity, Inc. (CSFB Private Equity), the global private equity
arm of Credit Suisse First Boston.
On December 12, 2003, MSW Merger LLC, an affiliate of CSFB
Private Equity, merged with and into Holdings Corp, a Delaware
corporation, which continued as the surviving corporation in the
merger. As a result of this merger, the Holdings Corp. ownership
in Ref-Fuel Holdings was transferred to MSW Energy
Holdings II LLC (MSW Energy Holdings II).
Upon consummation of the change in ownership and taking into
account the June 30, 2003 acquisition by MSW Energy
Holdings of Duke’s membership interest in Ref-Fuel Holdings
(the MSW Transactions), affiliates of CSFB Private Equity and
entities managed by AIGGIC (collectively, the Control Group)
own, directly and indirectly, 99.8% of the membership interests
in Ref-Fuel Holdings (and will exercise voting rights with
respect to Duke’s remaining 0.2% interest). As a result,
and in accordance with Emerging Issues Task Force
(EITF) Topic D-97, “Push-Down Accounting,”
the Company’s financial statements will reflect the effects
of its change in ownership and the new owners’ basis in the
net assets and liabilities acquired. As a result, the statement
of operations and the statement of cash flows for the period
from January 1, 2003 through December 12, 2003 and the
year ended December 31, 2002 (the Predecessor), reflect the
results prior to the change in basis resulting from the
application of push-down accounting. The statement of operations
and the statement of cash flows for the period after
December 12, 2003 reflect the results subsequent to the
push-down adjustments. Prior to the MSW Transactions, profits
and losses of the Company were allocated among its members based
on ownership percentages. Subsequent to the MSW Transactions,
profits and losses are allocated based upon the members’
ownership percentages adjusted for the amortization of the
respective members’ incremental basis in the assets and
liabilities. All significant intercompany accounts and
transactions have been eliminated in consolidation.
C-44
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
Prior to April 30, 2001, Hempstead, Essex, Niagara and
Seconn (collectively, the HENS) were a series of partnerships
that were equally owned by Allied and Ref-Fuel. On
April 30, 2001 the partnership interests in the HENS were
recapitalized (the Recapitalization). The terms of the
Recapitalization provided that indirect subsidiaries of American
Ref-Fuel Company LLC (ARC LLC), a wholly-owned subsidiary of
Ref-Fuel, became the managing general partners of the HENS. The
interest held by Ref-Fuel in the HENS converted to a
Class A interest, and the interest held by Allied converted
to a Class B interest. In conjunction with the
Recapitalization, the HENS contributed $163.5 million to
obtain 99 percent noncontrolling interests in equipment
leasing entities controlled by Allied. ARC LLC also agreed to
substitute as guarantor for certain guarantees previously
furnished by Duke and Allied.
The Class A and Class B partners were both general
partners in the HENS; however, the Class B partners had
limited involvement in the HENS’ management and had limited
participation in partnership distributions, except as expressly
agreed. Among other limitations, the Class A partners were
restricted from the following actions without the written
consent of the Class B partners: voluntary dissolution of
the HENS, sale or abandonment of a substantial portion of the
HENS’ assets, disposition of any of the HENS’
interests in the equipment leasing entities, and certain other
activities.
From April 30, 2001 through April 30, 2002, the
profits and losses of the HENS were allocated as follows:
(a) depreciation expense allocated to the HENS from the
equipment leasing entities was allocated to the Class A
partner only; (b) net income and loss before depreciation
of the equipment leasing entities allocated to the HENS was
allocated between the Class A and Class B partners
based on certain defined earnings tranches; and (c) all
other net income or loss of the HENS was allocated between the
Class A and Class B partners based on certain defined
earnings tranches which differed from the tranches used to
allocate the earnings of the equipment leasing entities. Both
Allied and Ref-Fuel Holdings had separate, nonconcurrent rights
to cause the HENS to redeem Allied’s Class B interests
in the HENS for the HENS’ interest in the equipment leasing
entities (the Redemption, together with the Recapitalization, is
known as the Allied Transactions).
The Redemption was completed on April 30, 2002. The
Redemption of the HENS resulted in the following: (a) gross
income for the period from January 1, 2002, through the
Redemption date, was reallocated first to the Class A
partners in an amount equal to the difference between the
Class A partners’ share of economic depreciation and
prior special allocations of depreciation expense to the
Class A partners with all remaining profits and losses
allocated consistent with profit and loss allocations described
above; (b) the HENS’ interests in the equipment
leasing entities were distributed to Allied in redemption of
Allied’s Class B interests in the HENS; and
(c) the $2.6 million difference between the fair value
of Allied’s interest in the HENS and the fair value
received by Allied in redemption of those interests was paid by
Allied to the HENS.
The Redemption of Allied’s Class B interest in the
HENS resulted in the application of purchase accounting to the
HENS in accordance with Statement of Financial Accounting
Standards (SFAS) No. 141, “Business
Combinations”, and adjusted the assets and liabilities
of the HENS to fair value.
In conjunction with the Recapitalization, all of the American
Ref Fuel Partnerships are indirect wholly-owned subsidiaries or
controlled subsidiaries of the Company. The consolidated
financial statements include the accounts of Ref-Fuel, its
controlled subsidiaries and certain investments.
C-45
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| 2. | Summary of Significant Accounting Policies |
| Reclassifications |
Certain reclassifications have been made to the prior years to
conform to the current year’s presentation.
Use of Estimates
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management of the Company to make estimates and
assumptions that affect the (a) reported amounts of assets
and liabilities at the date of the financial statements,
(b) disclosures of contingent assets and liabilities at the
date of the financial statements, and (c) the reported
amounts of revenues and expenses recognized during the reporting
period. Significant management estimates include the estimated
lives of long-lived assets, allowances for doubtful accounts
receivable, estimated useful lives and fair value adjustments of
net tangible and intangible assets, liabilities for
self-insurance and certain landfill liabilities. Such estimates
may be revised as necessary when additional information becomes
available. Actual results could differ from those estimates.
Cash and Cash
Equivalents
Cash and cash equivalents include all cash balances and all
unrestricted short-term investments with original maturities of
three months or less.
Restricted Cash and
Investments
The Company is required to maintain cash and investment balances
that are restricted by provisions of its debt or lease
agreements. These amounts are held by financial institutions in
order to comply with contractual provisions requiring such
reserves.
Restricted cash and investments are invested in accounts earning
market rates; therefore, the carrying value approximates fair
value. Restricted cash and investments are excluded from cash
and cash equivalents in the accompanying financial statements,
and changes in these assets are characterized as investing
activities in the consolidated statements of cash flows.
Restricted cash and investments include certain investments
stated at amortized cost, which approximates market, including
debt securities that are classified as
“held-to-maturity” as the Company has the intent and
ability to hold the securities to maturity. The Company accounts
for marketable securities in accordance with SFAS Statement
No. 115, “Accounting for Certain Investments in
Debt and Equity Securities”. Under the provisions of
this statement, investments that are classified as
available-for-sale are marked to market with unrealized gains
and losses reported as a component of other comprehensive
income. These investments were sold during 2004.
Fair Value of Financial
Instruments
Unless disclosed otherwise, all other financial instruments of
the Company are stated at cost, which management believes
approximates fair market value.
Property, Plant and
Equipment
Property, plant and equipment are stated at cost. The Company
provides for depreciation of its depreciable assets using the
straight-line method over the estimated useful lives.
Routine repairs and maintenance are charged against current
operations. Expenditures that materially increase value, change
capacities or extend useful lives are capitalized.
C-46
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
When property and equipment are retired, sold, or otherwise
disposed of, the cost net of accumulated depreciation are
removed from the accounts and any resulting gain or loss is
included in operating income for the period.
The Company maintains a supply of various spare parts integral
to its operations. Certain spare parts that are not expected to
be used within the upcoming year have been classified as
long-term spare parts inventory within property, plant and
equipment.
Landfill costs, including original acquisition cost and incurred
construction costs, are amortized over the estimated capacity of
the landfill based on a per-unit basis as landfill airspace is
consumed. Landfill retirement costs arising from post-closure
obligations, are capitalized as part of the landfill asset, will
are being amortized consistent with the landfill’s current
estimated life. Landfill retirement costs arising from final
capping obligations are being amortized on a
units-of-consumption basis over the estimated number of tons of
waste that each final capping event covers.
In accordance with SFAS No. 144, “Accounting
for the Impairment or Disposal of Long-Lived Assets”,
management periodically reviews long-lived assets and
intangibles whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If
factors indicate that an asset should be evaluated for possible
impairment, management compares estimated undiscounted future
operating cash flows associated with the asset to its carrying
amount. If the carrying amount of the asset is greater than
undiscounted future operating cash flows, an impairment loss is
calculated and recognized. The effect of any impairment would be
to expense the difference between the fair value of such asset
and its carrying value.
| Goodwill |
Goodwill represents the total consideration paid in excess of
the fair value of the net tangible and identifiable intangible
assets acquired and liabilities assumed. Prior to the MSW
Transactions, goodwill related to Ref-Fuel Management and
TransRiver in excess of the fair value of the net tangible and
identifiable intangible assets acquired. Subsequent to the MSW
Transactions, goodwill relates to the excess of the fair value
of the net tangible and identifiable intangible assets acquired
by MSW Energy Holdings.
In July 2001, the Financial Accounting Standards Board
(FASB) issued SFAS 141 Business Combinations
(SFAS 141) and SFAS No. 142,
“Goodwill and Other Intangible Assets”
(SFAS 142), effective for fiscal years beginning
after December 15, 2001. The provisions of SFAS 141
provide specific criteria for the initial recognition and
measurement of intangible assets apart from goodwill. The
provisions of SFAS 142 (i) prohibit the amortization
of goodwill and indefinite-lived intangible assets;
(ii) require that goodwill and indefinite-lived intangible
assets be tested annually for impairment (and in interim periods
if certain events occur which would impact the carrying value of
such assets); and (iii) require that the Company’s
operations be formally identified into reporting units for the
purpose of assessing potential future impairments of goodwill.
Effective January 1, 2002, upon adoption of SFAS 142,
the Company stopped recording goodwill amortization and
performed its assessment of its reporting units and its initial
assessment of impairment, which was estimated using discounted
cash flows. Additionally, the Company performed its required
annual fair value testing of its recorded goodwill for its
reporting units using the discounted cash flows approach. As of
December 31, 2004 and 2003, the Company’s estimate of
the fair value of its reporting units indicated no impairment of
goodwill in its annual assessment.
| Intangible Assets |
Energy contract intangibles represent the amount by which the
contract rates in long-term energy sales contracts held by
certain subsidiaries of the Company exceeded fair value on the
dates that these subsidiaries were acquired. These contracts
relate intangibles are being amortized into income as a
reduction of energy
C-47
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
revenues on a straight-line basis over the remaining terms of
the applicable contracts, which range from five to fifteen years.
Waste contract intangibles represents the amount by which the
contract rates in long-term waste sales contracts held by
Hempstead exceeded fair value on the dates that the partnership
was acquired. These contract-related intangibles are being
amortized into income as a reduction of waste revenues on a
straight-line basis through 2009, the term of the applicable
contracts.
The Company has intangible assets relating to Nitrous Oxide
(NOx) emission allowances. These assets have indefinite lives
and, as such, are not amortized. Consistent with all the
Company’s intangible assets, these are reviewed under the
provisions of SFAS 142 for potential impairment on an
annual basis. Based on the review, the indefinite-lived assets
at December 31, 2004 are not impaired.
Deferred financing costs represent certain capitalizable costs
incurred by the Company to finance its long-term debt
obligations. These costs are amortized to interest expense over
the life of the related debt. No value was assigned to these
costs in the purchase accounting resulting from the MSW
Transactions.
| Equity in Unconsolidated Affiliates |
On April 30, 2001, the HENS contributed an aggregate of
$163.5 million in cash to obtain 99 percent
noncontrolling interests in four equipment leasing entities.
Allied owned the remaining one percent controlling interest in
the entities and managed their operations. These entities were
formed to purchase equipment to be leased to Allied under
operating lease agreements. Since the HENS owned a
noncontrolling interest in these equipment leasing entities, the
Company accounted for these investments using the equity method
of accounting. On April 30, 2002, the HENS interests in the
equipment leasing entities were distributed to Allied in
redemption of Allied’s Class B interests in the HENS.
| Other Liabilities |
Other current and other long-term liabilities primarily consist
of (a) fair value adjustments related to certain operating
leases and long-term waste contracts acquired by the Company;
(b) deferred revenue; (c) accruals for certain
long-term incentive plans; and (d) energy contract
levelization (see Notes 10 and 14).
The fair value adjustment related to the operating lease
represents the amount by which future rent payments on the
Delaware Valley facility lease exceed the fair market value of
that facility as of the acquisition dates. This amount is being
amortized as a decrease in facility rent expense on a
straight-line basis through 2016, the end of the associated
lease.
The fair value adjustment related to long-term waste contracts
represents the amount by which the fair value of the long-term
waste sales contracts held by Ref-Fuel Semass and Essex exceeded
estimated contract rates at their respective acquisition dates.
These costs are being amortized as an increase to waste disposal
revenues using the straight-line method over the term of the
applicable contracts.
Landfill closure and postclosure costs are also included in
other long-term liabilities. The Company accrues landfill
closure and postclosure costs as the remaining permitted space
of the landfill is consumed over the expected life cycle of the
landfill.
The Company is accounting for the long-term power contracts at
the Ref-Fuel Semass in accordance with EITF Issues 91-6
“Revenue Recognition of Long-Term Power Sales”
Contracts and 96-17 “Revenue Recognition under
Long-Term Power Sales Contracts That Contain both Fixed and
Variable Pricing Terms”, which require the Company to
recognize power revenues under these contracts as the lesser of
(a) amounts billable under the respective contracts; or
(b) an amount determinable by the kilowatt hours made
available during the period multiplied by the estimated average
revenue per kilowatt hour over the term of the contract. The
determination of the lesser amount is to be made annually based
on the cumulative amounts that would
C-48
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
have been recognized had each method been applied consistently
from the beginning of the contract. The difference between the
amount billed and the amount recognized is included in other
long-term liabilities.
| Revenue Recognition |
The Company recognizes revenue from two major sources: waste
disposal services and energy production. Revenue from waste
disposal services is recognized as waste is received, and
revenue from energy production is recognized as the energy is
delivered.
| Concentration of Credit Risk |
The Company invests excess cash and funds held in trust in bank
deposit accounts, government securities, commercial paper,
certificates of deposit and money market investments with a
limited number of financial institutions.
The Company has exposure to credit risk in accounts receivable
as the Company disposes of waste and sells power to a limited
number of customers. The Company maintains adequate reserves for
potential credit losses. Furthermore, these and other customers
are primarily located in the northeastern region of the
United States of America.
| Unamortized Debt Premium |
Unamortized debt premium represents the increase in the fair
value of the Company’s debt recorded as a result of the MSW
Transactions (defined below). These costs are amortized to
interest expense over the life of the related debt using the
effective interest method.
| Stock-Based Compensation |
The Company has adopted the disclosure-only provisions of
SFAS No. 123, “Accounting for Stock-Based
Compensation”, (SFAS 123) as amended by
SFAS No. 148, “Accounting for Stock-Based
Compensation — Transition and Disclosure —
an Amendment of FAS No. 123”, concerning
certain transition and disclosure provisions, but applies the
intrinsic value recognition provisions of Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for
stock-based compensation plans of the Company.
| Income Taxes |
The Company’s subsidiaries primarily consist of limited
liability companies and partnerships. Accordingly, income taxes
are not levied at the Company level, but rather on the
individual members. Certain wholly-owned nonoperating
subsidiaries of the Company are taxable corporations. For the
year ended December 31, 2004, the period from December 12
to December 31, 2003, the period from January 1, 2003
through December 12, 2003 and the year ended
December 31, 2002 income tax expense amounted to
approximately $0.7 million, $0.1 million,
$0.5 million, and $0.7 million, respectively.
Long-term deferred taxes of approximately $2.8 million and
$1.7 million as of December 31, 2004 and
December 31, 2003, respectively, are included in Other
long-term liabilities.
| 3. | Business Combinations |
| The Allied Transactions |
In 1997 and 1998, the Company purchased a 50 percent
interest in all of the American Ref-Fuel Partnerships, except
for TransRiver, in which the Company purchased a 49 percent
interest, and Delaware
C-49
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
Valley, for which no interest was purchased. These acquisitions
were accounted for using the purchase method of accounting.
On April 30, 2001, the Company completed its acquisition of
Allied’s interests in Ref-Fuel Management, TransRiver,
Ref-Fuel Semass, Semass Operator, and Delaware Valley, as well
as Allied’s interests in notes due from the HENS. The
Company also acquired two other businesses during the year for
approximately $5.8 million. The acquisitions were accounted
for in accordance with the provisions of SFAS No. 141.
Accordingly, the consolidated statement of operations includes
the results of these entities beginning on each of their
respective dates of acquisition. The assets acquired and
liabilities assumed were recorded at estimated fair values as
determined by Company management, after obtaining independent
appraisals of the fair values of material acquired property,
plant and equipment and identified intangible assets and debt.
A summary of the assets acquired and liabilities assumed in the
2001 acquisitions follows (in thousands):
| Useful Life | |||||||||||||
| Amount | |||||||||||||
|
Fair value of assets acquired
|
|||||||||||||
|
Current assets
|
$ | 51,111 | |||||||||||
|
Property, plant and equipment
|
2-50 years | 168,704 | |||||||||||
|
Energy contracts
|
8-20 years | 161,456 | |||||||||||
|
Other long-term assets
|
23,579 | ||||||||||||
|
Notes due from the HENS
|
80,124 | ||||||||||||
| $ | 484,974 | ||||||||||||
|
Fair value of liabilities assumed
|
|||||||||||||
|
Current liabilities
|
(40,024 | ) | |||||||||||
|
Long-term debt obligations
|
(156,227 | ) | |||||||||||
|
Waste contracts
|
6-19 years | (71,075 | ) | ||||||||||
|
Operating lease acquired
|
15 years | (79,184 | ) | ||||||||||
|
Other long-term liabilities
|
(9,546 | ) | |||||||||||
| (356,056 | ) | ||||||||||||
|
Net assets acquired, net of cash acquired
|
128,918 | ||||||||||||
|
Transaction costs paid in prior year
|
(3,300 | ) | |||||||||||
|
Goodwill
|
18,331 | ||||||||||||
|
Cash paid, net of cash acquired
|
$ | 143,949 | |||||||||||
Also on April 30, 2001, the Recapitalization of the HENS
occurred. The Recapitalization of Allied’s 50 percent
interest, combined with the 50 percent interest previously
held, resulted in the Company having control of the HENS. The
consolidated results for the period from April 30, 2001
through April 30, 2002 included the Company’s basis in
the 50 percent of the HENS purchased in 1997 and 1998, and
the HENS’ historical basis for the remaining
50 percent.
Since both Allied and the Company had separate, nonconcurrent
rights to cause the Redemption, the fair value of the
Class B interests was estimated based on the value that the
HENS contributed to the equipment leasing entities at the
Recapitalization date. The difference in the final recorded
value of Allied’s member’s equity in the HENS prior to
the Recapitalization and the fair value of the Class B
interests at the Recapitalization date was $144.2 million,
which reduced the Company’s members’ equity as of the
Recapitalization.
C-50
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
In January 2002, Allied provided notice of its intent to
exercise its rights to cause the Redemption. On April 30,
2002, the HENS distributed their interests in the equipment
leasing entities to Allied in redemption of Allied’s
Class B interest in the HENS. The $2.6 million
difference between the fair value of Allied’s interest in
the HENS and the fair value of the interests in the equipment
leasing entities received by Allied in redemption of those
interests was paid by Allied to the HENS. The effective purchase
price paid in connection with the redemption of the Class B
interests was determined as $193.1 million, which was the
value of the equipment leasing entities held by the HENS less
the amounts received from Allied as of the date of the
Redemption.
In recording the Redemption, the Company released the previously
recorded $144.2 million reduction to member’s equity
and applied purchase accounting to the HENS in accordance with
SFAS No. 141. The assets acquired and liabilities
assumed were recorded at estimated fair values as determined by
Company management, after obtaining independent appraisals of
the fair values of acquired tangible property, plant and
equipment and identified intangible assets and debt. The change
in basis was allocated as follows (in thousands):
| Useful Life | Amount | |||||||
|
Current assets
|
$ | (714 | ) | |||||
|
Property, plant and equipment
|
2-50 years | 31,336 | ||||||
|
Energy contracts
|
8-20 years | 85,793 | ||||||
|
Waste contracts assets
|
8 years | 9,717 | ||||||
|
Other intangibles
|
5-30 years | (3,957 | ) | |||||
|
Write-off deferred income
|
42,199 | |||||||
|
Long-term debt
|
(20,413 | ) | ||||||
|
Total
|
$ | 143,961 | ||||||
| The MSW Transactions |
As described in Note 1, the MSW Transactions consisted of
MSW Energy Holdings’ purchase of Duke’s 49.8% indirect
ownership of the Company and MSW Energy Holdings II’s
purchase of Holdings Corp.’s 50% indirect ownership of the
Company, resulting in a change of control for the Company as of
December 12, 2003. As a result, the Company’s assets
were valued by an independent appraisers in order to assist
management in the determination of the purchase price
allocations relating to the fair market value of assets and
liabilities acquired.
In recording the MSW Transactions in accordance with EITF Topic
D-97, “Push-Down Accounting”, the Company
recorded incremental fair value of $407.7 million as an
addition to members’ equity and applied the respective fair
value of the acquisitions in accordance with
SFAS No. 141. The assets acquired and liabilities
assumed were recorded at estimated fair values as determined by
Company management, using a preliminary valuation prepared by
the independent appraisers.
C-51
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
On June 30, 2003, MSW Energy Holdings acquired its interest
in the Company for $363.5 million, allocated as follows (in
thousands):
| Useful Life | Amount | ||||||||||||
|
Fair value of assets acquired
|
|||||||||||||
|
Current assets
|
$ | 110,930 | |||||||||||
|
Property, plant and equipment
|
2-50 years | 623,054 | |||||||||||
|
Intangible assets
|
4-20 years | 314,228 | |||||||||||
|
Other long-term assets
|
43,252 | ||||||||||||
| $ | 1,091,464 | ||||||||||||
|
Fair value of liabilities assumed
|
|||||||||||||
|
Current liabilities
|
(77,944 | ) | |||||||||||
|
Long-term debt obligations
|
(556,083 | ) | |||||||||||
|
Other long-term liabilities
|
(96,130 | ) | |||||||||||
| (730,157 | ) | ||||||||||||
|
Net assets acquired
|
361,307 | ||||||||||||
|
Goodwill
|
2,175 | ||||||||||||
|
Acquisition cost
|
$ | 363,482 | |||||||||||
On December 12, 2003, MSW Energy Holdings II acquired
Holdings Corp.’s indirect 50% ownership of Ref-Fuel
Holdings for $364.7 million, allocated as follows (in
thousands):
| Useful Life | Amount | ||||||||||||
|
Fair value of assets acquired
|
|||||||||||||
|
Current assets
|
$ | 114,035 | |||||||||||
|
Property, plant and equipment
|
2-50 years | 613,195 | |||||||||||
|
Intangible assets
|
4-20 years | 294,517 | |||||||||||
|
Other long-term assets
|
48,417 | ||||||||||||
| $ | 1,070,164 | ||||||||||||
|
Fair value of liabilities assumed
|
|||||||||||||
|
Current liabilities
|
(72,327 | ) | |||||||||||
|
Long-term debt obligations
|
(536,833 | ) | |||||||||||
|
Other long-term liabilities
|
(96,293 | ) | |||||||||||
| (705,453 | ) | ||||||||||||
|
Acquisition cost
|
$ | 364,711 | |||||||||||
C-52
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
The incremental purchase price pushed down was approximately
$218.5 million and $202.2 million, for MSW Energy
Holdings and MSW Energy Holdings II, respectively, as
follows (in thousands):
| MSW Energy | Adjusted | MSW | ||||||||||||||||||
| Holdings Initial | MSW Energy | Energy | Total | |||||||||||||||||
| Allocation of Excess Purchase Price | Purchase | Amortization | Holdings | Holdings II | Adjustments | |||||||||||||||
|
Property, plant and equipment, net
|
$ | 76,363 | $ | (1,968 | ) | $ | 74,395 | $ | 74,395 | $ | 148,790 | |||||||||
|
Intangible assets, net
|
154,068 | (14,231 | ) | 139,837 | 140,433 | 280,270 | ||||||||||||||
|
Goodwill
|
(12,050 | ) | — | (12,050 | ) | (14,225 | ) | (26,275 | ) | |||||||||||
|
Other long-term assets
|
(2,892 | ) | — | (2,892 | ) | (2,891 | ) | (5,783 | ) | |||||||||||
|
Long-term debt
|
(22,405 | ) | 2,063 | (20,342 | ) | (20,341 | ) | (40,683 | ) | |||||||||||
|
Other long-term liabilities
|
25,465 | 1,088 | 26,553 | 24,852 | 51,405 | |||||||||||||||
|
Member’s equity
|
$ | 218,549 | $ | (13,048 | ) | $ | 205,501 | $ | 202,223 | $ | 407,724 | |||||||||
|
Reconciliation of excess purchase price:
|
||||||||||||||||||||
|
Investments in Ref-Fuel
|
$ | 363,482 | $ | 364,711 | ||||||||||||||||
|
Historical net cost of assets acquired
|
144,933 | 162,488 | ||||||||||||||||||
|
Excess purchase price
|
$ | 218,549 | $ | 202,223 | ||||||||||||||||
| Pro Forma Information (Unaudited) |
The accompanying unaudited pro forma consolidated statement of
operations for the year ended December 31, 2003 gives
effect to the ownership change as if it occurred on
January 1, 2003.
C-53
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
The pro forma financial information is presented for
informational purposes only and is not necessarily indicative of
the actual results of operations that would have been achieved
had the MSW Transactions acquisitions taken place at the
beginning of the year (in thousands):
| The Period from | The period from | ||||||||||||||||
| December 12, 2003 | January 1, 2003 | Pro Forma | |||||||||||||||
| through | through | Year Ended | |||||||||||||||
| December 31 | December 12, | Pro Forma | December 31, | ||||||||||||||
| 2003 | 2003 | Adjustments | 2003 | ||||||||||||||
|
Revenues
|
|||||||||||||||||
|
Waste disposal and related services
|
$ | 15,398 | $ | 269,493 | $ | (760 | ) | $ | 284,131 | ||||||||
|
Energy
|
8,194 | 160,821 | (29,191 | ) | 139,824 | ||||||||||||
|
Other
|
1,255 | 14,147 | (880 | ) | 14,522 | ||||||||||||
|
Total net revenues
|
24,847 | 444,461 | (30,831 | ) | 438,477 | ||||||||||||
|
Expenses
|
|||||||||||||||||
|
Operating
|
8,417 | 181,615 | 1,368 | 191,400 | |||||||||||||
|
Depreciation and amortization
|
3,391 | 55,838 | (8,767 | ) | 67,996 | ||||||||||||
|
General and administrative
|
2,184 | 42,118 | — | 44,302 | |||||||||||||
|
Loss on asset retirements
|
— | 2,207 | — | 2,207 | |||||||||||||
|
Operating income
|
10,855 | 162,683 | (40,966 | ) | 132,572 | ||||||||||||
|
Interest income
|
275 | 2,956 | — | 3,231 | |||||||||||||
|
Interest expense
|
(2,954 | ) | (59,189 | ) | 11,620 | (50,523 | ) | ||||||||||
|
Loss on early extinguishment of debt
|
— | (3,191 | ) | — | (3,191 | ) | |||||||||||
|
Other income, net
|
— | 265 | — | 265 | |||||||||||||
|
Net income before provision for income taxes
|
8,176 | 103,523 | (29,346 | ) | 82,353 | ||||||||||||
|
Provision for income taxes
|
(94 | ) | (452 | ) | — | (546 | ) | ||||||||||
|
Net income
|
$ | 8,082 | $ | 103,071 | $ | (29,346 | ) | $ | 81,807 | ||||||||
| 4. | Property, Plant and Equipment |
Property, plant and equipment consists of the following (in
thousands):
| December 31, | ||||||||||||
| Useful Life | 2004 | 2003 | ||||||||||
|
Plant and equipment
|
2-50 years | $ | 1,168,962 | $ | 1,145,961 | |||||||
|
Land
|
3,813 | 3,885 | ||||||||||
|
Leasehold improvements
|
Up to 17 years | 43,171 | 40,412 | |||||||||
|
Landfill
|
13 years | 17,768 | 15,470 | |||||||||
|
Spare parts
|
12,282 | 12,253 | ||||||||||
|
Construction in progress
|
6,244 | 6,359 | ||||||||||
|
Total property, plant and equipment
|
1,252,240 | 1,224,340 | ||||||||||
|
Accumulated depreciation
|
(65,062 | ) | (3,391 | ) | ||||||||
|
Property, plant and equipment, net
|
$ | 1,187,178 | $ | 1,220,949 | ||||||||
C-54
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| 5. | Intangible Assets |
Intangible assets consist of the following (in thousands):
| December 31, | ||||||||||||
| Useful Life | 2004 | 2003 | ||||||||||
|
Energy contracts
|
6-18 years | $ | 525,125 | $ | 522,430 | |||||||
|
Waste contracts
|
6 years | 23,600 | 23,600 | |||||||||
|
Emissions credits
|
Indefinite | 43,377 | 37,827 | |||||||||
|
Other intangibles
|
Indefinite | 3,579 | 3,579 | |||||||||
| 595,681 | 587,436 | |||||||||||
|
Accumulated amortization
|
(67,195 | ) | (3,161 | ) | ||||||||
|
Intangible assets, net
|
$ | 528,486 | $ | 584,275 | ||||||||
The following table details the amount of actual/ estimated
amortization expense associated with intangible assets included
or expected to be included in the Company’s statement of
operations for each of the periods indicated (in thousands):
| Energy | Waste | |||||||||||
| Contracts | Contracts | Totals | ||||||||||
|
The year ended December 31, 2004
|
$ | 59,770 | $ | 4,229 | $ | 63,999 | ||||||
|
The period from January 1, 2003 through December 12,
2003
|
27,293 | 1,207 | 28,500 | |||||||||
|
The period from December 12, 2003 through December 31,
2003
|
2,944 | 217 | 3,161 | |||||||||
|
(Estimated)
|
||||||||||||
|
2005
|
$ | 58,306 | $ | 4,256 | $ | 62,562 | ||||||
|
2006
|
58,306 | 4,256 | 62,562 | |||||||||
|
2007
|
58,305 | 4,256 | 62,561 | |||||||||
|
2008
|
58,206 | 4,256 | 62,462 | |||||||||
|
2009
|
36,907 | 2,130 | 39,037 | |||||||||
|
Thereafter
|
192,381 | — | 192,381 | |||||||||
|
Total
|
$ | 462,411 | $ | 19,154 | $ | 481,565 | ||||||
| 6. | Goodwill |
Goodwill consists of the following (in thousands):
| December 31, | ||||||||
| 2004 | 2003 | |||||||
|
Beginning balance
|
$ | 2,175 | $ | — | ||||
|
Goodwill MSW Energy Holdings
|
— | 2,175 | ||||||
|
Ending balance
|
$ | 2,175 | $ | 2,175 | ||||
C-55
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| 7. | Investments in Unconsolidated Affiliates and Equity in Earnings of Unconsolidated Affiliates |
| Equipment Leasing Entities |
Between April 30, 2001 and April 30, 2002, the HENS
owned 99 percent noncontrolling interests in equipment
leasing entities and accounted for them using the equity method.
Summarized combined financial information are as follows (in
thousands):
| H,E,N and S Leasing Companies, LLC | ||||
| Combined Balance Sheets | ||||
| April 30, | ||||
| 2002 | ||||
|
Current assets
|
$ | 53,212 | ||
|
Noncurrent assets
|
404,028 | |||
| $ | 457,240 | |||
|
Current liabilities
|
$ | 52,176 | ||
|
Noncurrent liabilities
|
207,408 | |||
|
Members’ equity
|
197,656 | |||
| $ | 457,240 | |||
| Combined Statements of Operations | ||||
| For the Period | ||||
| January 1, 2002 | ||||
| to April 30, | ||||
| 2002 | ||||
|
Net revenue
|
$ | 30,291 | ||
|
General and administrative expenses
|
238 | |||
|
Depreciation and amortization expense
|
10,597 | |||
|
Operating income
|
19,456 | |||
|
Interest income
|
245 | |||
|
Interest expense
|
(4,044 | ) | ||
|
Net income
|
$ | 15,657 | ||
|
The Company’s equity in earnings of equipment leasing
entities
|
$ | 15,500 | ||
| 8. | Accounts Payable and Other Current Liabilities |
Accounts payable and other current liabilities consists of the
following (in thousands):
| December 31, | ||||||||
| 2004 | 2003 | |||||||
| $ | 24,986 | $ | 23,530 | |||||
|
Accounts payable
|
3,569 | 3,628 | ||||||
|
Incentive plan accruals
|
8,254 | 7,924 | ||||||
|
Compensation liabilities
|
4,355 | 4,528 | ||||||
|
Other
|
$ | 41,164 | $ | 39,610 | ||||
C-56
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| 9. | Financing Arrangements |
Long-term debt obligations of the Company consist of the
following (in thousands):
| December 31, | |||||||||||||||||
| Interest Rate | |||||||||||||||||
| (Average Rate) | Final Maturity | 2004 | 2003 | ||||||||||||||
|
ARC LLC-supported debt
|
|||||||||||||||||
|
Senior Notes
|
6.26% | 2015 | $ | 240,000 | $ | 259,000 | |||||||||||
|
Niagara Series 2001A
|
5.45%-5.625% | 2015 | 165,010 | 165,010 | |||||||||||||
|
Seconn Corporate Credit Bonds
|
5.50%-6.45% | 2022 | 43,500 | 43,500 | |||||||||||||
|
Hempstead Corporate Credit Bonds
|
5.00% | 2010 | 42,670 | 42,670 | |||||||||||||
|
ARC LLC-supported debt
|
491,180 | 510,180 | |||||||||||||||
|
Other debt
|
|||||||||||||||||
|
Hempstead project debt
|
4.625%-5.00% | 2009 | 114,543 | 133,278 | |||||||||||||
|
Essex project debt
|
5.248%-7.375% | 2020 | 96,496 | 108,662 | |||||||||||||
|
Seconn project debt
|
5.125%-5.50% | 2015 | 50,602 | 53,499 | |||||||||||||
|
Semass Series 2001A
|
5.50%-5.625% | 2016 | 134,345 | 134,345 | |||||||||||||
|
Semass Series 2001B
|
5.00%-5.50% | 2010 | 104,385 | 118,010 | |||||||||||||
|
Semass Series 2001C
|
2.90%-4.00% | 2004 | — | 13,935 | |||||||||||||
| 500,371 | 561,729 | ||||||||||||||||
|
Other obligations
|
273 | 378 | |||||||||||||||
|
Total debt at par value
|
991,824 | 1,072,287 | |||||||||||||||
|
Unamortized debt premium, net
|
54,189 | 70,400 | |||||||||||||||
|
Current portion
|
(87,184 | ) | (81,907 | ) | |||||||||||||
|
Total long-term debt obligations
|
$ | 958,829 | $ | 1,060,780 | |||||||||||||
On May 9, 2003, ARC LLC completed the sale of
$275 million aggregate principal amount of
6.26 percent Senior Notes due 2015. The proceeds of the
financing were used to repay $242.6 million under the
outstanding Credit Facility, fund debt service reserve accounts
and for general corporate purposes. As part of this refinancing,
ARC LLC entered into a three year amended and restated revolving
credit facility (the Amended Credit Facility) for up to
$75 million, including $45 million of which could be
used for letters of credit. Under the terms of the Amended
Credit Facility, the Company is subject to certain financial
covenants, as defined, with respect to leverage and adjusted
cash flow coverage ratios. As of December 31, 2004 and
2003, there were no borrowings and $10.2 million and
$7.0 million of letters of credit outstanding under the
Amended Credit Facility, respectively. Pursuant to the terms of
certain guarantee agreements as of December 31, 2004 and
2003, the Company was contingently obligated to issue
$29 million in letters of credit in the event that the
ratings of ARC LLC’s senior debt are reduced to below
investment grade. The Amended Credit Facility allows for two
one-year extensions at ARC LLC’s request. As a result of
the refinancing, the Company expensed approximately
$3.3 million of deferred financing costs associated with
the retired debt in 2003.
ARC LLC-supported debt includes obligations of subsidiary
companies for which the Company has issued a guarantee. Other
debt obligations mainly consist of indebtedness supported by the
facility to which the indebtedness belongs and certain
contingent credit support obligations of the Company.
Certain of the debt agreements held by ARC LLC and/or its
subsidiaries contain restrictions on distributions and new
borrowings and require certain defined leverage ratios and
adjusted cash flow coverage
C-57
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
ratios. Substantially all of the assets and revenues of the
facilities owned or controlled and operated by subsidiaries of
ARC LLC are pledged to trustees under the terms of the debt
agreements. In addition, the terms of the documents governing
these obligations limit the business activities and the
circumstances and timing of making partnership distributions.
The aggregate amounts of long-term debt mature as follows (in
thousands):
|
2005
|
$ | 87,184 | |||
|
2006
|
79,331 | ||||
|
2007
|
90,466 | ||||
|
2008
|
98,472 | ||||
|
2009
|
78,463 | ||||
|
Thereafter
|
557,908 | ||||
| $ | 991,824 | ||||
The fair market value of the Company’s indebtedness as of
December 31, 2004 and 2003, approximated $1.1 billion.
The Company determined fair values based on quoted market values.
| 10. | Other Long-Term Liabilities |
Other long-term liabilities consist of the long-term portion of
the following (in thousands):
| December 31, | ||||||||||||
| Amortization | ||||||||||||
| Period (Years) | 2004 | 2003 | ||||||||||
|
Long-term waste contracts acquired
|
9-17 | $ | 116,634 | $ | 131,676 | |||||||
|
Operating lease acquired
|
14 | 42,094 | 42,094 | |||||||||
|
Deferred revenue
|
8-20 | 5,113 | 3,130 | |||||||||
|
Long-term incentive plan accruals
|
3,333 | 2,894 | ||||||||||
|
Energy contract levelization
|
12 | 24,123 | 995 | |||||||||
|
Landfill liabilities
|
13 | 10,699 | 10,017 | |||||||||
|
Other
|
2,821 | 1,664 | ||||||||||
| $ | 204,817 | $ | 192,470 | |||||||||
See Note 15 for amortization of certain other long-term
liabilities.
| 11. | Operational and Other Agreements |
Hempstead, Essex, Seconn, Semass and Delaware Valley operate
under various long-term service agreements, the terms of which
extend from 2009 through 2020. These service agreements require
the projects to provide disposal services for waste delivered by
counterparties to these agreements at prices determined by
various formulas contained in such agreements. Duke and Allied
Waste Industries Inc. (Allied) are each obligated to fund
one-half of the cash shortfalls of Essex arising out of
operating cost needs subject to a cumulative combined total of
$50 million unless funds are required to satisfy certain
environmental claims. In the event of such environmental claims,
the cumulative total is increased to the lesser of
(a) $100 million or (b) $50 million plus
cumulative Essex distributions. In circumstances of default,
Duke and Allied would be responsible to fund up to amounts not
expended for funding prior cash shortfalls. On April 30,
2001, Essex and ARC LLC entered into agreements with Duke and
Allied requiring Essex and ARC LLC to reimburse, indemnify and
defend Duke and Allied from any liability in respect to these
obligations.
C-58
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
With respect to the Delaware Valley facility, ARC LLC has
guaranteed amounts payable by Delaware Valley pursuant to
certain agreements. ARC LLC has indemnified the Delaware County
Solid Waste Authority for amounts arising out of, or relating to
any failure of Delaware Valley under its service agreement. In
conjunction with the acquisition of the facility, the Company
also provides an indemnity to the sellers of the facility from
all environmental damages as a result of remedial action and
releases or threatened releases of hazardous substances at the
facility.
| Credit Support |
In order to provide the ARC LLC with an additional source of
funds to meet calls on its project support obligations, MSW
Energy Holdings and Holdings Corp. (collectively referred to as
the Members) have each entered into the Equity Contribution
Agreement pursuant to which each of the Members has agreed to
provide up to $50 million in equity capital to ARC LLC.
Each Members’ obligation to make equity contributions under
the Equity Contribution Agreement is conditioned upon the other
making an equal contribution and is limited to each making no
more than $50 million of aggregate equity contributions. If
either of the Members is not rated at least BBB by S&P, such
Member is required to provide a letter of credit from a
commercial bank that is rated at least A-by S&P to secure
its obligations under the Equity Contribution Agreement.
| Significant Customers |
All of the Company’s WTE facilities have contracted to sell
power under long-term power contracts with utility companies,
the terms of which expire from 2009 to 2021. These contracts
require the facilities to deliver, and the utility companies to
purchase, substantially all of the power generated by the
facilities at rates defined in the contracts. Total revenues
recognized under these energy contracts approximated
$133.2 million, $7.2 million, $143.5 million and
$144.1 million for the year ended December 31, 2004,
the period from December 12 through December 31, 2003, the
period from January 1 to December 12, 2003 and the year
ended December 31, 2002, respectively, representing
approximately 30.5 percent, 29.0 percent,
32.3 percent and 32.9 percent, respectively, of total
net revenues.
| 12. | Commitments and Contingencies |
| Environmental and Regulatory Risk |
The Company operates in an environmentally sensitive industry
and is subject to extensive federal, state and local laws and
regulations adopted for the protection of the environment. The
laws and regulations primarily applicable to the Company are
those related to discharge of emissions into the air and
management of solid waste but can also include those related to
water use, discharges to water, wetlands preservation and
hazardous waste management. Certain of these laws have extensive
and complex requirements relating to obtaining construction and
operating permits, monitoring, record keeping and reporting.
While management believes that it is in substantial compliance
with permits and other applicable environmental laws relating to
the Company, its facilities, from time to time, may not be in
full compliance with all such laws.
Noncompliance with environmental laws and regulations can result
in the imposition of civil or criminal fines or penalties. In
some instances, environmental laws also may impose clean-up or
other remedial obligations in the event of a release of
pollutants or contaminants into the environment. The Company
incurs operating costs and capital expenditures related to
various environmental protection and monitoring programs. Such
expenditures have not had a material adverse effect on the
Company’s consolidated financial position or results of
operations. However, federal, state and local regulatory
authorities may consider proposals to restrict or tax certain
emissions, which proposals, if adopted, could impose additional
costs on the operation of the Company.
C-59
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| Landfill Agreements |
Ref-Fuel Semass has a waste management agreement (the WMA) dated
May 25, 1982, as amended, with the Carver, Marion, Wareham
Regional Refuse Disposal District (CMW). The WMA allows Ref-Fuel
Semass to utilize a portion of a landfill (the CMW Landfill),
which CMW leases from Wankinco River, Inc. (Wankinco).
Beginning in May 1997, Wankinco provided several notices
purportedly terminating the lease on the CMW Landfill based upon
an allegation that the lease term automatically expired due to
alleged failures to strictly comply with the terms of the lease.
In June 1997, Ref-Fuel Semass and CMW filed suit against
Wankinco and A. D. Makepeace Company, Inc., Wankinco’s
parent company, seeking a declaratory judgment that Ref-Fuel
Semass and CMW may continue to operate the CMW Landfill. Trial
of the matter before the court was completed in 2001 and a
decision was received by the Company in December 2002, which
decided virtually all issues in favor of Ref-Fuel Semass. Ref-
Fuel Semass avoided both forfeiture of possession and any
liability for damages due to landfill operations. Wankinco
appealed in January 2003, and on August 19, 2004, the
Appellate Court upheld the Trial Courts decision in respect of
all decisions related to the alleged lease violations. One
ruling unrelated to lease forfeiture or damages for unlawful
possession was remanded because the Judge’s ruling that
Ref-Fuel Semass had not engaged in “an unfair and
deceptive act or practice” applied the law conjunctively
rather than disjunctively (as required by the law). The
Appellate Court affirmed the Judge’s ruling that there was
no unfairness, but remanded the question of deception for
further findings since the Appellate Court, due to the use of
the conjunctive rather than disjunctive, was unable to infer
that the Judge did not find a compensable deceptive act.
Management believes that the Judge’s ruling on remand will
clarify this issue in favor of the Company. In addition,
Wankinco appealed the Appellate Court’s decision on the
lease issues to the Supreme Judicial Court of Massachusetts and,
on September 30, 2004, the Supreme Judicial Court denied
Wankinco’s Application for Further Appellate Review.
Accordingly, except for the remand discussed above, the
favorable decisions received by Ref-Fuel Semass have become
final and nonappealable. Apart from this decision, Ref-Fuel
Semass and Wankinco continue litigating several other actions
involving regulatory issues at the landfill.
In March 1990, Ref-Fuel Semass, CMW and Wankinco entered into an
agreement related to the CMW Landfill, as amended (the
Settlement Agreement), which requires, among other things,
Ref-Fuel Semass to make annual deposits into an environmental
protection trust fund (the Fund) in lieu of obtaining
environmental impairment liability insurance for the CMW
Landfill. Ref-Fuel Semass is required under the Settlement
Agreement to deposit $500,000 annually into the Fund, payable in
equal quarterly installments. Certain additional deposits are
required subject to the availability of cash in accordance with
the Loan Agreement. Ref-Fuel Semass’ obligation to make
deposits into the Fund ceases when the Fund reaches a balance of
$20.0 million, unless the fund limit is increased by
agreement of the parties, or absent such agreement, arbitration,
wherein it is determined the fund limit needs to be increased to
adequately protect against environmental damage. Management
believes that the $20.0 million fund limit is adequate for
this purpose. Proceeds from the Fund are to be used primarily
for remediation of the CMW Landfill in the event of any
environmental damages. Ref-Fuel Semass and Wankinco are each
entitled to receive one-half of the balance of the Fund upon
final closure of the CMW Landfill and receipt of required
governmental approvals. During the year ended December 31,
2004, Ref-Fuel Semass made the required quarterly deposits into
the Fund and charged operations for one-half of the deposits
into the Fund, representing one-half of the balance of the Fund
which will be disbursed to Wankinco upon final closure of the
CMW Landfill. Additional charges to operations may be required
in future years if any disbursements are required from the Fund
to remediate any environmental damages. To date, management is
not aware of any such environmental damages. As of
December 31, 2004 and 2003, the balance in the Fund is
approximately $14.0 million and $13.5, respectively, and is
included in restricted cash and long-term investments. A
corresponding liability of approximately $7.0 million and
$6.5 million, representing approximately one-half of the
deposits and related earnings in the Fund, is included in other
long-term liabilities as of December 31, 2004 and 2003,
respectively.
C-60
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
Future Mercury Regulation at the Essex Facility. On
December 6, 2004 the New Jersey Department of Environmental
Protection (NJDEP) promulgated regulations applicable
to the Essex facility that will make mercury emission
requirements more stringent. Specifically, the new regulations
increase the required removal efficiency to 85% removal on
January 3, 2006 and 95% removal on January 3, 2012
versus the current 80% removal, while retaining the alternative
limit of 28 micrograms per cubic meter. As a result of the new
regulations, there is an increased risk that emission
exceedances will occur and therefore an increased probability
that additional controls will ultimately be required to prevent
such exceedances. ARC believes that the new requirements may at
a minimum result in increased operating costs due to increased
use of activated carbon in the current control equipment. It is
also possible that the regulations will require the installation
of additional pollution control equipment such as compact hybrid
particulate collector units, a device similar to a baghouse.
Management estimates that the cost of the installation of such
additional pollution control equipment, if required, would be
approximately $38 million. The Essex service agreement
provides a mechanism for a pass-through to the Port Authority of
New York and New Jersey of the majority of any additional
capital and operating costs that may be required. We cannot
currently determine the likelihood of additional and operating
capital costs being incurred in connection with these changes in
regulation, or the total of any such costs.
Lower Passaic River Study. In August 2004, USEPA notified
American Ref-Fuel Company of Essex County (Essex) that it was
potentially liable under CERCLA Section 107(a) for response
actions in the Lower Passaic River Study Area (LPRSA), a
17 mile stretch of river in northern New Jersey. Essex is
one of at least 52 Potentially Responsible Parties (PRPs) named
thus far. USEPA alleges that hazardous substances found in the
LPRSA were being released from the Essex site, which abuts the
river. USEPA’s notice letter states that Essex may be
liable for costs related to a proposed $10 million study of
the Lower Passaic River and for unspecified natural resource
damages. Considering the history of industrial and other
discharges into the LPRSA from other sources, including named
PRPs, Essex believes that its contribution will be determined to
be de minimus; however, it is not possible at this time to
predict that outcome with certainty or to estimate Ref-Fuel
Holdings’ liability for the study or any eventual natural
resource damage.
| Future Minimum Payments Under Operating Leases |
Delaware Valley leases the Delaware Valley Project pursuant to
an operating lease that expires in July 2019. The Company also
leases office space for its Montvale, New Jersey headquarters
pursuant to operating leases expiring in August 2007.
As of December 31, 2004, total minimum net rental payments
on these leases are as follows (in thousands):
|
2005
|
$ | 14,566 | ||
|
2006
|
13,923 | |||
|
2007
|
14,049 | |||
|
2008
|
12,711 | |||
|
2009
|
28,809 | |||
|
Thereafter
|
70,502 | |||
| $ | 154,560 | |||
The Company is contingently liable for the payment of stipulated
losses, a portion of which is included in the minimum net rental
payments for Delaware Valley reflected in the table above. This
stipulated loss value as of December 31, 2004 is
approximately $170.1 million. Total net rental expense was
$7.9 million, $0.3 million, $6.7 million and
$6.5 million for the year ended December 31, 2004, the
period from
C-61
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
December 12, 2003 through December 31, 2003, the
period from January 1, 2003 through December 12, 2003
and the year ended December 31, 2002, respectively.
| Capital Expenditures |
As of December 31, 2004, the Company has commitments for
capital expenditures of approximately $10.8 million, all of
which are expected to be incurred in 2005.
| Other Matters |
The Company is involved in various claims or litigation in the
ordinary course of business. Management believes that the
ultimate resolution of these matters, either individually or in
the aggregate, will not have a material adverse impact on the
future results of operations, cash flows or financial position
of the Company.
The Company is required to provide financial assurance to
government agencies under applicable environmental and
procurement regulations relating to the landfill operations and
waste disposal contract. Performance bonds to secure the
obligations, of which $23.0 million in surety bonds was
outstanding as of December 31, 2004, satisfy these
financial requirements.
| 13. | Related Party Transactions |
Included in the consolidated statement of operations for the
year ended December 31, 2002 are revenues of approximately
$12.2 million generated from the waste disposal services
provided to Allied and expenses of $1.0 million, for the
hauling of ash and disposal of bypass waste by Allied for the
four months ended April 30, 2002.
All of the revenues from the equipment leasing entities
explained in Note 1 are derived from operating leases
between those entities and Allied; as such, the equity in
earnings of equipment leasing entities of $15.5 million is
from Allied for the year ended December 31, 2002. As of the
Redemption, Allied is no longer an affiliated entity.
In the ordinary course of business, the Company and its
subsidiaries hold insurance policies with AIG, for which the AIG
insurance company subsidiaries receive customary annual
premiums. As of June 30, 2003, AIG and its subsidiaries are
related parties of the Company. Fees paid for such services were
$2.8 million, $0.0 million and $3.3 million for
the year ended December 31, 2004 and the period from
December 12, 2003 through December 31, 2003 and the
period from January 1, 2003 through December 12, 2003
respectively.
| 14. | Employee Compensation and Benefit Plans |
| Retirement Savings Plan |
ARC LLC is the sponsor of the American Ref-Fuel Company
Retirement Savings Plan (the Savings Plan), which covers
substantially all employees of the Company. The Savings Plan,
adopted July 1, 1988, as amended, incorporates a defined
contribution account for each employee with deferred savings
features permitted under Internal Revenue Code
Section 401(k). Employees may make voluntary contributions
to one or more of various investment funds through payroll
deductions. The Company’s matching contribution is defined
as 50 percent of the first five percent of covered
compensation contributed by the employee. In addition, the
Company makes a basic contribution on an employee’s behalf
in an amount equal to three percent of an employee’s
regular earnings which are less than the Social Security Wage
Base. Company contributions are directed to the investment funds
in the same proportion as the employees have directed their
voluntary contributions. Amounts contributed to the Savings Plan
were approximately $2.8 million, $0.2 million,
$2.7 million, and $3.0 million for the year ended
December 31, 2004, the period from December 12, 2003
C-62
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
through December 31, 2003, the period from January 1,
2003 through December 12, 2003, and the year ended
December 31, 2002, respectively.
| Long-Term Incentive Plans |
The Company has granted certain appreciation rights and/or
performance awards to its officers and certain key employees
that were issued under two separate long-term incentive plans;
the Long-Term Incentive Plan (dated as of January 2001) and the
Management Incentive Plan (dated as of January 2004). The
incentive plans are administered by the compensation committee
of the Board of Directors. Awards under long-term incentive
plans are based on the achievement of certain management
objectives during each plan year. Awards under the long-term
incentive plans mature in equal amounts of 25 percent in
the years following the award. The Long-Term Compensation Plan
(the LTC Plan), effective as of January 1, 2001, replaced
the Long-Term Compensation Plan (the LTI Plan). Awards under the
LTC Plan are based on the achievement of certain management
objectives during each plan year. Awards under the LTC Plan
mature in equal amounts of 25 percent in the years
following the award.
The Company recognized compensation expense of approximately
$3.7 million, $0.3 million, $4.9 million, and
$4.1 million during the year ended December 31, 2004,
the period from December 12, 2003 through December 31,
2003, the period from January 1, 2003 through
December 12, 2003, and the year ended December 31,
2002, respectively. The Company’s obligation under these
plans is approximately $6.0 million and $4.6 million
at December 31, 2004 and 2003, respectively, of which
approximately $2.7 million and $2.4 million is
included in other long-term liabilities with the remainder in
current liabilities, respectively. The Company paid out
approximately $3.4 million, $0.0 million,
$25.2 million and $0.9 million under these plans for
the year ended December 31, 2004, the period from
December 12, 2003 through December 31, 2003, the
period from January 1, 2003 through December 12, 2003
and the year ended December 31, 2002, respectively.
| Employment Agreements |
Ref-Fuel Holdings has employment agreements with its seven
officers. The agreements, which expire on December 31,
2006, provide for annual base salaries, subject to annual review
by the Board of Directors of Ref-Fuel Holdings. Each officer is
also eligible to participate in cash-based short-term and
long-term bonus and incentive compensation arrangements,
retirement plans and other arrangements that are generally
provided to senior officers. If an officer’s employment is
terminated by Ref-Fuel Holdings “without cause” or by
the officer for “good reason” (each defined in the
agreement), such officer is entitled to an amount equal to the
sum of two times the annual base salary, two times the average
annual bonus for the three preceding years and prorated target
cash bonus for the calendar year which includes the date of
termination.
| Stock Option Plan |
On August 11, 2004, the Board of Directors of Holdings
Corp., managing member of the Company, adopted the 2004 Stock
Option Plan (the SOP), effective January 1, 2004, as
further modified on September 16, 2004. The SOP was
designed to link the interests of officers of Holdings Corp. and
other senior management of Ref-Fuel Holdings to the interests of
Holdings Corp. shareholders through the granting of options to
purchase stock of Holdings Corp. Holdings Corp. is a privately
held company. During 2004 Holdings Corp. granted 13,199 options
to the executive officers of Ref-Fuel Holdings under the SOP.
Options awarded under the SOP vest over a period of four years
and expire ten years from the date of grant, unless a triggering
event (as defined in the agreement) has not occurred during the
option period.
On January 31, 2005, in conjunction with the Sale, as
discussed in Note 16, the Board of Directors and optionees
under the SOP adopted an Option Modification Agreement (OMA).
Under the terms of the OMA, at the completion of the Sale, the
SOP plan will be canceled in exchange for a cash payment. The
cash payment is calculated as the value of all outstanding
options granted or ungranted but authorized under the
C-63
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
terms of the SOP, together with certain amounts due and
anticipated under other long term compensation plans.
A summary of the Company’s stock options for the year ended
December 31, 2004, is as follows:
| Weighted Average | ||||||||
| Shares | Exercise Price | |||||||
|
Options outstanding:
|
||||||||
|
Beginning of year
|
— | $ | — | |||||
|
Granted
|
13,199 | 1,189.51 | ||||||
|
Exercised
|
— | — | ||||||
|
Forfeited or terminated
|
— | — | ||||||
|
Purchased by MSW Merger
|
— | |||||||
|
End of year
|
13,199 | $ | 1,189.51 | |||||
|
Options exercisable at year end
|
— | — | ||||||
|
Weighted average fair value of options granted during the year
|
$ | 132.30 | ||||||
The fair value of each stock option granted during the year
ended December 31, 2004 is an estimate on the date of grant
that is calculated using the minimum value option pricing model
with the following assumptions:
| Year Ended | ||||
| December 31, | ||||
| 2004 | ||||
|
Expected life (years)
|
3 | |||
|
Expected dividend
|
— | |||
|
Risk free interest rate
|
3.9 | % | ||
The Company applies the recognition provisions of Accounting
Principles Board Opinion No. 25 and related interpretations
in accounting for its stock-based compensation plans. No
compensation cost has been recognized for the stock option plan.
Set forth as follows are the Company’s net income presented
both as reported and pro forma, as if compensation cost had been
determined consistent with the provisions of
SFAS No. 123 for the year ended December 31, 2004
(in thousands):
| Year Ended | ||||
| December 31, | ||||
| 2004 | ||||
|
Net income, as reported
|
$ | 92,030 | ||
|
Add: stock-based compensation expense included in reported net
income, net of taxes
|
— | |||
|
Less: stock-based compensation expense included using fair value
method, net of taxes
|
(1,746 | ) | ||
|
Pro forma net earnings
|
$ | 90,284 | ||
The effects of applying SFAS No. 123 in this pro forma
disclosure are not necessarily indicative of future amounts.
C-64
Table of Contents
Ref-Fuel Holdings LLC and Subsidiaries
Notes to Consolidated Financial
Statements — (Continued)
| 15. | Supplemental Disclosure of Cash Flow Information |
Depreciation and amortization expense included in the Statements
of Cash Flows consists of the following (in thousands):
| Consolidated | ||||||||||||||||||||
| The Period from | The Period from | |||||||||||||||||||
| For the Year | December 12 | January 1 | For the Year | |||||||||||||||||
| Ended | through | through | Ended | |||||||||||||||||
| December 31, | December 31, | December 12, | December 31, | |||||||||||||||||
| Asset/Liability | Statement of Operations | 2004 | 2003 | 2003 | 2002 | |||||||||||||||
|
Property, plant and equipment
|
Depreciation and amortization (1) | $ | 67,996 | $ | 3,391 | $ | 55,838 | $ | 67,249 | |||||||||||
|
Energy contracts
|
Energy revenues | 59,770 | 3,286 | 27,293 | 25,984 | |||||||||||||||
|
Long-term waste contracts
|
Waste disposal and related services | (7,171 | ) | (477 | ) | (7,454 | ) | (8,453 | ) | |||||||||||
|
Lease
|
Operating expenses (rent expense) | (3,641 | ) | — | (5,009 | ) | (5,279 | ) | ||||||||||||
|
Debt
|
Interest expense | (16,211 | ) | (494 | ) | (4,097 | ) | (4,608 | ) | |||||||||||
|
Deferred revenue
|
Waste disposal and related services revenues and Energy Revenues and energy revenues | (29 | ) | — | (909 | ) | (198 | ) | ||||||||||||
|
Total
|
$ | 100,714 | $ | 5,706 | $ | 65,662 | $ | 74,695 | ||||||||||||
|
Supplemental cash flow information
|
||||||||||||||||||||
|
Cash paid for interest
|
$ | 64,372 | $ | 11,094 | $ | 54,594 | $ | 57,306 | ||||||||||||
|
Noncash investing and financing activities
|
||||||||||||||||||||
|
Push-down basis of accounting — MSW Energy Holdings
|
$ | — | $ | 205,501 | — | $ | — | |||||||||||||
|
Push-down basis of accounting — MSW Energy Holdings II
|
— | 202,223 | — | — | ||||||||||||||||
|
Unrealized gain on investments
|
— | 517 | — | — | ||||||||||||||||
|
Redemption of Class B minority interest in the HENS
|
— | — | — | 144,194 | ||||||||||||||||
|
Finalization of purchase accounting
|
4,573 | — | — | — | ||||||||||||||||
| 16. | Subsequent Event |
DLJ Merchant Banking Partners and AIG Highstar Capital, L.P.
announced on February 1, 2005 that they have signed a
definitive agreement to sell Holdings Corp. to Danielson Holding
Corporation (Danielson). Holdings Corp. is the parent of MSW
Energy Holdings LLC and MSW Energy Holdings II LLC.
Danielson will pay $740 million in cash for the equity of
ARC Holdings and will assume the consolidated net debt of ARC
Holdings. Subject to receipt of regulatory approvals and
required financing, the transaction is expected to close in the
second quarter of 2005.
In connection with the Sale, costs relating to transaction
expenses, severance, employment contracts, the OMA, Long-Term
Incentive Plans, housing subsidies, lease termination and other
related items are estimated to be between $50 million and
$70 million.
C-65
Table of Contents
APPENDIX D
Condensed Consolidated Financial Statements of Covanta ARC
Holdings, Inc. and Subsidiaries
|
Condensed Consolidated Financial Statements as of
September 30, 2005 and December 31, 2004 and for the
period January 1, 2005 through June 24, 2005, the
period June 25, 2005 through September 30, 2005, the
three months ended September 30, 2005 and 2004, and nine
months ended September 30, 2004 (Unaudited):
|
|||||
|
Condensed Consolidated Balance Sheets as of September 30,
2005 (Unaudited) and December 31, 2004
|
D-2 | ||||
|
Condensed Consolidated Statements of Operations for Three Months
Ended September 30, 2005 and 2004 (Unaudited)
|
D-3 | ||||
|
Condensed Consolidated Statements of Operations and
Comprehensive Income for the period from June 25 through
September 30, 2005, the period from January 1 through
June 24, 2005 and the Nine Months Ended September 30,
2004 (Unaudited)
|
D-4 | ||||
|
Condensed Consolidated Statements of Stockholders’ Equity
for the period from January 1, 2004 to June 24, 2005
(Predecessor) and the period from June 24 to September 30,
2005 (Successor) (Unaudited)
|
D-5 | ||||
|
Condensed Consolidated Statements of Cash Flows for the period
from June 25 through September 30, 2005, the period from
January 1 through June 24, 2005 and the Nine Months Ended
September 30, 2004 (Unaudited)
|
D-6 | ||||
|
Notes to the Condensed Consolidated Financial Statements
(Unaudited)
|
D-7 | ||||
D-1
Table of Contents
Covanta ARC Holdings, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(Unaudited, in Thousands)
| September 30, | December 31, | ||||||||||
| 2005 | 2004 | ||||||||||
| (Predecessor) | |||||||||||
| ASSETS | |||||||||||
|
Current assets:
|
|||||||||||
|
Cash and cash equivalents
|
$ | 74,138 | $ | 88,945 | |||||||
|
Restricted cash and cash equivalents
|
68,949 | 73,103 | |||||||||
|
Receivables, net of allowance of $2,044 and $1,491
|
74,803 | 72,027 | |||||||||
|
Income tax receivable
|
12,933 | 4,338 | |||||||||
|
Prepaid expenses and other current assets
|
14,191 | 12,846 | |||||||||
|
Total current assets
|
245,014 | 251,259 | |||||||||
|
Restricted cash and cash equivalents
|
88,179 | 90,971 | |||||||||
|
Property, plant and equipment, net
|
1,879,580 | 1,174,896 | |||||||||
|
Intangible assets, net
|
261,836 | 542,877 | |||||||||
|
Goodwill
|
292,810 | 123,984 | |||||||||
|
Other assets
|
12,382 | 17,088 | |||||||||
|
Total assets
|
$ | 2,779,801 | $ | 2,201,075 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
|
Current liabilities:
|
|||||||||||
|
Accounts payable
|
$ | 4,282 | $ | 6,684 | |||||||
|
Accounts payable — intercompany
|
984 | — | |||||||||
|
Taxes payable
|
8,945 | — | |||||||||
|
Current portion of intermediate long-term debt
|
25,121 | 20,000 | |||||||||
|
Current portion of project debt
|
64,724 | 67,184 | |||||||||
|
Accrued interest
|
18,002 | 22,115 | |||||||||
|
Accrued expenses and other current liabilities
|
44,047 | 42,195 | |||||||||
|
Total current liabilities
|
166,105 | 158,178 | |||||||||
|
Long-term portion of intermediate debt
|
643,356 | 645,000 | |||||||||
|
Long-term portion of project debt
|
682,137 | 738,829 | |||||||||
|
Deferred income taxes
|
376,991 | 149,419 | |||||||||
|
Other liabilities
|
161,930 | 224,649 | |||||||||
|
Total liabilities
|
2,030,519 | 1,916,075 | |||||||||
|
Commitments and contingencies (Note 13)
|
|||||||||||
|
Minority interest in consolidated subsidiary
|
— | 742 | |||||||||
|
Stockholders’ equity:
|
|||||||||||
|
Common stock, Class A, 263,987 of $0.001 par value
authorized, issued and outstanding
|
1 | 1 | |||||||||
|
Additional paid-in capital
|
747,216 | 300,306 | |||||||||
|
Accumulated earnings (deficit)
|
2,065 | (16,049 | ) | ||||||||
|
Total stockholders’ equity
|
749,282 | 284,258 | |||||||||
|
Total liabilities and stockholders’ equity
|
$ | 2,779,801 | $ | 2,201,075 | |||||||
The accompanying notes are an integral part of these condensed
consolidated financial statements.
D-2
Table of Contents
Covanta ARC Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited, in Thousands)
| For the Three Months | For the Three Months | ||||||||||
| Ended September 30, 2005 | Ended September 30, 2004 | ||||||||||
| (Predecessor) | |||||||||||
|
Revenues
|
|||||||||||
|
Waste disposal and related services revenues
|
$ | 81,719 | $ | 81,606 | |||||||
|
Electricity and steam sales
|
43,482 | 43,066 | |||||||||
|
Total net revenues
|
125,201 | 124,672 | |||||||||
|
Expenses
|
|||||||||||
|
Plant operating expenses
|
47,028 | 47,329 | |||||||||
|
Depreciation and amortization
|
26,802 | 29,457 | |||||||||
|
Net interest expense on project debt
|
7,692 | 7,526 | |||||||||
|
General and administrative
|
4,541 | 5,888 | |||||||||
|
Gain on asset retirement
|
(494 | ) | (218 | ) | |||||||
|
Total operating expenses
|
85,569 | 89,982 | |||||||||
|
Operating income
|
39,632 | 34,690 | |||||||||
|
Interest income
|
587 | 357 | |||||||||
|
Interest expense
|
(12,847 | ) | (14,900 | ) | |||||||
|
Minority interests in net income of subsidiary
|
(72 | ) | (7,785 | ) | |||||||
|
Income before income taxes
|
27,300 | 12,362 | |||||||||
|
Income tax (provision)
|
(11,498 | ) | (6,606 | ) | |||||||
|
Income from continuing operations
|
15,802 | 5,756 | |||||||||
|
Discontinued operations:
|
|||||||||||
|
Income from discontinued operations, net of income tax expense
of $0 and $1,091, respectively
|
— | 1,134 | |||||||||
|
Net income
|
$ | 15,802 | $ | 6,890 | |||||||
The accompanying notes are an integral part of these condensed
consolidated financial statements.
D-3
Table of Contents
Covanta ARC Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations and
Comprehensive Income
(Unaudited, in Thousands)
| For the Period | |||||||||||||||
| For the Period | from | ||||||||||||||
| from June 25 | January 1 | For the Nine | |||||||||||||
| through | through | Months Ended | |||||||||||||
| September 30, 2005 | June 24, 2005 | September 30, 2004 | |||||||||||||
| (Predecessor) | |||||||||||||||
|
Revenues
|
|||||||||||||||
|
Waste disposal and related services revenues
|
$ | 87,400 | $ | 148,792 | $ | 135,408 | |||||||||
|
Electricity and steam sales
|
46,461 | 79,660 | 69,630 | ||||||||||||
|
Total net revenues
|
133,861 | 228,452 | 205,038 | ||||||||||||
|
Expenses
|
|||||||||||||||
|
Plant operating expenses
|
49,797 | 103,617 | 80,891 | ||||||||||||
|
Depreciation and amortization
|
28,737 | 57,032 | 47,957 | ||||||||||||
|
Net interest expense on project debt
|
8,150 | 13,964 | 12,546 | ||||||||||||
|
General and administrative
|
4,822 | 52,133 | 11,529 | ||||||||||||
|
(Gain) loss on asset retirement
|
(494 | ) | 519 | 618 | |||||||||||
|
Total operating expenses
|
91,012 | 227,265 | 153,541 | ||||||||||||
|
Operating income
|
42,849 | 1,187 | 51,497 | ||||||||||||
|
Interest income
|
628 | 1,225 | 628 | ||||||||||||
|
Interest expense
|
(13,767 | ) | (26,368 | ) | (33,868 | ) | |||||||||
|
Equity in net earnings of unconsolidated subsidiaries
|
— | — | 6,148 | ||||||||||||
|
Minority interests in net income of subsidiary
|
(79 | ) | (56 | ) | (12,179 | ) | |||||||||
|
Income (loss) before income taxes
|
29,631 | (24,012 | ) | 12,226 | |||||||||||
|
Income tax (provision) benefit
|
(12,446 | ) | 6,033 | (6,533 | ) | ||||||||||
|
Income (loss) from continuing operations
|
17,185 | (17,979 | ) | 5,693 | |||||||||||
|
Discontinued operations:
|
|||||||||||||||
|
Income from discontinued operations, net of income tax expense
of $0, $0 and $5,374, respectively
|
— | — | 5,589 | ||||||||||||
|
Net income (loss)
|
17,185 | (17,979 | ) | 11,282 | |||||||||||
|
Other comprehensive loss
|
— | — | (211 | ) | |||||||||||
|
Comprehensive income (loss)
|
$ | 17,185 | $ | (17,979 | ) | $ | 11,071 | ||||||||
The accompanying notes are an integral part of these condensed
consolidated financial statements.
D-4
Table of Contents
Covanta ARC Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders’
Equity
(Unaudited, in Thousands)
| Common | Additional | Retained | Accumulated | Total | ||||||||||||||||
| Stock | Paid-In | Earnings | Comprehensive | Stockholders’ | ||||||||||||||||
| Class A | Capital | (Deficit) | Income (Loss) | Equity | ||||||||||||||||
|
Balance at January 1, 2004
|
$ | 1 | $ | 123,908 | $ | 994 | $ | — | $ | 124,903 | ||||||||||
|
Unrealized gain on investment from the consolidation of Covanta
Ref-Fuel Holdings
|
— | — | — | 211 | 211 | |||||||||||||||
|
Contribution of Senior Notes
|
— | 40,000 | — | — | 40,000 | |||||||||||||||
|
Equity contributed in the August 31 Transactions
|
— | 136,398 | — | — | 136,398 | |||||||||||||||
|
Comprehensive income
|
— | — | 21,107 | (211 | ) | 20,896 | ||||||||||||||
|
Dividends paid
|
— | — | (38,150 | ) | — | (38,150 | ) | |||||||||||||
|
Balance at December 31,2004
|
1 | 300,306 | (16,049 | ) | — | 284,258 | ||||||||||||||
|
Net loss
|
— | — | (17,979 | ) | — | (17,979 | ) | |||||||||||||
|
Dividends paid
|
— | — | (35,000 | ) | — | (35,000 | ) | |||||||||||||
|
Capital contribution from members
|
— | 39,631 | — | — | 39,631 | |||||||||||||||
|
Balance at June 24, 2005 (predecessor)
|
$ | 1 | $ | 304,937 | $ | (34,028 | ) | $ | — | $ | 270,910 | |||||||||
|
Balance at June 24, 2005 (successor)
|
$ | 1 | $ | 747,216 | $ | — | $ | — | $ | 747,217 | ||||||||||
|
Net income
|
— | — | 17,185 | — | 17,185 | |||||||||||||||
|
Dividends paid
|
— | — | (15,120 | ) | — | (15,120 | ) | |||||||||||||
|
Balance at September 30, 2005
|
$ | 1 | 747,216 | $ | 2,065 | $ | — | $ | 749,282 | |||||||||||
The accompanying notes are an integral part of these condensed
consolidated financial statements.
D-5
Table of Contents
Covanta ARC Holdings, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited, in Thousands)
| For the Period | |||||||||||||||
| from | |||||||||||||||
| For the Period from | January 1 | For the Nine | |||||||||||||
| June 25 through | through | Months Ended | |||||||||||||
| September 30, 2005 | June 24, 2005 | September 30, 2004 | |||||||||||||
| (Predecessor) | |||||||||||||||
|
Cash flows from operating activities:
|
|||||||||||||||
|
Net income (loss)
|
$ | 17,185 | $ | (17,979 | ) | $ | 11,282 | ||||||||
|
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
|
|||||||||||||||
|
Depreciation and amortization
|
28,737 | 57,032 | 47,957 | ||||||||||||
|
Deferred income taxes
|
4,307 | 4,101 | 3,895 | ||||||||||||
|
Revenue contract levelization
|
1,007 | 692 | 9,002 | ||||||||||||
|
Interest on loss contracts
|
462 | 1,069 | 874 | ||||||||||||
|
Amortization of debt premium
|
(3,231 | ) | (5,854 | ) | (4,671 | ) | |||||||||
|
Amortization of lease
|
748 | (1,593 | ) | (275 | ) | ||||||||||
|
Amortization of deferred revenue
|
(7 | ) | (74 | ) | (16 | ) | |||||||||
|
(Gain) loss on asset retirements
|
(494 | ) | 519 | 618 | |||||||||||
|
Earnings from equity investments
|
— | — | (6,148 | ) | |||||||||||
|
Distributions from equity investments
|
— | — | 31,500 | ||||||||||||
|
Minority interests in net income of subsidiaries
|
79 | 56 | 12,179 | ||||||||||||
|
Changes in assets and liabilities:
|
|||||||||||||||
|
Receivables
|
1,916 | (4,211 | ) | (6,467 | ) | ||||||||||
|
Prepaid expenses and other current assets
|
2,360 | (2,400 | ) | 740 | |||||||||||
|
Other long-term assets
|
(3,060 | ) | (2,943 | ) | (38 | ) | |||||||||
|
Accounts payable, and other current liabilities
|
7,341 | (8,142 | ) | 1,157 | |||||||||||
|
Income taxes receivable
|
(820 | ) | (7,775 | ) | 16,072 | ||||||||||
|
Accrued interest
|
(9,404 | ) | 5,292 | (2,675 | ) | ||||||||||
|
Other accrued liabilities
|
(19 | ) | 2,667 | (5,228 | ) | ||||||||||
|
Net cash provided by operating activities
|
47,107 | 20,457 | 109,758 | ||||||||||||
|
Cash flows from investing activities:
|
|||||||||||||||
|
Capital expenditures
|
(1,898 | ) | (25,228 | ) | (9,220 | ) | |||||||||
|
Acquisition of Duke interest
|
(1,307 | ) | — | — | |||||||||||
|
Proceeds from sale of equipment
|
487 | 2,651 | 20 | ||||||||||||
|
Acquisition of intangible
|
— | — | (335 | ) | |||||||||||
|
Cash from the consolidation of unconsolidated subsidiary
|
— | — | 40,238 | ||||||||||||
|
Proceeds from the sale of subsidiary
|
— | — | 42,508 | ||||||||||||
|
Acquisition, net of cash
|
— | — | 7,678 | ||||||||||||
|
Net cash (used in) provided by investing activities
|
(2,718 | ) | (22,577 | ) | 80,889 | ||||||||||
|
Cash flows from financing activities:
|
|||||||||||||||
|
Payments from (to) from restricted cash investments
|
6,766 | 179 | (42,995 | ) | |||||||||||
|
Payments on long-term debt
|
(24,255 | ) | (29,178 | ) | (52,217 | ) | |||||||||
|
Dividends paid
|
(15,120 | ) | (35,000 | ) | (24,695 | ) | |||||||||
|
Dividends paid to minority interests
|
— | (100 | ) | (1,420 | ) | ||||||||||
|
Capital contributions
|
— | 39,632 | — | ||||||||||||
|
Net cash used in financing activities
|
(32,609 | ) | (24,467 | ) | (121,327 | ) | |||||||||
|
Net decrease in cash and cash equivalents
|
11,780 | (26,587 | ) | 69,320 | |||||||||||
|
Cash and cash equivalents at beginning of period
|
62,358 | 88,945 | 17,537 | ||||||||||||
|
Cash and cash equivalents at end of period
|
$ | 74,138 | $ | 62,358 | $ | 86,857 | |||||||||
The accompanying notes are an integral part of these condensed
consolidated financial statements.
D-6
Table of Contents
Notes to Condensed Consolidated Financial Statements
| 1. | Organization and Basis of Presentation |
Covanta ARC Holdings, Inc. (“Holdings Inc.”), formerly
known as American Ref-Fuel Holdings Corp., and subsidiaries
(collectively, the “Company”) is engaged in the
business of acquiring, developing, owning and managing waste and
energy-related businesses in the United States. The Company has
had investments in and/or manages waste-to-energy facilities,
transfer stations, landfills, electric-generating facilities and
steam cogeneration facilities.
On December 12, 2003, Holdings Inc. completed a merger
with MSW Merger, a Delaware limited liability company, pursuant
to an agreement and plan of merger dated August 22, 2003
with Holdings Inc. becoming the surviving entity (the “MSW
Transaction”). Prior to the MSW Transaction, the Company
primarily derived its revenue from: (i) the sale of
electrical energy and capacity, thermal energy and waste
disposal services; (ii) earnings on equity investments; and
(iii) providing operating and management services to
various energy businesses for fixed and variable fees. Following
the MSW Transaction, the Company sold several of its operating
subsidiaries to a wholly-owned subsidiary of Delta Power
Company, LLC (“Delta”) on December 15, 2003. As
of December 31, 2003, the Company had a 50% equity
ownership in Covanta Ref-Fuel Holdings LLC (“Covanta
Ref-Fuel Holdings”), formerly known as Ref-Fuel Holdings
LLC, through its ownership of MSW Energy Holdings II LLC
(“MSW Energy Holdings II”), and 100% ownership of UAE
Mecklenburg Cogeneration LP, a coal-fired facility in
Clarksville, VA (the “Mecklenburg Facility”). The
Company sold the Mecklenburg Facility on August 18, 2004
(see Note 5). As a result of these transactions, the
Company’s primary business is the ownership, operation and
development of waste-to-energy facilities.
As a result of a series of transactions known as the
Equalization Transactions, which were consummated on
April 30, 2004, affiliates of Credit Suisse First Boston
Private Equity, Inc. (“CSFB Private Equity”) and AIG
Global Investment Corp. (“AIGGIC”) beneficially owned
60% and 40%, respectively, of the equity interests in the
Company. Also in the Equalization Transactions, Holdings Inc.
was named managing member of MSW Energy Holdings LLC (“MSW
Energy Holdings”) and purchased a 0.01% ownership.
The Equalization Transactions also resulted in Holdings Inc.
assuming full control of the management and operations of
Covanta Ref-Fuel Holdings through its interests in MSW Energy
Holdings II and MSW Energy Holdings. As a result of the
Equalization Transactions, the Company had effective control of
Covanta Ref-Fuel Holdings, and therefore consolidated its
results of operations and cash flows for the period from
May 1, 2004.
On August 31, 2004, the Company and several private equity
funds (the “DLJMB Funds”), each of which is managed by
entities affiliated with CSFB Private Equity, and several
investment funds (the “Highstar Funds”) managed by
AIGGIC effected a series of transactions that resulted in
Holdings Inc. becoming the indirect parent of MSW Energy
Holdings (the “August 31 Transactions”).
Effective June 24, 2005, Covanta Holding Corporation
(“CHC”), a Delaware corporation, acquired all of the
issued and outstanding shares of capital stock of Holdings Inc.
(the “Acquisition”). The Acquisition was made pursuant
to the terms of a Stock Purchase Agreement, dated as of
January 31, 2005 among CHC. and its owners (the
“Purchase Agreement”). As a result of the Acquisition,
CHC, through a wholly-owned subsidiary, owns 100% of the voting
securities of Holdings Inc.
CHC paid $747 million in cash for transaction costs and for
the shares of Holdings Inc. and assumed the consolidated net
debt of Holdings Inc., which was approximately $1.3 billion
as of June 24, 2005. Upon consummation of the Acquisition,
a change in ownership occurred, and in accordance with Emerging
Issues Task Force (“EITF”) Topic D-97,
“Push-Down Accounting,” the Company’s
financial statements reflect the effects of its change in
ownership and the new owner’s basis in the net assets and
liabilities acquired. As a result, the statements of operations
and the statements of cash flows for the period from
January 1, 2005 through June 24, 2005 reflect the
results of the Company prior to purchase accounting adjustments
and the statement of operations and statement of cash flows for
the period from June 25 to September 30, 2005, reflect
D-7
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
the impact of preliminary purchase accounting adjustments
(labeled “predecessor”) arising from the Acquisition.
See Note 3 for further information.
On September 30, 2005, the Company acquired the remaining
0.2% ownership of Covanta Ref-Fuel Holdings, from Duke Energy
Corporation (“Duke”), and as such, holds 100% interest
in Covanta Ref-Fuel Holdings as of September 30, 2005.
The Company indirectly owns Covanta ARC LLC (“Covanta
ARC”), formerly known as American Ref-Fuel Company LLC, a
wholly-owned subsidiary of Covanta Ref-Fuel Holdings, who owns
partnerships that develop, own and operate waste-to-energy
facilities, which combust municipal solid waste and produce
energy in the form of electricity and steam. Through such
partnerships, Covanta Ref-Fuel Holdings owns or controls six
waste-to-energy facilities located in the northeastern United
States (the “ARC operating facilities”). The ARC
operating facilities derive revenue principally from disposal or
tipping fees received for accepting waste and from the sale of
electricity and steam produced by those facilities. ARC
subsidiaries include: (a) Covanta ARC Company, formerly
American Ref-Fuel Company (“Ref-Fuel Management”);
(b) TransRiver Marketing Company, L.P.
(“TransRiver”); (c) Covanta Hempstead Company,
formerly American Ref-Fuel Company of Hempstead
(“Hempstead”); (d) Covanta Essex Company,
formerly American Ref-Fuel Company of Essex County
(“Essex”); (e) Covanta Southeastern Connecticut
Company, formerly American Ref-Fuel Company of Southeastern
Connecticut (“Seconn”); (f) Covanta Niagara,
L.P., formerly American Ref-Fuel Company of Niagara, L.P.
(“Niagara”); (g) Covanta Company of Semass, L.P.,
formerly American Ref-Fuel Company of Semass, L.P.
(“Ref-Fuel Semass”); (h) Covanta of Semass, L.P.,
formerly American Ref-Fuel Operations of Semass, L.P.
(“Semass Operator”); and (i) Covanta Delaware
Valley, L.P., formerly American Ref-Fuel Company of Delaware
Valley, L.P. (“Delaware Valley”) (collectively
referred to as the “American Ref-Fuel Partnerships”).
The accompanying condensed consolidated financial statements are
unaudited. In the opinion of management, such statements include
all adjustments, including normal recurring accruals and
adjustments, necessary for a fair presentation of the results
for the period presented. The accounting policies followed
during interim periods reported are in conformity with
accounting principles generally accepted in the United States of
America; however, certain information and footnote disclosures
normally included in financial statements have been condensed or
omitted pursuant to the rules and regulations of the Securities
and Exchange Commission. These consolidated financial statements
should be read in conjunction with the financial statements and
notes thereto included in the Company’s annual financial
statements for the year ended December 31, 2004 that are
included in this registration statement. The Company believes
that the disclosures included are adequate and provide
sufficient information. The results of operations for the
interim periods are not necessarily indicative of the results
that might be expected for future interim periods or for a full
year.
| 2. | Summary of Significant Accounting Policies |
| Principles of consolidation |
The accompanying consolidated financial statements include the
accounts of Holdings Inc., its wholly-owned subsidiaries
including MSW Energy Holdings, MSW Energy Holdings II, and
Covanta Ref-Fuel Holdings. Prior to the Equalization
Transactions, the Company’s investment in Covanta Ref-Fuel
Holdings was accounted for using the equity method of
accounting. As a result of the Equalization Transactions and the
associated acquisition of MSW Energy Holdings, the Company has
effective control of Covanta Ref-Fuel Holdings and MSW Energy
Holdings and as of April 30, 2004, consolidated their
results of operations, cash flows, and balance sheets. All
significant intercompany transactions and balances have been
eliminated in consolidation. The minority interests shown relate
to Duke’s 0.2% interest in Covanta Ref-Fuel Holdings, which
was acquired on September 30, 2005.
D-8
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
| Reclassifications |
Certain reclassifications have been made to the prior periods to
conform to the current periods’ presentation as described
in Note 4.
| Use of Estimates |
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management of the Company to make estimates and
assumptions that affect (a) the reported amounts of assets
and liabilities at the date of the financial statements;
(b) the disclosures of contingent assets and liabilities at
the date of the financial statements; and (c) the reported
amounts of revenues and expenses recognized during the reporting
period. Significant estimates include the estimated lives of
long-lived assets, allowances for doubtful accounts receivable,
estimated useful lives and fair value adjustments of net
tangible and intangible assets, liabilities for self-insurance
and certain landfill liabilities. Such estimates may be
subsequently revised as necessary when additional information
becomes available. Actual results could differ from those
estimates.
| Equity method investment |
Investments are accounted for using the equity method of
accounting if the investment gives the Company the ability to
exercise significant influence, but not control, over an
investee. Significant influence is generally deemed to exist if
the Company has an ownership interest in the voting stock of the
investee of between 20% and 50%, although other factors, such as
representation on the investee’s board of directors, are
considered in determining whether the equity method of
accounting is appropriate.
The Company’s investment in Covanta Ref-Fuel Holdings was
accounted for using the equity method of accounting prior to the
Equalization Transactions. As a result, the accompanying
consolidated results of operations include the Company’s
share of net earnings in “Equity in net earnings of
unconsolidated subsidiaries” for the period up to
April 30, 2004.
| Income Taxes |
The Company accounts for income taxes under the asset and
liability method. The provision for income taxes includes
deferred income taxes resulting from items reported in different
periods for income tax and financial statement purposes.
Deferred income tax assets and liabilities represent the
expected future tax consequences of the differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. The effects of
changes in tax rates on deferred income tax assets and
liabilities are recognized in the period that includes the
enactment date. A valuation allowance is provided when necessary
to reduce deferred tax assets to amounts expected to be realized.
Quarterly income taxes are calculated in accordance with the
interim financial reporting requirements as set forth in
Accounting Principles Board Opinion No. 28. Such Opinion
considers interim quarterly periods as an integral part of the
annual period, with interim quarterly tax periods reflecting the
estimated annual effective tax rate.
| Revenue Recognition |
The Company recognizes revenue from two major sources: waste
disposal services and energy production. Revenue from waste
disposal services is recognized as waste is received, and
revenue from energy production is recognized as the energy is
delivered.
| Stock-Based Compensation |
The Company has adopted the disclosure-only provisions of
Statement of Financial Accounting Standards (“FAS”)
No. 123, Accounting for Stock-Based Compensation,
(“FAS 123”) as amended by
D-9
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
FAS No. 148, Accounting for Stock-Based
Compensation — Transition and Disclosure —
an Amendment of FAS No. 123, concerning certain
transition and disclosure provisions, but applies the intrinsic
value recognition provisions of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for
stock-based compensation plans of the Company.
On December 16, 2004, the Financial Accounting Standards
Board (“FASB”) issued FASB Statement No. 123(R),
“Share-Based Payment”
(“FAS 123(R)”). FAS 123(R) revises
FAS 123 and requires companies to expense the fair value of
employee stock options and other forms of stock-based
compensation. This requirement represents a change from the
current practice. On April 14, 2005, the SEC announced that
FAS 123(R) is now effective for public companies for
annual, rather than interim, periods that begin after
June 15, 2005. As a result of the termination of Holdings
Inc.’s stock plan, there will be no impact upon the
adoption of SFAS 123(R) on the company (see Note 14).
| Treatment of Pass Through Costs |
Pass through costs are costs for which the Company receives a
direct contractually committed reimbursement from the
municipality. These costs generally include utility charges,
insurance premiums, ash residue transportation and disposal, and
certain chemical costs. These costs are recorded net of the
reimbursements from the municipalities in the Company’s
consolidated financial statements. Total pass through expenses
for the periods from January 1, 2005 through June 24,
2005; June 25, 2005 through September 30, 2005;
July 1, 2005 through September 30, 2005;
January 1, 2004 through September 30, 2004;
July 1, 2004 through September 30, 2004, were
$2.8 million, $1.7 million, $1.6 million,
$2.5 million, and $1.6 million, respectively.
| Risks and Uncertainties |
The Company’s operations involve a number of significant
risks and uncertainties. Factors that could affect the
Company’s future operating results and cause actual results
to vary materially from expectations and adversely affect the
Company’s financial condition and prevent it from
fulfilling its obligations include, but are not limited to, the
Company’s dependency on the operations of the Covanta ARC
operating companies and the Company’s substantial
indebtedness.
| 3. | Business Combinations |
The Company’s assets have been valued by independent
appraisers in order to assist management in the determination of
the purchase price allocations relating to the fair market value
of the assets and liabilities acquired in the Acquisition.
In recording the Acquisition and in accordance with EITF Topic
D-97, “Push-Down Accounting,” the Company recorded
incremental fair value of $476.3 million as an addition to
members’ equity and applied the respective fair value of
the acquisitions in accordance with Statement of Financial
Accounting Standards No. 141 “Business
Combinations” (“SFAS No. 141”). The
assets acquired and liabilities assumed were recorded at
estimated fair values as determined by the Company’s
management, using a preliminary valuation prepared by the
independent appraisers.
D-10
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
The purchase price was allocated as follows, as of (unaudited,
in thousands of dollars):
| June 24, 2005 | September 30, 2005 | |||||||||
|
Fair value of assets acquired
|
||||||||||
|
Current assets
|
$ | 233,885 | $ | 233,885 | ||||||
|
Property, plant and equipment
|
1,901,786 | 1,901,786 | ||||||||
|
Intangible assets (excluding goodwill)
|
269,436 | 269,436 | ||||||||
|
Other assets
|
111,458 | 108,869 | ||||||||
|
Goodwill
|
298,089 | 292,810 | ||||||||
|
Total Assets Acquired
|
$ | 2,814,654 | $ | 2,806,786 | ||||||
|
Fair value of liabilities assumed
|
||||||||||
|
Current liabilities
|
156,610 | 156,610 | ||||||||
|
Long-term Intermediate debt
|
655,270 | 655,270 | ||||||||
|
Long-term Project debt
|
718,805 | 706,732 | ||||||||
|
Deferred income taxes
|
368,907 | 372,684 | ||||||||
|
Other liabilities
|
164,787 | 165,215 | ||||||||
|
Total Liabilities Assumed
|
2,064,379 | 2,056,511 | ||||||||
|
Minority interest acquired
|
3,058 | 3,058 | ||||||||
|
Net assets acquired
|
$ | 747,217 | $ | 747,217 | ||||||
As a result of the Acquisition, the Company recorded a liability
relating to the closure of its headquarters of approximately
$2.1 million and liabilities for severance and other
compensation in the amount of $9.2 million, approximately
$0.7 million have been paid relating to these liabilities
as of September 30, 2005. As of September 30, 2005,
goodwill was $292.8 million which reflected adjustments to
the carrying value of project debt by $12.1 million, a fair
value adjustment related to a service agreement of
$2.5 million, a deferred tax adjustment of
$3.8 million and various other liability adjustments of
$0.5 million, which also impacted minority interest, as
part of management’s ongoing purchase accounting true-up.
| 4. | Reclassifications of Prior Periods |
In order to conform to CHC’s statements of operations
presentation, the following reclassifications were made to the
statements of operations. These reclassifications consisted of
the following:
| • | The amortization of above and below market contracts were reclassified from waste disposal and related service revenues (in the amount of $1.7 million and $4.0 million for the three and nine months ended September 30, 2004, respectively) and electricity and steam sales (in the amount of $14.4 million and $24.0 million for the three and nine months ended September 30, 2004, respectively) into depreciation and amortization expense. | |
| • | Other revenues, which primarily consisted of sales of scrap metals, were reclassified from other revenues into waste and service revenues (in the amount of $3.9 million and $6.0 million for the three and nine months ended September 30, 2004, respectively). | |
| • | Interest expense on project debt and interest income on funds restricted for the payment of project debt were reclassified as part of operating income (in the amount of $7.5 million and $12.5 million for the three and nine months ended September 30, 2004, respectively). | |
| • | Certain costs associated with operating facilities and TransRiver were reclassified from general and administrative expenses into plant operating expenses (in the amount of $3.8 million and $7.2 million for the three and nine months ended September 30, 2004, respectively). | |
D-11
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
| • | Reimbursements from certain municipal clients for operating expenses were reclassified from revenues to reductions of operating expenses (in the amount of $1.6 million and $2.5 million for the three and nine months ended September 30, 2004, respectively). | |
| • | Reductions of revenues shared with certain municipal customers for energy produced were reclassified from waste and service revenues to energy revenues (in the amount of $7.7 million and $13.1 million for the three and nine months ended September 30, 2004, respectively). | |
| • | Other minor miscellaneous reclassifications were also made. | |
| 5. | Discontinued Operations |
Mecklenburg Transaction. The Company entered into an
agreement to sell the Mecklenburg Facility to Virginia Electric
and Power Company (“Virginia Power”). On
August 18, 2004, the Company consummated the sale of the
Mecklenburg Facility to Virginia Power. The cash received as a
result of the sale was $42.5 million (with cash on the
balance sheet as of the date of sale of $14.5 million). No
gain or loss resulted from this sale.
| Summarized results of operations: |
Operating results of discontinued operations for the three
months and nine months ended September 30, 2004, related to
the Mecklenburg Facility is as follows (unaudited, in thousands):
| Nine Months | ||||||||
| Three Months Ended | Ended | |||||||
| September 30, 2004 | September 30, 2004 | |||||||
|
Revenue
|
$ | 7,467 | $ | 34,554 | ||||
|
Income before income taxes
|
$ | 2,225 | $ | 10,963 | ||||
|
Income tax expense
|
(1,091 | ) | (5,374 | ) | ||||
|
Income from discontinued operations
|
$ | 1,134 | $ | 5,589 | ||||
| 6. | Equity Investments |
Summarized statement of operations information for Covanta
Ref-Fuel Holdings is as follows (unaudited, in thousands):
| For the Four | ||||
| Months Ended | ||||
| April 30, 2004 | ||||
|
Revenues
|
$ | 156,623 | ||
|
Operating income
|
18,000 | |||
|
Net earnings
|
12,753 | |||
|
Company’s equity in net earnings
|
6,148 | |||
D-12
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
| Pro Forma Information |
The following results represent the unaudited pro forma results
as if the Acquisition, the Equalization Transactions and the
August 31 Transactions had occurred on January 1,
2004. These results are presented for informational purposes
only, and are not necessarily indicative of the actual results
that would have resulted had the Acquisition, the Equalization
Transactions and the August 31 Transactions actually
occurred on January 1, 2004 (unaudited, in thousands):
| Pro Forma | Pro Forma | |||||||
| For the Nine | For the Nine | |||||||
| Months Ended | Months Ended | |||||||
| September 30, 2005 | September 30, 2004 | |||||||
|
Revenues
|
||||||||
|
Waste disposal and related services revenues
|
$ | 236,192 | $ | 238,574 | ||||
|
Electricity and steam sales
|
126,121 | 123,085 | ||||||
|
Total operating revenues
|
362,313 | 361,659 | ||||||
|
Expenses
|
||||||||
|
Plant operating expenses
|
156,551 | 165,194 | ||||||
|
Depreciation and amortization
|
80,389 | 80,808 | ||||||
|
Net interest expense on project debt
|
23,587 | 26,945 | ||||||
|
General and administrative
|
15,765 | 13,972 | ||||||
|
Loss on asset retirements
|
25 | 960 | ||||||
|
Operating income
|
$ | 85,996 | $ | 73,780 | ||||
7. Property, Plant and
Equipment
A summary of property, plant and equipment is as follows
(unaudited, in thousands):
| Useful Life | September 30, 2005 | December 31, 2004 | |||||||||||
| (Predecessor) | |||||||||||||
|
Plant and equipment
|
2-50 years | $ | 1,873,996 | $ | 1,206,558 | ||||||||
|
Land
|
3,813 | 3,813 | |||||||||||
|
Leasehold improvements
|
Up to 17 years | 5,575 | 5,575 | ||||||||||
|
Landfill
|
13 years | 17,831 | 17,768 | ||||||||||
|
Construction in progress
|
2,268 | 6,244 | |||||||||||
|
Total property, plant and equipment
|
1,903,483 | 1,239,958 | |||||||||||
|
Accumulated depreciation
|
(23,903 | ) | (65,062 | ) | |||||||||
|
Property, plant and equipment, net
|
$ | 1,879,580 | $ | 1,174,896 | |||||||||
D-13
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
| 8. | Intangible Assets |
A summary of intangible assets is as follows (unaudited, in
thousands):
| September 30, | |||||||||||||
| Useful Life | 2005 | December 31, 2004 | |||||||||||
| (Predecessor) | |||||||||||||
|
Waste, electricity and steam contracts
|
3-11 years | $ | 194,562 | $ | 548,725 | ||||||||
|
Financing costs
|
6 years | — | 17,652 | ||||||||||
|
Lease asset
|
24 years | 71,845 | — | ||||||||||
|
Emissions credits
|
Indefinite | — | 43,377 | ||||||||||
|
Other intangibles
|
Indefinite | 3,029 | 3,579 | ||||||||||
| 269,436 | 613,333 | ||||||||||||
|
Accumulated amortization
|
(7,600 | ) | (70,456 | ) | |||||||||
|
Intangible assets, net
|
$ | 261,836 | $ | 542,877 | |||||||||
The following table represents the amount of estimated expense
associated with the intangible assets expected to be included in
the statement of operations for each of the years indicated
(unaudited, in thousands):
| Waste, | Lease | |||||||||||
| Electricity and | Asset | |||||||||||
| Steam Contracts | Contract | Totals | ||||||||||
|
Estimated 2005 (after September 30, 2005)
|
$ | 7,026 | $ | 748 | $ | 7,774 | ||||||
|
2006
|
26,979 | 2,994 | 29,973 | |||||||||
|
2007
|
26,979 | 2,994 | 29,973 | |||||||||
|
2008
|
26,969 | 2,994 | 29,963 | |||||||||
|
2009
|
23,423 | 2,994 | 26,417 | |||||||||
|
Thereafter
|
76,372 | 58,335 | 134,707 | |||||||||
|
Total
|
$ | 187,748 | $ | 71,059 | $ | 258,807 | ||||||
| Goodwill |
In connection with the Acquisition, approximately
$292.8 million of goodwill was recorded, which represents
the total consideration paid in excess of the fair value of net
tangible and intangible assets acquired in accordance with
Statement of Financial Accounting Standards No. 142
“Goodwill and Other Intangibles”
(“SFAS No. 142”).
| 9. | Accrued Expenses and Other Current Liabilities |
Accounts expenses and other current liabilities consist of the
following (unaudited, in thousands):
| September 30, 2005 | December 31, 2004 | ||||||||
| (Predecessor) | |||||||||
|
Accrued expenses
|
$ | 21,821 | $ | 19,249 | |||||
|
Compensation liabilities
|
11,637 | 11,237 | |||||||
|
Incentive plan accruals
|
1,688 | 3,569 | |||||||
|
Short-term Duke liability
|
2,500 | 2,500 | |||||||
|
Other
|
6,401 | 5,640 | |||||||
|
Total
|
$ | 44,047 | $ | 42,195 | |||||
D-14
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
| 10. | Debt |
The following is a summary of long-term debt by obligor
(unaudited, in thousands):
| Final | September 30, | December 31, | |||||||||||||||||
| Interest Rate | Maturity | 2005 | 2004 | ||||||||||||||||
| (Predecessor) | |||||||||||||||||||
|
Company and Intermediate Debt
|
|||||||||||||||||||
|
MSW Energy Holdings Senior Note
|
8.50% | 2010 | $ | 195,785 | $ | 200,000 | |||||||||||||
|
MSW Energy Holdings II Senior Note
|
7.38% | 2010 | 224,100 | 225,000 | |||||||||||||||
|
Senior Notes
|
6.26% | 2015 | 234,000 | 240,000 | |||||||||||||||
| 653,885 | 665,000 | ||||||||||||||||||
|
Project Debt
|
|||||||||||||||||||
|
Niagara Series 2001A
|
5.45%-5.625% | 2015 | 165,010 | 165,010 | |||||||||||||||
|
Seconn Corporate Credit Bonds
|
5.50%-6.45% | 2022 | 43,500 | 43,500 | |||||||||||||||
|
Hempstead Corporate Credit Bonds
|
5.00% | 2010 | 42,670 | 42,670 | |||||||||||||||
|
Hempstead project debt
|
4.625%-5.00% | 2009 | 114,543 | 114,543 | |||||||||||||||
|
Essex project debt
|
5.248%-7.375% | 2020 | 83,422 | 96,496 | |||||||||||||||
|
Seconn project debt
|
5.125%-5.50% | 2015 | 50,602 | 50,602 | |||||||||||||||
|
Semass Series 2001A
|
5.50%-5.625% | 2016 | 134,345 | 134,345 | |||||||||||||||
|
Semass Series 2001B
|
5.25%-5.50% | 2010 | 75,250 | 104,385 | |||||||||||||||
|
Other obligations
|
215 | 273 | |||||||||||||||||
|
Subtotal of Project debt
|
709,557 | 751,824 | |||||||||||||||||
|
Total debt at par value
|
1,363,442 | 1,416,824 | |||||||||||||||||
|
Unamortized debt premium, net
|
51,896 | 54,189 | |||||||||||||||||
|
Current portion
|
(89,845 | ) | (87,184 | ) | |||||||||||||||
|
Total long-term debt obligations
|
$ | 1,325,493 | $ | 1,383,829 | |||||||||||||||
As a result of the Acquisition, a Change of Control (as defined
in the Indenture entered in connection with the issuance of the
Senior Notes) occurred. The Indenture provides that, upon the
occurrence of a Change of Control, MSW Energy Holdings LLC and
MSW Energy Holdings II LLC shall make an offer (a
“Change of Control Offer”) to each registered holder
of the 8.50% Series B Senior Secured Notes due 2010 and the
7.375% Series B Senior Secured Notes due 2010 to repurchase
all or any part (equal to $1,000 or an integral multiple of
$1,000) of each Holder of the Senior Notes at a purchase price
equal to 101% of the aggregate principal amount thereof, plus
accrued and unpaid interest on these Senior Notes repurchased,
if any, to (but not including) the payment date (the Purchase
Price).
Accordingly, on June 24, 2005, MSW Energy Holding LLC and
MSW Energy Holdings II LLC made a Change of Control Offer,
pursuant to which MSW Energy Holding LLC and MSW Energy
Holdings II LLC offered to repurchase, for cash, all or any
part of each Holder’s Senior Notes at the Purchase Price,
subject to the terms and conditions set forth in a Change of
Control Notice and Offer to Purchase, and the accompanying
Letter of Transmittal (the “Offer Documents”).
As a result of the Change of Control Offer issued by MSW Energy
Holdings LLC and MSW Energy Holdings II LLC on
June 24, 2005, holders of approximately $4.2 million
of the MSW Energy Holdings LLC’s 8.50% Series B Senior
Notes tendered their notes for repurchase and holders of
approximately $0.9 million of the MSW Energy
Holdings II LLC’s 7.375% Series B Senior Notes
tendered their notes for repurchase. All such notes were
repurchased on July 26, 2005.
D-15
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
| 11. | Other liabilities |
Other liabilities consist of the following (unaudited, in
thousands):
| Amortization | September 30, | December 31, | |||||||||||
| Period | 2005 | 2004 | |||||||||||
| (Predecessor) | |||||||||||||
|
Waste contracts acquired
|
9-17 years | $ | 118,881 | $ | 116,635 | ||||||||
|
Operating lease acquired
|
14 years | — | 42,092 | ||||||||||
|
Duke liability
|
16 years | 25,074 | 22,622 | ||||||||||
|
Energy contract levelization
|
12 years | 1,007 | 24,123 | ||||||||||
|
Landfill liabilities
|
13 years | 11,596 | 10,699 | ||||||||||
|
Deferred revenue
|
8-20 years | 31 | 5,113 | ||||||||||
|
Other
|
5,341 | 3,363 | |||||||||||
| $ | 161,930 | $ | 224,649 | ||||||||||
| 12. | Income Taxes |
The components of the provision for income taxes consist of the
following (unaudited, in thousands):
| For the Period from | For the Period from | ||||||||||||
| June 25, | January 1, | For the Nine | |||||||||||
| through | through | Months Ended | |||||||||||
| September 30, 2005 | June 24, 2005 | September 30, 2004 | |||||||||||
| (Predecessor) | |||||||||||||
|
Current provision
|
$ | (8,139 | ) | $ | 10,134 | $ | 395 | ||||||
|
Deferred provision
|
(4,307 | ) | (4,101 | ) | (6,928 | ) | |||||||
|
Total consolidated income tax (provision)/benefit
|
$ | (12,446 | ) | $ | 6,033 | $ | (6,533 | ) | |||||
The Company has federal net operating loss carryforwards of
approximately $1.3 million at of December 31, 2004,
which expire between 2021 and 2024 and state net operating loss
carryforwards of approximately $22.7 million, which have
various expiration dates. The Company had federal capital loss
carryforwards of approximately $22.4 million in at
December 31, 2004 related to the disposal of certain
subsidiaries, which have been offset by a valuation allowance.
Such capital losses can only be offset by future capital gains.
The capital loss carryforwards expire beginning in the year 2008.
| 13. | Commitments and Contingencies |
The Company is party to a number of claims, lawsuits and pending
actions, most of which are routine and all of which are
incidental to its business. The Company’s management
assesses the likelihood of potential losses on an ongoing basis
and when losses are considered probable and reasonably
estimable, records as a loss an estimate of the ultimate
outcome. If the Company can only estimate the range of a
possible loss, an amount representing the low end of the range
of possible outcomes is recorded. The final consequences of
these proceedings are not presently determinable with certainty.
| Environmental |
The Company’s operations are subject to environmental
regulatory laws and environmental remediation laws. Although the
Company’s 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, the Company
believes that it is in substantial compliance with existing
environmental laws and regulations.
D-16
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
The Company may be identified, along with other entities, as
being among potentially responsible parties (“PRPs”)
for contribution to costs associated with the correction and
remediation of environmental conditions at disposal sites
subject to CERCLA and/or analogous state laws. In certain
instances, the Company may be exposed to joint and several
liabilities for remedial action or damages. The Company’s
ultimate liability in connection with such environmental claims
will depend on many factors, including its volumetric share of
waste, the total cost of remediation, and the financial
viability of other companies that also sent waste to a given
site and, in the case of divested operations, its contractual
arrangement with the purchaser of such operations.
Lower Passaic River Study. By letters dated
August 13, 2004 and May 3, 2005, USEPA notified Essex
that it was potentially liable under CERCLA Section 107(a)
for response actions in the Lower Passaic River Study Area
(“LPRSA”), a 17 mile stretch of river in northern
New Jersey. Essex is one of at least 52 PRPs named thus far.
USEPA alleged that hazardous substances found in the LPRSA were
being released from the Essex site, which abuts the river.
USEPA’s notice letters stated that Essex may be liable for
costs related to a proposed $10 million study of the Lower
Passaic River, for certain past costs incurred by USEPA totaling
approximately $2.8 million, and for unspecified natural
resource damages. Considering the history of industrial and
other discharges into the LPRSA from other sources, including
named PRPs, Essex believes any releases from its site to be
de minimus; however, it is not possible at this time to
predict that outcome with certainty or to estimate Essex’s
ultimate liability in the matter, including for natural resource
damage. Given the uncertainty, Essex has entered an arrangement
with USEPA and the cooperating PRP group to settle the potential
liability Essex might have for the $2.8 million in past
costs incurred by USEPA and for the $10 million cost of the
study, by contributing $250,000 to the cost of the study and by
agreeing to share in certain past and ongoing legal fees and
other costs of the cooperating PRP group.
CMW Landfill. Semass Partnership, a 90% owned subsidiary
of Ref-Fuel Semass, has a waste management agreement (the
“WMA”) dated May 25, 1982, as amended, with the
Carver, Marion, Wareham Regional Refuse Disposal District
(“CMW”). The WMA allows Semass Partnership to utilize
a portion of a landfill (the “CMW Landfill”), which
CMW leases from Wankinco River, Inc. (“Wankinco”).
In March 1990, the Semass Partnership, CMW and Wankinco entered
into an agreement related to the CMW Landfill, as amended (the
“Settlement Agreement”), which requires, among other
things, the Semass Partnership to make annual deposits into an
environmental protection trust fund (the “Fund”) in
lieu of obtaining environmental impairment liability insurance
for the CMW Landfill. The Semass Partnership is required under
the Settlement Agreement to deposit $500,000 annually into the
Fund, payable in equal quarterly installments. Certain
additional deposits are required subject to the availability of
cash in accordance with the Loan Agreement. The Semass
Partnership’s obligation to make deposits into the Fund
ceases when the Fund reaches a balance of $20.0 million
unless the fund limit is increased by agreement of the parties,
or absent such agreement, by arbitration, wherein it is
determined the fund limit needs to be increased to adequately
protect against environmental damage. Wankinco, by letter dated
March 29, 2005 and pursuant to its rights under the
Settlement Agreement, has requested a re-evaluation of the Fund
limit and an increase of such limit to $29.7 million. The
Company believes that the $20.0 million fund limit is
adequate for its intended purpose. Proceeds from the Fund are to
be used primarily for remediation of the CMW Landfill in the
event of environmental damage. The Semass Partnership and
Wankinco are each entitled to receive one-half of the balance of
the Fund upon final closure of the CMW Landfill and receipt of
required governmental approvals. During the first nine months of
2005 and the year ended December 31, 2004, the Semass
Partnership made the required quarterly deposits into the Fund
and charged operations for one-half of the deposits into the
Fund, representing one-half of the balance of the Fund which
will be disbursed to Wankinco upon final closure of the CMW
Landfill. Additional charges to operations may be required in
future years if any disbursements are required from the Fund to
remediate any environmental damages. To date, management is not
aware of any such environmental damages. As of
September 30, 2005 and December 31, 2004, the balance
in the Fund was approximately $15.6 million and
$14.0 million, respectively, and was included in
D-17
Table of Contents
Notes to Condensed Consolidated Financial
Statements — (Continued)
restricted cash and long-term investments. A corresponding
liability, representing approximately one-half of the deposits
and related earnings in the Fund, was included in other
long-term liabilities.
| 14. | Stock Option Plans |
On August 11, 2004, the Board of Directors of Holdings Inc.
adopted the 2004 Stock Option Plan (the “SOP”),
effective January 1, 2004, as further modified on
September 16, 2004. The SOP was designed to link the
interests of officers of Holdings Inc. (who were also the senior
management of Covanta Ref-Fuel Holdings) to the interests of
Holdings Inc. shareholders through the granting of options to
purchase stock of Holdings Inc. Holdings Inc. is a privately
held company. During 2004, Holdings Inc. granted 13,199 options
to the executive officers of Covanta Ref-Fuel Holdings under the
SOP. Options awarded under the SOP vest over a period of four
years and expire ten years from the date of grant. Such ten-year
period is automatically extended under certain circumstances.
On January 31, 2005, in conjunction with the Acquisition,
the Board of Directors of Holdings Inc. and optionees under the
SOP adopted an Option Modification Agreement (“OMA”).
Under the terms of the OMA, immediately prior to the
Acquisition, the SOP plan was terminated, and on June 24,
2005, a cash payment representing all outstanding options
granted or ungranted, but authorized under the terms of the SOP,
together with certain amounts due and anticipated under other
long term compensation plans was made in the amount of
$30.2 million and was recorded as compensation expense
prior to the Acquisition.
The Company has applied the recognition provisions of Accounting
Principles Board Opinion No. 25 and related interpretations
in accounting for its stock-based compensation plans. No
compensation cost had been recognized for the stock option plan
prior to its termination.
D-18
Table of Contents
APPENDIX E
Consolidated Financial Statements of Covanta Energy
Corporation and Subsidiaries
|
Audited Consolidated Financial Statements of Covanta Energy
Corporation and Subsidiaries as of December 31, 2004 and
December 31, 2003 and for the periods January 1, 2004
through March 10, 2004 and March 11, 2004 through
December 31, 2004 and for the years ended December 31,
2003 and 2002:
|
||||||
|
Reports of Independent Registered Public Accounting Firms
|
E-2 | |||||
|
Consolidated Statements of Operations and Comprehensive Income
(Loss) for the Periods January 1, 2004 through
March 10, 2004 and March 11, 2004 through
December 31, 2004 and the Years ended December 31,
2003 and 2002
|
E-5 | |||||
|
Consolidated Balance Sheets — December 31, 2004
and 2003 (Restated)
|
E-6 | |||||
|
Statements of Shareholders’ Equity (Deficit) for the
Periods January 1, 2004 through March 10, 2004 and
March 11, 2004 through December 31, 2004 and the Years
Ended December 31, 2003 and 2002
|
E-7 | |||||
|
Consolidated Statements of Cash Flows for the Periods
January 1, 2004 through March 10, 2004 and
March 11, 2004 through December 31, 2004 and the Years
Ended December 31, 2003 (Restated) and 2002 (Restated)
|
E-8 | |||||
|
Notes to Consolidated Financial Statements
|
E-9 | |||||
|
Quarterly Results of Operations
|
E-80 | |||||
|
Financial Statement Schedules
|
||||||
|
Schedule II: Valuation and Qualifying Accounts
|
E-81 | |||||
E-1
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholder of Covanta Energy
Corporation
We have audited the accompanying consolidated balance sheet of
Covanta Energy Corporation and subsidiaries (the
“Company”) as of December 31, 2004, and the
related consolidated statements of operations,
shareholder’s equity (deficit), and cash flows for the
periods January 1, 2004 through March 10, 2004
(“Predecessor”) and March 11, 2004 through
December 31, 2004 (“Successor”). These
consolidated financial statements are the responsibility of the
management of the Company. Our audit also included the financial
statement schedule listed in the Index at Item 8. These
financial statements and schedule are the responsibility of the
Company’s management. Our responsibility is to express an
opinion on these financial statements and schedule based on our
audit.
We conducted our audit 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 audit provides 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 Energy Corporation and
subsidiaries at December 31, 2004, and the consolidated
results of their operations and cash flows for the periods
January 1, 2004 through March 10, 2004
(“Predecessor”) and March 11, 2004 through
December 31, 2004 (“Successor”), in conformity
with U.S. generally accepted accounting principles. Also,
in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken
as a whole, presents fairly in all material respects the
information set forth therein.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Covanta Energy Corporation’s internal
control over financial reporting as of December 31, 2004,
based on criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report [NOT
INCLUDED HEREIN] dated March 14, 2005 expressed an
unqualified opinion on management’s assessment and an
adverse opinion on the effectiveness of internal control over
financial reporting.
/s/ Ernst & Young LLP
MetroPark, New Jersey
March 14, 2005
E-2
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Covanta Energy
Corporation (Debtor in Possession)
We have audited the accompanying Consolidated Balance Sheet of
Covanta Energy Corporation (Debtor in Possession) and its
subsidiaries (the “Company”) as of December 31,
2003, and the related Consolidated Statements of Operations and
Comprehensive Income (Loss), Shareholders’ Equity (Deficit)
and Cash Flows for each of the two years in the period ended
December 31, 2003. Our audits also included the 2003 and
2002 financial statement schedules listed in the Index at
Item 15. 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 did not audit
the financial statements of Quezon Power, Inc.
(“Quezon”) for the year ended December 31, 2003,
the Company’s investment in which is accounted for by use
of the equity method. The Company’s equity of $92,492,179
in Quezon’s net assets at December 31, 2003 and of
$17,782,000 in that company’s net income for the year then
ended is included in the accompanying financial statements. The
financial statements of Quezon were audited by other auditors
whose report has been furnished to us, and our opinion, insofar
as it relates to the amounts included for such company, is based
solely on the report of such other auditors.
We conducted our audits in accordance with 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 and the
report of the other auditors provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the report of the other
auditors, such financial statements present fairly, in all
material respects, the financial position of the Company at
December 31, 2003, and the results of their operations and
their cash flows for each of the two years in the period ended
December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America. Also, in our
opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as
a whole, present fairly in all material respects the information
for 2003 and 2002 set forth therein.
As discussed in Notes 1 and 2, the Company and various
domestic subsidiaries filed voluntary petitions for
reorganization under Chapter 11 of the Federal Bankruptcy
Code. The accompanying 2003 and 2002 financial statements do not
purport to reflect or provide for the consequences of the
bankruptcy proceedings. In particular, such 2003 and 2002
financial statements do not purport to show (a) as to
assets, their realizable value on a liquidation basis or their
availability to satisfy liabilities; (b) as to prepetition
liabilities, the amounts that may be allowed for claims or
contingencies, or the status and priority thereof; (c) as
to stockholder accounts, the effect of any changes that may be
made in the capitalization of the Company; or (d) as to
operations, the effect of any changes that may be made in their
businesses. The Bankruptcy Court entered an order confirming the
Company’s plan of reorganization which became effective
after the close of business on March 10, 2004.
The accompanying 2003 and 2002 financial statements have been
prepared assuming that the Company will continue as a going
concern. As discussed in Notes 1 and 2, the
Company’s dependence upon, among other things, the
Company’s ability to utilize the net operating loss carry
forwards of Danielson Holding Corporation and the Company’s
ability to generate sufficient cash flows from operations, asset
sales and financing arrangements to meet its obligations, raise
substantial doubt about the Company’s ability to continue
as a going concern. Management’s plans concerning these
matters are also discussed in Notes 1 and 2. The
financial statements do not include adjustments that might
result from the outcome of this uncertainty.
As discussed in Note 3, on January 1, 2003 the Company
adopted Statement of Financial Accounting Standards
No. 143, “Accounting for Asset Retirement
Obligations”, on January 1, 2002, the Company adopted
Statement of Financial Accounting Standards No. 142,
“Goodwill and Other Intangible Assets” and
E-3
Table of Contents
Statement of Financial Accounting Standards No. 144,
“Accounting for the Impairment or Disposal of
Long-Lived-Assets”.
As discussed in Note 35, the accompanying Consolidated
Balance Sheet as of December 31, 2003 and Consolidated
Statements of Cash Flows for each of the two years in the period
ended December 31, 2003 have been restated.
/s/ Deloitte & Touche LLP
Parsippany, New Jersey
March 26, 2004 (March 14, 2005 as to the effects of
the restatements discussed in Note 35)
E-4
Table of Contents
Covanta Energy Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
| Successor | Predecessor | ||||||||||||||||
| For the Period | For the Period | ||||||||||||||||
| March 11, | January 1, | Years Ended | |||||||||||||||
| Through | Through | December 31, | |||||||||||||||
| December 31, | March 10, | ||||||||||||||||
| 2004 | 2004 | 2003 | 2002 | ||||||||||||||
| (In thousands, except per share amounts) | |||||||||||||||||
|
Service revenues
|
$ | 374,622 | $ | 89,867 | $ | 499,245 | $ | 493,960 | |||||||||
|
Electricity and steam sales
|
181,074 | 53,307 | 277,766 | 289,281 | |||||||||||||
|
Construction revenues
|
1,506 | 58 | 13,448 | 42,277 | |||||||||||||
|
Other revenues
|
— | — | 9 | 263 | |||||||||||||
|
Total revenues
|
557,202 | 143,232 | 790,468 | 825,781 | |||||||||||||
|
Plant operating expenses
|
352,617 | 100,774 | 500,627 | 496,443 | |||||||||||||
|
Construction costs
|
1,925 | 73 | 20,479 | 42,698 | |||||||||||||
|
Depreciation and amortization
|
55,821 | 13,426 | 71,932 | 77,368 | |||||||||||||
|
Net interest on project debt
|
32,586 | 13,407 | 76,770 | 86,365 | |||||||||||||
|
Other operating costs and expenses
|
1,366 | (209 | ) | 2,209 | 15,163 | ||||||||||||
|
Net (gain) loss on sales of businesses and equity
investments
|
(245 | ) | (175 | ) | 7,246 | 1,943 | |||||||||||
|
Selling, general and administrative expenses
|
38,076 | 7,597 | 35,639 | 54,329 | |||||||||||||
|
Project development costs
|
— | — | — | 3,844 | |||||||||||||
|
Other expense (income)—net
|
(1,952 | ) | (1,923 | ) | (1,119 | ) | 16,008 | ||||||||||
|
Write down of and obligations related to assets held for use
|
— | — | 16,704 | 84,863 | |||||||||||||
|
Total costs and expenses
|
480,194 | 132,970 | 730,487 | 879,024 | |||||||||||||
|
Operating income (loss)
|
77,008 | 10,262 | 59,981 | (53,243 | ) | ||||||||||||
|
Interest income
|
1,858 | 935 | 2,948 | 2,472 | |||||||||||||
|
Interest expense (excluding post-petition contractual interest
of $243, $970 and $3,607 for the period January 1, 2004
through March 10, 2004, 2003 and 2002, respectively)
|
(34,706 | ) | (6,142 | ) | (39,938 | ) | (44,059 | ) | |||||||||
|
Reorganization items
|
— | (58,282 | ) | (83,346 | ) | (49,106 | ) | ||||||||||
|
Gain on cancellation of pre-petition debt
|
— | 510,680 | — | — | |||||||||||||
|
Fresh start adjustments
|
— | (399,063 | ) | — | — | ||||||||||||
|
Income (loss) from continuing operations before income taxes,
minority interests, equity in net income from unconsolidated
investments, discontinued operations and the cumulative effect
of changes in accounting principles
|
44,160 | 58,390 | (60,355 | ) | (143,936 | ) | |||||||||||
|
Income tax (expense) benefit
|
(23,637 | ) | (30,240 | ) | 18,096 | 986 | |||||||||||
|
Minority interests
|
(6,919 | ) | (2,511 | ) | (8,905 | ) | (9,104 | ) | |||||||||
|
Equity in net income from unconsolidated investments
|
17,535 | 3,924 | 24,400 | 24,356 | |||||||||||||
|
Income (loss) from continuing operations before discontinued
operations and change in accounting principles
|
31,139 | 29,563 | (26,764 | ) | (127,698 | ) | |||||||||||
|
Gain (loss) from discontinued operations (net of income tax
(expense) benefit of $(16,147) and $13,165, in 2003 and
2002, respectively)
|
— | — | 78,814 | (43,355 | ) | ||||||||||||
|
Cumulative effect of change in accounting principles (net of
income tax benefit of $5,532 in 2003)
|
— | — | (8,538 | ) | (7,842 | ) | |||||||||||
|
Net income (loss)
|
31,139 | 29,563 | 43,512 | (178,895 | ) | ||||||||||||
|
Other comprehensive income (loss), net of income tax:
|
|||||||||||||||||
|
Foreign currency translation adjustments (net of income tax
(expense) benefit of $0, $0, $0, and $415, respectively)
|
549 | 248 | 2,743 | (1,485 | ) | ||||||||||||
|
Reclassification adjustments for translation adjustments
included in:
|
|||||||||||||||||
|
Continuing operations
|
— | — | (2,753 | ) | 1,233 | ||||||||||||
|
Discontinued operations
|
— | — | — | 297 | |||||||||||||
|
Unrealized holding gains (losses) on securities arising during
period (net of income tax (expense) benefit of $35, $150,
$(262) and $112, respectively)
|
53 | (225 | ) | 392 | (167 | ) | |||||||||||
|
Minimum pension liability adjustment
|
187 | — | — | 88 | |||||||||||||
|
Other comprehensive income (loss)
|
789 | 23 | 382 | (34 | ) | ||||||||||||
|
Comprehensive income (loss)
|
$ | 31,928 | $ | 29,586 | $ | 43,894 | $ | (178,929 | ) | ||||||||
|
Basic income (loss) per share:
|
|||||||||||||||||
|
Income (loss) from continuing operations
|
$ | 0.59 | $ | (0.54 | ) | $ | (2.56 | ) | |||||||||
|
Income (loss) from discontinued operations
|
— | 1.58 | (0.88 | ) | |||||||||||||
|
Cumulative effect of change in accounting principles
|
— | (0.17 | ) | (0.16 | ) | ||||||||||||
|
Net income (loss)
|
$ | 0.59 | $ | 0.87 | $ | (3.60 | ) | ||||||||||
|
Diluted (loss) income per share:
|
|||||||||||||||||
|
Income (loss) from continuing operations
|
$ | 0.59 | $ | (0.54 | ) | $ | (2.56 | ) | |||||||||
|
Income from discontinued operations
|
— | 1.58 | (0.88 | ) | |||||||||||||
|
Cumulative effect of change in accounting principles
|
— | (0.17 | ) | (0.16 | ) | ||||||||||||
|
Net income (loss)
|
$ | 0.59 | $ | 0.87 | $ | (3.60 | ) | ||||||||||
The accompanying notes are an integral part of the consolidated
financial statements.
E-5
Table of Contents
Covanta Energy Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
| As of December 31, | ||||||||
| Successor | Predecessor | |||||||
| 2003 | ||||||||
| As Restated | ||||||||
| 2004 | (see Note 35) | |||||||
| (In thousands, except | ||||||||
| per share amounts) | ||||||||
| Assets | ||||||||
|
Current Assets:
|
||||||||
|
Cash and cash equivalents
|
$ | 78,112 | $ | 260,902 | ||||
|
Marketable securities available for sale
|
3,100 | — | ||||||
|
Restricted funds held for emergence costs
|
32,805 | — | ||||||
|
Restricted funds held in trust
|
116,092 | 102,199 | ||||||
|
Receivables (less allowances of $433 and $27,893, respectively)
|
131,301 | 166,753 | ||||||
|
Unbilled service receivables
|
58,206 | 63,340 | ||||||
|
Deferred income taxes
|
8,868 | 9,763 | ||||||
|
Prepaid expenses and other current assets (less allowance of
$5,000 in 2003)
|
60,893 | 82,115 | ||||||
|
Total current assets
|
489,377 | 685,072 | ||||||
|
Property, plant and equipment — net
|
859,973 | 1,453,354 | ||||||
|
Restricted funds held in trust
|
123,826 | 125,207 | ||||||
|
Other non-current receivables (less allowance of $170 and
$5,026, respectively)
|
13,798 | 10,096 | ||||||
|
Unbilled service receivables
|
98,248 | 115,267 | ||||||
|
Service and energy contracts and other intangible assets
|
188,637 | 7,073 | ||||||
|
Investments in and advances to investees and joint ventures
|
65,647 | 133,439 | ||||||
|
Other assets
|
31,016 | 84,072 | ||||||
|
Total Assets
|
$ | 1,870,522 | $ | 2,613,580 | ||||
| Liabilities and Shareholders’ Equity (Deficit) | ||||||||
|
Liabilities:
|
||||||||
|
Current Liabilities:
|
||||||||
|
Current portion of recourse debt
|
$ | 112 | $ | 21 | ||||
|
Current portion of project debt
|
109,701 | 108,687 | ||||||
|
Accounts payable
|
16,199 | 23,584 | ||||||
|
Accrued expenses
|
121,013 | 208,342 | ||||||
|
Accrued emergence costs
|
32,805 | — | ||||||
|
Deferred revenue
|
13,965 | 37,431 | ||||||
|
Total current liabilities
|
293,795 | 378,065 | ||||||
|
Recourse debt
|
312,784 | 57 | ||||||
|
Project debt
|
835,036 | 935,278 | ||||||
|
Deferred income taxes
|
166,186 | 195,059 | ||||||
|
Deferred revenue
|
— | 129,304 | ||||||
|
Other liabilities
|
97,848 | 78,358 | ||||||
|
Liabilities subject to compromise
|
— | 956,095 | ||||||
|
Total Liabilities
|
1,705,649 | 2,672,216 | ||||||
|
Minority interests
|
85,420 | 69,398 | ||||||
|
Shareholders’ Equity (Deficit):
|
||||||||
|
Successor common stock, par value $0.01 per share;
authorized and issued two hundred shares as of December 31,
2004
|
— | — | ||||||
|
Predecessor serial cumulative convertible preferred stock, par
value $1.00 per share, authorized, 4,000 shares;
shares outstanding: 33 shares net of treasury shares of 30
|
— | 33 | ||||||
|
Predecessor common stock, par value $0.50 per share;
authorized, 80,000 shares; outstanding: 49,825 shares
net of treasury shares of 4,125
|
— | 24,912 | ||||||
|
Capital surplus
|
47,525 | 188,156 | ||||||
|
Notes receivable from key employees for common stock issuance
|
— | (451 | ) | |||||
|
Retained earnings (deficit)
|
31,139 | (340,661 | ) | |||||
|
Accumulated other comprehensive income (loss)
|
789 | (23 | ) | |||||
|
Total Shareholders’ Equity (Deficit)
|
79,453 | (128,034 | ) | |||||
|
Total Liabilities and Shareholders’ Equity (Deficit)
|
$ | 1,870,522 | $ | 2,613,580 | ||||
The accompanying notes are an integral part of the consolidated
financial statements.
E-6
Table of Contents
Covanta Energy Corporation and Subsidiaries
STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)
| Successor | Predecessor | ||||||||||||||||||||||||||||||||
| For the Period | |||||||||||||||||||||||||||||||||
| March 11, | December 31, | ||||||||||||||||||||||||||||||||
| Through | For the Period | ||||||||||||||||||||||||||||||||
| December 31, | January 1, Through | ||||||||||||||||||||||||||||||||
| 2004 | March 10, 2004 | 2003 | 2002 | ||||||||||||||||||||||||||||||
| Shares | Amounts | Shares | Amounts | Shares | Amounts | Shares | Amounts | ||||||||||||||||||||||||||
| (In thousands, except per share amounts) | |||||||||||||||||||||||||||||||||
|
SERIAL CUMULATIVE CONVERTIBLE PREFERRED STOCK:
|
|||||||||||||||||||||||||||||||||
|
Balance at beginning of period
|
$ | — | 63 | $ | 63 | 63 | $ | 63 | 63 | $ | 64 | ||||||||||||||||||||||
|
Shares converted into common stock
|
— | — | — | — | — | (1 | ) | ||||||||||||||||||||||||||
|
Fresh start adjustments
|
— | (63 | ) | (63 | ) | — | — | — | — | ||||||||||||||||||||||||
|
Total
|
— | — | — | 63 | 63 | 63 | 63 | ||||||||||||||||||||||||||
|
Treasury shares
|
— | (30 | ) | (30 | ) | (30 | ) | (30 | ) | (30 | ) | (30 | ) | ||||||||||||||||||||
|
Cancellation of treasury shares
|
— | 30 | 30 | — | — | — | — | ||||||||||||||||||||||||||
|
Balance at end of period
|
— | — | — | 33 | 33 | 33 | 33 | ||||||||||||||||||||||||||
|
COMMON STOCK:
|
|||||||||||||||||||||||||||||||||
|
Balance at beginning of period
|
— | 53,950 | 26,975 | 53,950 | 26,975 | 53,947 | 26,974 | ||||||||||||||||||||||||||
|
Conversion of preferred shares
|
— | — | — | — | — | 3 | 1 | ||||||||||||||||||||||||||
|
Fresh start adjustment
|
— | (53,950 | ) | (26,975 | ) | — | — | — | — | ||||||||||||||||||||||||
|
Total
|
— | — | — | 53,950 | 26,975 | 53,950 | 26,975 | ||||||||||||||||||||||||||
|
Treasury shares at beginning of period
|
— | 4,125 | 2,063 | 4,125 | 2,063 | 4,112 | 2,056 | ||||||||||||||||||||||||||
|
Issuance of restricted stock
|
— | — | — | — | — | 13 | 7 | ||||||||||||||||||||||||||
|
Fresh start adjustment
|
— | (4,125 | ) | (2,063 | ) | — | — | — | — | ||||||||||||||||||||||||
|
Treasury shares at end of period
|
— | — | — | 4,125 | 2,063 | 4,125 | 2,063 | ||||||||||||||||||||||||||
|
Balance at end of period
|
— | — | — | 49,825 | 24,912 | 49,825 | 24,912 | ||||||||||||||||||||||||||
|
CAPITAL SURPLUS:
|
|||||||||||||||||||||||||||||||||
|
Balance at beginning of period
|
47,525 | 188,156 | 188,156 | 188,371 | |||||||||||||||||||||||||||||
|
Fresh start adjustment
|
(188,156 | ) | — | — | |||||||||||||||||||||||||||||
|
Issuance of common stock
|
29,825 | ||||||||||||||||||||||||||||||||
|
Acquisition costs paid
|
6,400 | ||||||||||||||||||||||||||||||||
|
Stock rights issued
|
11,300 | ||||||||||||||||||||||||||||||||
|
Cancellation of restricted stock
|
— | — | — | (215 | ) | ||||||||||||||||||||||||||||
|
Balance at end of period
|
47,525 | 47,525 | 188,156 | 188,156 | |||||||||||||||||||||||||||||
|
NOTES RECEIVABLE FROM KEY EMPLOYEES FOR
COMMON STOCK ISSUANCE: |
|||||||||||||||||||||||||||||||||
|
Balance at beginning of period
|
— | (451 | ) | (870 | ) | (870 | ) | ||||||||||||||||||||||||||
|
Settlement
|
— | 451 | 419 | — | |||||||||||||||||||||||||||||
|
Balance at end of period
|
— | — | (451 | ) | (870 | ) | |||||||||||||||||||||||||||
|
UNEARNED RESTRICTED STOCK COMPENSATION:
|
|||||||||||||||||||||||||||||||||
|
Balance at beginning of period
|
— | (54 | ) | (664 | ) | ||||||||||||||||||||||||||||
|
Issuance (cancellation) of restricted common stock
|
— | 222 | |||||||||||||||||||||||||||||||
|
Amortization of unearned restricted stock compensation
|
— | — | 54 | 388 | |||||||||||||||||||||||||||||
|
Balance at end of period
|
— | — | — | (54 | ) | ||||||||||||||||||||||||||||
|
EQUITY (DEFICIT):
|
|||||||||||||||||||||||||||||||||
|
Balance at beginning of period
|
— | (340,661 | ) | (384,173 | ) | (205,262 | ) | ||||||||||||||||||||||||||
|
Net income (loss)
|
31,139 | 29,563 | 43,512 | (178,895 | ) | ||||||||||||||||||||||||||||
|
Fresh start adjustment
|
— | 311,098 | — | — | |||||||||||||||||||||||||||||
|
Total
|
31,139 | — | (340,661 | ) | (384,157 | ) | |||||||||||||||||||||||||||
|
Preferred dividends-per share of $$0.47 in 2002
|
— | — | — | 16 | |||||||||||||||||||||||||||||
|
Balance at end of period
|
31,139 | — | (340,661 | ) | (384,173 | ) | |||||||||||||||||||||||||||
|
CUMULATIVE TRANSLATION ADJUSTMENT:
|
|||||||||||||||||||||||||||||||||
|
Balance at beginning of period
|
— | (248 | ) | (238 | ) | (283 | ) | ||||||||||||||||||||||||||
|
Foreign currency translation adjustments
|
549 | 935 | 2,743 | (1,485 | ) | ||||||||||||||||||||||||||||
|
Fresh start adjustment
|
— | (687 | ) | — | — | ||||||||||||||||||||||||||||
|
Less reclassification adjustments for translation adjustments:
|
|||||||||||||||||||||||||||||||||
|
Gain (loss) from continuing operations
|
— | — | (2,753 | ) | 1,233 | ||||||||||||||||||||||||||||
|
Gain from discontinued operations
|
— | — | — | 297 | |||||||||||||||||||||||||||||
|
Balance at end of period
|
549 | — | (248 | ) | (238 | ) | |||||||||||||||||||||||||||
|
MINIMUM PENSION LIABILITY ADJUSTMENT:
|
|||||||||||||||||||||||||||||||||
|
Balance at beginning of period
|
— | — | 88 | — | |||||||||||||||||||||||||||||
|
Minimum pension liability adjustment
|
187 | — | (88 | ) | 88 | ||||||||||||||||||||||||||||
|
Balance at end of period
|
187 | — | — | 88 | |||||||||||||||||||||||||||||
|
NET UNREALIZED GAIN (LOSS) ON SECURITIES
AVAILABLE FOR SALE: |
|||||||||||||||||||||||||||||||||
|
Balance at beginning of period
|
— | 225 | (167 | ) | — | ||||||||||||||||||||||||||||
|
Gain (loss) for period
|
53 | 167 | 392 | (167 | ) | ||||||||||||||||||||||||||||
|
Fresh start adjustment
|
— | (392 | ) | — | — | ||||||||||||||||||||||||||||
|
Balance at end of period
|
53 | — | 225 | (167 | ) | ||||||||||||||||||||||||||||
|
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
|
789 | — | (23 | ) | (317 | ) | |||||||||||||||||||||||||||
|
TOTAL SHAREHOLDERS’ EQUITY (DEFICIT)
|
$ | 79,453 | $ | 47,525 | $ | (128,034 | ) | $ | (172,313 | ) | |||||||||||||||||||||||
The accompanying notes are an integral part of the consolidated
financial statements.
E-7
Table of Contents
Covanta Energy Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Successor | Predecessor | |||||||||||||||||
| December 31, | ||||||||||||||||||
| For the | For the | |||||||||||||||||
| Period | Period | 2003 | 2002 | |||||||||||||||
| March 11, | January 1, | As | As | |||||||||||||||
| Through | Through | Restated | Restated | |||||||||||||||
| December 31, | March 10, | (See | (See | |||||||||||||||
| 2004 | 2004 | Note 35) | Note 35) | |||||||||||||||
| (In thousands) | ||||||||||||||||||
|
Cash Flows From Operating Activities:
|
||||||||||||||||||
|
Net income (loss)
|
$ | 31,139 | $ | 29,563 | $ | 43,512 | $ | (178,895 | ) | |||||||||
|
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities of continuing operations:
|
||||||||||||||||||
|
Loss (gain) from discontinued operations
|
— | — | (78,814 | ) | 43,355 | |||||||||||||
|
Gain on cancellation of pre-petition debt
|
— | (510,680 | ) | — | — | |||||||||||||
|
Fresh start adjustments
|
— | 399,063 | — | — | ||||||||||||||
|
Fresh start tax adjustments
|
— | 29,601 | — | — | ||||||||||||||
|
Reorganization items
|
— | 58,282 | 83,346 | 49,106 | ||||||||||||||
|
Payment of reorganization items
|
— | (49,782 | ) | (57,034 | ) | (26,928 | ) | |||||||||||
|
Depreciation and amortization
|
55,821 | 13,426 | 71,932 | 77,368 | ||||||||||||||
|
Deferred income taxes provided
|
12,335 | 1,927 | (23,734 | ) | 4,119 | |||||||||||||
|
Provision for doubtful accounts
|
733 | 852 | 10,241 | 20,013 | ||||||||||||||
|
Bank fees
|
— | — | — | 23,685 | ||||||||||||||
|
Gain on sale of business
|
(245 | ) | — | — | — | |||||||||||||
|
Write-downs and obligations related to assets held for sale
|
— | — | 16,704 | 84,863 | ||||||||||||||
|
Equity in income from unconsolidated investments
|
(17,535 | ) | (3,924 | ) | (24,400 | ) | (24,356 | ) | ||||||||||
|
Dividends from equity investees
|
3,106 | — | — | — | ||||||||||||||
|
Amortization of project debt premium and discount
|
(10,457 | ) | — | — | — | |||||||||||||
|
Accretion on principal of senior secured notes
|
2,736 | — | — | — | ||||||||||||||
|
Cumulative effect of change in accounting principles, net of
income taxes
|
— | — | 8,538 | 7,842 | ||||||||||||||
|
Minority interests
|
6,919 | 2,511 | 8,905 | 9,104 | ||||||||||||||
|
Other
|
3,400 | (243 | ) | 7,781 | (22,107 | ) | ||||||||||||
|
Management of operating assets and liabilities:
|
||||||||||||||||||
|
Decrease (increase) in assets:
|
||||||||||||||||||
|
Receivables
|
10,947 | 2,989 | (1,715 | ) | 15,674 | |||||||||||||
|
Restricted funds held for emergence costs
|
65,681 | (99,986 | ) | — | — | |||||||||||||
|
Unbilled service receivables
|
11,221 | 284 | 9,163 | 5,371 | ||||||||||||||
|
Other assets
|
(3,265 | ) | (14,043 | ) | 4,221 | 2,666 | ||||||||||||
|
Increase (decrease) in liabilities:
|
||||||||||||||||||
|
Accounts payable
|
(8,059 | ) | 3,853 | 23,150 | 33,571 | |||||||||||||
|
Accrued expenses
|
10,050 | (83,546 | ) | (73,240 | ) | 853 | ||||||||||||
|
Accrued emergence costs
|
(65,681 | ) | 99,986 | — | — | |||||||||||||
|
Deferred revenue
|
(1,395 | ) | 229 | (693 | ) | (2,815 | ) | |||||||||||
|
Other liabilities
|
6,380 | (371 | ) | 6,539 | (55,006 | ) | ||||||||||||
|
Net cash provided by (used in) operating activities of
continuing operations
|
113,831 | (120,009 | ) | 34,402 | 67,483 | |||||||||||||
|
Cash Flows From Investing Activities:
|
||||||||||||||||||
|
Proceeds from sale of businesses
|
1,799 | — | 33,171 | 18,871 | ||||||||||||||
|
Proceeds from sale of property, plant, and equipment
|
1,232 | 86 | 406 | 988 | ||||||||||||||
|
Proceeds from sale of marketable securities
|
276 | 87 | 564 | 646 | ||||||||||||||
|
Investment in marketable securities available for sale
|
(4,421 | ) | — | — | — | |||||||||||||
|
Proceeds from sale of investment
|
— | — | 493 | — | ||||||||||||||
|
Investments in facilities
|
(11,877 | ) | (4,192 | ) | (21,174 | ) | (18,164 | ) | ||||||||||
|
Other capital expenditures
|
— | — | (980 | ) | (3,103 | ) | ||||||||||||
|
Distributions from investees and joint ventures
|
14,705 | 6,401 | 11,511 | 27,863 | ||||||||||||||
|
Increase in investments in and advances to investees and joint
ventures
|
— | (279 | ) | — | (296 | ) | ||||||||||||
|
Net cash provided by investing activities of continuing
operations
|
1,714 | 2,103 | 23,991 | 26,805 | ||||||||||||||
|
Cash Flows From Financing Activities:
|
||||||||||||||||||
|
Borrowings for facilities
|
14,488 | — | 10,562 | 3,825 | ||||||||||||||
|
New borrowings
|
— | — | — | 2,277 | ||||||||||||||
|
Decrease (increase) in restricted funds held in trust
|
(13,839 | ) | (6,075 | ) | 30,321 | (23,100 | ) | |||||||||||
|
Payment of project debt
|
(67,943 | ) | (28,089 | ) | (149,956 | ) | (120,924 | ) | ||||||||||
|
Payment of recourse debt
|
(19,673 | ) | — | — | — | |||||||||||||
|
Distributions to secured lenders and 9.25% holders
|
— | (80,507 | ) | — | — | |||||||||||||
|
Proceeds from issuance of stock
|
— | 29,825 | — | — | ||||||||||||||
|
Distribution to minority partners
|
(8,261 | ) | (530 | ) | — | — | ||||||||||||
|
Proceeds from sale of minority interests
|
— | 175 | — | — | ||||||||||||||
|
Other
|
— | — | (5,265 | ) | (4,103 | ) | ||||||||||||
|
Net cash used in financing activities of continuing operations
|
(95,228 | ) | (85,201 | ) | (114,338 | ) | (142,025 | ) | ||||||||||
|
Net cash provided by discontinued operations
|
— | — | 217,783 | 63,228 | ||||||||||||||
|
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
20,317 | (203,107 | ) | 161,838 | 15,491 | |||||||||||||
|
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
|
57,795 | 260,902 | 99,064 | 83,573 | ||||||||||||||
|
CASH AND CASH EQUIVALENTS AT END OF PERIOD
|
$ | 78,112 | $ | 57,795 | $ | 260,902 | $ | 99,064 | ||||||||||
The accompanying notes are an integral part of the consolidated
financial statements.
E-8
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
(In thousands, except per share amounts)
| 1. | Basis of Presentation |
The accompanying consolidated financial statements include the
accounts of Covanta Energy Corporation and its subsidiaries. The
consolidated financial statements presented reflect the
reorganization under which Covanta became a wholly-owned
subsidiary of Danielson as of March 10, 2004. See
Note 2 to the Consolidated Financial Statements for a
description of the reorganization.
Accordingly, the consolidated financial statements for the
period beginning on the day after the Effective Date through
December 31, 2004 reflect both fresh start accounting in
accordance with American Institute of Certified Public
Accountants Statement of Position 90-7 “Financial
Reporting by Entities in Reorganization under the Bankruptcy
Code” (“SOP 90-7”) and business combination
accounting in accordance with Statement of Financial Accounting
Standards No. 141 “Business Combinations”
(“SFAS No. 141”) and SFAS No. 109
“Accounting for Income Taxes”
(“SFAS No. 109”). References in the
financial statements to the “Predecessor” refer to the
Company prior to and including March 10, 2004. References
to the “Successor” refer to the Company after
March 10, 2004.
The consolidated financial statements of the Predecessor were
prepared in accordance with SOP 90-7. Accordingly, all
pre-petition liabilities believed to be subject to compromise
were segregated in the Consolidated Balance Sheet and classified
as liabilities subject to compromise, at the estimated amount of
allowable claims. Liabilities not believed to be subject to
compromise were separately classified as current and
non-current, as appropriate. Revenues, expenses (including
professional fees relating to the bankruptcy proceeding),
realized gains and losses, and provisions for losses resulting
from the reorganization were reported separately as
reorganization items. Also, interest expense was accrued during
the Chapter 11 Cases only to the extent that it was to be
paid. As authorized by the Bankruptcy Court, debt service
continued to be paid on the Company’s project debt
throughout the Chapter 11 Cases. Cash used for
reorganization items is disclosed separately in the Consolidated
Statements of Cash Flows.
The Predecessor consolidated financial statements for the years
ended December 31, 2003 and 2002 have been prepared on a
“going concern” basis in accordance with accounting
principles generally accepted in the United States of America.
The “going concern” basis of presentation assumes that
the Company will continue in operation for the foreseeable
future and will be able to realize its assets and discharge it
liabilities in the normal course of business. The Company’s
ability to continue as a “going concern” was subject
to substantial doubt in 2003 and 2002 and was dependent upon,
among other things, (i) the Company’s ability to
utilize the NOLs of Danielson, and (ii) the Company’s
ability to generate sufficient cash flows from operations, asset
sales and financing arrangements to meet its obligations. If the
“going concern” basis were not used for the
consolidated financial statements in the years ended
December 31, 2003 and 2002, significant adjustments would
have been necessary to the carrying values of assets and
liabilities, the revenues and expenses reported, and the balance
sheet classifications used. See Note 2, for a description
about the Company’s reorganization.
Covanta is engaged in developing, constructing, owning and
operating for others, key infrastructure for the conversion of
waste-to-energy, independent power production and the treatment
of water and wastewater in the United States and abroad.
Companies in which Covanta has significant influence are
accounted for using the equity method. Those companies in which
Covanta owns less than 20% are accounted for using the cost
method.
The Company’s subsidiaries owning and operating the
Company’s Warren County, New Jersey and Lake County,
Florida waste-to-energy facilities and which were engaged in the
Tampa Bay, Florida desalination project remained
debtors-in-possession (the “Remaining Debtors”) after
the Effective Date, and were not the subject of the
Reorganization Plan. As a result, the Company recorded its
investment in the Remaining Debtors using the equity method as
of March 10, 2004. Subsequent to the Effective Date, the
Tampa Bay, Florida subsidiaries and the Lake County, Florida
subsidiaries reached agreements with their counterparties
E-9
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
and emerged from bankruptcy on August 6, 2004 and
December 14, 2004, respectively. The Company has included
these entities as consolidated subsidiaries in its financial
statements since their respective emergence dates. See
Note 2 to the Consolidated Financial Statements for
additional information regarding these settlements.
Three of the Company’s subsidiaries, which relate to the
Warren Facility, have not reorganized or filed a liquidation
plan under Chapter 11 of the United States Bankruptcy Code.
While Covanta exercises significant influence over the operating
and financial policies of these subsidiaries, these subsidiaries
will continue to operate as debtors in possession in the
Chapter 11 case until they reorganize or liquidate. Because
any plan of reorganization or liquidation relating to these
debtors would have to be approved by the Bankruptcy Court, and
possibly their respective creditors, the Company does not
control these debtors or the ultimate outcome of their
respective Chapter 11 case. Accordingly, Covanta no longer
includes these subsidiaries as consolidated subsidiaries in the
consolidated financial statements. Covanta’s investment in
these subsidiaries is recorded using the equity method effective
as of March 10, 2004. Unless these subsidiaries emerge from
bankruptcy under Covanta’s control, it is unlikely that
they will contribute to Covanta’s results of operations.
All intercompany transactions and balances have been eliminated.
| 2. | Reorganization and Financing Agreements |
| Reorganization Plan |
On March 10, 2004, Covanta consummated a plan of
reorganization and except for six subsidiaries, emerged from its
reorganization proceeding under the Bankruptcy Code. As a result
of the consummation of the plan, Covanta is a wholly owned
subsidiary of Danielson. The Chapter 11 proceedings
commenced on April 1, 2002 (the “First Petition
Date”), when Covanta and 123 of its domestic subsidiaries
filed voluntary petitions for relief under Chapter 11 of
the Bankruptcy Code in the United States Bankruptcy Court for
the Southern District of New York (the “Bankruptcy
Court”). After the First Petition Date, thirty-two
additional subsidiaries filed their Chapter 11 petitions
for relief under the Bankruptcy Code. Eight subsidiaries that
had filed petitions on the First Petition Date were sold as part
of the Company’s disposition of assets during the
bankruptcy cases and are no longer owned by the Company. All of
the bankruptcy cases (the “Chapter 11 Cases”)
were jointly administered under the caption “In re Ogden
New York Services, Inc., et al., Case
Nos. 02-40826 (CB), et al.” During the
Chapter 11 Cases, the debtors in the proceeding
(collectively, the “Debtors”) operated their business
as debtors-in-possession pursuant to the Bankruptcy Code.
International operations and certain other subsidiaries and
joint venture partnerships were not included in the bankruptcy
filings.
Over the course of the Chapter 11 Cases, the Company held
discussions with the Official Committee of Unsecured Creditors
(the “Creditors Committee”), representatives of
certain of the Company’s prepetition bank lenders and other
lenders (the “DIP Lenders” and together with the
Company’s pre-petition bank lenders, the “Secured Bank
Lenders”) under the DIP Financing Facility, as discussed
below, and the holders of the 9.25% Debentures with respect
to possible capital and debt structures for the Debtors and the
formulation of a plan for its reorganization.
On December 2, 2003, Covanta and Danielson entered into the
Danielson Agreement, which provided for:
| • | Danielson to purchase 100% of the Covanta New Common for $30 million as part of a plan of reorganization (the “Danielson Transaction”); | |
| • | agreement as to new revolving credit and letter of credit facilities for the Company’s domestic and international operations, provided by certain of the Secured Bank Lenders and a group of additional lenders organized by Danielson; and | |
E-10
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| • | execution and consummation of the Tax Sharing Agreement between Danielson and Covanta, pursuant to which (a) Covanta (exclusive of its international holding company), will file a consolidated tax return with Danielson, and (b) Danielson will make all of Danielson’s NOLs generated through December 31, 2002, available to Covanta for purposes of Covanta’s calculation for its portion of the consolidated tax liability it pays to Danielson. |
The Company determined that the Danielson Transaction was in the
best interests of their estates and their creditors, and was
preferable to other alternatives under consideration because it
provided:
| • | a more favorable capital structure for the Company upon emergence from Chapter 11; | |
| • | the injection of $30 million in equity from Danielson; | |
| • | enhanced access to capital markets through Danielson; | |
| • | diminished syndication risk in connection with the Company’s financing under the exit financing agreements; and | |
| • | reduced exposure of the Secured Bank Lenders as a result of financing arranged by new lenders. | |
On March 5, 2004, the Bankruptcy Court entered an order
confirming the Company’s plan of reorganization premised on
the Danielson Transaction and liquidation for certain of those
Debtors involved in non-core businesses. On March 10, 2004
both plans were effected upon the consummation of the Danielson
Transaction. The following is a summary of material provisions
of the Reorganization Plan. The Remaining Debtors owning or
operating the Company’s Warren County, New Jersey, Lake
County, Florida, and Tampa Bay, Florida projects initially
remained debtors-in-possession, and were not the subject of the
Reorganization Plan. During 2004, the Company’s
subsidiaries involved with Tampa Bay project and the Lake County
project emerged from bankruptcy under separate reorganization
plans. The Company’s subsidiaries involved with the Warren
County project remain in Bankruptcy. As part of its
reorganization, the Company disposed of all of its interests in
its former entertainment and aviation businesses, which were
either sold prior to the Effective Date or included in the
liquidation plan.
The Reorganization Plan provided for, among other things, the
following distributions:
(i) Secured Lender and 9.25% Debenture Holder Claims
On account of their allowed secured claims, the Secured Lenders
and the 9.25% Debenture holders received, in the aggregate,
a distribution consisting of:
| • | the cash available for distribution after payment by the Company of exit costs necessary to confirm the Reorganization Plan and establishment of required reserves pursuant to the Reorganization Plan, | |
| • | new high-yield secured notes issued by Covanta and guaranteed by its subsidiaries (other than Covanta Power International Holdings, Inc. (“CPIH”) and its subsidiaries) which are not contractually prohibited from incurring or guaranteeing additional debt (Covanta and such subsidiaries, the “Domestic Borrowers”) with a stated maturity of seven years (the “High Yield Notes”), and | |
| • | a term loan of CPIH with a stated maturity of 3 years. | |
In addition, the 9.25% Debenture holders were granted the
right to purchase up to 3 million shares of Danielson
common stock.
(ii) Unsecured Claims against Operating Company Subsidiaries
The holders of allowed unsecured claims against any of the
Company’s operating subsidiaries received or will receive
unsecured notes bearing interest at 7.5% per annum in a
principal amount equal to the amount of their allowed unsecured
claims with a stated maturity of 8 years (the
“Unsecured Notes”).
E-11
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
(iii) Unsecured Claims against Covanta and Holding Company
Subsidiaries
The holders of allowed unsecured claims against Covanta or
certain of its holding company subsidiaries will receive, in the
aggregate, their pro rata share of a distribution consisting of
(a) $4 million in principal amount of the Unsecured
Notes, (b) a participation interest equal to 5% of the
first $80 million in net proceeds received in connection
with the sale or other disposition of CPIH and its subsidiaries
used to pay-down CPIH debt, if it were to affect asset sales,
and (c) the recoveries, if any, from actions which such
holders are entitled to bring under the Reorganization Plan on
behalf of the Debtors’ estates. In addition, the holders of
such claims are entitled to receive a pro rata distribution
which is equal to 12.5% of the value of distributions otherwise
payable to the 9.25% Debenture Holders.
(iv) Subordinated Claims of Holders of Convertible
Subordinated Debentures
The holders of Covanta’s 6% Convertible Subordinated
Debentures and its 5.75% Convertible Subordinated
Debentures together, (the “Convertible Subordinated
Debentures”) received no distribution or retain any
property pursuant to the proposed Reorganization Plan. The
Convertible Subordinated Debentures were cancelled as of
March 10, 2004, the Effective Date of the Reorganization
Plan.
(v) Equity interests of Old Common and Old Preferred
stockholders
The holders of Covanta’s Old Preferred and Old Common stock
outstanding immediately before consummation of the DHC
Transaction received no distribution and retained no property
pursuant to the Reorganization Plan. The Old Preferred stock and
Old Common stock was cancelled as of March 10, 2004, the
Effective Date of the Reorganization Plan.
The Reorganization Plan provided for the complete liquidation of
those of the Company’s subsidiaries that have been
designated as liquidating entities. Substantially all of the
assets of these liquidating entities have already been sold.
Under the Reorganization Plan the creditors of the liquidating
entities will not receive any distribution other than those
administrative creditors with respect to claims against the
liquidating entities that have been incurred in the
implementation of the Reorganization Plan and priority claims
required to be paid under the Bankruptcy Code.
Covanta had the right during the Chapter 11 Cases, subject
to Bankruptcy Court approval and certain other limitations, to
assume or reject executory contracts and unexpired leases. As a
condition to assuming a contract, the Company was required to
cure all existing defaults (including payment defaults). The
Company paid approximately $9 million in cure amounts
associated with assumed executory contracts and unexpired
leases. Several counterparties have indicated that they believe
that actual cure amounts are greater than the amounts specified
in the Company’s notices, and there can be no assurance
that the cure amounts ultimately associated with assumed
executory contracts and unexpired leases will not be materially
higher than the amounts estimated by the Company.
The Company has substantially completed the process of
reconciling recorded pre-petition liabilities with proofs of
claim filed by creditors with the Bankruptcy Court. The Company
expects this process to conclude during 2005. The Company
intends to contest claims to the extent they materially exceed
the amounts the Company believes may be due. The Company
believes the claims resolution process will not result in
material liabilities in excess of those recorded in its
consolidated financial statements.
E-12
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| Financing the Reorganization Plan |
As a result of the consummation of the Danielson Transaction,
the Company emerged from bankruptcy with a new debt structure.
Domestic Borrowers have two credit facilities:
| • | a letter of credit facility (the “First Lien Facility”), for the issuance of letters of credit required in connection with one waste-to-energy facility, the current aggregate amount of which is approximately $120 million at December 31, 2004, and | |
| • | a letter of credit and liquidity facility (the “Second Lien Facility”), in the aggregate amount of $118 million, of which approximately $71 million is outstanding at December 31, 2004, up to $10 million of which shall also be available for cash borrowings on a revolving basis and the balance for letters of credit. | |
Both facilities expire on March 10, 2009, and are secured
by the assets of the Domestic Borrowers not otherwise pledged.
The lien of the Second Lien Facility is junior to that of the
First Lien Facility.
The Domestic Borrowers also issued the High Yield Notes and
issued or will issue the Unsecured Notes. The High Yield Notes
are secured by a third priority lien in the same collateral
securing the First Lien Facility and the Second Lien Facility.
The High Yield Notes were issued in the initial principal amount
of $205 million, which will accrete to $230 million at
maturity in 7 years. The current accreted amount of the
High Yield Notes at December 31, 2004 is approximately
$207.7 million.
Unsecured Notes in a principal amount of $4 million were
issued on the effective date of the Reorganization Plan. The
Company issued additional Unsecured Notes in the principal
amount of $20 million after emergence and recorded
additional Unsecured Notes in a principal amount of
$4 million in 2004 which it expects to issue in 2005. The
final principal amount of all Unsecured Notes will be equal to
the amount of allowed unsecured claims against the
Company’s operating subsidiaries which were Reorganizing
Debtors, and such amount will be determined at such time as the
allowance of all such claims are resolved through settlement or
further proceedings in the Bankruptcy Court. Notwithstanding the
date on which Unsecured Notes are issued, interest on the
Unsecured Notes accrues from March 10, 2004.
Also, CPIH and each of its domestic subsidiaries, which hold all
of the assets and operations of the Company’s international
businesses (the “CPIH Borrowers”) entered into two
secured credit facilities:
| • | a revolving credit facility, secured by a first priority lien on substantially all of the CPIH Borrowers’ assets not otherwise pledged, consisting of commitments for cash borrowings in the initial amount of up to $10 million (reduced to $9.1 million as of December, 2004), which remains undrawn as of December 31, 2004, for purposes of supporting the international businesses and | |
| • | a term loan facility of up to $95 million of which approximately $77 million is outstanding at December 31, 2004, secured by a second priority lien on the same collateral. | |
Both facilities will mature in March 2007. The debt of the CPIH
Borrowers is non-recourse to Covanta and its other domestic
subsidiaries.
| Project Developments Post Emergence |
The Debtors and contract parties have reached agreement with
respect to material restructuring of their mutual obligations in
connection with the waste-to-energy projects and the water
project described below. The Debtors were also involved in
material disputes and/or litigation with respect to the
waste-to-energy project in Warren County, New Jersey. See
Note 31 to the Consolidated Financial Statements for
possible ramifications if agreement is not reached in this
restructuring.
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| 1. The Town of Babylon, New York (“Babylon”) filed a proof of claim against Covanta Babylon, Inc. (“Covanta Babylon”) for approximately $13.4 million in pre-petition damages and $5.5 million in post-petition damages, alleging that Covanta Babylon has accepted less waste than required under the Service Agreement between Babylon and Covanta Babylon, and that Covanta’s Chapter 11 proceeding imposed on Babylon additional costs for which Covanta Babylon should be responsible. The Company filed an objection to Babylon’s claim, asserting that it is in full compliance with the express requirements of the Service Agreement and was entitled to adjust the amount of waste it is required to accept to reflect the energy content of the waste delivered. Covanta Babylon also asserted that the costs arising from its Chapter 11 proceeding are not recoverable by Babylon. After lengthy discussions, Babylon and Covanta Babylon reached a settlement in principle pursuant to which, in part, (i) the parties agree to amend the Service Agreement to adjust Covanta Babylon’s operational procedures for accepting waste, reduce Covanta Babylon’s waste processing obligations, increase Babylon’s additional waste service fee to Covanta Babylon, and reduce Babylon’s annual operating and maintenance fee to Covanta Babylon; (ii) Covanta Babylon agreed to pay a specified amount to Babylon in consideration for a release of any and all claims (other than its rights under the settlement documents) that Babylon held against the Company and in satisfaction of Babylon’s administrative expense claims against Covanta Babylon; and (iii) allocates additional costs relating to the project’s swap financing as a result of Covanta Babylon’s Chapter 11 proceedings until such costs are eliminated. The restructuring became effective on March 12, 2004. A settlement charge of $2.7 million was recorded in reorganization items for 2003. | |
| 2. During 2003 Covanta Tampa Construction, Inc. (“CTC”) completed construction of a 25 million gallon per day desalination-to-drinking water facility under a contract with Tampa Bay Water (“TBW”) near Tampa, Florida. Covanta Energy Group, Inc., guaranteed CTC’s performance under its construction contract with TBW. A separate subsidiary, Covanta Tampa Bay, Inc. (“CTB”) entered into a contract with TBW to operate the Tampa Water Facility after construction and testing was to be completed by CTC. | |
| As construction of the Tampa Water Facility neared completion, the parties had material disputes between them. These disputes led to TBW issuing a default notice to CTC and shortly thereafter CTC filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code. | |
| In February 2004 the Company and TBW reached a tentative compromise of their disputes which was approved by the Bankruptcy Court. | |
| On July 14, 2004, the Bankruptcy Court confirmed a plan of reorganization for CTC and CTB, which incorporated the terms of the settlement between the Company and TBW. That plan became effective on August 6, 2004 when CTC and CTB emerged from bankruptcy. After payment of certain creditor claims under the CTC and CTB plan, the Company realized approximately $4 million of the proceeds from the settlement with TBW. These subsidiaries emerged from bankruptcy without material assets or liabilities, and without contractual rights to operate the Tampa Bay facility. | |
| 3. In late 2000, Lake County, Florida commenced a lawsuit in Florida state court against Covanta Lake, Inc. (now merged with Covanta Lake II, Inc., (“Covanta Lake”) which also refers to its merged successor, as defined below) relating to the waste-to-energy facility operated by Covanta in Lake County, Florida (the “Lake Facility”). In the lawsuit, Lake County sought to have its service agreement with Covanta Lake declared void and in violation of the Florida Constitution. That lawsuit was stayed by the commencement of the Chapter 11 Cases. Lake County subsequently filed a proof of claim seeking in excess of $70 million from Covanta Lake and Covanta. | |
| On June, 20, 2003, Covanta Lake filed a motion with the Bankruptcy Court seeking entry of an order (i) authorizing Covanta Lake to assume, effective upon confirmation of a plan of reorganization for Covanta Lake, its service agreement with Lake County, (ii) finding no cure amounts due under the | |
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| service agreement, and (iii) seeking a declaration that the service agreement is valid, enforceable and constitutional, and remains in full force and effect. | |
| Contemporaneously with the filing of the assumption motion, Covanta Lake filed an adversary complaint asserting that Lake County is in arrears to Covanta Lake in the amount of more than $8.5 million. Shortly before trial commenced in these matters, the Company and Lake County reached a tentative settlement calling for a new agreement specifying the parties’ obligations and restructuring of the project. That settlement and the proposed restructuring involved, among other things, termination of the existing service agreement and the execution of a new waste disposal agreement providing for a put-or-pay obligation on Lake County’s part to deliver 163,000 tons per year of acceptable waste to the Lake Facility and a different fee structure; a replacement guarantee from Covanta in a reduced amount; the payment by Lake County of all amounts due as “pass through” costs with respect to Covanta Lake’s payment of property taxes; the payment by Lake County of a specified amount in each of 2004, 2005 and 2006 in reimbursement of certain capital costs; the settlement of all pending litigation; and a refinancing of the existing bonds. | |
| The Lake settlement was contingent upon, among other things, receipt of all necessary approvals, as well as a favorable outcome to the Company’s pending objection to the proof of claims filed by F. Browne Gregg, a third-party claiming an interest in the existing service agreement that would be terminated under the proposed settlement. In November, 2003, the Bankruptcy Court conducted a trial on Mr. Gregg’s proofs of claim. At issue in the trial was whether Mr. Gregg was entitled to damages as a result of Covanta Lake’s proposed termination of the existing service agreement and entry into a waste disposal agreement with Lake County. On August 19, 2004, the Bankruptcy Court ruled on the Company’s claims objections, finding in favor of Covanta Lake. Based on the foregoing, the Company determined to propose a plan of reorganization for Covanta Lake, and on September 10, 2004 filed a plan of reorganization based on the Lake settlement (the “Lake Plan”). | |
| Subsequent to filing of the Lake Plan, the Company entered into a settlement agreement with Mr. Gregg, pursuant to which the parties exchanged mutual releases. The settlement was approved by the Bankruptcy Court. | |
| The Lake Plan of reorganization provides for, among other things, a settlement of all litigation between Covanta Lake and Lake County and the refunding and payment of all amounts due with respect to secured project debt associated with the Lake project through new financing procured by the County, and includes the following treatment of creditor claims: | |
| (i) the forgiveness of all amounts advanced by Covanta to Covanta Lake as super-priority debtor-in-possession loans and post-petition intercompany indebtedness; and | |
| (ii) cash distributions to unsecured creditors of Covanta Lake reflecting each such unsecured creditor’s pro rata share of $0.3 million, which amount was be adequate to fund cash distributions to unsecured creditors in the full amount of their respective allowed. | |
The Lake Plan was confirmed by the Bankruptcy Court on
December 3, 2004. On December 14, 2004, Covanta Lake
and the County entered into the new agreements, releases, and
financing arrangements contemplated by the Lake Plan, and
Covanta Lake emerged from bankruptcy on that date.
| Reorganization Disclosures |
On October 23, 2003, the Bankruptcy Court authorized
Covanta to enter into an agreement (the “Mackin
Agreement”) between the Company and Scott G. Mackin, the
then President/Chief Executive Officer of Covanta. Pursuant to
the Mackin Agreement, Mr. Mackin resigned as President/CEO
of Covanta on November 6, 2003. In order to retain the
critical knowledge and insight of the waste-to-energy business
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
which Mr. Mackin possesses and to further strengthen
Covanta, the Mackin Agreement provides that Covanta shall engage
Mr. Mackin as a consultant to the Company immediately upon
his resignation date for a term ending on the second anniversary
of his resignation. Also, Mr. Mackin remained a member of
the Board of Directors of Covanta until the effective date of
the Reorganization Plan. Additionally, pursuant to the Mackin
Agreement, Mr. Mackin has agreed to a three-year
non-compete with the Company’s waste-to-energy business and
has agreed not to work directly or indirectly for Client
Communities of the Company’s waste-to-energy business for
three years following his resignation date. Pursuant to the
terms of the Mackin Agreement, Mr. Mackin was paid in 2003
the amounts due in respect of the Bankruptcy Court-approved
retention and severance plans and $1.0 million in
consulting fees. In 2004 he was paid the balance due under the
retention plan, approximately $2.1 million due under the
Bankruptcy Court-approved long-term incentive plan and his bonus
for year 2003. Mr. Mackin will be paid an additional
$0.6 million in consulting fees and vested retirement
benefits in accordance with the Mackin Agreement over the
two year period following his resignation. An expense of
$3.6 million was recorded in 2003 for
Mr. Mackin’s severance costs.
In connection with the Chapter 11 Cases, in September 2003,
Covanta and certain of its debtor and non-debtor subsidiaries
(collectively, the “Sellers”) executed an ownership
interest purchase agreement (as amended, the “Original
Agreement”) with certain affiliates of ArcLight Energy
Partners Fund I, L.P. and Caithness
Energy, L.L.C. (collectively, the “Original Geothermal
Buyers”) providing for the sale of the Sellers’
interests in the Geothermal Business, subject to higher or
better offers. The Original Agreement entitled the Original
Geothermal Buyers to a break-up fee of $5.4 million (the
“Break-Up Fee”) in the event that a higher or better
offer was chosen in an auction held in the Bankruptcy Court. The
purchase price under the Original Agreement was
$170 million, subject to adjustment.
On September 8, 2003, certain of the Debtors (the
“Heber Debtors”) filed a reorganization plan and
relating disclosure statement in connection with the proposed
sale (as amended, the “Heber Plan”). On
September 29, 2003, the Court entered an order approving
the competitive bidding and auction procedures, including the
Break-Up Fee (the “Break-Up Fee”), for the purpose of
obtaining the highest or best offer for the Geothermal Business
(the “Bidding Procedures Order”). On November 19,
2003, the Bankruptcy Court held an auction to consider bids for
the Geothermal Business pursuant to the Bidding Procedures
Order. Following the auction, Covanta, with the consent of its
creditor representatives, determined that the bid submitted by
certain affiliates of Ormat Nevada, Inc. (“Ormat”),
which offered a purchase price of $214 million, subject to
adjustment, represented the highest or best offer for the
Geothermal Business. On November 21, 2003, the Court
entered an order confirming the Heber Plan and approving the
sale of the Geothermal Business to Ormat pursuant to a purchase
agreement that was executed on November 21, 2003. On
December 18, 2003 Covanta sold the Geothermal Business to
Ormat for cash consideration of $214 million, subject to a
working capital adjustment. The Company paid the Original
Geothermal Buyers the Break-Up Fee.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
In accordance with SOP 90-7, the Company has segregated and
classified certain income and expenses as reorganization items.
The following reorganization items were incurred during the
periods ended March 10, 2004 and December 31, 2003 and
2002:
| For the | For the | For the | |||||||||||
| Period Ended | Year Ended | Year Ended | |||||||||||
| March 10, | December 31, | December 31, | |||||||||||
| 2004 | 2003 | 2002 | |||||||||||
|
Legal and professional fees
|
$ | 27,562 | $ | 48,246 | $ | 31,561 | |||||||
|
Severance, retention and office closure costs
|
7,097 | 2,536 | 7,380 | ||||||||||
|
Bank fees related to DIP Credit Facility
|
1,163 | 1,833 | 7,487 | ||||||||||
|
Bankruptcy exit costs
|
22,460 | — | — | ||||||||||
|
Other reorganization items
|
— | 30,731 | 2,678 | ||||||||||
|
Total
|
$ | 58,282 | $ | 83,346 | $ | 49,106 | |||||||
Legal and professional fees consist primarily of fees paid to
professionals for work associated with the bankruptcy of the
Company.
Severance, retention and office closure costs include costs
related to the restructurings and other severance charges. It
also includes a charge of $0.3 million for the announced
closing of the Company’s Fairfax office facility. See
Note 25 to the Notes to the Consolidated Financial
Statements for further discussion.
Other reorganization items in 2003 were primarily comprised of
the following:
| • | Hennepin restructuring charges of $15.4 million related primarily to the reduction in the fixed monthly service fee for the remainder of the operating agreement and the termination of the Company’s lease obligations at the Hennepin waste-to-energy. | |
| • | Worker’s compensation insurance charge of $7.0 million primarily relates to the unanticipated funding of a letter of credit related to casualty insurance obligations, which were previously carried as a liability at its net present value on the Company’s financial statements. | |
| • | The Babylon settlement charge of $2.7 million relates to the restructuring discussed above in “Project Developments Post Emergence.” | |
Lease rejection expenses of $0.6 million in other in 2002,
primarily relates to the lease of office space in New York City
that was rejected pursuant to an order entered by the Bankruptcy
Court on July 26, 2002. The lease rejection claim was
treated as a general unsecured claim in the Company’s
bankruptcy proceedings.
The write-off of deferred financing costs of $2.1 million
included in other in 2002 relate almost entirely to unamortized
costs incurred in connection with the issuance of the
Company’s (i) adjustable rate revenue bonds and
(ii) subordinated convertible debentures. The adjustable
rate revenue bonds were secured by letters of credit. Beginning
in April 2002, as a result of the Company’s failure to
renew these letters of credit, the trustees for those bonds
declared the principal and accrued interest on such bonds due
and payable immediately. Accordingly, letters of credit
supporting these bonds have been drawn in the amount of
$125.1 million. The bonds were redeemed and the proceeds of
the letters of credit were used to repay the bonds.
Covanta’s Convertible Subordinated Debentures were
cancelled under the Reorganization Plan and their holders
received no distribution.
Also in accordance with SOP 90-7, interest expense of $1.0
and $3.6 million for the year ended December 31, 2003
and 2002, respectively, has not been recognized on the
Company’s Convertible Subordinated Debentures that matured
in 2002 and approximately $10.2 million of other unsecured
debt due
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
to the seller of certain independent power projects because the
Company currently believes this interest will not ultimately be
paid.
Pursuant to SOP 90-7, the Company has segregated and
classified certain pre-petition obligations as Liabilities
subject to compromise. Liabilities subject to compromise have
been recorded at the likely allowed claim amount. The following
table sets forth the estimated liabilities of the Company
subject to compromise as of December 31, 2003:
| December 31, 2003 | ||||
|
Debt (See Note 16)
|
$ | 110,485 | ||
|
Debt under credit arrangement (See Note 15)
|
125,091 | |||
|
Accounts payable
|
66,117 | |||
|
Other liabilities
|
232,691 | |||
|
Obligations related to the Centre and the Team (See Note 5)
|
182,517 | |||
|
Obligations related to Arrowhead Pond (See Note 4)
|
90,544 | |||
|
Convertible Subordinated Debentures (See Note 20)
|
148,650 | |||
|
Total
|
$ | 956,095 | ||
As also required by SOP 90-7, below are the condensed
combined financial statements of the Debtors since the date of
the bankruptcy filing (“the Debtors’ Statements”)
up to March 10, 2004. The Debtors’ Statements have
been prepared on the same basis as the Company’s financial
statements.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
DEBTORS’ CONDENSED COMBINED STATEMENTS OF OPERATIONS
| For the Period | For the Period | |||||||||||
| January 1, | For the Year | April 1, 2002 | ||||||||||
| Through | Ended | Through | ||||||||||
| March 10, | December 31, | December 31, | ||||||||||
| 2004 | 2003 | 2002 | ||||||||||
|
Total revenues
|
$ | 86,447 | $ | 475,744 | $ | 351,370 | ||||||
|
Operating costs and expenses
|
77,439 | 406,137 | 284,471 | |||||||||
|
Cost allocation (to) from non-Debtor subsidiaries
|
(15,149 | ) | (23,724 | ) | 7,382 | |||||||
|
Write down of assets held for use
|
— | — | 153 | |||||||||
|
Obligations related to assets held for use
|
— | — | (6,000 | ) | ||||||||
|
Operating income (loss)
|
24,157 | 93,331 | 53,670 | |||||||||
|
Reorganization items
|
(58,263 | ) | (83,346 | ) | (49,106 | ) | ||||||
|
Gain on cancellation of pre-petition debt
|
510,680 | — | — | |||||||||
|
Fresh start adjustments
|
(393,476 | ) | — | — | ||||||||
|
Interest expense, net
|
(5,176 | ) | (33,272 | ) | (23,495 | ) | ||||||
|
Income/(loss) before income taxes (excluding taxes applicable to
non-Debtor subsidiaries), minority interests, equity in earning
of non-Debtor subsidiaries, discontinued operations and
cumulative effect of changes in accounting principles
|
77,922 | (23,287 | ) | (18,931 | ) | |||||||
|
Income tax expense
|
(36,207 | ) | (1,098 | ) | (1,676 | ) | ||||||
|
Minority interests
|
(1,147 | ) | (3,378 | ) | (2,768 | ) | ||||||
|
Equity in earnings of non-Debtor Subsidiaries (net of tax
benefit of ($5,967), $17,821 and $11,142, in 2004, 2003 and
2002, respectively)
|
(11,005 | ) | (5,476 | ) | (63,416 | ) | ||||||
|
Income/(loss) before discontinued operations and cumulative
effect of changes in accounting principles
|
29,563 | (33,239 | ) | (86,791 | ) | |||||||
|
Discontinued operations (net of income tax (expense) benefit of
zero, ($16,147) and $5,833)
|
— | 78,814 | (33,310 | ) | ||||||||
|
Cumulative effect of change in accounting principles (net of tax
benefit of $1,364)
|
— | (2,063 | ) | — | ||||||||
|
Net income (loss)
|
$ | 29,563 | $ | 43,512 | $ | (120,101 | ) | |||||
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
DEBTORS’ CONDENSED COMBINED BALANCE SHEETS
| December 31, 2003 | ||||
|
Assets:
|
||||
|
Current assets
|
$ | 533,638 | ||
|
Property, plant and equipment-net
|
1,014,476 | |||
|
Investments in and advances to investees and joint ventures
|
6,533 | |||
|
Other assets
|
288,453 | |||
|
Investments in and advances to non-debtor subsidiaries, net
|
201,924 | |||
|
Total assets
|
$ | 2,045,024 | ||
|
Liabilities:
|
||||
|
Current liabilities
|
$ | 216,962 | ||
|
Long-term debt
|
— | |||
|
Project debt
|
752,228 | |||
|
Deferred income taxes
|
146,179 | |||
|
Other liabilities
|
70,793 | |||
|
Liabilities subject to compromise
|
956,095 | |||
|
Total liabilities
|
2,142,257 | |||
|
Minority interests
|
30,801 | |||
|
Shareholders’ deficit
|
(128,034 | ) | ||
|
Total liabilities and shareholders’ deficit
|
$ | 2,045,024 | ||
DEBTORS’ CONDENSED COMBINED STATEMENTS OF CASH FLOWS
| For the Period | ||||||||
| For the Year | April 1, 2002 | |||||||
| Ended | Through | |||||||
| December 31, | December 31, | |||||||
| 2003 | 2002 | |||||||
|
Net cash provided by operating activities
|
$ | 38,086 | $ | 59,649 | ||||
|
Net cash used in investing activities
|
(7,030 | ) | (14,728 | ) | ||||
|
Net cash used in financing activities
|
(80,840 | ) | (54,576 | ) | ||||
|
Net cash provided by discontinued operations
|
217,783 | 24,677 | ||||||
|
Net increase in cash and cash equivalents
|
167,999 | 15,022 | ||||||
|
Cash and cash equivalents at beginning of period
|
80,813 | 65,791 | ||||||
|
Cash and cash equivalents at end of period
|
$ | 248,812 | $ | 80,813 | ||||
The Debtors’ Statements present the non-Debtor subsidiaries
on the equity method. Under this method, the net investments in
and advances to non-Debtor subsidiaries are recorded at cost and
adjusted for the Debtors’ share of the subsidiaries’
cumulative results of operations, capital contributions,
distributions and other equity changes. The Debtors’
Statements include an allocation of $7.4 million of costs
incurred by the non-Debtor subsidiaries that provide significant
support to the Debtors for the period ended December 31,
2002. The Debtor’s Statements also include an allocation of
$23.7 million of costs incurred by the Debtors that provide
significant support to the non-Debtor subsidiaries for the year
ended December 31, 2003. All the
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
assets and liabilities of the Debtors and non-Debtors are
subject to revaluation upon emergence from bankruptcy.
| 3. | Summary of Significant Accounting Policies |
| Principles of Consolidation |
The consolidated financial statements reflect the consolidated
results of operations, cash flows and financial position of
Covanta and its majority-owned or controlled subsidiaries.
Investments in companies that are not majority-owned or
controlled but in which the Company has significant influence
are accounted for under the equity method. All intercompany
accounts and transactions have been eliminated.
| Use of Estimates |
The preparation of financial statements requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from
those estimates. Significant estimates include estimated useful
lives of long-lived assets, liabilities for restructuring,
litigation and other claims against the Company and the fair
value of the Company’s assets and liabilities, including
guarantees.
| Cash and Cash Equivalents |
Cash and cash equivalents include all cash balances and highly
liquid investments having maturities from the date of
acquisition or purchase of three months or less.
| Revenue Recognition |
The Company’s revenues are generally earned under
contractual arrangements, and fall into three categories:
service revenues, electricity and steam revenues, and
construction revenues.
| Service Revenues |
(1) Fees earned under contract to operate and maintain
waste-to-energy, independent power and water facilities are
recognized as revenue when earned, regardless of the period they
are billed;
(2) Fees earned to service Project debt (principal and
interest) where such fees are expressly included as a component
on the service fee paid by the Client Community pursuant to
applicable waste-to-energy Service Agreements. Regardless of the
timing of amounts paid by Client Communities relating to Project
debt principal, the Company records service revenue with respect
to this principal component on a levelized basis over the term
of the Service Agreement. Unbilled service receivables related
to waste-to-energy operations are discounted in recognizing the
present value for services performed currently in order to
service the principal component of the Project debt. Such
unbilled receivables amounted to $156 million and
$179 million at December 31, 2004 and 2003,
respectively;
(3) Fees earned for processing waste in excess of Service
Agreement requirements are recognized as revenue beginning in
the period the Company processes waste in excess of the
contractually stated requirements;
(4) Tipping fees earned under waste disposal agreements are
recognized as revenue in the period waste is received;
(5) Other miscellaneous fees such as revenue for scrap
metal recovered and sold are generally recognized as revenue
when scrap metal is sold.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| Electricity and Steam Sales |
Revenue from the sale of electricity and steam are earned at
energy facilities and are recorded based upon output delivered
and capacity provided at rates specified under contract terms or
prevailing market rates net of amounts due to Client Communities
under applicable Service Agreements.
| Construction Revenues |
Revenues under fixed-price construction contracts, including
construction, are recognized on the basis of the estimated
percentage of completion of services rendered. Construction
revenues also include design, engineering and construction
management fees. Some of the construction costs have not been
billed or reimbursed due to the pending finalization of the
executed contracts. The Company anticipates the contracts will
be finalized in 2005 at which time it expects to be fully
reimbursed for all costs.
Anticipated losses are recognized when they become probable and
estimable.
| Property, Plant and Equipment |
As of March 10, 2004, the assets and liabilities of
Covanta’s business including property, plant, and equipment
were recorded at management’s estimate of their fair
values. For the Predecessor periods property, plant and
equipment was recorded at cost. Additions, improvements and
major expenditures are capitalized if they increase the original
capacity or extend the useful life of the original asset more
than one year. Maintenance, repairs and minor expenditures are
expensed in the period incurred. For financial reporting
purposes, depreciation is calculated by the straight-line method
over the estimated remaining useful lives of the assets, which
range up to 41 years for waste-to-energy facilities. The
original useful lives generally range from three years for
computer equipment to 50 years for waste-to-energy
facilities. Leaseholds are depreciated over the life of the
lease or the asset, whichever is shorter. Landfill costs are
amortized based on the quantities deposited into each landfill
compared to the total estimated capacity of such landfill.
| Restricted Funds |
Restricted funds held in trust are primarily amounts received by
third party trustees relating to projects owned by the Company,
and which may be used only for specified purposes. The Company
generally does not control these accounts. They include debt
service reserves for payment of principal and interest on
project debt, deposits of revenues received with respect to
projects prior to their disbursement as provided in the relevant
indenture or other agreements, lease reserves for lease payments
under operating leases, and proceeds received from financing the
construction of energy facilities. Such funds are invested
principally in United States Treasury bills and notes and United
States government agencies securities.
| Treatment of Pass Through Costs |
Pass through costs are costs for which the Company receives a
direct contractually committed reimbursement from the municipal
client which sponsors a waste-to-energy project. These costs
generally include utility charges, insurance premiums, ash
residue transportation and disposal, and certain chemical costs.
These costs are recorded net of municipal client reimbursements
in the Company’s consolidated financial statements. Total
pass through expenses for the periods March 11, 2004
through December 31, 2004, January 1, 2004 through
March 10, 2004, and 2003 and 2002 were $39.9 million,
$10.0 million, $59.8 million and $45.3 million,
respectively.
E-22
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| Financing Costs |
Costs incurred in connection with obtaining financing are
capitalized and amortized straight line over the terms of the
related financings and in accordance with respective letter of
credit reductions. Unamortized deferred financing costs are
included in other assets on the Consolidated Balance Sheets.
As of March 10, 2004, project debt issuance costs with
respect to pre-emergence debt were recorded at their fair value
of zero. Costs incurred in connection with the issuance of bonds
are amortized using the effective interest rate method over the
respective debt issues. Unamortized bond issuance costs are
included in other assets on the Consolidated Balance Sheets.
| Project Development and Contract Acquisition Costs |
The Company capitalizes project development costs once it is
determined that it is probable that such costs will be realized
through the ultimate construction of a plant. These costs
include outside professional services, permitting expense and
other third party costs directly related to the development of a
specific new project. Upon the start-up of plant operations or
the completion of an acquisition, these costs are generally
transferred to property, plant and equipment and are amortized
over the estimated useful life of the related plant or charged
to construction costs in the case of a construction contract for
a facility owned by a municipality. Capitalized project
development costs are charged to expense when it is determined
that the related project is impaired.
Contract acquisition costs are capitalized for external costs
incurred to acquire the rights to design, construct and operate
waste-to-energy facilities and are amortized over the life of
the contracts. Contract acquisition costs are presented net of
accumulated amortization and were $46.6 million at
December 31, 2003. As of March 10, 2004, contract
acquisition costs were recorded at their fair value of zero.
| Service and Energy Contracts and Other Intangible Assets |
As of March 10, 2004, service and energy contracts were
recorded at their estimated fair market values, in accordance
with SFAS No. 141, based upon discounted cash flows
from the service contracts on publicly owned projects and the
“above market” portion of the energy contracts on
Company owned projects using currently available information.
Amortization is calculated by the straight-line method over the
estimated contract lives of which the remaining weighted average
life of the agreements is approximately 17 years. However,
many of such contracts have remaining lives that are
significantly shorter. Other intangible assets are amortized by
the straight-line method over periods ranging from 15 to
25 years. See Note 11 to the Notes to the Consolidated
Financial Statements.
| Pension and Postretirement Plans |
The Company has pension and post-retirement obligations and
costs that are developed from actuarial valuations. Inherent in
these valuations are key assumptions including discount rates,
expected return on plan assets and medical trend rates. Changes
in these assumptions are primarily influenced by factors outside
the Company’s control and can have a significant effect on
the amounts reported in the financial statements.
| Interest Rate Swap Agreements |
The fair value of interest rate swap agreements are recorded as
assets and liabilities, with changes in fair value during the
year credited or charged to debt service revenue or debt service
charges, as appropriate. The Company identified all derivatives
within the scope of SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities”. The
Company’s policy is to enter into derivatives only to
protect the Company against fluctuations in interest rates and
foreign currency exchange rates as they relate to specific
assets and liabilities. The Company’s policy is to not
enter into derivative instruments for speculative purposes.
E-23
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The Company’s has one interest rate swap agreement that
economically fixes the interest rate on $80.2 million of
adjustable rate revenue bonds reported in the project debt
category “Revenue Bonds Issued by and Prime Responsibility
of Municipalities.” The carrying value of this asset and
liability was $14.9 million and $16.7 million at
December 31, 2004 and 2003. See Note 17 to the Notes
to the Consolidated Financial Statements.
Any payments made or received under the swap agreement,
including fair value amounts upon termination, are included as
an explicit component of the Client Communities obligation under
the related Service Agreement. Therefore, all payments made or
received under the swap agreement are a pass through to the
Client Community. See Note 17 to the Notes to the
Consolidated Financial Statements.
| Income Taxes |
Deferred income taxes are based on the difference between the
financial reporting and tax basis of assets and liabilities. The
deferred income tax provision represents the change during the
reporting period in the deferred tax assets and deferred tax
liabilities, net of the effect of acquisitions and dispositions.
Deferred tax assets include tax loss and credit carryforwards
and are reduced by a valuation allowance if, based on available
evidence, it is more likely than not that some portion or all of
the deferred tax assets will not be realized.
For the period ended March 10, 2004, the Company filed a
consolidated Federal income tax return, which included all
eligible United States and foreign subsidiary companies and
Covanta Lake for the period January 1, through
February 20, 2004. Foreign subsidiaries were taxed
according to regulations existing in the countries in which they
do business. Subsequent to March 10, 2004, Domestic Covanta
is included in Danielson’s consolidated tax group. CPIH and
its United States and foreign subsidiaries are not members of
the Danielson consolidated tax group after March 10, 2004.
In addition, Covanta Lake is not a member of any consolidated
tax group after February 20, 2004.
For the Predecessor periods ended December 31, 2003 and
2002, the Company filed a consolidated Federal income tax
return, which included all eligible United States subsidiary
companies. Foreign subsidiaries were taxed according to
regulations existing in the countries in which they do business.
Provision has not been made for United States income taxes on
income earned by foreign subsidiaries as the income is
considered to be permanently invested overseas.
| Impairment of Long-Lived Assets |
Long-lived assets, such as property, plant and equipment and
purchased intangible assets with finite lives, are evaluated for
impairment whenever events or changes in circumstances indicate
the carrying value of an asset may not be recoverable over their
estimated useful life in accordance with SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived
Assets.” The Company reviews its long-lived assets for
impairment when events or circumstances indicate that the
carrying value of such assets may not be recoverable over the
estimated useful life. Determining whether an impairment has
occurred typically requires various estimates and assumptions,
including which cash flows are directly attributable to the
potentially impaired asset, the useful life over which the cash
flows will occur, their amount and the assets residual value, if
any. Also, impairment losses require an estimate of fair value,
which is based on the best information available. The Company
principally uses discounted cash flow estimates, but also uses
quoted market prices when available and independent appraisals
as appropriate to determine fair value. Cash flow estimates are
derived from historical experience and internal business plans
with an appropriate discount rate applied.
| Foreign Currency Translation |
For foreign operations, assets and liabilities are translated at
year-end exchange rates and revenues and expenses are translated
at the average exchange rates during the year. Gains and losses
resulting from foreign
E-24
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
currency translation are included in the Consolidated Statements
of Operations and Comprehensive Income (Loss) as a component of
Other comprehensive income (loss). For subsidiaries whose
functional currency is deemed to be other than the
U.S. dollar, translation adjustments are included as a
separate component of Other comprehensive income (loss) and
Shareholders’ Equity (deficit). Currency transaction gains
and losses are recorded in Other-net in the Consolidated
Statements of Operations and Comprehensive Income (Loss).
| Earnings per Share |
Basic earnings (loss) per share is represented by net income
(loss) available to common shareholders divided by the
weighted-average number of common shares outstanding during the
period. Diluted earnings (loss) per share reflects the potential
dilution that could occur if securities or stock options were
exercised or converted into common stock during the period, if
dilutive. See Note 28 to the Notes to the Consolidated
Financial Statements.
In December 2002, the FASB issued SFAS No. 148,
“Accounting for Stock-Based Compensation —
Transition and Disclosure, an amendment of SFAS No 123
(“SFAS No. 148”). SFAS No. 148
provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for
stock-based employee compensation. In addition,
SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 “Accounting for Stock-Based
Compensation” (SFAS No. 123), to require
prominent disclosures in annual and interim financial statements
about the method of accounting for stock-based employee
compensation and the effect in measuring compensation expense.
The disclosure requirements of SFAS No. 148 are
effective for periods beginning after December 15, 2002. At
December 31, 2003, the Company has three stock-based
employee compensation plans, which are described more fully in
Note 22. The Company accounts for those plans under the
recognition and measurement provision of APB Opinion
No. 25, “Accounting for Stock Issued to
Employees”, and related Interpretations. No stock-based
employee compensation cost is reflected in 2003 and
2002 net income (loss), as all options granted under those
plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. No options were
granted in 2003 or 2002. Awards under the Company’s plans
vest over periods ranging from three to five years. Therefore,
the cost related to stock-based employee compensation included
in the determination of net income (loss) for 2003 and 2002 is
less than that which would have been recognized if the fair
value based method had been applied to all awards since the
original effective date of SFAS No. 123.
E-25
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The following table summarizes the pro forma impact on net
income (loss) and income (loss) per common share for the years
ended December 31, 2003 and 2002 including the effect on
net income (loss) and income (loss) per share if the fair value
based method had been applied to all outstanding and unvested
awards in each:
| Year Ended December 31, | ||||||||
| 2003 | 2002 | |||||||
|
Net income (loss), as reported
|
$ | 43,512 | $ | (178,895 | ) | |||
|
Deduct:
|
||||||||
|
SFAS No. 123 total stock based employee compensation
expense determined under the fair value method for all awards,
net of related tax effects
|
(2,975 | ) | (4,933 | ) | ||||
|
Pro forma net income (loss)
|
$ | 40,537 | $ | (183,828 | ) | |||
|
Basic income (loss), per share:
|
||||||||
|
Basic — as reported
|
$ | 0.87 | $ | (3.59 | ) | |||
|
Basic — pro forma
|
$ | 0.81 | $ | (3.69 | ) | |||
|
Diluted income (loss), per share:
|
||||||||
|
Diluted — as reported
|
$ | 0.87 | $ | (3.59 | ) | |||
|
Diluted — pro forma
|
$ | 0.81 | $ | (3.69 | ) | |||
As noted above, no options were granted in 2003 or 2002. All
options were cancelled as of March 10, 2004. Compensation
expense, under the fair value method shown in the table above
has been determined consistent with the provisions of
SFAS No. 123 using the binomial option-pricing model
with the following assumptions: dividend yield of 0% in 2001;
volatility of 42.47% in 2001, risk-free interest rate of 5.8% in
2001; and weighted average expected life of 6.5 years in
2001.
| Changes in Accounting Principles and New Accounting Pronouncements |
On June 30, 2002, the Company completed the required
impairment evaluation of goodwill in conjunction with its
adoption of SFAS No. 142. As a result of risks and
other conditions in its energy business and based upon the
expected present value of future cash flows, the Company
determined that $7.8 million of goodwill related to its
energy business was impaired and was therefore written-off. As
required by SFAS No. 142, this adjustment has been
accounted for as a cumulative effect of a change in accounting
principle as of January 1, 2002, which had no tax impact.
In August 2001, the FASB issued SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived
Assets” (“SFAS No. 144”). The Company
adopted SFAS No. 144 on January 1, 2002. SFAS
No. 144 replaces SFAS No. 121, “Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of,” and establishes accounting and reporting
standards for long-lived assets, including assets held for sale.
SFAS No. 144 requires that assets held for sale be measured
at the lower of carrying amount or fair value less associated
selling expenses. It also broadens this reporting to include all
components of an entity with operations that can be
distinguished from the rest of the entity that will be
eliminated from the ongoing operations of the entity in a
disposal transaction. SFAS No. 144 did not have a material
effect at the date of adoption.
The Company adopted SFAS No. 143, “Accounting for
Asset Retirement Obligations”
(“SFAS No. 143”), effective January 1,
2003. Under SFAS No. 143, entities are required to
record the fair value of a legal liability for an asset
retirement obligation in the period in which it is incurred. The
Company’s
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
legal liabilities include capping and post-closure costs of
landfill cells and site restoration at certain waste-to-energy
and power producing sites. When a new liability for asset
retirement obligations is recorded, the entity capitalizes the
costs of the liability by increasing the carrying amount of the
related long-lived asset. The liability is discounted to its
present value each period, and the capitalized cost is
depreciated over the useful life of the related asset. At
retirement, an entity settles the obligation for its recorded
amount or incurs a gain or loss. The Company adopted
SFAS No. 143 on January 1, 2003 and recorded a
cumulative effect of change in accounting principle of
$8.5 million, net of a related tax benefit of
$5.5 million.
The asset retirement obligation is included in other liabilities
on the consolidated balance sheet. The following table
summarizes the pro forma impact to net income (loss) and income
(loss) per common share for the years ended December 31,
2003 and 2002, as if the adoption of SFAS No. 143 was
implemented January 1, 2002:
| ProForma | ||||||||
| 2003 | 2002 | |||||||
|
Loss from continuing operations before discontinued operations
and the change in accounting principles, as reported
|
$ | (26,764 | ) | $ | (127,698 | ) | ||
|
Gain (loss) from discontinued operations
|
78,814 | (43,355 | ) | |||||
|
Cumulative effect of change in accounting principles
|
— | (7,842 | ) | |||||
|
Deduct:
|
||||||||
|
SFAS No. 143 depreciation and accretion expense
|
— | (1,356 | ) | |||||
|
Pro forma income (loss)
|
$ | 52,050 | $ | (180,251 | ) | |||
|
Basis income (loss) per share:
|
||||||||
|
Loss from continuing operations before discontinued operations
and the change in accounting principles, per share
|
$ | (0.54 | ) | $ | (2.56 | ) | ||
|
Income (loss) from discontinued operations
|
1.58 | (0.87 | ) | |||||
|
Cumulative effect of change in accounting principles
|
— | (0.16 | ) | |||||
|
Net income (loss) pro forma
|
$ | 1.04 | $ | (3.62 | ) | |||
|
Diluted income (loss) per share:
|
||||||||
|
Loss from continuing operations before discontinued operations
and the change in accounting principles, per share
|
$ | (0.54 | ) | $ | (2.56 | ) | ||
|
Income (loss) from discontinued operations
|
1.58 | (0.87 | ) | |||||
|
Cumulative effect of change in accounting principles
|
— | (0.16 | ) | |||||
|
Net income (loss) pro forma
|
$ | 1.04 | $ | (3.62 | ) | |||
The change to the non-current asset retirement obligation as of
December 31, 2004 and 2003 is as follows:
| 2004 | 2003 | |||||||
|
Balance at January 1
|
$ | 18,387 | $ | 19,136 | ||||
|
Change in liability estimate
|
151 | — | ||||||
|
Accretion expense
|
1,456 | 1,345 | ||||||
|
Less obligation related to assets sold (See Notes 4 and 5)
|
(1,082 | ) | (2,094 | ) | ||||
|
Balance at December 31
|
$ | 18,912 | $ | 18,387 | ||||
E-27
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| Reclassifications |
Certain prior year amounts have been reclassified in the
consolidated financial statements to conform with the current
year presentation. Such reclassifications include presenting
equity in income from unconsolidated investments (net of tax)
after operating income (loss).
| 4. | Discontinued Operations |
Revenues and income (loss) from discontinued operations for the
years ended December 31, 2003 and 2002 were as follows:
| 2003 | 2002 | |||||||
|
Revenues
|
$ | 90,812 | $ | 105,462 | ||||
|
Gain (loss) on sale of businesses
|
109,776 | (17,110 | ) | |||||
|
Operating income (loss)
|
(10,813 | ) | (34,489 | ) | ||||
|
Interest expense — net
|
(4,002 | ) | (5,134 | ) | ||||
|
Income (loss) before income taxes and minority interests
|
94,961 | (56,733 | ) | |||||
|
Income tax (expense) benefit
|
(16,147 | ) | 13,165 | |||||
|
Minority interests
|
— | 213 | ||||||
|
Income (loss) from discontinued operations
|
$ | 78,814 | $ | (43,355 | ) | |||
On December 18, 2003, following the approval of the
Bankruptcy Court, the Company sold its Geothermal Business to
Ormat. The total price for three of the Geothermal Businesses
was $184.8 million, and the Company realized a net gain of
$92.8 million on this sale after deducting costs relating
to the sale. In addition, the subsidiary holding companies which
owned the subsidiaries conducting the Geothermal Business and
three related operations and maintenance companies no longer
have operations as a result of the sale, and therefore are
included in discontinued operations
Prior to October 2003, Covanta Tulsa, Inc., a liquidating
debtor, (“Covanta Tulsa”) operated the waste-to-energy
Tulsa facility. The facility was leased under a long-term lease.
Covanta Tulsa was unable to restructure its arrangement with the
lessor on a more profitable basis. As a result, in October 2003
the Company terminated operations at the Tulsa facility.
Therefore, its results of operations have been reclassified as
discontinued operations. A net loss of $38.6 million was
recorded on the disposal of Covanta Tulsa.
In 2002, the Company reviewed the recoverability of its
long-lived assets. As a result of the review based on future
cash flows, an impairment was recorded for the Tulsa
waste-to-energy project resulting from the Company’s
inability, as determined at that time, to improve the operations
of or restructure the project in order to meet substantial
future lease payments. This impairment charge was
$22.3 million and resulted in a tax benefit of
$7.7 million.
On December 16, 2003 the Company and Ogden Facility
Management Corporation of Anaheim (“OFM”) closed a
transaction with the City of Anaheim (the “City”)
pursuant to which they have been released from their management
obligations and the Company and OFM have realized and
compromised their financial obligations, in connection with the
Arrowhead Pond Arena in Anaheim, California (“Arrowhead
Pond”). As a result of the transaction, OFM no longer has
continuing operations and therefore its results of operations
have been reclassified as discontinued operations. A net gain of
$17.0 million was recorded on the disposal of OFM as a
result of impairment charges of $98.0 million previously
recorded and payments made to settle the transaction of
$46.9 million offset by draw-downs on a letter of credit of
$115.8 million, a charge of $10.6 million related to
an interest rate swap, and the net settlement of a
lease-in/lease-out transaction of $1.6 million. See below
for further discussion.
E-28
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The income (loss) from discontinued operations includes
impairment charges related to the Arrowhead Pond of
$40.0 million in 2002. During 2003, the Company’s
limited ability to fund short-term working capital needs at the
Arrowhead Pond under the DIP credit facility and the need to
resolve its bankruptcy case created the need to dispose of the
management contract for the Arrowhead Pond at a time when
building revenues were not at levels consistent with past
experience. Based upon all the then currently available
information, including a valuation and certain assumptions as to
the future use, the Company recorded an impairment charge as of
December 31, 2001 of $74.4 million related to the
Company’s interest in the Arrowhead Pond.
OFM was the manager of the Arrowhead Pond under a long-term
management agreement. Covanta and the City of Anaheim were
parties to a reimbursement agreement to the financial
institution, which issued a letter of credit in the amount of
approximately $117.2 million which provided credit support
for Certificates of Participation issued to finance the
Arrowhead Pond project. As part of its management agreement, the
manager was responsible for providing working capital to pay
operating expenses and debt service (including interest rate
swap exposure of $10.4 million at December 31, 2002
and reimbursement of the lender for draws under the letter of
credit including draws related to an acceleration by the lender
of all amounts payable under the reimbursement agreement) if the
revenues of Arrowhead Pond were insufficient to cover these
costs. Covanta had guaranteed the obligations of the manager.
The City of Anaheim had given the manager notice of default
under the management agreement. In such notice, the City of
Anaheim indicated that it did not propose to exercise its
remedies at such time and was stayed from doing so as a result
of the Company’s Chapter 11 filing.
Covanta was also the reimbursement party on a $26.0 million
letter of credit and a $1.5 million letter of credit
relating to a lease transaction for Arrowhead Pond. The
$26.0 million letter of credit, which was security for the
lease investor, could be drawn upon the occurrence of an event
of default. The $1.5 million letter of credit was security
for certain indemnification payments under the lease transaction
documents, the amount of which could not be determined at that
time. The lease transaction documents required Covanta to
provide additional letter of credit coverage from time to time.
The additional amount required for 2002 was estimated to be
approximately $6.7 million. Notices of default were
delivered in 2002 under the lease transaction documents. As a
result of the default, Covanta’s counterparties could have
exercised remedies, including drawing on letters of credit
related to lease transactions and recovering fees to which the
manager was entitled for managing the Arrowhead Pond.
The Company recorded in 2002 a pre-tax $40.0 million
impairment charge which is included in Liabilities subject to
compromise in the December 31, 2003 Consolidated Balance
Sheet, in order to reflect its estimated total exposure with
respect to the Arrowhead Pond, including exercise of remedies by
the parties to the lease transaction as a result of the
occurrence of an event of default. The resulting tax benefit of
$14.0 million has been included in the deferred income
taxes liability at December 31, 2002.
In March 2003, the underlying swap agreement related to the
Company’s interest rate swap exposure was terminated
resulting in a fixed obligation of $10.6 million.
On December 16, 2003 the Company made a payment of
$45.4 million to Credit Suisse First Boston
(“CSFB”) which offset the total CSFB claim of
$115.8 million. At that time, as described above, the
agreement to terminate the management agreement and the release
of the Company and OFM from all obligations relating to the
management of the Arrowhead Pond (except for the residual
secured reimbursement claim of CSFB against the Company of
$70.4 million) was completed. The termination of the
lease-in/lease-out transaction (after a net payment of
$1.6 million) and a municipal bond financing transaction
was also completed.
On March 28, 2002, two of the Company’s subsidiaries
sold their interests in a power plant and an operating and
maintenance contractor based in Thailand. The total sale price
for both interests was
E-29
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
approximately $27.8 million, and the Company realized a net
loss of approximately $17.1 million on this sale after
deducting costs relating to the sale.
| 5. | Gain (Loss) on Sale of Businesses and Write-downs and Obligations |
The following is a list of assets sold or impaired during the
years ended December 31, 2004, 2003 and 2002, the gross
proceeds from those sales, the realized gain or (loss) on those
sales and the write-down of or recognition of liabilities
related to those assets:
| Writedown or | ||||||||||||
| Recognition of | ||||||||||||
| Description of Business | Proceeds | Gain (Loss) | Obligations | |||||||||
|
2004 (Successor)
|
||||||||||||
|
Equity investment in Linasa plant
|
$ | 1,844 | $ | 245 | $ | — | ||||||
|
2003
|
||||||||||||
|
Equity investment in Mammoth Pacific Plant
|
$ | 30,404 | $ | (10,983 | ) | $ | — | |||||
|
Metropolitan
|
254 | 254 | — | |||||||||
|
Aeropuertos Argentina 2000 S.A.
|
2,601 | 2,601 | — | |||||||||
|
Transair
|
417 | 417 | — | |||||||||
|
The Centre and The Team
|
— | — | (16,704 | ) | ||||||||
|
Asia Pacific Australia
|
465 | 465 | — | |||||||||
|
Total
|
$ | 34,141 | $ | (7,246 | ) | $ | (16,704 | ) | ||||
|
2002
|
||||||||||||
|
Port Authority of New York and New Jersey Fueling
|
$ | 5,700 | $ | 3,510 | $ | — | ||||||
|
Non Port Authority Fueling
|
1,000 | 1,000 | — | |||||||||
|
Metropolitan
|
2,308 | 248 | — | |||||||||
|
Casino Iguazu
|
3,439 | — | — | |||||||||
|
La Rural
|
500 | 500 | — | |||||||||
|
Rojana Power Plant
|
7,100 | (6,500 | ) | — | ||||||||
|
Empressa Valle Hermoso Project
|
900 | 600 | — | |||||||||
|
Magellan Cogeneration Energy
|
— | — | (41,651 | ) | ||||||||
|
Bataan Cogeneration Energy
|
— | — | (37,212 | ) | ||||||||
|
Compania General De Sondeos
|
— | (1,708 | ) | |||||||||
|
The Centre and The Team
|
— | — | (6,000 | ) | ||||||||
|
Other
|
407 | 407 | — | |||||||||
|
Total
|
$ | 21,354 | $ | (1,943 | ) | $ | (84,863 | ) | ||||
The Company’s interests in the Corel in Ottawa, Canada (the
“Centre”) and the Ottawa Senators Hockey Club
Corporation (the “Team”) were materially adversely
affected by events occurring at the end of 2001 and beginning of
2002. On December 21, 2001 the Company announced that its
inability to access the capital markets, the continuing delays
in payment of remaining California energy receivables and delays
in the sale of aviation and entertainment assets had adversely
impacted Covanta’s ability to meet cash flows covenants
under its Revolving Credit and Participation Agreement (the
“Master Credit Facility”). The Company also stated
that the banks had provided a waiver for the covenants only
through January of 2002, had not agreed to provide the
additional short-term liquidity the Company had sought and that
the Company was conducting a comprehensive review of its
strategic alternatives.
E-30
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
On December 27, 2001 and January 11, 2002 the
Company’s credit ratings were reduced by Moody’s and
Standard & Poor’s, respectively. The downgrade
triggered requirements to post in excess of $100 million in
performance and other letters of credit for energy projects for
which the Company no longer had available in commitments under
its Master Credit Facility.
The Company required further waivers from its cash flows
covenants under its Master Credit Facility for the period after
January 2002. On January 31, 2002 the Company announced
that it had obtained waivers through the end of March 2002,
subject, however, to its meeting stringent cash balance
requirements set by its banks.
Among other things, these cash balance requirements prevented
the Company from paying interest due on March 1, 2002 on
its 9.25% Debentures (the
“9.25% Debentures”). In addition, the
restrictions prevented contributions to the working capital
needs of the Team, the prime tenant of the Centre.
These events resulted in draws during March 2002 on the letters
of credit for the $19.0 million and $86.2 million
guarantees discussed below with respect to the Team and the
Centre, respectively. As a result of drawing on the letters of
credit, the Company obtained an interest in the loans that had
been secured by the letters of credit that had been drawn.
On April 1, 2002, the Company filed for relief under
Chapter 11 of the Bankruptcy Code. See Note 2 the
Notes to the Consolidated Financial Statements.
The events leading up to the bankruptcy filing and the filing
itself materially adversely affected the Company’s ability
to manage the timing and terms on which to dispose of its
interests and related obligations with respect to the Centre and
the Team as described below.
With respect to the Centre and the Team, these events led to the
termination, in early 2002, of a pending sale of limited
partnership interests and related recapitalization of the Team
that, if completed as contemplated, would have been expected to
stabilize the finances of the Centre and the Team for a
considerable period. Given the Company’s inability to fund
short-term working capital needs of the Team, and given the
events described above, the Company was not in a position to
manage the timing and terms of disposition of the Centre and the
Team in a manner most advantageous to the Company.
Based upon all available information, including an initial offer
to purchase dated June 20, 2002 and certain assumptions as
to the future use, and considering the factors listed above, the
Company recorded a pre-tax impairment charge as of
December 31, 2001 of $140.0 million related to the
Centre and the Team. As a result of the Team filing for
protection under the Canadian Company’s Creditor
Arrangement Act (“CCAA”) on January 9, 2003 and
the status of the Company’s current negotiations to dispose
of these interests, an additional $6.0 million pre-tax
charge was recorded as of December 31, 2002 in the
write-down of assets held for use.
The 2002 charges, which have been included in obligations
related to assets held for sale in the Consolidated Statements
of Operations and Comprehensive Income (Loss), represented the
Company’s estimate of the net cost to sell its interests in
the Centre and Team and to be discharged of all related
obligations and guarantees that are included in Liabilities
subject to compromise in the December 31, 2002 Consolidated
Balance Sheet. The resulting tax benefit of $22.8 million
has been included in the deferred income taxes liability at
December 31, 2002.
The Company’s guarantees at December 31, 2001 were
comprised of a: (1) $19.0 million guarantee of the
Team’s subordinated loan payable;
(2) $86.2 million guarantee of the senior term debt of
the Centre; (3) $45.8 million guarantee of the senior
subordinated debt of the Centre for which $6.3 million in
cash collateral had been posted by the borrower;
(4) $3.1 million guarantee of senior secured term debt
of the team; (5) guarantee of the interest payments on
$37.7 million of senior secured term debt of the Team;
(6) guarantee to make working capital advances to the
Centre from time to time in amounts necessary to
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
cover any shortfall between certain operating cash flows,
operating expenses and debt service of the Centre; and
(7) $17.5 million cost for terminated foreign exchange
currency swap agreements. The swap agreements had a notional
amount of $130.6 million and were entered into by the
Centre related to the $86.2 million senior term and
$45.8 million senior subordinated debt. These swap
agreements had extended originally through December 23,
2002 but were terminated by the counter-parties in May 2002.
The Company’s guarantees arose during 1994, when a
subsidiary of Covanta entered into a 30-year facility management
contract at the Centre pursuant to which it agreed to advance
funds to the Team, and if necessary, to assist the Centre’s
refinancing of senior secured debt incurred in connection with
the construction of the Centre. In compliance with these
guarantees, the Company entered into agreements pursuant to
which it was required to purchase the $19.0 million and
$86.2 million series of debt referred to above if such debt
was not timely refinanced or upon the occurrences of certain
defaults. In March 2002, the holders of the subordinated debt of
the Team required the Company to purchase such debt in the total
amount (together with accrued and unpaid dividends) of
$19.0 million and were paid that amount under a letter of
credit for which the Company was the reimbursement party. In
addition, in March, as the result of defaults occurring in 2002,
the holders of the senior debt relating to the Centre required
the Company to purchase such debt in the total amount (together
with accrued and unpaid dividends) of $86.2 million and
were paid that amount under a letter of credit for which the
Company was the reimbursement party. The subordinated secured
debt of the Centre in the amount of $45.8 million is also
subject to a put right pursuant to the terms of the underlying
agreements. Such subordinated secured debt has not been put to
the Company, although the holder has the right to do so. The
obligation to purchase such debt is not secured by a letter of
credit.
On January 9, 2003, the Team filed for protection with the
Ontario Superior Court of Justice (“Canadian Court”),
and was granted protection under Canada’s CCAA. A monitor
was appointed under the CCAA to supervise the selling of the
Team’s franchise. On April 25, 2003, the monitor
entered into an asset purchase agreement for the purchase of the
Team’s franchise and certain related assets, which the
Canadian Court approved on May 9, 2003. On May 27,
2003, the Canadian Court appointed an interim receiver of the
owner of the Corel Centre. On June 4, 2003, the interim
receiver entered into an asset purchase agreement for the
purchase of the Corel Centre and certain related assets, which
was approved on June 20, 2003. The transactions to purchase
the team and the Corel Centre were consummated on
August 26, 2003. Upon closing, Covanta received
$19.7 million and obtained releases from certain guarantees
provided to lenders of the Team. An additional charge of
$16.8 million was recorded in 2003 in write-down and
obligations related to assets held for use.
The impairment related to the Magellan Cogeneration Energy
project was due to a substantial 2002 second quarter
governmental imposed reduction of national electricity tariffs,
the duration of which was impossible to estimate then and at
this time. The Company recorded a pre-tax impairment charge of
$41.7 million related to the net book value of the assets
of this project at June 30, 2002. Although this project had
$32.1 million of non-recourse debt at June 30 2002, in
accordance with SFAS No. 144, the Company based the
impairment loss upon the measurement of the assets at their fair
market value. On May 31, 2004, Magellan Cogeneration Inc.
filed a petition for corporate rehabilitation under the laws of
the Philippines. On June 3, 2004, the presiding court
issued a stay order prohibiting the enforcement of all claims
against Magellan Cogeneration Inc. including principal and
interest on such project debt. On August 31, 2004, such
court issued a due course order allowing the corporate
rehabilitation process to proceed. The rehabilitation receiver
submitted his comments to the proposed rehabilitation plan and
an alternative rehabilitation plan in January 2005. The final
rehabilitation plan may provide for debt forgiveness, a debt to
equity swap, a reduction in interest rate and/or an extension of
debt tenor.
The impairment related to the Bataan project resulted from the
fact that the plant sold a portion of its power at a discount to
the regional grid tariff and the June 2004 expiration of one of
the project’s off-take agreements which matters were
together anticipated to result in the inability to recover the
project’s carrying
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
value. Therefore, a pre-tax impairment charge of
$37.2 million related to the net book value of the assets
of the project was recorded. In August 2004, the project company
exercised its option to pre-terminate its remaining
loss-producing off-take agreement and ceased operations. The
Company has determined to auction off the physical assets. Such
auction is anticipated to occur upon receipt of governmental
approvals.
The Company will continue to consider alternatives to maximize
the value of these projects.
On March 28, 2002, following approval from the Master
Credit Facility lenders, three of the Company’s
subsidiaries sold their interests in two power plants and an
operating and maintenance contractor based in Thailand. The
total sale price for the power plant and maintenance contractor
was approximately $27.8 million, and the Company realized a
net loss of approximately $17.1 million on this sale after
deducting costs relating to the sale (see Note 4 to the
Notes to the Consolidated Financial Statements). The total fixed
assets included in the sale were $82.5 million.
On December 18, 2003, following approval of the Heber Plan
by the Bankruptcy Court, the Company sold the Geothermal
Business for gross proceeds of $184.8 million excluding its
equity investments (see Note 4 to the Notes to the
Consolidated Financial Statements), subject to a working capital
adjustment, and the Company realized a net gain of approximately
$92.8 million on this sale. The total net fixed assets
included in the sale was $69.7 million.
| 6. | Investments In and Advances to Investees and Joint Ventures |
The Company is party to joint venture agreements through which
the Company has equity investments in several operating
projects. The joint venture agreements generally provide for the
sharing of operational control as well as voting percentages.
The Company records its share of earnings from its equity
investees in equity in net income from unconsolidated
investments in its Consolidated Statements of Operations and
Comprehensive Income (Loss).
The Company is a party to a joint venture formed to design,
construct, own and operate a coal-fired electricity generation
facility in the Quezon Province, the Philippines (“Quezon
Joint Venture”). The Company owns 26.1% of, and has
invested 27.5% of the total equity in, the Quezon Joint Venture.
This project commenced commercial operations in 2000.
Manila Electric Company (“Meralco”), the sole power
purchaser for the Company’s Quezon Project, is engaged in
discussions and legal proceedings with instrumentalities of the
government of the Philippines relating to past billings to its
customers, cancellations of recent tariff increases, and
potential tariff increases. The outcome of these proceedings may
affect Meralco’s financial condition.
Quezon Project management continues to negotiate with Meralco
with respect to proposed amendments to the power purchase
agreement to modify certain commercial terms under the existing
contract, and to resolve issues relating to the Quezon
Project’s performance during its first year of operation.
Following the first year of the operation, in 2001, based on a
claim that the plant’s performance did not merit full
payment, Meralco withheld a portion of each of several monthly
payments to the Quezon Project that were due under the terms of
the power purchase agreement. The total withheld amount was
$10.8 million (U.S.). Although the Quezon Project was able
to pay all of its debt service and operational costs, the
withholding by Meralco constituted a default by Meralco under
the power purchase agreement and a potential event of default
under the project financing agreements. To address this issue,
Quezon Project management agreed with project lenders to hold
back cash from distributions in excess of the reserve
requirements under the financing agreements in the amount of
approximately $20.5 million (U.S.).
In addition to the issues under the power purchase agreement,
issues under the financing agreements arose during late 2003 and
2004 regarding compliance with the Quezon Project operational
parameters and the Quezon Project’s inability to obtain
required insurance coverage. In October 2004, the Company and
other
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
Quezon project participants, with the consent of the Quezon
Project lenders, amended certain of the Quezon Project documents
to address such operational matters, resolving all related
contract issues. Subsequently, the project lenders granted a
waiver with respect to the insurance coverage issue because
contractual coverage levels were not then commercially available
on reasonable terms. At approximately the same time, Quezon
Project management sought, and successfully obtained, a
reduction of the hold back amount discussed above, resulting in
a new excess hold back of approximately $10.5 million
(U.S.) with effect from November 2004.
Adverse developments in Meralco’s financial condition or
delays in finalizing the power purchase agreement amendments and
potential consequent lender actions are not expected to
adversely affect Covanta’s liquidity, although it may have
a material affect on CPIH’s ability to repay its debt prior
to maturity. In late 2004, Meralco successfully refinanced
$228 million in expiring short-term debt on a long-term
7 year basis, improving Meralco’s financial condition.
In March of 2002, the Company sold its equity interest in the
Rojana Power Plant in Thailand contemporaneously with the sale
of the Saha Cogeneration Plant. The gross proceeds from this
sale were $7.1 million, which resulted in a loss of
$6.5 million after selling expenses which were recorded in
net loss on sale of businesses.
On December 18, 2003, following approval by the Bankruptcy
Court, the Company sold its equity interests in the Geothermal
Business for gross proceeds of $215.2 million of which
$29.4 million is allocated to the equity investment and the
Company realized a net loss of approximately $11.0 million
on this sale after deducting costs relating to the sale of
$1.0 million. The total equity investment included in the
sale was $40.4 million.
In August of 2004, the Company sold its equity interest in the
Linasa Plant in Spain. The gross proceeds from this sale were
$1.8 million which resulted in a gain on sale of business
of approximately $0.2 million.
The December 31, 2004 aggregate carrying value of the
investments in and advances to investees and joint ventures of
$65.6 million is less than the Company’s equity in the
underlying net assets of these investees by approximately
$52.3 million. The carrying value of $133.4 million at
December 31, 2003 was $13.4 million less than the
Company’s equity in the underlying net assets. In 2004, the
difference between carrying values and the Company’s equity
in the underlying net assets are primarily related to fresh
start adjustments, and the differences are being amortized over
the weighted average lives of the investees’ property,
plant and equipment. In 2003, the difference of cost over
acquired net assets are mainly related to property, plant and
equipment and power purchase agreements of several investees.
At December 31, 2004 and 2003, investments in and advances
to investees and joint ventures accounted for under the equity
method is as follows:
| Successor | Predecessor | |||||||||||
| Ownership Interest at | ||||||||||||
| December 31, 2004 | 2004 | 2003 | ||||||||||
|
Ultrapower Chinese Station Plant (U.S.)
|
50% | $ | 5,479 | $ | 8,137 | |||||||
|
South Fork Plant (U.S.)
|
50% | 673 | 1,027 | |||||||||
|
Koma Kulshan Plant (U.S.)
|
50% | 4,326 | 4,524 | |||||||||
|
Linasa Plant (Spain)
|
50% | (A) | — | 2,714 | ||||||||
|
Haripur Barge Plant (Bangladesh)
|
45% | 7,357 | 22,153 | |||||||||
|
Quezon Power (Philippines)
|
26% | 47,812 | 92,492 | |||||||||
|
Other
|
Various | — | 2,392 | |||||||||
|
Total Investments in Power Plants
|
$ | 65,647 | $ | 133,439 | ||||||||
(A) Sold in August 2004
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The unaudited combined results of operations and financial
position of the Company’s equity method affiliates are as
follows:
| Successor | Predecessor | |||||||||||||||
| For the Period | For the Period | |||||||||||||||
| March 11, | January 1, | |||||||||||||||
| Through | Through | |||||||||||||||
| December 31, | March 10, | |||||||||||||||
| 2004 | 2004 | 2003 | 2002 | |||||||||||||
|
Condensed Statements of Operations
|
||||||||||||||||
|
Revenues
|
$ | 219,016 | 53,424 | $ | 299,214 | $ | 305,835 | |||||||||
|
Gross profit
|
102,908 | 26,736 | 149,589 | 169,954 | ||||||||||||
|
Net income
|
60,724 | 16,513 | 93,211 | 82,892 | ||||||||||||
|
Company’s share of net income
|
17,535 | 3,924 | 24,400 | 24,356 | ||||||||||||
|
Condensed Balance Sheets
|
||||||||||||||||
|
Current assets
|
$ | 145,969 | $ | 183,080 | ||||||||||||
|
Non-current assets
|
854,014 | 893,477 | ||||||||||||||
|
Total assets
|
999,983 | 1,076,557 | ||||||||||||||
|
Current liabilities
|
76,533 | 81,438 | ||||||||||||||
|
Non-current liabilities
|
512,759 | 576,769 | ||||||||||||||
|
Total liabilities
|
589,292 | 658,207 | ||||||||||||||
| 7. | Investments in Marketable Securities Available for Sale |
The cost or amortized cost, unrealized gains, unrealized losses
and fair value of investments as of the year ended
December 31, 2004 and 2003 categorized by type of security,
were as follows:
| Cost or | ||||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | |||||||||||||
| Cost | Gain | Loss | Value | |||||||||||||
|
December 31, 2004 (Successor)
|
||||||||||||||||
|
Current investments:
|
||||||||||||||||
|
Fixed maturities
|
$ | 3,100 | $ | — | $ | — | $ | 3,100 | ||||||||
|
Fixed maturities
|
1,321 | — | — | — | ||||||||||||
|
Mutual and bond funds
|
2,325 | 53 | — | 2,378 | ||||||||||||
|
Total non-current investments
|
$ | 3,646 | $ | 53 | $ | — | $ | 3,699 | ||||||||
|
December 31, 2003 (Predecessor)
Mutual and bond funds — Non-current |
$ | 2,068 | $ | 392 | $ | — | $ | 2,460 | ||||||||
Non-current investments are classified in other long-term assets
in the balance sheet. Proceeds and realized gains and losses for
the years ended December 31, 2004, 2003 and 2002 were $0.3,
$0.6 million and $0.1 million; zero, $0.6 million
and zero. For the purpose of determining realized gains and
losses, the cost of securities sold was based on specific
identification.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| 8. | Service Revenues and Unbilled Service Receivables |
The following table summarized the components of Service
Revenues for the period March 11, 2004 through
December 31, 2004, for the period January 1, through
March 10, 2004 and the years ended December 31, 2003
and 2002.
| Successor | Predecessor | |||||||||||||||
| For the Period | For the Period | |||||||||||||||
| March 11, | January 1, | |||||||||||||||
| Through | Through | |||||||||||||||
| December 31, | March 10, | |||||||||||||||
| 2004 | 2004 | 2003 | 2002 | |||||||||||||
|
Service revenue unrelated to project debt
|
$ | 313,543 | $ | 72,749 | $ | 397,710 | $ | 382,942 | ||||||||
|
Revenue earned explicitly to service project debt-principal
|
36,029 | 9,937 | 56,030 | 58,788 | ||||||||||||
|
Revenue earned explicitly to service project debt-interest
|
25,050 | 7,181 | 45,505 | 52,230 | ||||||||||||
|
Total service revenue
|
$ | 374,622 | $ | 89,867 | $ | 499,245 | $ | 493,960 | ||||||||
Unbilled service receivables include fees earned to service
project debt (principal and interest) where such fees are
expressly included as a component of the service fee paid by the
municipality pursuant to applicable waste-to-energy service
agreements. Regardless of the timing of amounts paid by
municipalities relating to project debt principal, the Company
records service revenue with respect to this principal component
on a levelized basis over the term of the service agreement.
Long-term unbilled service receivables related to
waste-to-energy operations are recorded at their discounted
amount.
| 9. | Restricted Funds Held in Trust |
Restricted funds held in trust are primarily amounts received
and held by third party trustees relating to projects owned by
the Company, and which may be used only for specified purposes.
The Company generally does not control these accounts. They
include debt service reserves for payment of principal and
interest on project debt, deposits of revenues received with
respect to projects prior to their disbursement as provided in
the relevant indenture or other agreements, lease reserves for
lease payments under operating leases, and proceeds received
from financing the construction of energy facilities. Such funds
are invested principally in United States Treasury bills and
notes and United States government agencies securities.
Fund balances were as follows:
| Successor | Predecessor | |||||||||||||||
| 2004 | 2003 | |||||||||||||||
| Current | Non-Current | Current | Non-Current | |||||||||||||
|
Debt service funds
|
$ | 46,655 | $ | 112,012 | $ | 46,585 | $ | 113,033 | ||||||||
|
Revenue funds
|
20,530 | — | 26,652 | — | ||||||||||||
|
Lease reserve funds
|
3,970 | — | 3,826 | — | ||||||||||||
|
Construction funds
|
264 | — | 341 | — | ||||||||||||
|
Other funds
|
44,673 | 11,814 | 24,795 | 12,174 | ||||||||||||
|
Total
|
$ | 116,092 | $ | 123,826 | $ | 102,199 | $ | 125,207 | ||||||||
E-36
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| 10. | Property, Plant and Equipment |
Property, plant and equipment consisted of the following:
| Successor | Successor | Predecessor | ||||||||||
| Useful Lives | 2004 | 2003 | ||||||||||
|
Land
|
$ | 4,725 | $ | 5,270 | ||||||||
|
Energy facilities
|
3-50 years | 826,194 | 1,804,895 | |||||||||
|
Buildings and improvements
|
3-50 years | 51,464 | 188,942 | |||||||||
|
Machinery and equipment
|
3-50 years | 5,514 | 79,776 | |||||||||
|
Landfills
|
7,614 | 16,543 | ||||||||||
|
Construction in progress
|
5,403 | 6,689 | ||||||||||
|
Total
|
900,914 | 2,102,115 | ||||||||||
|
Less accumulated depreciation and amortization
|
(40,941 | ) | (648,761 | ) | ||||||||
|
Property, plant, and equipment — net
|
$ | 859,973 | $ | 1,453,354 | ||||||||
Depreciation and amortization for continuing operations related
to property, plant and equipment amounted to $39.7 million
for the period, March 11, through December 31, 2004,
$12.7 million for the period January 1, through
March 10, 2004 and, $68.0 million and
$72.7 million for the years ended December 31, 2003
and 2002, respectively.
In light of its Chapter 11 bankruptcy filing and
proceedings, the Company reviewed the recoverability of its
long-lived assets as of June 30, 2002. As a result of the
review based upon the future cash flows, the Company recorded in
write-down of assets held for use in the 2002 Consolidated
Statement of Operations and Comprehensive Income (Loss), a
pre-tax impairment charge totaling $78.9 million. The
charge related to two international projects, the Magellan
Cogeneration Energy project and the Bataan Cogeneration Energy
project which are both located in the Philippines. (See
Note 5 to the Notes to the Consolidated Financial
Statements.)
| 11. | Service and Energy Contracts and Other Intangible Assets |
The following tables present the Company’s intangible
assets as of December 31, 2004 and 2003:
| Successor | ||||||||||||
| Accumulated | ||||||||||||
| December 31, 2004 | Gross | Amortization | Net | |||||||||
|
Service and energy contracts
|
$ | 204,338 | $ | (16,054 | ) | $ | 188,284 | |||||
|
Other intangible assets
|
442 | (89 | ) | 353 | ||||||||
|
Total
|
$ | 204,780 | $ | (16,143 | ) | $ | 188,637 | |||||
| Predecessor | ||||||||||||
| Accumulated | ||||||||||||
| December 31, 2003 | Gross | Amortization | Net | |||||||||
|
Land rights and other intangibles
|
$ | 3,062 | $ | (862 | ) | $ | 2,200 | |||||
|
Deferred development costs
|
5,921 | (1,048 | ) | 4,873 | ||||||||
|
Sub-total
|
$ | 8,983 | $ | (1,910 | ) | $ | 7,073 | |||||
Amortization expense related to service and energy contracts and
other intangible assets amounted to $16.1 million for the
period March 11, through December 31, 2004 and
amortization expense was $0.7 million
E-37
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
for the period January 1, through March 10, 2004 and
$2 million and $2.6 million for the years ended
December 31, 2003 and 2002, respectively. As of
March 10, 2004, deferred development costs were fair valued
to zero.
The estimated future amortization expense of service and energy
contracts and other intangible assets as of December 31,
2004 is as follows:
| For the Year Ended | Amount | |||
|
2005
|
$ | 18,793 | ||
|
2006
|
18,793 | |||
|
2007
|
18,695 | |||
|
2008
|
16,917 | |||
|
2009
|
16,917 | |||
|
Thereafter
|
98,522 | |||
|
Total
|
$ | 188,637 | ||
On June 30, 2002, the Company completed the required
impairment evaluation of goodwill in conjunction with its
adoption of SFAS No. 142. As a result of risks and
other conditions in its energy business and based upon the
expected present value of future cash flows, the Company
determined that $7.8 million of goodwill related to its
energy business was impaired and was therefore written-off. As
required by SFAS No. 142, this adjustment has been
accounted for as a cumulative effect of a change in accounting
principle as of January 1, 2002, which had no tax impact.
| 12. | Other Assets |
Other assets consisted of the following:
| Successor | Predecessor | |||||||
| 2004 | 2003 | |||||||
|
Marketable securities available for sale
|
$ | 1,321 | $ | — | ||||
|
Unamortized bond issuance costs
|
1,736 | 25,559 | ||||||
|
Deferred financing costs
|
5,275 | 7,011 | ||||||
|
Non-current securities available for sale
|
2,325 | 2,460 | ||||||
|
Interest rate swap
|
14,920 | 16,728 | ||||||
|
Unamortized contract acquisition costs
|
— | 27,073 | ||||||
|
Other
|
5,439 | 5,241 | ||||||
|
Total
|
$ | 31,016 | $ | 84,072 | ||||
Amortization expense related to contract acquisition cost was
$3.9 million and $4.1 million in 2003 and 2002,
respectively.
In December 2003, the Company wrote-off $27.4 million in
contract acquisition costs associated with the sale of the
Geothermal Business and the remaining unamortized contract
acquisition costs were valued to zero as a fresh start
adjustment (see Notes 2 and 34 to the Notes to the
Consolidated Financial Statements) as of March 10, 2004.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| 13. | Accrued Expenses |
Accrued expenses consisted of the following:
| Successor | Predecessor | |||||||
| 2004 | 2003 | |||||||
|
Operating expenses
|
$ | 30,803 | $ | 40,418 | ||||
|
Severance
|
— | 2,305 | ||||||
|
Insurance
|
1,605 | 14,954 | ||||||
|
Debt service charges and interest
|
17,628 | 15,257 | ||||||
|
Municipalities’ share of energy revenues
|
36,897 | 29,737 | ||||||
|
Payroll
|
18,027 | 21,589 | ||||||
|
Payroll and other taxes
|
8,478 | 51,867 | ||||||
|
Lease payments
|
1,025 | 67 | ||||||
|
Pension
|
3,673 | 16,839 | ||||||
|
Other
|
2,877 | 15,309 | ||||||
|
Total
|
$ | 121,013 | $ | 208,342 | ||||
| 14. | Deferred Revenue |
Deferred revenue consisted of the following:
| Successor | Predecessor | |||||||||||||||
| 2004 | 2003 | |||||||||||||||
| Current | Non-Current | Current | Non-Current | |||||||||||||
|
Power sales agreement prepayment
|
$ | — | $ | — | $ | 9,001 | $ | 129,304 | ||||||||
|
Advance billings to municipalities
|
9,064 | — | 10,555 | — | ||||||||||||
|
Other
|
4,901 | — | 17,875 | — | ||||||||||||
|
Total
|
$ | 13,965 | $ | — | $ | 37,431 | $ | 129,304 | ||||||||
In 1998, the Company received a payment for future energy
deliveries required under a power sales agreement. This
prepayment was being amortized straight-line over the life of
the agreement, which expires in 2019. The gains from sale and
leaseback transactions consummated in 1986 and 1987 were
deferred and were being amortized as a reduction of rental
expense over the respective lease terms. The leases which
resulted in these gains were terminated in 2003. Advance
billings to various customers are billed one or two months prior
to performance of service and are recognized as income in the
period the service is provided.
| 15. | Credit Arrangements |
Successor
Upon the Company’s emergence from bankruptcy, it entered
into new financing arrangements for liquidity and letters of
credit for its domestic and international businesses. The
Domestic Borrowers entered into the First Lien Facility and the
Second Lien Facility (together, the “Domestic
Facilities”), and CPIH entered into the CPIH Revolving Loan
facility.
Material Terms of the Domestic Facilities. The First Lien
Facility provides commitments for the issuance of letters of
credit in the initial aggregate face amount of up to
$139 million with respect to Covanta’s Detroit,
Michigan waste-to-energy facility. The First Lien Facility
reduces semi-annually as the amount of the letter of credit
requirement for this facility reduces. As of December 31,
2004, this requirement was
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
approximately $119.7 million. The First Lien Facility is,
secured by a first priority lien on substantially all of the
assets of the Domestic Borrowers not subject to prior liens (the
“Collateral”).
Additionally, the Domestic Borrowers entered into the Second
Lien Facility, secured by a second priority lien on the
Collateral. The Second Lien Facility is a letter of credit and
liquidity facility which provides commitments for the issuance
of additional letters of credit in support of the Company’s
domestic and international businesses, and for general corporate
purposes. The Second Lien facility provided commitments in an
aggregate amount of $118 million, up to $10 million of
which may be used for cash borrowings on a revolving basis for
general corporate purposes. As of December 31, 2004, an
aggregate amount of $71 million in letters of credit had
been issued under the Second Lien Facility, and the Company had
made no cash borrowings under the Second lien Facility. Both
facilities expire in March, 2009.
The First Lien Facility and the Second Lien Facility require
cash collateral to be posted for issued letters of credit if
Covanta has cash in excess of specified amounts. Covanta paid a
1% upfront fee upon entering into the First Lien Facility, and
will pay with respect to each issued letter of credit (i) a
fronting fee equal to the greater of $500 or 0.25% per
annum of the daily amount available to be drawn under such
letter of credit, (ii) a letter of credit fee equal to
2.5% per annum of the daily amount available to be drawn
under such letter of credit, and (iii) an annual fee of
$1,500.
The revolving loan component of the Second Lien Facility bears
interest at either (i) 4.5% over a base rate with reference
to either the Federal Funds rate of the Federal Reserve System
or Bank One’s prime rate, or (ii) 6.5% over a formula
Eurodollar rate, the applicable rate to be determined by Covanta
(increasing by 2% over the then applicable rate in specified
default situations). Covanta also paid an upfront fee of
$2.8 million upon entering into the Second Lien Facility,
and will pay (i) a commitment fee equal to 0.5% per
annum of the daily calculation of available credit, (ii) an
annual agency fee of $30,000, and (iii) with respect to
each issued letter of credit an amount equal to 6.5% per
annum of the daily amount available to be drawn under such
letter of credit.
The Domestic Facilities provide for mandatory prepayments of all
or a portion of amounts funded by the lenders under letters of
credit and the revolving loan upon the sales of assets,
incurrence of additional indebtedness, availability of annual
cash flow, or cash on hand above certain base amounts, and
change of control transactions. To the extent that no amounts
have been funded under the revolving loan or letters of credit,
Covanta is obligated to apply excess cash to collateralize its
reimbursement obligations with respect to outstanding letters of
credit, until such time as such collateral equals 105% of the
maximum amount that may at any time be drawn under outstanding
letters of credit.
The terms of both of these facilities require Covanta to furnish
the lenders with periodic financial, operating and other
information. In addition, these facilities further restrict,
without the consent of its lenders under these facilities,
Covanta’s ability to, among others:
| • | incur indebtedness, or incur liens on its property, subject to specific exceptions; | |
| • | pay any dividends on or repurchase any of its outstanding securities, subject to specific exceptions; | |
| • | make new investments, subject to specific exceptions; | |
| • | deviate from specified financial ratios and covenants, including those pertaining to consolidated net worth, adjusted EBITDA, and capital expenditures; | |
| • | sell any material amount of assets, enter into a merger transaction, liquidate or dissolve; | |
| • | enter into any material transactions with shareholders and affiliates; amend its organization documents; and | |
| • | engage in a new line of business. | |
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
All unpaid principal of and accrued interest on the revolving
loan, and an amount equal to 105% of the maximum amount that may
at any time be drawn under outstanding letters of credit, would
become immediately due and payable in the event that Covanta or
certain of its affiliates (including Danielson) become subject
to specified events of bankruptcy or insolvency. Such amounts
shall also become immediately due and payable, upon action taken
by a certain specified percentage of the lenders, in the event
that any of the following occurs after the expiration of
applicable cure periods:
| • | a failure by Covanta to pay amounts due under the Domestic Facilities or other debt instruments; | |
| • | breaches of representations, warranties and covenants under the Domestic Facilities; | |
| • | a judgment or judgments are rendered against Covanta that involve an amount in excess of $5 million, to the extent not covered by insurance; | |
| • | any event that has caused a material adverse effect on Covanta; | |
| • | a change in control; | |
| • | the Intercreditor Agreement or any security agreement pertaining to the Domestic Facilities ceases to be in full force and effect; | |
| • | certain terminations of material contracts; or | |
| • | any securities issuance or equity contribution which is reasonably expected to have a material adverse effect on the availability of net operating losses. | |
Under these facilities, as described above, Covanta is obligated
to apply excess cash to collateralize its reimbursement
obligations with respect to outstanding letters of credit, until
such time as such collateral equals 105% of the maximum amount
that may at any time be drawn under outstanding letters of
credit. In accordance with the annual cash flow and the excess
cash on hand provisions of the First and Second Lien Facilities,
Domestic Covanta deposited $3.2 million and
$10.5 million on January 3, 2005 and March 1,
2005, respectively, into a restricted collateral account for
this purpose. This restricted collateral will become available
to the Domestic Borrowers if they are able to refinance their
current corporate debt.
Material Terms of the CPIH Revolving Loan Facility.
The CPIH Revolving Credit Facility is secured by a first
priority lien on the CPIH stock and substantially all of the
CPIH Borrowers’ assets not otherwise subject to security
interests existing as of the Effective Date, and consists of
commitments for cash borrowings of up to $10 million for
purposes of supporting the international businesses. This
$10 million commitment however is subject to permanent
reductions as CPIH asset sales occur. Permanent reductions to
the original commitment are determined by applying 50% of all
net asset sales proceeds as they occur subject to certain
specified limits. The CPIH revolving credit facility has a
maturity date of three years and to the extent drawn upon bears
interest at the rate of either (i) 7% over a base rate with
reference to either the Federal Funds rate, of the Federal
Reserve System or Deutsche Bank’s prime rate, or
(ii) 8% over a formula Eurodollar rate, the applicable rate
to be determined by CPIH (increasing by 2% over the then
applicable rate in specified default situations). CPIH also paid
a 2% upfront fee of $0.2 million, and will pay (i) a
commitment fee equal to 0.5% per annum of the average daily
calculation of available credit, and (ii) an annual agency
fee of $30,000. As of December 31, 2004, CPIH had not
sought to make draws on this facility and the outstanding
commitment amount has been reduced to $9.1 million.
The mandatory prepayment provisions, affirmative covenants,
negative covenants and events of default under the two
international credit facilities are similar to those found in
the Domestic Facilities.
The CPIH Revolving Credit Facility is non-recourse to Covanta
and its other domestic subsidiaries.
Of the Company’s outstanding letters of credit at
December 31, 2004, approximately $5.6 million secures
indebtedness that is included in the Consolidated Balance Sheet
and approximately $187.3 million principally
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
secured the Company’s obligations under energy contracts to
pay damages in the event of non-performance by the Company which
the Company believes to be unlikely. These letters of credit
were generally available for drawing upon if the Company
defaulted on the obligations secured by the letters of credit or
failed to provide replacement letters of credit as the current
ones expire.
Certain Domestic Borrowers are guarantors of performance
obligations of some international projects or are the
reimbursement parties with respect to letters of credit issued
to secure obligations relating to some international projects.
Domestic Borrowers are entitled to reimbursements of operating
expenses incurred by the Domestic Borrowers on behalf of the
CPIH Borrowers and payments, if any, made with respect to the
above mentioned guarantees and reimbursement obligations. Any
such obligation to reimburse the Domestic Borrowers, should it
arise, would be senior to the repayment of principal on the CPIH
Term Loan described in Note 15 to the Notes to the
Consolidated Financial Statements.
| Predecessor |
The Company entered into the Master Credit Facility as of
March 14, 2001. The Master Credit Facility was secured by
substantially all of the Company’s assets and was scheduled
to mature on May 31, 2002 but was not fully discharged by
the Debtor In Possession Credit Agreement (as amended, the
“DIP Credit Facility”) discussed below. This, as well
as the non-compliance with required financial ratios and
possible other items caused the Company to be in default under
its Master Credit Facility. However, as previously discussed, on
April 1, 2002, the Company and 123 of its subsidiaries
filed voluntary petitions for relief under Chapter 11 of
the Bankruptcy Code that, among other things, act as a stay of
enforcement of any remedies under the Master Credit Facility
against any debtor company. For 2002, bank fees of
$24.0 million relate to the Company’s Master Credit
Facility. These fees were recognized as Other expenses-net and
were payable in March 2002 and remained unpaid until resolved in
the Company’s bankruptcy proceedings. The Master Credit
Facility was discharged upon the effectiveness of the
Reorganization Plan (see Note 2).
In connection with the bankruptcy petition, Covanta and most of
its subsidiaries entered into the DIP Credit Facility with the
DIP Lenders. On April 5, 2002, the Bankruptcy Court issued
its interim order approving the DIP Credit Facility and on
May 15, 2002, a final order approving the DIP Credit
Facility. On August 2, 2002, the Bankruptcy Court issued an
order that overruled objections by holders of minority interests
in two limited partnerships who disputed the inclusion of the
limited partnerships in the DIP Credit Facility. Although the
holders of such interests are one of the limited partnerships
have appealed the order, they have reached an agreement with the
Company that in effect deferred the appeal. The DIP Credit
Facility’s terms are described below.
The DIP Credit Facility was largely for the continuation of
existing letters of credit and was secured by all of the
Company’s domestic assets not subject to liens of others
and generally 65% of the stock of its foreign subsidiaries held
by domestic subsidiaries. Obligations under the DIP Credit
Facility were senior in status to other pre-petition secured
claims, and the DIP Credit Facility was the operative debt
agreement with the Company’s banks. The Master Credit
Facility remained in effect during the Chapter 11 Cases to
determine the rights of the lenders who are a party to it with
respect to obligations not continued under the DIP Credit
Facility. The DIP Credit Facility was discharged upon the
effectiveness of the Reorganization Plan (see Note 2).
As of March 31 2002, letters of credit had been issued
under the Master Credit Facility for the Company’s benefit
to secure performance under certain energy contracts (totaling
$203.6 million); to secure obligations relating to the
entertainment businesses (totaling $153.0 million) largely
with respect to the Anaheim and Ottawa projects described in
Notes 3 and 4, in connection with the Company’s
insurance program (totaling $38.4 million); and for credit
support of the Company’s adjustable rate revenue bonds
(totaling $127.0 million). Of these letters of credit
issued under the Master Credit Facility, on $240.8 million
of the outstanding letters of credit, principally in connection
with energy facilities and the Company’s
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
insurance program, were replaced with letters of credit issued
under the DIP Credit Facility. As of December 31, 2003, the
Master Credit Facility had $3.0 million in letters of
credit that remained outstanding.
Beginning in April 2002 and as a result of the Company’s
Chapter 11 filing, trustees for the Company’s
adjustable rate revenue bonds declared the principal and accrued
interest on such bonds due and payable immediately. Accordingly,
letters of credit supporting these bonds have been drawn in the
amount of $125.1 million. In addition, letters of credit in
the amounts of $2.1 million, relating to the entertainment
businesses, were drawn in December 2002. In
December 2003 $113.7 million in letters of credit were
drawn and a payment of $45.4 million was made against the
drawn amount from a third party. The balance of
$68.9 million was already accrued on the Company’s
books as a liability subject to compromise. An additional letter
of credit in the amount of $27.5 million was released as
part of the settlement of Arrowhead Pond (see
Note 4 — Discontinued Operations for further
discussion).
The DIP Credit Facility when originally issued provided for
approximately $289.1 million in financing and comprised of
its two tranches. The Tranche A Facility (the
“Tranche A Facility”), originally provided the
Company with a credit line of approximately $48.2 million
in commitments for the issuance of letters of credit and for
cash borrowings under a revolving credit line. The
Tranche A Facility was reduced by amendment over time as
the need for additional letters of credit were reduced. At
December 31, 2003, the Tranche A Facility was
$7.2 million all of which was outstanding in letters of
credit. The Tranche A Facility was thereafter reduced by an
additional $0.2 million each month, in commitments for
letters of credit as a result of the reduced need for a letter
of credit in connection with the Company’s Hennepin project.
The Tranche B Facility (the “Tranche B
Facility”), originally provided the Company with a credit
line of approximately $240.8 million in commitments for the
continuation of existing letters of credit, which were
previously issued under the Master Credit Facility as discussed
above. The Tranche B Facility was reduced to approximately
$183.6 million in commitments at December 31, 2003 as
the need for letters of credit was reduced. The reductions in
the Tranche B Facility are as follows: in December, 2002, a
$3.0 million reduction when the Company sold its remaining
interest in the aviation business, in October and November,
2003, a $30.0 million reduction when the Company closed its
relationship with the prior workers’ compensation carrier
and issued $5.6 million in new letters of credit under the
Tranche A Facility for a new carrier, and a
$24.3 million reduction in the letter of credit issued in
support of lease payments made by the lessee at a
waste-to-energy facility over the period of the DIP Credit
Facility.
Of the outstanding letters of credit at December 31, 2003,
approximately $38.0 million secures indebtedness that is
included in the Condensed Consolidated Balance Sheet and
approximately $155.6 million principally secured the
Company’s obligations under energy contracts to pay damages
in the event of non-performance by the Company which the Company
believes to be unlikely. These letters of credit were generally
available for drawing upon if the Company defaulted on the
obligations secured by the letters of credit or failed to
provide replacement letters of credit as the current ones expire.
Borrowings under the Tranche A Facility were subject to
compliance with monthly and budget limits. The Company could
utilize the amount available for cash borrowings under the
Tranche A Facility to reimburse the issuers of letters of
credit issued under the Tranche A Facility if and when such
letters of credits were drawn. The Company could also utilize
the Tranche A Facility to fund working capital requirements
and for general corporate purposes of the Company relating to
the Company’s post-petition operations and other
expenditures in accordance with a monthly budget and applicable
restrictions typical of a Chapter 11 debtor in possession
financing.
On April 8, 2002, under its DIP Credit Facility, the
Company paid a facility fee of approximately $1.0 million,
equal to 2% of the amount of the Tranche A commitments,
$2.5 million of agent fees and $0.5 million of lender
advisor fees. During 2002 the Company paid additional amendment
fees and agent fees of $1.1 million and $0.8 million,
respectively.
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
In addition, the Company paid a commitment fee based on
utilization of the facility of .75% of the unused Tranche A
commitments. The Company also paid a fronting fee for each
Tranche A and Tranche B letter of credit equal to the
greater of $500 and 0.25% of the daily amount available to be
drawn under such letter of credit, as well as letter of credit
fees of 3.25% on Tranche A letters of credit and 2.50% on
Tranche B letters of credit, calculated over the daily
amount available for drawings thereunder.
Outstanding loans under the Tranche A Facility and the
Tranche B Facility bore interest at the Company’s
option at either the prime rate plus 2.50% or the Eurodollar
rate plus 3.50%.
The DIP Credit Facility contained covenants which restrict
(1) the incurrence of additional debt, (2) the
creation of liens, (3) investments and acquisitions,
(4) incurrence of contingent obligations and performance
guarantees, and (5) disposition of assets.
In addition, the DIP Credit Facility, as amended, included the
following reporting covenants:
(1) Cash flow: (a) provide biweekly operating and
variance reports and monthly compliance reports for total and
specific expenditures and (b) provide monthly budget and
13-week forecast updates;
(2) Financial statements: (a) provide quarterly
financial statements within 60 days of the end of each of
the Company’s first three fiscal quarters, or in lieu
thereof, a copy of its Quarterly Report on Form 10-Q,
(b) provide annual audited financial statements within
120 days of the end of the Company’s fiscal year or in
lieu thereof, a copy of its Annual Report on Form 10-K, and
(c) achieve quarterly minimum cumulative consolidated
operating income targets for April 1, 2003 through
March 31, 2004.
(3) Other: (a) deliver, when available, the
Chapter 11 restructuring plan and (b) provide other
information as reasonably requested by the DIP Lenders.
As of December 31, 2003 and the effective date of the
Reorganization Plan the Company was in material compliance with
all of the covenants of the DIP Credit Facility, as amended.
The Company did not make any cash borrowings under its DIP
Credit Facility, as amended, but approximately $7.2 million
in new letters of credit were issued under Tranche A of the
DIP Credit facility as of December 31, 2003.
The DIP Credit Facility initially was scheduled to mature on
April 1, 2003. On March 28, 2003 the DIP Credit
Facility was extended through October 1, 2003 and on
September 15, 2003 was extended through April 1, 2004.
On March 25, 2003, an extension fee of $0.1 million
was paid by the Company to the DIP Lenders. In addition, on
April 1, 2003, the Company paid an annual administrative
fee of $0.4 million.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| 16. | Recourse Debt |
Recourse debt consisted of the following at December 31,
2004 and 2003:
| Successor | Predecessor | |||||||
| 2004 | 2003 | |||||||
|
High Yield Notes
|
$ | 207,735 | $ | — | ||||
|
Unsecured Notes (estimated)
|
28,000 | — | ||||||
|
CPIH term loan facility
|
76,852 | — | ||||||
|
9.25% debentures due 2022
|
— | 100,000 | ||||||
|
Other long-term debt
|
309 | 10,563 | ||||||
| 312,896 | 110,563 | |||||||
|
Less amounts subject to compromise
|
— | (110,485 | ) | |||||
|
Less current portion of recourse debt
|
(112 | ) | (21 | ) | ||||
|
Long-term recourse debt
|
$ | 312,784 | $ | 57 | ||||
Recourse debt included the following obligations at
December 31, 2004:
| • | The High Yield Notes are secured by a third priority lien in the same collateral securing the First Lien Facility and the Second Lien Facility (See Note 14). The High Yield Notes were issued in the initial principal amount of $205 million, which will accrete to $230 million at maturity in seven years. Interest is payable at a rate of 8.25% per annum, semi-annually on the basis of the principal at final maturity; no principal is due prior to maturity of the High Yield Notes. | |
| • | Unsecured Notes in a principal amount of $4 million were issued on the effective date of the Reorganization Plan. The Company issued additional Unsecured Notes in the principal amount of $20 million after emergence from Chapter 11 and recorded additional Unsecured Notes in a principle amount of $4 million in 2004 which it expects to issue in 2005. Additional Unsecured Notes also may be issued to holders of allowed claims against the Remaining Debtors if and when they emerge from bankruptcy, and if the issuance of such notes is contemplated by the terms of any plan of reorganization confirmed with respect to such Remaining Debtors. The final principal amount of all Unsecured Notes will be equal to the amount of allowed unsecured claims against the Company’s operating subsidiaries which were reorganizing Debtors, and such amount will be determined when such claims are resolved through settlement or further proceedings in the Bankruptcy Court. The principal amount of Unsecured Notes indicated in the table above represents the expected liability upon completion of the claims process, excluding any additional Unsecured Notes that may be issued if and when Remaining Debtors reorganize and emerge from bankruptcy. Notwithstanding the date on which Unsecured Notes are issued, interest on the Unsecured Notes accrues from March 10, 2004. Interest is payable semi-annually on the Unsecured Notes at a rate of 7.5% per annum; principal is paid annually in equal installments beginning in March, 2006. The Unsecured Notes mature in eight years. | |
| • | The CPIH Borrowers entered into the CPIH Term Loan Facility in the principal amount of up to $95 million, of which $76.9 million was outstanding as of December 31, 2004. The CPIH Term Loan Facility is secured by a second priority lien on the same collateral as the CPIH Revolving Credit Facility, and bears interest at 10.5% per annum, 6.0% of such interest to be paid in cash and the remaining 4.5% to be paid in cash to the extent available and otherwise payable by adding it to the outstanding principal balance. The interest rate increases to 12.5% per annum in specified default situations. The CPIH Term Loan Facility matures in March 2007. The CPIH Term Loan Facility is non-recourse to Covanta and its other domestic subsidiaries. While the existing CPIH term loan and | |
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| revolver remain outstanding, CPIH’s cash balance is not available to be transferred to Domestic Covanta. |
Recourse debt included the following obligations at
December 31, 2003:
| • | The Company’s 9.25% Debentures represent pre-petition secured indebtedness that was discharged in bankruptcy as of March 10, 2004. Following the commencement of the Chapter 11 Cases in April 2002, the Company did not make interest payments on the 9.25% Debentures. As of December 31, 2003 the 9.25% Debentures have been included in liabilities subject to compromise. See Note 2 to the Notes to the Consolidated Financial Statements for a description of the treatment of the 9.25% Debentures under the Reorganization Plan. | |
| • | $22.5 million resulting from the sale of limited partnership interests in and related tax benefits of the Onondaga facility, which has been accounted for as a financing for accounting purposes. This obligation had an effective interest rate of 10% and extended through 2015. This waste-to-energy project was restructured in October, 2003, as part of the restructuring this financing was converted to Minority interest on the Consolidated Balance Sheet as of December 31, 2003. | |
| • | $28.4 million, related to a sale and leaseback arrangement relating to an energy facility in Hennepin, Minnesota. This arrangement was accounted for as a financing, had an effective interest rate of approximately 5%, and extended through 2017. As of December 31, 2002, this obligation was included in Liabilities subject to compromise. This waste-to-energy project was restructured in July, 2003, as part of the restructuring this financing was reclassified as an Other liability on the Consolidated Balance Sheet as of December 31, 2003. | |
| • | $1.5 million note associated with the acquisition of energy assets. The note bears interest at 6.0% and matures in 2009. As of December 31, 2003, this note is included in Liabilities subject to compromise. | |
The maturities on recourse debt including capital lease
obligations at December 31, 2004 were as follows:
|
2005
|
$ | 112 | ||
|
2006
|
4,024 | |||
|
2007
|
80,824 | |||
|
2008
|
3,900 | |||
|
2009
|
3,900 | |||
|
Thereafter
|
220,136 | |||
|
Total
|
312,896 | |||
|
Less current portion of recourse debt
|
(112 | ) | ||
|
Total long-term recourse debt
|
$ | 312,784 | ||
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| 17. | Project Debt |
Project debt consisted of the following:
| Successor | Predecessor | ||||||||
| December 31, | December 31, | ||||||||
| 2004 | 2003 | ||||||||
|
Revenue Bonds Issued by and Prime Responsibility of
Municipalities:
|
|||||||||
|
3.9-6.75% serial revenue bonds due 2005 through 2011
|
$ | 319,050 | $ | 320,960 | |||||
|
5.0-7.0% term revenue bonds due 2005 through 2015
|
223,518 | 238,281 | |||||||
|
Adjustable-rate revenue bonds due 2006 through 2013
|
127,237 | 134,367 | |||||||
|
Revenue Bonds Issued by Municipal Agencies with Sufficient
Service Revenues Guaranteed by Third Parties
|
|||||||||
|
5.25-5.5% serial revenue bonds due 2005 through 2008
|
30,301 | 58,620 | |||||||
|
Other Revenue Bonds:
|
|||||||||
|
4.85-5.5% serial revenue bonds due 2005 through 2015
|
72,954 | 79,390 | |||||||
|
5.5-6.7% term revenue bonds due 2014 through 2019
|
69,094 | 68,020 | |||||||
|
International project debt
|
102,583 | 144,327 | |||||||
| 944,737 | 1,043,965 | ||||||||
|
Less current portion of project debt
|
(109,701 | ) | (108,687 | ) | |||||
|
Long-term project debt
|
$ | 835,036 | $ | 935,278 | |||||
Domestic Covanta’s net unamoritized project debt premium
was $37.9 million and $46.6 million at
December 31, 2004 and March 10, 2004, respectively.
Project debt associated with the financing of waste-to-energy
facilities is generally arranged by municipalities through the
issuance of tax-exempt and taxable revenue bonds. The category
“Revenue Bonds Issued by and Prime Responsibility of
Municipalities” includes bonds issued with respect to
projects owned by the Company for which debt service is an
explicit component of the Client Community’s obligation
under the related service agreement. In the event that a
municipality is unable to satisfy its payment obligations, the
bondholders’ recourse with respect to the Company is
limited to the waste-to-energy facilities and restricted funds
pledged to secure such obligations.
The category “Revenue Bonds Issued by Municipal Agencies
with Sufficient Service Revenues Guaranteed by Third
Parties” includes municipal bonds issued to finance one
facility for which contractual obligations of third parties to
deliver waste provide sufficient revenues to pay debt service,
although such debt service is not an explicit component of the
third parties’ service fee obligations.
The category “Other Revenue Bonds” includes bonds
issued to finance one facility for which current contractual
obligations of third parties to deliver waste to provide
sufficient revenues to pay debt service related to that facility
through 2011, although such debt service is not an explicit
component of the third parties’ service fee obligations.
The Company anticipates renewing such contracts prior to 2011.
Payment obligations for the project debt associated with
waste-to-energy facilities owned by the Company are limited
recourse to the operating subsidiary and non-recourse to the
Company, subject to operating performance guarantees and
commitments. These obligations are secured by the revenues
pledged under various indentures and are collateralized
principally by a mortgage lien and a security interest in each
of the respective waste-to-energy facilities and related assets.
At December 31, 2004, such revenue bonds were
collateralized by property, plant and equipment with a net
carrying value of $773 million and restricted funds held in
trust of approximately $188.2 million.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The interest rates on adjustable-rate revenue bonds are adjusted
periodically based on current municipal-based interest rates.
The average adjustable rate for such revenue bonds was 1.96% and
1.16% at December 31, 2004 and 2003, respectively, and the
average adjustable rate for such revenue bonds was 1.24% and
1.05% during 2004 and 2003.
Long-term project debt includes the following obligations for
2004 and 2003:
| • | No amounts due at December 31, 2004 and $19.8 million at December 31, 2003, due to financial institutions for the purchase of the Magellan Cogeneration Inc. power plant in the Philippines. This debt is non-recourse to Covanta and is secured by all assets of the project, all revenues and contracts of the project and by a pledge of the Company’s ownership in the project. This debt bears interest at rates equal to the three-month LIBOR plus spreads that increase from plus 4.5% until June 2005, to plus 4.875% from June 2005 to June 2007. The rate all in was 6.94% and 5.68% at December 31, 2004 and 2003, respectively. On May 31, 2004, Magellan Cogeneration Inc. filed a petition for corporate rehabilitation under the laws of the Philippines and is no longer included as a consolidated subsidiary after such date. On June 3, 2004, the presiding court issued a stay order prohibiting the enforcement of all claims against Magellan Cogeneration Inc. including principal and interest on such project debt. On August 31, 2004, such court issued a due course order allowing the corporate rehabilitation process to proceed. The rehabilitation receiver submitted his comments to the proposed rehabilitation plan and an alternative rehabilitation plan in January 2005. The final rehabilitation plan may provide for debt forgiveness, a debt to equity swap, a reduction in interest rate and/or an extension of debt tenor. | |
| • | $40.0 and $46.0 million due to financial institutions, of which $12.2 and $27.2 million is denominated in U.S. dollars and $27.8 and $18.8 million is denominated in Indian rupees at December 31, 2004 and 2003, respectively. This debt relates to the construction of a heavy fuel oil fired diesel engine power plant in India. The U.S. dollar debt bears interest at the three-month LIBOR, plus 4.5% (6.51% and 5.65% at December 31, 2004 and 2003, respectively). The Indian rupee debt bears interest at 7.75% at December 31, 2004 and rates ranging from 16.0% to 16.5% at December 31, 2003. The debt extends through 2011, is non-recourse to Covanta, and is secured by the project assets. The power off-taker has failed to fund the escrow account or post the letter of credit required under the energy contract which failure constitutes a technical default under the project finance documents. The project lenders have not declared an event of default due to this matter and have permitted continued distributions of project dividends. | |
| • | $37.6 and $44.2 million at December 31, 2004 and 2003, respectively, due to a financial institution which relates to the construction of a second heavy fuel oil fired diesel engine power plant in India. It is denominated in Indian rupees and bears interest at rates ranging from 7.5% to 16.15% and 11.75% to 16.15% in 2004 and 2003 respectively. The debt extends through 2010, is non-recourse to Covanta and is secured by the project assets. The power off-taker has failed to fund the escrow account or post the letter of credit required under the energy contract which failure constitutes a technical default under the project finance documents. The project lenders have not declared an event of default due to this matter and have permitted continued distributions of project dividends. | |
| • | $0.9 million at December 31, 2003, due to a financial institution, which relates to the construction of a second heavy fuel oil fired diesel engine power plant in India. The U.S. dollar denominated amount bears interest at an adjustable rate that is the three-month LIBOR rate plus 4.0% (5.64% at December 31, 2003). The debt extends through 2005. | |
| • | $1.2 million at December 31, 2003, due to a financial institution, which relates to the construction of a coal fired power plant in China. The U.S. dollar denominated amount bears interest at an adjustable rate that is the three-month LIBOR rate plus 4.0% (5.49% at December 31, 2003). The debt extends through 2006. | |
E-48
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
At December 31, 2004, the Company had one interest rate
swap agreement that economically fixes the interest rate on
certain adjustable-rate revenue bonds. The swap agreement was
entered into in September 1995 and expires in January 2019. This
swap agreement relates to adjustable rate revenue bonds in the
category “Revenue Bonds Issued by and Prime Responsibility
of Municipalities.” Any payments made or received under the
swap agreement, including fair value amounts upon termination,
are included as an explicit component of the Client
Community’s obligation under the related service agreement.
Therefore, all payments made or received under the swap
agreement are a pass through to the Client Community. Under the
swap agreement, the Company will pay an average fixed rate of
9.8% for 2002 through January 2005, and 5.18% thereafter through
January 2019, and will receive a floating rate equal to the rate
on the adjustable rate revenue bonds, unless certain triggering
events occur (primarily credit events), which results in the
floating rate converting to either a set percentage of LIBOR or
a set percentage of the BMA Municipal Swap Index, at the option
of the swap counterparty, (see Note 3 to the Notes to the
Consolidated Financial Statements). In the event the Company
terminates the swap prior to its maturity, the floating rate
used for determination of settling the fair value of the swap
would also be based on a set percentage of one of these two
rates at the option of the counterparty. For the years ended
December 31, 2004, 2003 and 2002, the floating rate on the
swap averaged 1.24%, 1.09% and 1.41%, respectively. The notional
amount of the swap at December 31, 2004 was
$80.2 million and is reduced in accordance with the
scheduled repayments of the applicable revenue bonds. The
counterparty to the swap is a major financial institution. The
Company believes the credit risk associated with nonperformance
by the counterparty is not significant. The swap agreement
resulted in increased debt service expense of $3.2 million,
$3.7 million and $3.4 million for 2004, 2003 and 2002,
respectively. The effect on Covanta’s weighted-average
borrowing rate of the project debt was an increase of 0.33%,
0.32% and 0.25%, for 2004, 2003 and 2002, respectively.
The maturities on long-term project debt at December 31,
2004 were as follows:
|
2005
|
$ | 109,701 | ||
|
2006
|
105,156 | |||
|
2007
|
103,734 | |||
|
2008
|
103,967 | |||
|
2009
|
82,319 | |||
|
Thereafter
|
439,860 | |||
|
Total
|
944,737 | |||
|
Less current portion
|
(109,701 | ) | ||
|
Total long-term project debt
|
$ | 835,036 | ||
E-49
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| 18. | Net Interest on Project Debt |
Net interest on project debt for Covanta consisted of the
following:
| Successor | Predecessor | |||||||||||||||
| For the Period | For the Period | |||||||||||||||
| March 11, | January 1, | |||||||||||||||
| Through | Through | |||||||||||||||
| December 31, | March 10, | |||||||||||||||
| 2004 | 2004 | 2003 | 2002 | |||||||||||||
|
Interest incurred on taxable and tax-exempt borrowings
|
$ | 33,492 | $ | 13,433 | $ | 77,046 | $ | 86,954 | ||||||||
|
Interest earned on temporary investment of certain restricted
funds
|
(906 | ) | (26 | ) | (276 | ) | (589 | ) | ||||||||
|
Net interest on project debt
|
$ | 32,586 | $ | 13,407 | $ | 76,770 | $ | 86,365 | ||||||||
Interest earned on temporary investment of certain unrestricted
funds to service principal and interest obligations is related
to the Alexandria, Virginia and Haverhill, Massachusetts
waste-to-energy facilities project debt.
| 19. | Other Liabilities |
Other liabilities consisted of the following:
| Successor | Predecessor | |||||||
| 2004 | 2003 | |||||||
|
Interest rate swap
|
$ | 14,920 | $ | 16,728 | ||||
|
Pension benefit obligation
|
45,430 | — | ||||||
|
Deferred revenue
|
— | 24,670 | ||||||
|
Asset retirement obligation
|
18,912 | 18,387 | ||||||
|
Service contract liabilities
|
7,873 | — | ||||||
|
Other
|
10,713 | 18,573 | ||||||
|
Total
|
$ | 97,848 | $ | 78,358 | ||||
Deferred revenue of $24.7 million in 2003 is a result of
the Hennepin County, Minnesota restructuring. As of
March 10, 2004 Hennepin deferred revenue was recorded at
its fair value of zero. See Notes 2 and 34 to the Notes to
the Consolidated Financial Statements.
| 20. | Convertible Subordinated Debentures |
Convertible subordinated debentures of the predecessor consisted
of the following:
| 2003 | ||||
|
6% debentures due June 1, 2002
|
$ | 85,000 | ||
|
5.75% debentures due October 20, 2002
|
63,650 | |||
|
Total
|
148,650 | |||
|
Less: Liabilities subject to compromise
|
(148,650 | ) | ||
|
Total
|
$ | — | ||
In accordance with SOP 90-7, since April 1, 2002
interest expense was not accrued on the subordinated debentures
as it was not likely to be paid. As of December 31, 2003
debentures have been included in
E-50
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
Liabilities subject to compromise. The holders of these
debentures did not participate in the new capital structure or
receive any value under the Reorganization Plan.
| 21. | Preferred Stock |
All preferred shares were cancelled as of the effective date and
the holders of the preferred shares did not participate in the
new capital structure of Covanta or receive any value under the
Reorganization Plan.
The outstanding Series A $1.875 Cumulative Convertible
Preferred Stock was convertible at any time at the rate of
5.97626 common shares for each preferred share. Covanta could
redeem the outstanding shares of preferred stock at $50 per
share, plus all accrued dividends. These preferred shares were
entitled to receive cumulative annual dividends at the rate of
$1.875 per share, plus an amount equal to 150% of the
amount, if any, by which the dividend paid or any cash
distribution made on the common stock in the preceding calendar
quarter exceeded $.0667 per share. With the filing of
voluntary petitions for reorganization under Chapter 11 on
April 1, 2002 (see Note 2 to the Notes to the
Consolidated Financial Statements) dividend payments were
suspended.
| 22. | Common Stock and Stock Options |
The plans described in this note were terminated, together with
all options and rights there-under with the Reorganization Plan.
In 1986, Covanta adopted a nonqualified stock option plan (the
“1986 Plan”). Under this plan, options and/or stock
appreciation rights were granted to key management employees to
purchase Covanta common stock at prices not less than the fair
market value at the time of grant, which became exercisable
during a five-year period from the date of grant. Options were
exercisable for a period of ten years after the date of grant.
As adopted and as adjusted for stock splits, the 1986 Plan
called for up to an aggregate of 2,700,000 shares of
Covanta common stock to be available for issuance upon the
exercise of options and stock appreciation rights, which were
granted over a ten-year period ending March 10, 1996.
In October 1990, Covanta adopted a nonqualified stock option
plan (the “1990 Plan”). Under this plan, nonqualified
options, incentive stock options, and/or stock appreciation
rights and stock bonuses could be granted to key management
employees and outside directors to purchase Covanta common stock
at an exercise price to be determined by the Covanta
Compensation Committee, which become exercisable during the
five-year period from the date of grant. These options were
exercisable for a period of ten years after the date of grant.
Pursuant to the 1990 Plan, which was amended in 1994 to increase
the number of shares available by 3,200,000 shares, an
aggregate of 6,200,000 shares of Covanta common stock were
available for grant over a ten-year period which ended
October 11, 2000.
In 1999, Covanta adopted a nonqualified stock option plan (the
“1999 Plan”). Under this plan, nonqualified options,
incentive stock options, limited stock appreciation rights
(“LSAR’s”) and performance-based cash awards
could be granted to employees and outside directors to purchase
Covanta common stock at an exercise price not less than 100% of
the fair market value of the common stock on the date of grant
which become exercisable over a three-year period from the date
of grant. These options were exercisable for a period of ten
years after the date of grant. In addition, performance-based
cash awards could also be granted to employees and outside
directors. As adopted, the 1999 Plan called for up to an
aggregate of 4,000,000 shares of Covanta common stock to be
available for issuance upon the exercise of such options and
LSAR’s, which could be granted over a ten-year period
ending May 19, 2009. At December 31, 2003,
2,042,032 shares were available for grant.
Effective January 1, 2000, the 1999 Plan was amended and
restated to change the name of the plan to the “1999 Stock
Incentive Plan” and to include the award of restricted
stock to key employees based on the
E-51
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
attainment of pre-established performance goals. The maximum
number of shares of common stock that is available for awards of
restricted stock is 1,000,000.
Under the foregoing plans, Covanta issued 3,952,900 LSAR’s
between 1990 and 2001 in conjunction with the stock options
granted. These LSAR’s were exercisable only during the
period commencing on the first day following the occurrence of
any of the following events and terminate 90 days after
such date: the acquisition by any person of 20% or more of the
voting power of Covanta’s outstanding securities; the
approval by Covanta shareholders of an agreement to merge or to
sell substantially all of its assets; or the occurrence of
certain changes in the Company’s Board of Directors. The
exercise of these limited rights entitled participants to
receive an amount in cash with respect to each share subject
thereto, equal to the excess of the market value of a share of
Covanta common stock on the exercise date or the date these
limited rights became exercisable, over the related option price.
In February 2000, Covanta adopted (through an amendment to the
1999 Stock Incentive Plan) the Restricted Stock Plan for Key
Employees (the “Key Employees Plan”) and the
Restricted Stock Plan for Non-Employee Directors (the
“Directors Plan”). The Plans, as amended, called for
up to 500,000 shares and 160,000 shares, respectively,
of restricted Covanta common stock to be available for issuance
as awards. Awards of restricted stock were to be made from
treasury shares of Covanta common stock, par value $.50 per
share. The Company accounted for restricted shares at their
market value on their respective dates of grant. Restricted
shares awarded under the Directors Plan vested 100% at the end
of three months from the date of award. Shares of restricted
stock awarded under the Key Employees Plan were subject to a
two-year vesting schedule, 50% one year following the date of
award and 50% two years following the date of award. As of
December 31, 2003, an aggregate of 169,198 shares of
restricted stock had been awarded under the Key Employees Plan
and an aggregate of 95,487 shares of restricted stock had
been awarded under the Directors Plan. The Company did not
record any compensation costs in 2004, 2003 or 2002.
E-52
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
Information regarding the Company’s stock option plans is
summarized as follows:
| Weighted- | ||||||||||||||||
| Option Price | Average | |||||||||||||||
| Per Share | Outstanding | Exercisable | Exercise Price | |||||||||||||
|
1986 Plan:
|
||||||||||||||||
|
December 31, 2001
|
$22.50 | 10,000 | 10,000 | $ | 22.50 | |||||||||||
|
December 31, 2002, balance
|
$22.50 | 10,000 | 10,000 | $ | 22.50 | |||||||||||
|
December 31, 2003, balance
|
$22.50 | 10,000 | 10,000 | $ | 22.50 | |||||||||||
|
Cancelled
|
$22.50 | (10,000 | ) | (10,000 | ) | $ | 22.50 | |||||||||
|
March 10, 2004 balance
|
— | — | — | — | ||||||||||||
|
1990 Plan:
|
||||||||||||||||
|
December 31, 2001, balance
|
$ | 9.97-$29.38 | 1,809,000 | 1,343,000 | $ | 23.51 | ||||||||||
|
Became exercisable
|
$ | 9.97-$29.38 | 200,000 | |||||||||||||
|
Cancelled
|
$ | 20.06-$26.78 | (272,000 | ) | (235,000 | ) | $ | 23.03 | ||||||||
|
December 31, 2002, balance
|
$ | 9.97-$29.38 | 1,537,000 | 1,308,000 | $ | 23.43 | ||||||||||
|
Became exercisable
|
$ | 9.97-$29.38 | 152,000 | |||||||||||||
|
Cancelled
|
$ | 20.06-$26.78 | (133,500 | ) | (130,500 | ) | $ | 23.45 | ||||||||
|
December 31, 2003, balance
|
$ | 9.97-$29.38 | 1,403,500 | 1,329,500 | $ | 23.63 | ||||||||||
|
Cancelled on March 10, 1004
|
$ | 9.97-$29.38 | (1,403,500 | ) | (1,329,500 | ) | $ | 23.63 | ||||||||
|
March 10, 2004 balance
|
— | — | ||||||||||||||
|
1999 Plan
|
||||||||||||||||
|
December 31, 2001, balance
|
$ | 8.66-$26.59 | 1,957,968 | 831,679 | $ | 14.68 | ||||||||||
|
Became exercisable
|
$ | 8.66-$26.59 | 613,280 | |||||||||||||
|
Cancelled
|
$ | 11.28-$20.23 | (181,633 | ) | (52,399 | ) | $ | 14.23 | ||||||||
|
December 2002, balance
|
$ | 8.66-$26.59 | 1,776,335 | 1,392,560 | $ | 13.76 | ||||||||||
|
Became exercisable
|
$ | 9.97-$17.93 | 205,880 | |||||||||||||
|
Cancelled
|
$ | 11.78-$17.93 | (99,467 | ) | (65,338 | ) | $ | 16.00 | ||||||||
|
December 2003, balance
|
$ | 8.66-$26.59 | 1,676,868 | 1,533,102 | $ | 14.14 | ||||||||||
|
Cancelled on March 10, 2004
|
$ | 8.66-$25.59 | (1,676,868 | ) | (1,533,120 | ) | $ | 14.14 | ||||||||
|
March 10, 2004, balance
|
— | — | ||||||||||||||
|
Total March 10, 2004
|
— | — | ||||||||||||||
The following table summarizes information about stock options
outstanding at December 31, 2003:
| Options Outstanding | Options Exercisable | |||||||||||||||||||||
| Number of | Weighted-Average | Number of | ||||||||||||||||||||
| Range of | Shares | Remaining | Weighted-Average | Shares | Weighted-Average | |||||||||||||||||
| Exercise Prices | Outstanding | Contractual Life | Exercise Price | Outstanding | Exercise Price | |||||||||||||||||
| $8.66-$12.98 | 792,800 | 5.9 Years | $ | 11.51 | 773,633 | $ | 11.55 | |||||||||||||||
| $14.10-$20.19 | 1,175,568 | 5.5 Years | $ | 17.25 | 1,030,969 | $ | 17.20 | |||||||||||||||
| $21.50-$29.38 | 1,122,000 | 3.0 Years | $ | 25.04 | 1,068,000 | $ | 24.95 | |||||||||||||||
| $8.66-$29.38 | 3,090,368 | 4.7 Years | $ | 18.60 | 2,872,602 | $ | 18.56 | |||||||||||||||
E-53
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
All options were cancelled on the effective date. The
weighted-average exercise prices for all exercisable options at
December 31, 2003 and 2002 was $18.56, and $18.46,
respectively. At December 31, 2003, there were
5,865,576 shares of common stock reserved for the exercise
of stock options, the issuance of restricted stock and the
conversion of preferred shares and debentures.
No shares were purchased during 2003, and 2002.
Existing common stock and stock option holders did not
participate in the new capital structure or receive any value
under the Reorganization Plan (see Note 2 to the Notes to
the Consolidated Financial Statements).
The holders of any rights associated with the Old Common stock
and Old Preferred stock were terminated under the Reorganization
Plan. Holders of such rights did not participate in the new
capital structure or receive any value under the Reorganization
Plan.
| 23. | Foreign Exchange |
Foreign currency translation adjustments net of tax amounted to
$0.5 million for the period March 11 through
December 31, 2004, $0.2 million for the period
January 1, through March 10, 2004 and
$2.7 million and $(1.5) million in 2003 and 2002,
respectively, and have been charged directly to Other
Comprehensive Income (Loss). In 2003, $2.8 million was
reclassified to income from continuing operations; in 2002,
$1.2 million was reclassified to loss on sale of businesses
and $0.3 million was reclassified to loss from discontinued
operations. Foreign exchange transaction gain (loss), amounting
to $0.5 million, $0.4 million, zero and
$(0.4) million have been charged directly to net income
(loss) for the periods March 11 through December 31,
2004, January 1 through March 10, 2004 and the years
2003 and 2002, respectively.
| 24. | Pensions and Other Postretirement Benefits |
Covanta has defined benefit and defined contribution retirement
plans that cover substantially all of its employees. The defined
benefit plans provide benefits based on years of service and
either employee compensation or a fixed benefit amount.
Covanta’s funding policy for those plans is to contribute
annually an amount no less than the minimum funding required by
ERISA. Contributions are intended to provide not only benefits
attributed to service to date but also for those expected to be
earned in the future. The Company expects to make contributions
of $3.1 million to its defined benefit plans and
$1.7 million to its postretirement benefit plans during
2005.
E-54
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
As of January 1, 2002, a defined contribution plan for
approximately 1,200 employees was frozen and the employees were
transferred to the Company’s qualified defined benefit
plan. The following table sets forth the details of
Covanta’s defined benefit plans’ and other
postretirement benefit plans’ funded status (using a
December 31 measurement date) and related amounts recognized in
Covanta’s Consolidated Balance Sheets:
| Pension Benefits | Other Benefits | ||||||||||||||||
| 2004 | 2003 | 2004 | 2003 | ||||||||||||||
|
Change in benefit obligation:
|
|||||||||||||||||
|
Benefit obligation at beginning of year
|
$ | 55,109 | $ | 38,907 | $ | 22,337 | $ | 21,125 | |||||||||
|
Service cost
|
8,147 | 5,986 | — | — | |||||||||||||
|
Interest cost
|
3,434 | 2,717 | 804 | 1,389 | |||||||||||||
|
Actuarial (loss) gain
|
2,093 | 8,120 | (10,528 | ) | 1,370 | ||||||||||||
|
Settlement
|
— | — | (47 | ) | — | ||||||||||||
|
Benefits paid
|
(1,685 | ) | (621 | ) | (748 | ) | (1,367 | ) | |||||||||
|
Aviation fueling sale
|
— | — | — | (180 | ) | ||||||||||||
|
Benefit obligation at end of year
|
67,098 | 55,109 | 11,818 | 22,337 | |||||||||||||
|
Change in plan assets:
|
|||||||||||||||||
|
Plan assets at fair value at beginning of year
|
$ | 26,043 | $ | 14,879 | $ | — | $ | — | |||||||||
|
Actual return on plan assets
|
3,344 | 5,251 | — | — | |||||||||||||
|
Company contributions
|
9,274 | 6,534 | 748 | 1,367 | |||||||||||||
|
Benefits paid
|
(1,685 | ) | (621 | ) | (748 | ) | (1,367 | ) | |||||||||
|
Plan assets at fair value at end of year
|
36,976 | 26,043 | — | — | |||||||||||||
|
Reconciliation of accrued benefit liability and net amount
recognized:
|
|||||||||||||||||
|
Funded status of the plan
|
(30,122 | ) | (29,066 | ) | (11,818 | ) | (22,337 | ) | |||||||||
|
Unrecognized:
|
|||||||||||||||||
|
Prior service cost
|
— | (1,712 | ) | — | — | ||||||||||||
|
Net (loss) gain
|
(4,609 | ) | 14,605 | (405 | ) | 9,729 | |||||||||||
|
Net amount recognized
|
(34,731 | ) | (16,173 | ) | (12,223 | ) | (12,608 | ) | |||||||||
|
Accumulated Benefit Obligation
|
$ | 46,464 | $ | 38,060 | $ | 12,223 | $ | 22,337 | |||||||||
|
Amounts recognized in the consolidated balance sheets consist
of:
|
|||||||||||||||||
|
Accrued benefit liability
|
$ | (34,918 | ) | $ | (16,173 | ) | $ | — | $ | (12,608 | ) | ||||||
|
Accumulated other comprehensive income
|
187 | — | — | — | |||||||||||||
|
Net amount recognized
|
$ | (34,731 | ) | $ | (16,173 | ) | $ | (12,223 | ) | $ | (12,608 | ) | |||||
|
Weighted-average assumptions used to determine net periodic
benefit costs for years ending December 31:
|
|||||||||||||||||
|
Discount rate
|
6.25 | % | 6.75 | % | 6.25 | % | 6.75 | % | |||||||||
|
Discount rate beginning March 10, 2004
|
5.75 | % | — | — | — | ||||||||||||
|
Expected return on plan assets
|
8.00 | % | 8.00 | % | — | — | |||||||||||
|
Rate of compensation increase
|
4.50 | % | 4.50 | % | — | — | |||||||||||
|
Weighted-average assumptions used to determine benefit
obligations for years ending December 31:
|
|||||||||||||||||
|
Discount rate
|
6.00 | % | 6.25 | % | 6.00 | % | 6.25 | % | |||||||||
|
Rate of compensation increase
|
4.00 | % | 4.50 | % | — | — | |||||||||||
E-55
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The weighted average assumptions used to determine net periodic
benefit costs for pension and other benefits for the year ended
December 31, 2002 were as follows; discount rate, 7.25% and
7.25%, respectively, expected return on plan assets 8.0% and
zero, respectively; and rate of compensation increase 4.5% and
zero, respectively.
Pension plan assets had a fair value of $37.0 million and
$26.0 million at December 31, 2004 and 2003. The
allocation of plan assets at December 31 was as follows:
| 2004 | 2003 | |||||||
|
Equities
|
69 | % | 75 | % | ||||
|
U.S. Debt Securities
|
25 | % | 24 | % | ||||
|
Other
|
6 | % | 1 | % | ||||
|
Total
|
100 | % | 100 | % | ||||
The Company’s expected return on plan assets assumption is
based on historical experience and by evaluating input from the
trustee managing the plan’s assets. The expected return on
the plan assets is also impacted by the target allocation of
assets, which is based on the company’s goal of earning the
highest rate of return while maintaining risk at acceptable
levels. The plan strives to have assets sufficiently diversified
so that adverse or unexpected results from one security class
will not have an unduly detrimental impact on the entire
portfolio.
The target ranges of allocation of assets are as follows:
|
Equities
|
40 - 75 | % | ||
|
U.S. Debt Securities
|
25 - 60 | % | ||
|
Other
|
0 - 20 | % |
The Company anticipates that the long-term asset allocation on
average will approximate the targeted allocation. Actual asset
allocations are reviewed and the pension plans’ investments
are rebalanced to reflect the targeted allocation when
considered appropriate.
For management purposes, an annual rate of increase of 11.0% in
the per capita cost of health care benefits was assumed for 2004
for covered employees. The rate is assumed to decrease gradually
to 5.5% in 2010 and remain at that level.
For the pension plans with accumulated benefit obligations in
excess of plan assets the projected benefit obligation,
accumulated benefit obligation, and fair value of plan assets
were $67.1 million, $46.5 million, and
$37.0 million, respectively as of December 31, 2004
and $55.1 million, $38.1 million and
$26.0 million, respectively as of December 31, 2003.
The Company estimates that the future benefits payable for the
retirement and post-retirement plans in place are as follows at
December 31, 2004:
| Pension | Other Benefits | Other Benefits | ||||||||||
| Benefits | Post Medicare | Pre Medicare | ||||||||||
|
2005
|
$ | 1,207 | $ | 1,744 | $ | 1,744 | ||||||
|
2006
|
659 | 1,699 | 1,826 | |||||||||
|
2007
|
793 | 1,766 | 1,899 | |||||||||
|
2008
|
964 | 1,818 | 1,954 | |||||||||
|
2009
|
1,102 | 1,830 | 1,967 | |||||||||
|
2010 - 2014
|
12,953 | 9,202 | 9,892 | |||||||||
E-56
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
Contributions and costs for defined contribution plans are
determined by benefit formulas based on percentage of
compensation as well as discretionary contributions and totaled
$3.5 million, $3.2 million and $3.3 million, in
2004, 2003, and 2002, respectively. Plan assets at
December 31, 2004, 2003 and 2002, primarily consisted of
common stocks, United States government securities, and
guaranteed insurance contracts.
With respect to its union employees, the Company is required
under contracts with various unions to pay retirement, health
and welfare benefits, generally based on hours worked. These
multi-employer defined contribution plans are not controlled or
administered by the Company and primarily related to businesses
sold by the Company in 2002. The amount charged to expense for
such plans during 2004, 2003 and 2002 was zero, zero, and
$1.7 million, respectively.
Pension costs for Covanta’s defined benefit plans and other
post-retirement benefit plans included the following components:
| Pension Benefits | Other Benefits | ||||||||||||||||||||||||||||||||
| Successor | Predecessor | Successor | Predecessor | ||||||||||||||||||||||||||||||
| For the Period | For the Period | For the Period | For the Period | ||||||||||||||||||||||||||||||
| March 11 | January 1 | March 11 | January 1 | ||||||||||||||||||||||||||||||
| Through | Through | Through | Through | ||||||||||||||||||||||||||||||
| December 31, | March 10, | December 31, | March 10, | ||||||||||||||||||||||||||||||
| 2004 | 2004 | 2003 | 2002 | 2004 | 2004 | 2003 | 2002 | ||||||||||||||||||||||||||
|
Components of Net Periodic
|
|||||||||||||||||||||||||||||||||
|
Benefit Cost:
|
|||||||||||||||||||||||||||||||||
|
Service Cost
|
$ | 6,716 | $ | 1,431 | $ | 5,986 | $ | 4,187 | $ | — | $ | — | $ | — | $ | 53 | |||||||||||||||||
|
Interest Cost
|
2,783 | 651 | 2,717 | 2,111 | 546 | 258 | 1,389 | 1,409 | |||||||||||||||||||||||||
|
Expected return on plan assets
|
(1,905 | ) | (450 | ) | (1,360 | ) | (1,421 | ) | — | — | — | — | |||||||||||||||||||||
|
Settlement
|
— | — | — | — | — | (53 | ) | — | — | ||||||||||||||||||||||||
|
Amortization of unrecognized:
|
|||||||||||||||||||||||||||||||||
|
Prior service cost
|
— | — | (185 | ) | (185 | ) | — | — | — | ||||||||||||||||||||||||
|
Net (gain) loss
|
— | 127 | 1,644 | 195 | 128 | 591 | * | 527 | * | ||||||||||||||||||||||||
|
Net periodic benefit cost
|
$ | 7,594 | $ | 1,759 | $ | 8,802 | $ | 4,887 | $ | 546 | $ | 333 | $ | 1,980 | $ | 1,989 | |||||||||||||||||
| * | Excludes gains of $196 and $842 in 2003 and 2002 respectively, related to the sale of non-core businesses. |
Assumed health care cost trend rates have a significant effect
on the amounts reported for the health care plan. A
one-percentage point change in the assumed health care trend
rate would have the following effects (expressed in thousands of
dollars):
| One-Percentage | One-Percentage | |||||||
| Point Increase | Point Decrease | |||||||
|
Effect on total service and interest cost components
|
$ | 59 | $ | (52 | ) | |||
|
Effect on postretirement benefit obligation
|
$ | 922 | $ | (804 | ) | |||
On December 8, 2003, the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (the “Act”)
was signed into Law. The Act introduces a prescription drug
benefit under Medicare as well as a federal subsidy to sponsors
of retiree health care benefit plans that provide a prescription
drug benefit that is at least actuarially equivalent to Medicare
Part D. In accordance with FASB Staff Position 106-1 (as
amended by FASB Staff Position 106-2), effective in 2004 the
accumulated post-retirement benefit obligation and net periodic
post-retirement benefit cost in the Company’s Consolidated
Financial Statements and this note reflects the effects of the
Act on the plans.
E-57
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
25. Special Charges
As a result of the decisions discussed below, the Company has
incurred various expenses, described as special charges, which
have been recognized in its continuing and discontinued
operations
In September 1999, the Company’s Board of Directors
approved a plan to dispose of its aviation and entertainment
businesses and close its New York headquarters, and in December
1999 approved a plan to exit other non-energy businesses so that
the Company could focus its resources on its core energy
business. Of the New York employees, 24, 139, 29, 14, and 6
employees were terminated in 1999, 2000, 2001, 2002 and 2003,
respectively. As of December 31, 2003, 5 such employees
remained and the Company terminated them at various dates
throughout 2004. As of December 31, 2004 one employee
remained at the Company.
In December 2000, the Company approved a plan to reorganize its
development office in Hong Kong and its New Jersey headquarters.
As a result, the Company implemented a reduction in its
workforce of approximately 80 employees, both domestically and
internationally, in connection with the refocusing of the
Company’s energy development activities and streamlining
its organizational structure. This plan included closure of the
Company’s Hong Kong office and consolidation of its
waste-to-energy regional organizational structure. The plan was
completed as of December 31, 2001. However certain
remaining termination claims will be resolved through the
Company’s bankruptcy proceeding.
In December 2003, the Company announced a reduction in force of
approximately 13 domestic energy non-plant employees and closure
of the Fairfax Virginia office, which was completed in the
second quarter of 2004. The reduction in force was primarily a
result of the sale of the geothermal business in December 2003.
These employees are entitled to aggregate severance and employee
benefit payments of $0.7 million in accordance with the
severance and retention plan approved by the Bankruptcy Court on
September 20, 2002. In the fourth quarter of 2003,
$0.3 million of the $0.7 million in one-time
termination benefits was recorded as reorganization items in the
Consolidated Statement of Operations and Comprehensive Income
(Loss), in accordance with SFAS No. 146,
“Accounting for Costs Associated with Exit or Disposal
Activities”. No costs were paid or otherwise settled during
2003.
On September 23, 2002, the Company announced a reduction in
force of approximately 60 energy non-plant employees and
closure of various satellite offices. In accordance with the
severance and retention plan approved by the Bankruptcy Court on
September 20, 2002, these employees and the remaining New
York City employees may be entitled to aggregate severance
payments of approximately $5.0 million. In the third
quarter of 2002 and in accordance with EITF 94-3, this
amount was recognized as reorganization items in the 2002
Consolidated Statement of Operations and Comprehensive Income
(Loss) and the prior severance accrual was reduced by
$13.4 million as a credit to operating expense. In
addition, the Company accrued office closure and outplacement
costs of $0.7 million that were recognized as
Reorganization items.
Pursuant to the key employee retention plan approved by the
Bankruptcy Court on September 20, 2002, retention payments
of approximately $3.6 million in the aggregate for
approximately 72 key employees began to be recognized
during the third quarter of 2002 and were recognized as
Reorganization items. The first payment of $1.1 million was
made on September 30, 2002. The second payment of
$1.1 million was made on September 30, 2003. Payments
in the aggregate of approximately $1.4 million were paid to
eligible key employees remaining with the Company upon emergence
of the Company from bankruptcy.
E-58
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The following is a summary of the principal special charges
(both cash and non-cash charges) recognized in the years ended
December 31, 2004, 2003 and 2002:
| Balance at | Charged | Transferred to | Balance at | |||||||||||||||||
| March 11, | (Credited to) | Amounts | Liabilities Subject | December 31, | ||||||||||||||||
| 2004 | Operations | Paid | to Compromise | 2004 | ||||||||||||||||
|
Successor
|
||||||||||||||||||||
|
March 11, 2004 — December 31, 2004
|
||||||||||||||||||||
|
Severance for approximately 216 New York City employees
|
$ | 988 | $ | — | $ | (529 | ) | $ | — | $ | 459 | |||||||||
|
Severance for approximately 60 employees terminated post
petition
|
34 | (10 | ) | (24 | ) | — | — | |||||||||||||
|
Key employee retention plan
|
985 | — | (985 | ) | — | — | ||||||||||||||
|
Total
|
$ | 2,007 | $ | (10 | ) | $ | (1,538 | ) | $ | — | $ | 459 | ||||||||
| Balance at | Charged | Transferred to | Balance at | |||||||||||||||||
| January 1, | (Credited to) | Amounts | Liabilities Subject | March 10, | ||||||||||||||||
| 2004 | Operations | Paid | to Compromise | 2004 | ||||||||||||||||
|
Predecessor
|
||||||||||||||||||||
|
January 1, 2004 — March 10, 2004
|
||||||||||||||||||||
|
Severance for approximately 216 New York City employees
|
$ | 1,470 | $ | (312 | )(A) | $ | (170 | ) | $ | — | $ | 988 | ||||||||
|
Severance for approximately 60 employees terminated post petition
|
277 | (239 | )(A) | (4 | ) | — | 34 | |||||||||||||
|
Key employee retention plan
|
1,425 | (440 | )(A) | — | — | 985 | ||||||||||||||
|
Office closure costs
|
518 | — | (48 | ) | (470 | ) | — | |||||||||||||
|
Total
|
$ | 3,690 | $ | (991 | ) | $ | (222 | ) | $ | (470 | ) | $ | 2,007 | |||||||
E-59
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| Charges for | Transferred to | |||||||||||||||||||
| Balance at | (Credited to) | Amounts | Liabilities Subject | Balance at | ||||||||||||||||
| January 1, | Operations | Paid | to Compromise | December 31, | ||||||||||||||||
|
2003
|
||||||||||||||||||||
|
Severance for approximately 216 New York city employees
|
$ | 1,600 | $ | — | $ | (130 | ) | $ | — | $ | 1,470 | |||||||||
|
Severance for approximately 80 energy employees
|
2,500 | — | (704 | ) | (1,796 | ) | — | |||||||||||||
|
Severance for approximately 60 employees terminated post petition
|
4,350 | (873 | ) | (3,200 | ) | — | 277 | |||||||||||||
|
Key employee retention plan
|
700 | 1,800 | (1,075 | ) | — | 1,425 | ||||||||||||||
|
Contract termination settlement
|
400 | (400 | ) | — | — | — | ||||||||||||||
|
Office closure costs
|
1,200 | (317 | ) | (365 | ) | — | 518 | |||||||||||||
|
Total
|
$ | 10,750 | $ | 210 | $ | (5,474 | ) | $ | (1,796 | ) | $ | 3,690 | ||||||||
|
2002
|
||||||||||||||||||||
|
Severance for approximately 216 New York city employees
|
$ | 17,500 | $ | (15,100 | ) | $ | (800 | ) | $ | — | $ | 1,600 | ||||||||
|
Severance for approximately 80 energy employees
|
3,800 | — | (1,300 | ) | — | 2,500 | ||||||||||||||
|
Severance for approximately 60 employees terminated post petition
|
— | 5,000 | (650 | ) | — | 4,350 | ||||||||||||||
|
Key employee retention plan
|
— | 1,800 | (1,100 | ) | — | 700 | ||||||||||||||
|
Contract termination settlement
|
400 | — | — | — | 400 | |||||||||||||||
|
Office closure costs
|
600 | 730 | (130 | ) | — | 1,200 | ||||||||||||||
|
Total
|
$ | 22,300 | $ | (7,570 | ) | $ | (3,980 | ) | $ | — | $ | 10,750 | ||||||||
The amount accrued for severance is based upon the
Company’s written severance policy and the positions
eliminated. The accrued severance does not include any portion
of the employees’ salaries through their severance dates.
E-60
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
26. Income Taxes
The components of the provision (benefit) for income taxes
for continuing operations were as follows:
| Successor | Predecessor | ||||||||||||||||
| For the Period | For the Period | ||||||||||||||||
| March 11 | January 1 | ||||||||||||||||
| Through | Through | ||||||||||||||||
| December 31, | March 10, | ||||||||||||||||
| 2004 | 2004 | 2003 | 2002 | ||||||||||||||
|
Current:
|
|||||||||||||||||
|
Federal
|
$ | 1,899 | 185 | $ | — | $ | (10,488 | ) | |||||||||
|
State
|
4,324 | 27,615 | 1,926 | 1,469 | |||||||||||||
|
Foreign
|
5,079 | 513 | 3,712 | 3,914 | |||||||||||||
|
Total current
|
11,302 | 28,313 | 5,638 | (5,105 | ) | ||||||||||||
|
Deferred:
|
|||||||||||||||||
|
Federal
|
13,766 | 29,527 | (22,701 | ) | 5,283 | ||||||||||||
|
State
|
(870 | ) | (27,600 | ) | (779 | ) | (888 | ) | |||||||||
|
Foreign
|
(561 | ) | — | (254 | ) | (276 | ) | ||||||||||
|
Total deferred
|
12,335 | 1,927 | (23,734 | ) | 4,119 | ||||||||||||
|
Total provision (benefit) for income taxes
|
$ | 23,637 | $ | 30,240 | $ | (18,096 | ) | $ | (986 | ) | |||||||
The provision (benefit) for income taxes varied from the
Federal statutory income tax rate due to the following:
| Successor | Predecessor | |||||||||||||||||||||||||||||||
| For the Period | For the Period | |||||||||||||||||||||||||||||||
| March 11, | January 1, | |||||||||||||||||||||||||||||||
| Through | Through | |||||||||||||||||||||||||||||||
| December 31, | March 10, | |||||||||||||||||||||||||||||||
| 2004 | 2004 | 2003 | 2002 | |||||||||||||||||||||||||||||
| Percent | Percent | Percent | Percent | |||||||||||||||||||||||||||||
| of Income | of Income | of Loss | of Loss | |||||||||||||||||||||||||||||
| Amount | Before | Amount | Before | Amount | Before | Amount | Before | |||||||||||||||||||||||||
| of tax | Taxes | of Tax | Taxes | of Tax | Taxes | of Tax | Taxes | |||||||||||||||||||||||||
|
Taxes at statutory rate
|
$ | 15,456 | 35 | % | $ | 20,436 | 35 | % | $ | (21,124 | ) | 35 | % | $ | (50,378 | ) | 35 | % | ||||||||||||||
|
State income taxes, net of Federal tax benefit
|
2,245 | 5 | 10 | — | 746 | (2 | ) | 381 | — | |||||||||||||||||||||||
|
Taxes on foreign earnings
|
(81 | ) | — | — | 549 | (1 | ) | 32,380 | (23 | ) | ||||||||||||||||||||||
|
Taxes on equity earnings
|
425 | 1 | — | |||||||||||||||||||||||||||||
|
Subpart F income and foreign dividends
|
5,153 | 12 | (374 | ) | (1 | ) | 1,732 | (3 | ) | 350 | — | |||||||||||||||||||||
|
Amortization of goodwill
|
— | — | — | — | — | — | 47 | — | ||||||||||||||||||||||||
|
Tax effect of fresh start accounting revaluation
|
— | — | 79,376 | 136 | — | — | — | — | ||||||||||||||||||||||||
|
Reorganization items
|
— | — | 10,284 | 18 | 6,300 | (10 | ) | 5,600 | (4 | ) | ||||||||||||||||||||||
|
Change in valuation allowance
|
45 | — | (79,492 | ) | (136 | ) | (3,449 | ) | 6 | 11,648 | (8 | ) | ||||||||||||||||||||
|
Other—net
|
394 | 1 | — | — | (2,850 | ) | 5 | (1,014 | ) | 1 | ||||||||||||||||||||||
|
Provision (benefit) for income taxes
|
$ | 23,637 | 54 | % | $ | 30,240 | 52 | % | $ | (18,096 | ) | 30 | % | $ | (986 | ) | 1 | % | ||||||||||||||
E-61
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The components of the net deferred income tax liability as of
December 31, 2004 and 2003 were as follows:
| Successor | Predecessor | |||||||
| 2004 | 2003 | |||||||
|
Deferred Tax Assets:
|
||||||||
|
Accrued expenses
|
$ | 50,817 | $ | 68,066 | ||||
|
Tax basis in bond and other costs
|
20,271 | 33,725 | ||||||
|
Non energy assets and related obligations
|
— | 51,626 | ||||||
|
Deferred tax assets of unconsolidated subsidiary
|
9,390 | — | ||||||
|
Net operating loss carry forwards
|
73,249 | 45,239 | ||||||
|
Investment tax credits
|
— | 26,073 | ||||||
|
Alternative minimum tax credits
|
855 | 18,624 | ||||||
|
Total deferred tax assets
|
154,582 | 243,353 | ||||||
|
Less: Valuation allowance
|
(9,390 | ) | (79,492 | ) | ||||
|
Net deferred tax asset
|
145,192 | 163,861 | ||||||
|
Deferred Tax Liabilities:
|
||||||||
|
Unremitted earnings of foreign subsidiaries
|
9,823 | — | ||||||
|
Unbilled accounts receivable
|
39,071 | 75,886 | ||||||
|
Property, plant, and equipment
|
178,207 | 272,745 | ||||||
|
Intangible assets and other
|
75,409 | 526 | ||||||
|
Total deferred tax liabilities
|
302,510 | 349,157 | ||||||
|
Net deferred tax liability
|
$ | 157,318 | $ | 185,296 | ||||
| Predecessor Period |
As of December 31, 2003, a valuation allowance of
$53.4 million was recorded because the Company did not
believe it was more likely than not that certain of the losses
resulting from the sales and write-downs of and obligations
related to discontinued operations and assets held for sales
will be realized for tax purposes. At December 31, 2003,
for Federal income tax purposes, the Company had net operating
loss carry-forwards of approximately $120.9 million, which
would expire between 2021 and 2023, investment and energy tax
credit carry-forwards of approximately $26.1 million, which
will expire in 2004 through 2009, and alternative minimum tax
credit carry-forwards of approximately $18.6 million, which
have no expiration date. A valuation allowance of
$26.1 million was recorded against the investment and
energy tax credit carry-forwards because the Company did not
believe it was more likely than not that those credits will be
realized for tax purposes.
Upon the acquisition by Danielson of Covanta, Covanta and
Danielson entered into a tax sharing agreement by which existing
NOLs of Danielson generated before 2003 would be made available
to Covanta. In its Annual Report on Form 10-K for the year
ended December 31, 2003, Danielson estimated it had NOL
carryforwards available to offset future taxable income of
approximately $652 million for federal income tax purposes.
These NOLs were to expire in various amounts through 2023 if not
used, and Danielson reported that the amount of the NOLs
available to Covanta would be reduced by any taxable income
generated by the then current members of Danielson’s tax
consolidated group. The existence and availability of
Danielson’s NOL’s is dependent on factual and
substantive tax issues, including issues in connection with a
1990 restructuring by Danielson. The IRS has not audited any of
Danielson’s tax returns for the years in which these NOLs
were generated and it could challenge the past or future use of
the NOLs. There is no assurance that Danielson would prevail if
the IRS would challenge the use of the NOLs. Predecessor had not
requested a ruling from the IRS or an opinion of tax counsel
with respect to the use and availability of the NOLs.
As stated in Covanta’s Form 10-K for year ended
December 31, 2003, if Danielson’s NOLs were not
available to offset the taxable income of Covanta’s
consolidated group, Covanta did not expect to have
E-62
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
sufficient cash flows available to pay debt service on the
Domestic Borrowers’ obligations. Covanta’s ability to
continue as a “going concern” was at that time subject
to substantial doubt and was dependent upon, among other things,
(i) Covanta’s ability to utilize the NOLs, and
(ii) Covanta’s ability to generate sufficient cash
flows from operations, asset sales and financing arrangements to
meet its obligations.
| Successor Period |
No cash taxes are expected to be paid as a result of the
$510.7 million gain on extinguishment of debt resulting
from Covanta’s emergence from Bankruptcy. However, for
U.S. income tax reporting purposes, as of the beginning of
its short taxable period ended December 31, 2004, the
Company will be required to reduce certain tax attributes,
including (a) net operating loss carry-forwards of Covanta
and (b) certain tax credit carry-forwards of Covanta, equal
to the gain on the extinguishment of debt. The reorganization of
the Company on the Effective Date constituted an ownership
change under Section 382 of the Code, and the use of any of
the Covanta generated NOL carry-forwards and tax credit
carry-forwards generated prior to the ownership change that are
not reduced pursuant to these provisions will be subject to an
overall annual limitation. The availability to Covanta of
Danielson’s NOLs under the tax sharing agreement is not
expected to be impacted by the extinguishment of Covanta’s
debt.
At December 31, 2004 a valuation allowance of approximately
$9.4 million has been recorded against the deferred tax
assets of Covanta Lake because Covanta Lake is not includible in
the Company’s consolidated federal tax return group. The
Company doe not believe that the net deferred tax assets of
Covanta Lake are more likely than not to be realized and has
recorded a valuation allowance accordingly.
Upon the acquisition by Danielson, Covanta and Danielson entered
into a tax sharing agreement by which existing NOLs of Danielson
generated before 2003 would be made available to Covanta.
Following its acquisition by Danielson, and based on a review by
management of the NOLs made available to Successor Covanta, it
was determined to be more likely than not that Covanta would
benefit from the use of Danielson’s NOLs, and Covanta
recorded a deferred tax asset of approximately
$88.2 million in purchase accounting pursuant to
FAS 109.
Based on Danielson’s Form 10-K for the fiscal year
ended December 31, 2004 filed with the SEC, Danielson
reports it has NOLs available to offset future taxable income
estimated to be approximately $516 million. The NOLs will
expire in various amounts beginning on December 31, 2005
through December 31, 2023. The amount of NOLs available to
Covanta will be reduced by any taxable income generated by
current members of Danielson’s tax consolidated group. The
Internal Revenue Service (“IRS”) has not audited any
of Danielson’s tax returns for the years in which the
losses giving rise to NOLs were reported and it could challenge
any past and future use of the NOLs.
If Danielson were to undergo an “ownership change” as
such term is used in Section 382 of the Internal Revenue
Code, the use of its NOLs would be limited. Danielson will be
treated as having had an “ownership change” if there
is a more than 50% increase in stock ownership during a 3-year
“testing period” by “5% stockholders”. For
this purpose, stock ownership is measured by value, and does not
include so-called “straight preferred” stock.
Danielson’s Certificate of Incorporation contains stock
transfer restrictions that were designed to help preserve
Danielson’s NOLs by avoiding an ownership change. The
transfer restrictions were implemented in 1990, and Danielson
expects that they will remain in-force as long as Danielson has
NOLs. Danielson cannot be certain, however, that these
restrictions will prevent an ownership change.
In October 2004, new United States federal income tax
legislation entitled “The American Jobs Creation Act of
2004” was enacted. This legislation includes provisions
that may affect the Company, such as provisions requiring
additional federal income tax disclosure and reporting,
provisions regarding the preferential federal income tax
treatment of certain qualified dividend distributions from
foreign subsidiaries, certain additional federal income tax
deductions based on qualified production income, additional
restrictions on the flexibility of executive deferred
compensation plans, and other matters. The Company is currently
evaluating the impact of this new federal income tax law.
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
27. Leases
Total rental expense amounted to $15.8 million,
$24.8 million, and $30.2 million (net of sublease
income of zero, $2.7 million, and $3.5 million) for
2004, 2003 and 2002, respectively. Principal leases are for
leaseholds, sale and leaseback arrangements on waste-to-energy
facilities and independent power projects, trucks and
automobiles, and machinery and equipment. Some of these
operating leases have renewal options. Some leases relating to
sale and leaseback transactions were terminated during 2003 (see
Note 2 to the Notes to the Consolidated Financial
Statements for further discussion).
The following is a schedule, by year, of future minimum rental
payments required under operating leases that have initial or
remaining non-cancelable lease terms in excess of one year
as of December 31, 2004:
|
2005
|
$ | 18,950 | ||
|
2006
|
18,926 | |||
|
2007
|
17,926 | |||
|
2008
|
20,998 | |||
|
2009
|
24,716 | |||
|
Later years
|
211,445 | |||
|
Total
|
$ | 312,961 | ||
These future minimum rental payment obligations include
$279.7 million of future non-recourse rental payments that
relate to energy facilities. Of this amount $160.7 million
is supported by third-party commitments to provide sufficient
service revenues to meet such obligations. The remaining
$119.0 million related to a waste-to-energy facility at
which the Company serves as operator and directly markets one
half of the facility’s disposal capacity. This facility
currently generates sufficient revenues from short-, medium-,
and long-term contracts to meet rental payments. The Company
anticipates renewing the contracts or entering into new
contracts to generate sufficient revenues to meet remaining
future rental payments.
These non-recourse rental payments are due as follows:
|
2005
|
$ | 15,392 | ||
|
2006
|
15,555 | |||
|
2007
|
15,749 | |||
|
2008
|
19,278 | |||
|
2009
|
23,062 | |||
|
Later years
|
190,660 | |||
|
Total
|
$ | 279,696 | ||
Electricity and steam sales includes lease income of
approximately $64.7 million for the period from
March 11, 2004 to December 31, 2004 related to two
Indian and one Chinese power project that were deemed to be
operating lease arrangements under EITF 01-08
“Determining Whether an Arrangement Contains a Lease”
as of March 10, 2004. This amount represents contingent
rentals because the lease payments for each facility depend on a
factor directly related to the future use of the leased
property. The output deliverable and capacity provided by the
two Indian facilities have been purchased by a single party
under long-term power purchase agreements which expire in 2016.
The electric power and steam off-take arrangements and
maintenance agreement for the Chinese facility are also with one
party and are presently contemplated to be continued through the
term of the joint venture which expires in 2017. Such
arrangements have effectively provided the purchaser
(lessee) with “rights to use” these facilities.
This EITF consensus must be applied prospectively to
arrangements agreed to, modified, or acquired in business
combinations in fiscal periods
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
beginning after May 28, 2003. This determination did not
have a material impact on the Company’s results of
operations and financial condition.
Property, plant and equipment under leases consisted of the
following as of December 31, 2004:
|
Land
|
$ | 33 | ||
|
Energy facilities
|
94,612 | |||
|
Buildings and improvements
|
936 | |||
|
Machinery and equipment
|
1,464 | |||
|
Total
|
97,045 | |||
|
Less accumulated depreciation and amortization
|
(6,947 | ) | ||
|
Property, plant, and equipment — net
|
$ | 90,098 | ||
28. Income (Loss) Per Share
As of March 10, 2004, all of the outstanding shares of
Covanta stock were cancelled as part of the Plan of
Reorganization. The following table reflects earnings
(loss) per share prior to such cancellation. On
March 10, 2004 Covanta issued 200 shares of common
stock to Danielson and became a wholly owned subsidiary of
Danielson. Accordingly, earnings per share information for
periods subsequent to that date are not presented.
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The reconciliation of the income (loss) from continuing
operations and common shares included in the computation of
basic loss per common share and diluted earnings per common
share for the years ended December 31, 2004, 2003 and 2002,
is as follows:
| For the Period | ||||||||||||||||||||||||||||||||||||
| January 1, Through March 10, | ||||||||||||||||||||||||||||||||||||
| 2004 | 2003 | 2002 | ||||||||||||||||||||||||||||||||||
| Income | Per | Income | Per | Income | Per | |||||||||||||||||||||||||||||||
| (Loss) | Shares | Share | (Loss) | Shares | Share | (Loss) | Shares | Share | ||||||||||||||||||||||||||||
| (Numerator) | (Denominator) | Amount | (Numerator) | (Denominator) | Amount | (Numerator) | (Denominator) | Amount | ||||||||||||||||||||||||||||
|
Basic Earnings (Loss) Per Share:
|
||||||||||||||||||||||||||||||||||||
|
Loss from continuing operations
|
$ | 29,563 | $ | (26,764 | ) | $ | (127,698 | ) | ||||||||||||||||||||||||||||
|
Less: Preferred stock Dividend
|
— | — | 16 | |||||||||||||||||||||||||||||||||
|
Loss to common stockholders
|
$ | 29,563 | 49,821 | $ | 0.59 | $ | (26,764 | ) | 49,819 | $ | (0.54 | ) | $ | (127,714 | ) | 49,794 | $ | (2.56 | ) | |||||||||||||||||
|
Income (loss) from discontinued operations
|
$ | 78,814 | 49,819 | $ | 1.58 | $ | (43,355 | ) | 49,794 | $ | (0.88 | ) | ||||||||||||||||||||||||
|
Loss from cumulative effect of change in accounting principle
|
$ | (8,538 | ) | 49,819 | $ | (0.17 | ) | $ | (7,842 | ) | 49,794 | $ | (0.16 | ) | ||||||||||||||||||||||
|
Effect of Diluted Securities:
|
||||||||||||||||||||||||||||||||||||
|
Stock options
|
(A | ) | (A | ) | (A | ) | ||||||||||||||||||||||||||||||
|
Restricted stock
|
3 | (A | ) | (A | ) | |||||||||||||||||||||||||||||||
|
Convertible preferred shares
|
198 | (A | ) | (A | ) | |||||||||||||||||||||||||||||||
|
Diluted Loss Per Share:
|
||||||||||||||||||||||||||||||||||||
|
Loss to common stockholders
|
$ | 29,563 | 50,022 | $ | 0.59 | $ | (26,764 | ) | 49,819 | $ | (0.54 | ) | $ | (127,714 | ) | 49,794 | $ | (2.56 | ) | |||||||||||||||||
|
Income (loss) from discontinued operations
|
$ | 78,814 | 49,819 | $ | 1.58 | $ | (43,355 | ) | 49,794 | $ | (0.88 | ) | ||||||||||||||||||||||||
|
Loss from cumulative effect of change in accounting principle
|
$ | (8,538 | ) | 49,819 | $ | (0.17 | ) | $ | (7,842 | ) | 49,794 | $ | (0.16 | ) | ||||||||||||||||||||||
| (A) | Antidilutive |
Basic income (loss) per share was computed by dividing net
income (loss) reduced by preferred stock dividend
requirements, by the weighted average of the number of shares of
common stock outstanding during each year.
Diluted income (loss) per share was computed on the
assumption that all convertible debentures, convertible
preferred stock, restricted stock, and stock options converted
or exercised during each year or outstanding at the end of each
year were converted at the beginning of each year or at the date
of issuance or grant, if dilutive. This computation provided for
the elimination of related convertible debenture interest and
preferred dividends.
Outstanding stock options to purchase common stock with an
exercise price greater than the average market price of common
stock were not included in the computation of diluted earnings
per share. The balance of such options was 3,090 in 2004, 3,121
in 2003, and 3,609 in 2002. Shares of common stock to be issued,
assuming conversion of convertible preferred shares, the 6%
convertible debentures, the 5.75% convertible debentures, and
unvested restricted stock issued to employees were not included
in computations of diluted earnings per share as to do so would
have been antidilutive. The common shares excluded from the
calculation were zero in 2004 and 2003 and 908 in 2002 for the
6% convertible debentures, respectively; zero in 2004 and 2003
and 1,228 in 2002 for the 5.75% convertible debentures; 198 in
2004, 2003 and 2002,
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
respectively for convertible preferred stock; and 3, 6, and 25
in 2004, 2003 and 2002 for unvested restricted stock issued to
employees, respectively.
29. Business Segments
As a result of the reorganization, during which business
segments other than the Energy Business were disposed of, and
subsequent acquisition by Danielson Company, the Company now has
two reportable segments, Domestic and International.
Covanta’s Energy Business develops, constructs, owns and
operates for others key infrastructure for the conversion of
waste-to-energy and independent power production in the United
States and abroad.
The accounting policies of the reportable segments are
consistent with those described in the summary of significant
accounting policies, unless otherwise noted. The segment
information for the prior years has been restated to conform to
the current segments.
Revenues and income from continuing operations by segment for
the periods from March 11, through December 31, 2004,
January 1, through March 10, 2004, and 2003 and 2002
were as follows:
| Successor | Predecessor | ||||||||||||||||
| For the Period | For the Period | ||||||||||||||||
| March 11, | January 1, | ||||||||||||||||
| Through | Through | ||||||||||||||||
| December 31, | March 10, | ||||||||||||||||
| 2004 | 2004 | 2003 | 2002 | ||||||||||||||
|
Revenues:
|
|||||||||||||||||
|
Domestic
|
$ | 452,931 | $ | 107,697 | $ | 619,101 | $ | 640,417 | |||||||||
|
International
|
104,271 | 35,535 | 171,367 | 185,364 | |||||||||||||
|
Total revenue
|
557,202 | 143,232 | 790,468 | 825,781 | |||||||||||||
|
Operating income:
|
|||||||||||||||||
|
Domestic
|
62,232 | 7,132 | 35,846 | 11,695 | |||||||||||||
|
International
|
14,776 | 3,130 | 24,135 | (64,938 | ) | ||||||||||||
|
Operating income
|
77,008 | 10,262 | 59,981 | (53,243 | ) | ||||||||||||
|
Interest income
|
1,858 | 935 | 2,948 | 2,472 | |||||||||||||
|
Interest expense
|
(34,706 | ) | (6,142 | ) | (39,938 | ) | (44,059 | ) | |||||||||
|
Reorganization items
|
— | (58,282 | ) | (83,346 | ) | (49,106 | ) | ||||||||||
|
Gain on cancellation of pre-petition debt
|
— | 510,680 | — | — | |||||||||||||
|
Fresh start adjustments
|
— | (399,063 | ) | — | — | ||||||||||||
|
Income (loss) from continuing operations before income taxes,
minority interests, equity in net income from unconsolidated
investments, discontinued operations and the cumulative effect
of change in accounting principle
|
$ | 44,160 | $ | 58,390 | $ | (60,355 | ) | $ | (143,936 | ) | |||||||
Total revenues by segment reflect sales to unaffiliated
customers. In computing income (loss) from operations none of
the following have been added or deducted: unallocated corporate
expenses, non-operating interest expense, interest income and
income taxes.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
For the years ended December 31, 2004 and 2003 segment and
corporate assets and results are as:
| Identifiable | Depreciation and | Capital | ||||||||||
| Successor | Assets | Amortization | Additions | |||||||||
|
2004 (March 11, through December 31, 2004)
|
||||||||||||
|
Domestic energy
|
$ | 1,601,641 | $ | 48,805 | $ | 10,083 | ||||||
|
International energy
|
268,881 | 7,016 | 1,794 | |||||||||
|
Consolidated
|
$ | 1,870,522 | $ | 55,821 | $ | 11,877 | ||||||
|
2004 (January 1, through March 10, 2004)
|
||||||||||||
|
Domestic energy
|
$ | 10,059 | $ | 2,588 | ||||||||
|
International energy
|
3,367 | 1,604 | ||||||||||
|
Consolidated
|
$ | 13,426 | $ | 4,192 | ||||||||
|
2003
|
||||||||||||
|
Domestic energy
|
$ | 2,212,650 | $ | 55,331 | $ | 15,302 | ||||||
|
International energy
|
400,930 | 16,601 | 6,852 | |||||||||
|
Consolidated
|
$ | 2,613,580 | $ | 71,932 | $ | 22,154 | ||||||
|
2002
|
||||||||||||
|
Domestic energy
|
$ | 58,958 | $ | 19,326 | ||||||||
|
International energy
|
18,410 | 1,941 | ||||||||||
|
Consolidated
|
$ | 77,368 | $ | 21,267 | ||||||||
Covanta’s operations are principally in the United States.
Operations outside of the United States are primarily in Asia,
with some projects in Latin America and Europe. A summary of
revenues by geographic area for 2004, 2003 and 2002 is as
follows:
| Successor | Predecessor | ||||||||||||||||
| For the Period | For the Period | ||||||||||||||||
| March 11, | January 1, | ||||||||||||||||
| Through | Through | ||||||||||||||||
| December 31, | March 10, | ||||||||||||||||
| 2004 | 2004 | 2003 | 2002 | ||||||||||||||
|
Revenues:
|
|||||||||||||||||
|
United States
|
$ | 452,931 | $ | 107,696 | $ | 619,101 | $ | 640,045 | |||||||||
|
India
|
69,118 | 21,770 | 102,564 | 116,893 | |||||||||||||
|
Other Asia
|
34,164 | 13,672 | 67,793 | 67,237 | |||||||||||||
|
Other International
|
989 | 94 | 1,010 | 1,606 | |||||||||||||
|
Total
|
$ | 557,202 | $ | 143,232 | $ | 790,468 | $ | 825,781 | |||||||||
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
A summary of identifiable assets by geographic area for the
years ended December 31, 2004 and 2003 is as follows:
| Successor | Predecessor | ||||||||
| 2004 | 2003 | ||||||||
|
Identifiable Assets:
|
|||||||||
|
United States
|
$ | 1,606,077 | $ | 2,192,090 | |||||
|
India
|
93,462 | 165,170 | |||||||
|
Other Asia
|
100,655 | 141,598 | |||||||
|
Other International
|
70,328 | 114,722 | |||||||
|
Total
|
$ | 1,870,522 | $ | 2,613,580 | |||||
30. Supplemental Disclosure of
Cash Flow Information
| Successor | Predecessor | ||||||||||||||||
| For the Period | For the Period | ||||||||||||||||
| March 11, | January 1, | ||||||||||||||||
| Through | Through | ||||||||||||||||
| December 31, | March 11, | ||||||||||||||||
| 2004 | 2004 | 2003 | 2002 | ||||||||||||||
|
Cash Paid for Interest and Income Taxes:
|
|||||||||||||||||
|
Interest (net of amounts capitalized)
|
$ | 66,917 | $ | 13,543 | $ | 91,718 | $ | 93,139 | |||||||||
|
Income taxes paid
|
24,207 | 892 | 11,112 | 11,485 | |||||||||||||
|
Noncash Investing and Financing Activities:
|
|||||||||||||||||
|
Reduction of notes receivable from key employees
|
— | 451 | $ | 419 | — | ||||||||||||
31. Commitments and Contingent
Liabilities
The Company is party to a number of other claims, lawsuits and
pending actions, most of which are routine and all of which are
incidental to its business. The Company assesses the likelihood
of potential losses on an ongoing basis and when losses are
considered probable and reasonably estimable, the Company
records as a loss an estimate of the ultimate outcome. If the
Company can only estimate the range of a possible loss, an
amount representing the low end of the range of possible
outcomes is recorded. The final consequences of these
proceedings are not presently determinable with certainty.
Generally claims and lawsuits against Covanta and its
subsidiaries that had filed bankruptcy petitions and
subsequently emerged from bankruptcy arising from events
occurring prior to their respective petition dates have been
resolved pursuant to the Reorganization Plan, and have been
discharged pursuant to the March 5, 2004 order of the
Bankruptcy Court which confirmed the Reorganization Plan.
However, to the extent that claims are not dischargeable in
bankruptcy, such claims may not be discharged. For example, the
claims of certain persons who were personally injured prior to
the petition date but whose injury only became manifest
thereafter may not be discharged pursuant to the Reorganization
Plan.
| Environmental Matters |
The Company’s operations are subject to environmental
regulatory laws and environmental remediation laws. Although the
Company’s 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, the Company
believes that it is in substantial compliance with existing
environmental laws and regulations.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
Covanta 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 laws. In certain instances, Covanta may be exposed to
joint and several liabilities for remedial action or damages.
The Company’s ultimate liability in connection with such
environmental claims will depend on many factors, including its
volumetric share of waste, the total cost of remediation, the
financial viability of other companies that also sent waste to a
given site and, in the case of divested operations, its
contractual arrangement with the purchaser of such operations.
Generally such claims arising prior to the first petition date
were resolved in and discharged by the Chapter 11 Cases.
The potential costs related to the matters described below and
the possible impact on future operations are uncertain due in
part to the complexity of governmental laws and regulations and
their interpretations, the varying costs and effectiveness of
cleanup technologies, the uncertain level of insurance or other
types of recovery and the questionable level of the
Company’s responsibility. Although the ultimate outcome and
expense of any litigation, including environmental remediation,
is uncertain, the Company believes that the following
proceedings will not have a material adverse effect on the
Company’s consolidated financial position or results of
operations.
In June, 2001, the EPA named Covanta’s wholly-owned
subsidiary, Ogden Martin Systems of Haverhill, Inc., now known
as Covanta Haverhill, Inc., as one of 2,000 potentially
responsible parties (“PRPs”) at the Beede Waste Oil
Superfund Site, Plaistow, New Hampshire, a former waste oil
recycling facility. The total quantity of waste oil alleged by
EPA to have been disposed of by PRPs at the Beede site is
approximately 14.3 million gallons, of which Covanta
Haverhill’s contribution is alleged to be approximately
44,000 gallons. On January 9, 2004, the EPA signed its
Record of Decision with respect to the cleanup of the site.
According to the EPA, the costs of response actions incurred as
of January 2004 by the EPA and the State of New Hampshire
Department of Environmental Services (“DES”) total
approximately $19 million, and the estimated cost to
implement the remedial alternative selected in the Record of
Decision is an additional $48 million. Covanta Haverhill,
Inc. is participating in discussions with other PRPs concerning
EPA’s selected remedy for the site, in anticipation of
eventual settlement negotiations with EPA and DES. Covanta
Haverhill, Inc.’s share of liability, if any, cannot be
determined at this time as a result of uncertainties regarding
the source and scope of contamination, the large number of PRPs
and the varying degrees of responsibility among various classes
of PRPs. The Company believes that based on the amount of waste
oil materials Covanta Haverhill, Inc. is alleged to have sent to
the site, its liability will not be material to the
Company’s results of operations and financial position.
| Other Matters |
During the course of the Chapter 11 Cases, the Debtors and
certain contract counterparties reached agreement with respect
to material restructuring of their mutual obligations in
connection with several waste-to-energy projects. The Debtors
were also involved in material disputes and/or litigation with
respect to the Warren County, New Jersey, which matters remain
unresolved. As a result, Covanta’s subsidiaries involved in
these projects remain in Chapter 11 and are not
consolidated in the Company’s consolidated financial
statements. The Company expects that the outcome of the issues
described below will have a material not adverse effect the
Company’s results of operations and financial position.
| Warren County, New Jersey |
The Covanta subsidiary (“Covanta Warren”) which
operates the waste-to-energy facility in Warren County, New
Jersey (the “Warren Facility”) and the Pollution
Control Financing Authority of Warren County (“Warren
Authority”) have been engaged in negotiations for an
extended time concerning a potential restructuring of the
parties’ rights and obligations under various agreements
related to Covanta Warren’s operation of the Warren
Facility. Those negotiations were in part precipitated by a 1997
federal court of
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
appeals decision invalidating certain of the State of New
Jersey’s waste-flow laws, which resulted in significantly
reduced revenues for the Warren Facility. Since 1999, the State
of New Jersey has been voluntarily making all debt service
payments with respect to the project bonds issued to finance
construction of the Warren Facility, and Covanta Warren has been
operating the Warren Facility pursuant to an agreement with the
Warren Authority which modifies the existing service agreement.
Principal on the Warren Facility project debt is due annually in
December of each year, while interest is due semi-annually in
June and December of each year. The State of New Jersey provided
sufficient funds to the project bond trustee to pay interest to
bondholders during June, 2004.
Although discussions continue, to date Covanta Warren and the
Warren Authority have been unable to reach an agreement to
restructure the contractual arrangements governing Covanta
Warren’s operation of the Warren Facility.
Also as part of Covanta’s emergence from bankruptcy,
Covanta and Covanta Warren entered into several agreements
approved by the Bankruptcy Court that permit Covanta Warren to
reimburse Covanta for employees and employee-related expenses,
provide for payment of a monthly allocated overhead expense
reimbursement in a fixed amount, and permit Covanta to advance
up to $1.0 million in super-priority debtor-in-possession
loans to Covanta Warren in order to meet any liquidity needs. As
of December 31, 2004, Covanta Warren owed Covanta
$1.9 million.
In the event the parties are unable to timely reach agreement
upon and consummate a restructuring of the contractual
arrangements governing Covanta Warren’s operation of the
Warren Facility, the Debtors may, among other things, elect to
litigate with counterparties to certain agreements with Covanta
Warren, assume or reject one or more executory contracts related
to the Warren Facility, attempt to file a plan of reorganization
on a non-consensual basis, or liquidate Covanta Warren. In such
an event, creditors of Covanta Warren may receive little or no
recovery on account of their claims.
See Notes 2, 15 and 33 for additional information regarding
commitments and contingent liabilities.
32. Related Party
Transactions
With respect to Covanta’s predecessor entity, one member of
the Company’s previous Board of Directors was a partner in
a major law firm, and another member is an employee of another
major law firm. From time to time, the Company sought legal
services and advice from those two law firms. During 2004 (prior
to March 10, 2004), 2003 and 2002, the Company paid those
two law firms approximately $0.4 million, $0.5 million
and $1.4 million, and zero, zero and $2.7 million,
respectively, for services rendered. With respect to
Covanta’s Successor entity, one member of Danielson’s
Board of Directors is a partner in a major law firm. Covanta has
sought legal advice from this firm after March 10, 2004 and
paid this law firm approximately $0.1 million.
As part of the investment and purchase agreement with Covanta,
Danielson was obligated to arrange the Second Lien Facility.
Covanta paid a fee shared by the Bridge Lenders, among others,
to the agent bank for the Second Lien Facility. In order to
finance its acquisition of Covanta and to arrange the Second
Lien Facility, Danielson entered into a note purchase agreement
with SZ Investments, L.L.C., a Danielson stockholder (SZI),
Third Avenue Trust, on behalf of Third Avenue Value
Fund Series, a Danielson stockholder (TAVF), and D.E. Shaw
Laminar Portfolios, L.L.C., a creditor of Covanta and a
Danielson stockholder (“Laminar”). In addition, in
connection with such note purchase agreement, Laminar arranged
for a $10 million revolving loan facility for CPIH secured
by CPIH’s assets. Subsequent to the signing of the
investment and purchase agreement, each of TAVF, Laminar and SZI
assigned approximately 30% of their participation in the second
lien letter of credit facility to Goldman Sachs Credit Partners,
L.P. and Laminar assigned the remainder of its participation in
the second lien letter of credit facility to TRS Elara, LLC.
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
Danielson and Covanta have entered into a corporate services
agreement, pursuant to which Danielson provides to Covanta, at
Covanta’s expense, certain administrative and professional
services and Covanta pays most of Danielson’s expenses,
which totaled $3 million for the period March 11, 2004
through December 31, 2004. In addition, Danielson and
Covanta have entered into an agreement pursuant to which Covanta
provides, at Danielson’s expense, payroll and benefit
services for Danielson employees which totaled $0.5 million
for the period March 11, 2004 through December 31, 2004.
The amounts accrued under these arrangements totaled
$0.9 million for the period March 11, 2004 through
December 31, 2004.
On November 26, 2001 the remaining notes receivable and
accrued interest from other officers were restructured as a
settlement of a dispute surrounding the circumstances under
which the loans were originally granted. That settlement changed
the notes from a fixed principal amount which accrued interest
to a variable amount equal to the market value, from time to
time, of the Covanta common shares purchased by the officers
when exercising the above-mentioned stock options. At that time,
the notes receivable and accrued interest recorded by the
Company, were adjusted to the $0.9 million market value of
the Company’s common shares underlying those notes. Also,
the subsequent indexing to the Company’s stock price of the
balance due under the notes is marked to fair value each
reporting period, with the change in fair value recorded in
earnings and as an asset or liability. As of December 31,
2003 Notes receivable from key employees for common stock
issuance were, as a result of the resignation of one of the
officers reduced by $0.4 million, the original amount
recorded on such note. The notes remaining are due upon the sale
of the stock. Through December 31, 2003, none of the stock
has been sold.
33. Fair Value of Financial
Instruments
The following disclosure of the estimated fair value of
financial instruments is made in accordance with the
requirements of SFAS No. 107, “Disclosures About
Fair Value of Financial Instruments.” The estimated
fair-value amounts have been determined using available market
information and appropriate valuation methodologies. However,
considerable judgment is necessarily required in interpreting
market data to develop estimates of fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the
amounts that Covanta would realize in a current market exchange.
The following methods and assumptions were used to estimate the
fair value of each class of financial instruments for which it
is practicable to estimate that value.
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 long-term
unbilled receivables is estimated by using a discount rate that
approximates the current rate for comparable notes. The fair
value of non-current receivables is estimated by discounting the
future cash flows using the current rates at which similar loans
would be made to such borrowers based on the remaining
maturities, consideration of credit risks, and other business
issues pertaining to such receivables. The fair value of
restricted funds held in trust is based on quoted market prices
of the investments held by the trustee. Other assets, consisting
primarily of insurance and escrow deposits, and other
miscellaneous financial instruments used in the ordinary course
of business are valued based on quoted market prices or other
appropriate valuation techniques.
Fair values for debt were determined based on interest rates
that are currently available to the Company 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. Other liabilities are valued by
discounting the future stream of payments using the incremental
borrowing rate of the Company. The fair value of the
Company’s interest rate swap agreements is the estimated
amount the Company would receive or pay to terminate the
agreement based on the net present value of the future cash
flows as defined in the agreement.
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Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The fair-value estimates presented herein are based on pertinent
information available to management as of December 31, 2004
and 2003. However, such amounts have not been comprehensively
revalued for purposes of these financial statements since
December 31, 2004 and current estimates of fair value may
differ significantly from the amounts presented herein.
The estimated fair value of financial instruments at
December 31, 2004 and 2003 is summarized as follows:
| Successor | Predecessor | |||||||||||||||
| 2004 | 2003 | |||||||||||||||
| Carrying | Estimated | Carrying | Estimated | |||||||||||||
| Amount | Fair Value | Amount | Fair Value | |||||||||||||
|
Assets:
|
||||||||||||||||
|
Cash and cash equivalents
|
$ | 78,112 | $ | 78,112 | $ | 260,902 | $ | 260,902 | ||||||||
|
Marketable securities
|
3,100 | 3,100 | 2,068 | 2,460 | ||||||||||||
|
Receivables
|
301,553 | 299,480 | 355,456 | 356,549 | ||||||||||||
|
Restricted funds
|
272,723 | 272,877 | 227,406 | 227,425 | ||||||||||||
|
Interest rate swap receivable
|
14,920 | 14,920 | 16,728 | 16,728 | ||||||||||||
|
Liabilities:
|
||||||||||||||||
|
Recourse debt
|
312,896 | 290,538 | 78 | 78 | ||||||||||||
|
Project debt
|
944,737 | 936,926 | 1,043,965 | 1,080,129 | ||||||||||||
|
Interest rate swap payable
|
14,920 | 14,920 | 16,728 | 16,728 | ||||||||||||
|
Liabilities subject to compromise
|
$ | — | $ | — | $ | 956,095 | (b) | $ | — | |||||||
|
Off Balance-Sheet Financial Instruments:
|
||||||||||||||||
|
Guarantees(a)
|
||||||||||||||||
| (a) | Additionally guarantees include approximately $9.0 million of guarantees related to international energy projects. | |
| (b) | See Note 2 to the Notes to the Consolidated Financial Statements | |
Effective with the adoption of SFAS No. 133 on
January 1, 2001, the interest rate swap is recorded in
other noncurrent assets and other noncurrent liabilities in the
Consolidated Balance Sheets (See Note 3 to the Notes to the
Consolidated Financial Statements).
34. Fresh Start and Purchase
Accounting Adjustments
The Company’s emergence from Chapter 11 proceedings on
March 10, 2004 resulted in a new reporting entity and
adoption of fresh start accounting as of that date, in
accordance with SOP 90-7. Also, on the Effective Date,
because of its acquisition by Danielson, the Company applied
purchase accounting, which like fresh start accounting requires
assets and liabilities to be recorded at fair value. The
incremental impact of applying purchase accounting was to adjust
the value of the Company’s equity to the price paid by
Danielson, including relevant acquisition costs and the
consideration of the NOLs made available to the Company under
the Tax Sharing Agreement.
The consolidated financial statements beginning March 10,
2004, reflect a preliminary allocation of equity value to the
assets and liabilities of the Company in proportion to their
relative fair values in conformity with SFAS No. 141.
Preliminary fair value determinations of the tangible and
intangible assets were made by management based on anticipated
cash flows using currently available information.
Management’s estimate of the fair value of long term debt
was based on the new principal amounts of recourse debt that was
part of the reorganized capital structure of the Company upon
emergence. Management’s estimate of the fair value of
E-73
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
project debt was based on market information available to the
Company. The Company has engaged valuation consultants to review
its valuation methodology and their work is ongoing.
In accordance with SFAS No. 141, the preliminary
allocation of the equity values is subject to additional
adjustment within one year after emergence from bankruptcy when
additional information on asset and liability valuations becomes
available. The Company expects that adjustment to recorded fair
values may include those relating to:
| • | property, plant, and equipment, intangibles, debt, and equity investments, all of which may change based on the consideration of additional analysis by the Company and its valuation consultants; | |
| • | accrued expenses which may change based on identification of final fees and costs associated with emergence from bankruptcy, resolution of disputed claims, and completion of Chapter 11 Cases relating to the Remaining Debtors; | |
| • | the principal amount of the Unsecured Notes (recorded as an estimated principal amount of $28 million), which estimate excludes any notes that may be issued if and when Remaining Debtors emerge from bankruptcy under a plan of reorganization, and which will adjust based upon the resolution of claims of creditors entitled to such notes as distributions; and | |
| • | tax liabilities, which may be adjusted based upon additional information to be received from taxing authorities. | |
The table below reflects preliminary reorganization adjustments
for the discharge of indebtedness, cancellation of old common
stock and issuance of new common stock, issuance of notes, and
the fresh start adjustments through December 31, 2004 and
the resulting fresh start consolidated balance sheet as of
March 10, 2004:
| Discharge of | ||||||||||||||||||||||||
| Predecessor | Liquidating Entities | Indebtedness and | Purchase | Successor | ||||||||||||||||||||
| March 10, | and Deconsolidation | Issuance of New | Accounting | Fresh Start | March 10, | |||||||||||||||||||
| 2004 | of Entities(a) | Indebtedness | Adjustments | Adjustments | 2004 | |||||||||||||||||||
| (In thousands of dollars) | ||||||||||||||||||||||||
|
Assets:
|
||||||||||||||||||||||||
|
Current Assets:
|
||||||||||||||||||||||||
|
Cash and cash equivalents
|
$ | 110,332 | $ | 877 | $ | (81,204 | ) | $ | 29,825 | (c) | $ | (2,035 | ) | $ | 57,795 | |||||||||
|
Restricted funds for emergence costs
|
99,986 | — | — | — | (1,500 | ) | 98,486 | |||||||||||||||||
|
Restricted funds held in trust
|
115,657 | (4,845 | ) | — | — | (19 | ) | 110,793 | ||||||||||||||||
|
Receivables
|
223,835 | (20,307 | ) | — | — | (7,079 | )(f) | 196,449 | ||||||||||||||||
|
Deferred income taxes
|
9,763 | — | — | — | (8,474 | )(g) | 1,289 | |||||||||||||||||
|
Prepaid expenses and other current assets
|
81,894 | (5,121 | ) | — | — | (20,290 | )(h) | 56,483 | ||||||||||||||||
|
Total current assets
|
641,467 | (29,396 | ) | (81,204 | ) | 29,825 | (39,397 | ) | 521,295 | |||||||||||||||
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| Discharge of | |||||||||||||||||||||||||
| Predecessor | Liquidating Entities | Indebtedness and | Purchase | Successor | |||||||||||||||||||||
| March 10, | and Deconsolidation | Issuance of New | Accounting | Fresh Start | March 10, | ||||||||||||||||||||
| 2004 | of Entities(a) | Indebtedness | Adjustments | Adjustments | 2004 | ||||||||||||||||||||
| (In thousands of dollars) | |||||||||||||||||||||||||
|
Property, plant and equipment — net
|
$ | 1,444,838 | $ | (97,101 | ) | $ | — | $ | — | $ | (492,635 | ) | $ | 855,102 | |||||||||||
|
Restricted funds held in trust
|
117,824 | (8,196 | ) | — | — | (2,564 | ) | 107,064 | |||||||||||||||||
|
Unbilled service and other receivables
|
130,168 | (15,035 | ) | — | — | (946 | ) | 114,187 | |||||||||||||||||
|
Other intangible assets — net
|
33,381 | (3,561 | ) | — | — | (29,820 | ) | — | |||||||||||||||||
|
Service and energy contracts
|
— | — | — | — | 204,041 | 204,041 | |||||||||||||||||||
|
Investments in and advances to investees and Joint ventures
|
134,656 | 54,405 | — | — | (117,357 | ) | 71,704 | ||||||||||||||||||
|
Other assets and other intangibles
|
63,946 | (275 | ) | — | — | (26,263 | )(i) | 37,408 | |||||||||||||||||
|
Goodwill
|
— | — | (8,500 | ) | (70,503 | ) | 79,003 | (p) | — | ||||||||||||||||
|
Total Assets
|
$ | 2,566,280 | $ | (99,159 | ) | $ | (89,704 | ) | $ | (40,678 | ) | $ | (425,938 | ) | $ | 1,910,801 | |||||||||
|
Liabilities and Shareholders’ Equity (Deficit):
|
|||||||||||||||||||||||||
|
Liabilities:
|
|||||||||||||||||||||||||
|
Current Liabilities:
|
|||||||||||||||||||||||||
|
Current portion of long-term
debt |
$ | 20 | $ | — | $ | — | $ | — | $ | — | $ | 20 | |||||||||||||
|
Current portion of project debt
|
113,681 | (10,070 | ) | — | — | 25 | (j) | 103,636 | |||||||||||||||||
|
Accounts payable
|
27,437 | (3,235 | ) | — | — | (669 | ) | 23,533 | |||||||||||||||||
|
Accrued expenses
|
132,845 | (5,296 | ) | — | — | (13,854 | )(k) | 113,695 | |||||||||||||||||
|
Accrued emergence costs
|
99,986 | — | — | — | (1,500 | ) | 98,486 | ||||||||||||||||||
|
Deferred revenue
|
37,660 | (2,453 | ) | — | — | (12,516 | )(n) | 22,691 | |||||||||||||||||
|
Total current liabilities
|
411,629 | (21,054 | ) | — | — | (28,514 | ) | 362,061 | |||||||||||||||||
|
Long-term debt
|
53 | — | 328,000 | (b) | — | — | 328,053 | ||||||||||||||||||
|
Project debt
|
903,650 | (71,905 | ) | — | — | 18,846 | (l) | 850,591 | |||||||||||||||||
|
Deferred income taxes
|
195,164 | — | — | (88,203 | )(d) | 38,802 | (m) | 145,763 | |||||||||||||||||
|
Deferred revenue
|
127,925 | — | — | — | (127,925 | )(n) | — | ||||||||||||||||||
|
Other liabilities
|
99,650 | — | — | — | (6,956 | )(o) | 92,694 | ||||||||||||||||||
|
Liabilities subject to compromise
|
934,752 | (6,368 | ) | (928,384 | ) | — | — | — | |||||||||||||||||
|
Total Liabilities
|
2,672,823 | (99,327 | ) | (600,384 | ) | (88,203 | ) | (105,747 | ) | 1,779,162 | |||||||||||||||
|
Minority interests
|
71,372 | — | — | — | 12,742 | 84,114 | |||||||||||||||||||
E-75
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| Discharge of | ||||||||||||||||||||||||
| Predecessor | Liquidating Entities | Indebtedness and | Purchase | Successor | ||||||||||||||||||||
| March 10, | and Deconsolidation | Issuance of New | Accounting | Fresh Start | March 10, | |||||||||||||||||||
| 2004 | of Entities(a) | Indebtedness | Adjustments | Adjustments | 2004 | |||||||||||||||||||
| (In thousands of dollars) | ||||||||||||||||||||||||
|
Shareholders’ Equity (Deficit):
|
||||||||||||||||||||||||
|
Serial cumulative convertible preferred stock
|
$ | 33 | $ | — | $ | — | $ | — | $ | (33 | ) | $ | — | |||||||||||
|
Common stock
|
24,912 | — | — | — | (24,912 | ) | — | |||||||||||||||||
|
Capital surplus
|
188,156 | — | — | 47,525 | (e) | (188,156 | ) | 47,525 | ||||||||||||||||
|
Deficit
|
(392,095 | ) | 46 | 510,680 | — | (118,631 | ) | — | ||||||||||||||||
|
Accumulated other comprehensive income
|
1,079 | 122 | — | — | (1,201 | ) | — | |||||||||||||||||
|
Total Shareholders’ Equity (Deficit)
|
(177,915 | ) | 168 | 510,680 | 47,525 | (332,933 | ) | 47,525 | ||||||||||||||||
|
Total Liabilities and Shareholders’ Equity (Deficit)
|
$ | 2,566,280 | $ | (99,159 | ) | $ | (89,704 | ) | $ | (40,678 | ) | $ | (425,938 | ) | $ | 1,910,801 | ||||||||
Following are footnotes to the above Successor Condensed
Consolidated Balance Sheet.
| (a) | Excludes Covanta entities which are part of the Liquidating Plan and Covanta entities which remain in Chapter 11 and have been deconsolidated. |
| (b) | Reflects the issuance by Covanta of $205.0 million principal amount of new high yield secured notes, $28.0 million of estimated principal amount of new reorganization plan unsecured notes, and $95.0 million in principal amount of new CPIH term debt. |
| (c) | Reflects cash portion of the purchase price paid by Danielson. |
| (d) | Represents the reduction in net deferred income tax liabilities resulting from recording the income tax benefits arising from the estimated future utilization of Danielson’s NOLs. |
| (e) | Danielson’s purchase price includes $29.8 million in cash, $6.4 million in expenses and $11.3 million for the estimated fair value of stock purchase rights to be issued to certain of Covanta’s pre-petition creditors. Certain of these creditors were granted the right to purchase up to 3.0 million shares of Danielson common stock at $1.53 per share. |
| (f) | Reflects the effect of adjusting receivables to fair value. |
| (g) | Reflects the change, as a result of fresh start accounting in deferred tax asset that relates to current assets and liabilities expected to be realized within one year of the balance sheet date. |
| (h) | Includes a decrease of $16.3 million in the fair value of spare parts. |
| (i) | Includes a $18.5 million reduction of unamortized bond issuance costs, exclusive of minority interests, to a fair value of $0 and a fair value adjustment of $6.2 million in deferred costs related to the Haverhill facility. |
| (j) | Includes a $10.2 million reduction of the current portion of the MCI facility project debt to a fair value of $0 and an increase of $10.5 million for the current portion of the fair market value premium on waste-to-energy project debt. |
| (k) | Includes a $11.0 million reduction in the MCI facility accrued expenses to a fair value of $0 in the Philippines and a reduction of $6.0 million to reclassify pension liabilities to long-term liabilities. |
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
| (l) | Primarily reflects an $18.3 million reduction of the long-term portion of the MCI facility project debt to a fair value of $0 and an increase of $36.1 million for the long-term portion of the fair market value premium on waste-to-energy project debt. |
| (m) | Reflects the change in deferred taxes resulting from the fair valuation of property, plant and equipment and intangibles, offset by the change in deferred taxes resulting from the decrease in the Company’s net operating loss carry forward and tax credit carry forwards which resulted from the extinguishment of debt. |
| (n) | Deferred income related to a power contract restructuring at the Haverhill facility was fair valued at $0. |
| (o) | Reflects a decrease of $17.4 million to reduce tax reserves to $2.2 million, an increase of $6 million for the reclassification pension liabilities from current liabilities, an increase of $18.4 million for additional pension liabilities, and a decrease of $24.5 million to fair value a deferred credit at the Hennepin facility at $0 and an increase of $7.2 million to reflect a liability related to the extension of a service contract. |
| (p) | As of March 10, 2004, goodwill of $24.5 million was recorded to reflect the excess of the purchase price over the estimated net fair value of assets acquired. Subsequent to March 10, 2004, as a result of revisions to fair value estimates, the fair value of net assets acquired exceeded the purchase price paid. The excess has been used to reduce the carrying value of non current assets. The net effect of all such adjustments is as follows: (in millions of dollars): |
| Balance Sheet Item | Impact on Goodwill | |||
|
Property, plant and equipment
|
$ | 179.7 | ||
|
Service and energy contracts
|
114.1 | |||
|
Investment in joint ventures
|
(2.9 | ) | ||
|
Deferred revenue — non-current
|
(127.9 | ) | ||
|
Deferred income taxes
|
(160.0 | ) | ||
|
Other liabilities
|
(34.7 | ) | ||
|
Minority interests
|
12.7 | |||
|
Long-term debt
|
(8.5 | ) | ||
|
Other items
|
3.0 | |||
|
Goodwill
|
$ | (24.5 | ) | |
35. Restatements
Subsequent to the issuance of the Predecessor’s 2003
consolidated financial statements, the Company’s management
determined that restricted funds held in trust at certain of the
Company’s international subsidiaries should not have been
included in cash and cash equivalents as of December 31,
2003, 2002 and 2001 and that certain debt, previously reported
as recourse debt, at certain of the Company’s international
subsidiaries should have been included in project debt at those
dates. As a result, the Predecessor’s consolidated balance
sheet as of December 31, 2003 and its consolidated
statements of cash flows for 2003 and 2002 have been restated
from the amounts previously reported to include such funds as
restricted funds held in trust and to include such debt as
project debt. The restatements had no impact on the
Predecessor’s shareholders’ deficit as of
December 31, 2003, or on net cash flows provided by
operating activities for the years ended December 31, 2003
and 2002. Furthermore, the restatements had no impact on the
consolidated statements of operations and comprehensive income
(loss) for the years ended December 31, 2003 and 2002.
E-77
Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
The following table summarizes the significant effects of the
restatements referred to above.
| As of December 31, 2003 | |||||||||
| As Previously | As | ||||||||
| Reported | Restated | ||||||||
|
Consolidated Balance Sheet
|
|||||||||
|
Current assets
|
|||||||||
|
Cash and cash equivalents
|
$ | 289,424 | $ | 260,902 | |||||
|
Restricted funds held in trust
|
79,404 | 102,199 | |||||||
|
Total current assets
|
690,799 | 685,072 | |||||||
|
Non-current assets
|
|||||||||
|
Restricted funds held in trust
|
119,480 | 125,207 | |||||||
|
Current liabilities
|
|||||||||
|
Current portion of recourse (long-term) debt
|
9,492 | 21 | |||||||
|
Current portion of project debt
|
99,216 | 108,687 | |||||||
|
Non-current liabilities
|
|||||||||
|
Recourse (long-term) debt
|
2,150 | 57 | |||||||
|
Project debt
|
933,185 | 935,278 | |||||||
| For the Years Ended | ||||||||||||||||
| December 31, 2003 | December 31, 2002 | |||||||||||||||
| As Previously | As Previously | As | ||||||||||||||
| Reported | As Restated | Reported | Restated | |||||||||||||
|
Consolidated Statements of Cash Flows
|
||||||||||||||||
|
Net cash used in financing activities of continuing operations
|
$ | (102,567 | ) | $ | (114,338 | ) | $ | (128,474 | ) | $ | (142,025 | ) | ||||
|
Net increase in cash and cash equivalents
|
173,609 | 161,838 | 29,042 | 15,491 | ||||||||||||
|
Cash and cash equivalents at end of period
|
289,424 | 260,902 | 115,815 | 99,064 | ||||||||||||
36. Subsequent Events —
Proposed American Ref-Fuel Corp. Acquisition
On January 31, 2005, Covanta’s parent, Danielson
Holding Corporation, entered into a stock purchase agreement
(the “Purchase Agreement”) with American Ref-Fuel
Holdings Corp. (“American Ref-Fuel”), an owner and
operator of waste-to-energy facilities in the northeast United
States, and Ref-Fuel’s stockholders (the “Selling
Stockholders”) to purchase 100% of the issued and
outstanding shares of Ref-Fuel capital stock. Under the terms of
the Purchase Agreement, Danielson will pay $740 million in
cash for the stock of Ref-Fuel and will assume the consolidated
net debt of Ref-Fuel, which as of December 31, 2004 was
approximately $1.2 billion net of debt service reserve
funds and other restricted fund held in trust for payment of
debt service. After the transaction is completed, Ref-Fuel will
be a wholly-owned subsidiary of Covanta.
The acquisition is expected to close when all of the closing
conditions to the Purchase Agreement have been satisfied or
waived. These closing conditions include the receipt of
approvals, clearances and the satisfaction of all waiting
periods as required under the Hart-Scott-Rodino Antitrust Act of
1976 (“HSR Approval”) and as required by certain
governmental authorities such as the Federal Energy Regulatory
Commission (“FERC Approval”) and other applicable
regulatory authorities. Other closing conditions of the
transaction include Danielson’s completion of debt
financing and an equity rights offering, as further described
below, Danielson providing letters of credit or other financial
accommodations in the aggregate amount of $100 million to
replace two currently outstanding letters of credit that have
been entered into by two respective subsidiaries of American
Ref-Fuel and issued in favor of a third subsidiary of American
Ref-Fuel, and other customary closing conditions. While it is
anticipated that all of the applicable conditions will be
satisfied, there can be no assurance as to whether or when all
of those conditions will be satisfied or, where permissible,
waived.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Notes to the Consolidated Financial
Statements — (Continued)
Either Danielson or the Selling Stockholders may terminate the
Purchase Agreement if the acquisition does not occur on or
before June 30, 2005, but if a required governmental or
regulatory approval has not been received by such date then
either party may extend the closing to a date that is no later
than the later of August 31, 2005 or the date 25 days
after which American Ref-Fuel has provided to Danielson certain
financial statements described in the Purchase Agreement.
Danielson intends to finance this transaction through a
combination of debt and equity financing. The equity component
of the financing is expected to consist of an approximately
$400 million offering of warrants or other rights to
purchase Danielson’s common stock to all of
Danielson’s existing stockholders at $6.00 per share (the
“Ref-Fuel Rights Offering”). In the Ref-Fuel Rights
Offering, Danielson’s existing stockholders will be issued
rights to purchase Danielson’s stock on a pro rata basis,
with each holder entitled to purchase approximately 0.9 shares
of Danielson’s common stock at an exercise price of $6.00
per full share for each share of Danielson’s common stock
then held.
Three of Danielson’s largest stockholders, SZI, TAVF and
Laminar, representing ownership of approximately 40% of
Danielson’s outstanding common stock, have committed to
participate in the Ref-Fuel Rights Offering and acquire their
pro rata portion of the shares.
Danielson has received a commitment from Goldman Sachs Credit
Partners, L.P. and Credit Suisse First Boston for a debt
financing package necessary to finance the acquisition, as well
as to refinance the existing recourse debt of Covanta and
provide additional liquidity for the Company. As discussed
below, this financing will replace entirely all of Domestic
Covanta’s and CPIH’s corporate debt that was issued on
March 10, 2004. The financing will consist of two tranches,
each of which is secured by pledges of the stock of
Covanta’s subsidiaries that has not otherwise been pledged,
guarantees from certain of Covanta’s subsidiaries and all
other available assets of Covanta’s subsidiaries. The first
tranche, a first priority senior secured bank facility, is
comprised of a funded $250 million variable rate term loan
facility due 2012, a $100 million revolving credit facility
expiring 2011, and a $340 million letter of credit facility
expiring 2012. The revolving credit facility and the letter of
credit facility will be available for the Company’s needs
in connection with its domestic and international businesses,
including the existing businesses of Ref-Fuel. The second
tranche is a second priority senior secured term loan facility
consisting of a funded $450 variable rate million term loan
facility due 2013, of which a portion may be converted, to fixed
rate notes without premium or penalty.
The closing of the financing and receipt of proceeds under the
Ref-Fuel Rights Offering are closing conditions under the
Purchase Agreement.
Immediately upon closing of the acquisition, Ref-Fuel will
become a wholly-owned subsidiary of Covanta, and Covanta will
control the management and operations of the Ref-Fuel
facilities. The current project and other debt of Ref-Fuel
subsidiaries will be unaffected by the acquisition, except that
the revolving credit and letter of credit facility of Ref-Fuel
Company LLC (the direct parent of each Ref-Fuel project company)
will be cancelled and replaced with new facilities at the
Covanta level. For additional information concerning the
combined capital structure of Covanta and Ref-Fuel following the
acquisition, see Item 7, Management’s Discussion and
Analysis of Financial Condition and Results of Operations,
Liquidity, and Capital Resources and Commitments.
There can be no assurance that Danielson will be able to
complete the acquisition of Ref-Fuel.
E-79
Table of Contents
Covanta Energy Corporation and Subsidiaries
QUARTERLY RESULTS OF OPERATIONS (Unaudited)
(In thousands of dollars, except per-share amounts)
The following table summarizes the 2004 and 2003 quarterly
results of operations. (See Note 3 to the Notes to the
Consolidated Financials Statements for further discussion).
| Predecessor | Successor | |||||||||||||||||||
| For the Period | For the Period | |||||||||||||||||||
| January 1, | March 11, | |||||||||||||||||||
| Through | Through | |||||||||||||||||||
| 2004 Quarter Ended | March 10 | March 31 | June 30 | September 30 | December 31 | |||||||||||||||
|
Total revenues from continuing operations
|
$ | 143,232 | $ | 38,976 | $ | 179,999 | $ | 168,151 | $ | 170,076 | ||||||||||
|
Operating income
|
$ | 10,262 | $ | 4,474 | $ | 31,044 | $ | 21,077 | $ | 20,413 | ||||||||||
|
Net income
|
$ | 29,563 | $ | 981 | $ | 13,004 | $ | 10,258 | $ | 6,896 | ||||||||||
|
Basic earnings per common share
|
$ | 0.59 | ||||||||||||||||||
|
Diluted earnings (loss) per common share
|
$ | 0.59 | ||||||||||||||||||
| Predecessor | ||||||||||||||||
| 2003 Quarter Ended | March 31 | June 30 | September 30 | December 31 | ||||||||||||
|
Total revenues from continuing operations
|
$ | 196,411 | $ | 211,596 | $ | 192,055 | $ | 190,406 | ||||||||
|
Operating income
|
17,351 | 30,748 | 7,586 | 4,296 | ||||||||||||
|
Loss from continuing operations
|
(2,781 | ) | 6,588 | (18,328 | ) | (12,243 | ) | |||||||||
|
Income from discontinued operations
|
1,789 | 4,902 | 8,068 | 64,055 | ||||||||||||
|
Loss from cumulative effect of change in accounting principle
|
(8,538 | ) | — | — | — | |||||||||||
|
Net income (loss)
|
$ | (9,530 | ) | $ | 11,490 | $ | (10,260 | ) | $ | 51,812 | ||||||
|
Basic earnings (loss) per common share:
|
||||||||||||||||
|
Income (loss) from continuing operations
|
$ | (0.06 | ) | $ | 0.13 | $ | (0.37 | ) | $ | (0.25 | ) | |||||
|
Income from discontinued operations
|
0.04 | 0.10 | 0.16 | 1.29 | ||||||||||||
|
Loss from cumulative effect of change in accounting principles
|
(0.17 | ) | — | — | — | |||||||||||
|
Total
|
$ | (0.19 | ) | $ | 0.23 | $ | (0.21 | ) | $ | 1.04 | ||||||
|
Diluted earnings (loss) per common share:
|
||||||||||||||||
|
Income (loss) from continuing operations
|
$ | (0.06 | ) | $ | 0.13 | $ | (0.37 | ) | $ | (0.25 | ) | |||||
|
Income from discontinued operations
|
0.04 | 0.10 | 0.16 | 1.29 | ||||||||||||
|
Loss from cumulative effect of change in accounting principle
|
(0.17 | ) | — | — | — | |||||||||||
|
Total
|
$ | (0.19 | ) | $ | 0.23 | $ | (0.21 | ) | $ | 1.04 | ||||||
See Note 2, 3, 4, 5, 11, 15, and 25 to the Consolidated
Financial Statements for information regarding reorganization
items, write-offs and special charges during the years ended
December 31, 2004 and 2003.
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Table of Contents
Covanta Energy Corporation and Subsidiaries
Schedule II — Valuation and Qualifying
Accounts
| Column A | Column B | Column C | Column D | Column E | ||||||||||||||||
| Additions | ||||||||||||||||||||
| Balance at | Charged to | Charged to | Balance at | |||||||||||||||||
| Beginning | Costs and | Other | End | |||||||||||||||||
| of Period | Expenses | Accounts | Deductions | of Period | ||||||||||||||||
|
Description
|
||||||||||||||||||||
|
For the Period March 11, through December 31,
2004
|
||||||||||||||||||||
|
Allowances deducted in the balance sheet from the assets to
which they apply:
|
||||||||||||||||||||
|
Doubtful receivables — current
|
$ | — | $ | 733 | $ | — | $ | 299 | (a) | $ | 434 | |||||||||
|
Retention receivables — current
|
— | — | — | — | — | |||||||||||||||
|
Doubtful receivables — non-current
|
— | — | — | (170 | ) | 170 | ||||||||||||||
|
Total
|
$ | — | $ | 733 | $ | — | $ | 129 | $ | 604 | ||||||||||
|
For the Period January 1, through
March 10, 2004
|
||||||||||||||||||||
|
Allowances deducted in the balance sheet from the assets to
which they apply:
|
||||||||||||||||||||
|
Doubtful receivables — current
|
$ | 27,893 | $ | 852 | $ | — | $ | 27,151 | (b) | $ | — | |||||||||
| 1,594 | (a) | |||||||||||||||||||
|
Retention receivables — current
|
5,026 | — | — | 5,026 | (c) | — | ||||||||||||||
|
Doubtful receivables — non-current
|
5,000 | — | — | 5,000 | (c) | — | ||||||||||||||
|
Total
|
$ | 37,919 | $ | 852 | $ | — | $ | 38,771 | $ | — | ||||||||||
|
Allowances not deducted:
|
||||||||||||||||||||
|
Reserves relating to tax indemnification and other contingencies
in connection with the sale of limited partnership interests in
and related tax benefits of a waste-to-energy facility
|
$ | 300 | — | — | $ | (300 | ) | $ | — | |||||||||||
|
Total
|
$ | 300 | $ | (300 | ) | $ | — | |||||||||||||
|
For the Year ended December 31, 2003
|
||||||||||||||||||||
|
Allowances deducted in the balance sheet from the assets to
which they apply:
|
||||||||||||||||||||
|
Doubtful receivables — current
|
$ | 20,476 | $ | 5,241 | $ | 8,368 | $ | 6,192 | (a) | $ | 27,893 | |||||||||
|
Retention receivables — current
|
— | 5,000 | — | — | 5,000 | |||||||||||||||
|
Doubtful receivables — non-current
|
2,957 | — | 3,270 | 1,201 | (c) | 5,026 | ||||||||||||||
|
Total
|
$ | 23,433 | $ | 10,241 | $ | 11,638 | $ | 7,393 | $ | 37,919 | ||||||||||
|
Allowances not deducted:
|
||||||||||||||||||||
|
Reserves relating to tax indemnification and other contingencies
in connection with the sale of limited partnership interests in
and related tax benefits of a waste-to-energy facility
|
$ | 300 | — | — | — | $ | 300 | |||||||||||||
|
Total
|
$ | 300 | $ | 300 | ||||||||||||||||
E-81
Table of Contents
| Column A | Column B | Column C | Column D | Column E | ||||||||||||||||
| Additions | ||||||||||||||||||||
| Balance at | Charged to | Charged to | Balance at | |||||||||||||||||
| Beginning | Costs and | Other | End | |||||||||||||||||
| of Period | Expenses | Accounts | Deductions | of Period | ||||||||||||||||
|
For the Year ended December 31, 2002
|
||||||||||||||||||||
|
Allowances deducted in the balance sheet from the assets to
which they apply:
|
||||||||||||||||||||
|
Doubtful receivables — current
|
$ | 16,444 | $ | 17,056 | — | $ | 13,024 | (a)(c) | $ | 20,476 | ||||||||||
|
Doubtful receivables — non-current
|
— | 2,957 | — | 2,957 | ||||||||||||||||
|
Total
|
$ | 16,444 | $ | 20,013 | $ | 13,024 | $ | 23,433 | ||||||||||||
|
Allowances not deducted:
|
||||||||||||||||||||
|
Reserves relating to tax indemnification and other contingencies
in connection with the sale of limited partnership interests in
and related tax benefits of a waste-to-energy facility
|
$ | 300 | — | — | — | $ | 300 | |||||||||||||
|
Total
|
$ | 300 | $ | 300 | ||||||||||||||||
NOTES:
| (a) | Write-off of receivables considered uncollectible. |
| (b) | Fresh start adjustments. |
| (c) | Settlement of receivable on company sold. |
Covanta Energy Corporation and Subsidiaries
Schedule II — Tax Valuation Allowance
| Column A | Column B | Column C | Column D | Column E | ||||||||||||||||
| Subtractions | ||||||||||||||||||||
| Credit | ||||||||||||||||||||
| Balance at | (charges) | Charged to | Balance at | |||||||||||||||||
| Beginning | to Tax | Other | End | |||||||||||||||||
| of Period | Expense | Accounts | Deductions | of Period | ||||||||||||||||
|
Description
|
||||||||||||||||||||
|
2004
|
||||||||||||||||||||
|
March 11, through December 31, 2004 (Successor)
|
$ | — | $ | 45 | $ | (9,435 | ) | $ | — | $ | 9,390 | |||||||||
|
2004
|
||||||||||||||||||||
|
January 1, through December 31, 2004 (Predecessor)
|
$ | 79,492 | $ | 79,492 | $ | — | $ | — | $ | — | ||||||||||
|
2003
|
101,571 | 3,449 | 18,630 | — | 79,492 | |||||||||||||||
|
2002
|
89,923 | (11,648 | ) | — | — | 101,571 | ||||||||||||||
E-82
Table of Contents
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
| Item 13. | Other Expenses of Issuance and Distribution. |
The following table sets forth the various expenses in
connection with the sale and distribution of securities being
registered, other than discounts, concessions and brokerage
commissions. All amounts set forth below are estimates, other
than the SEC registration fee.
|
SEC registration fee
|
$ | 2,316 | |||
|
Legal fees and expenses
|
650,000 | ||||
|
Accounting fees and expenses
|
85,000 | ||||
|
Miscellaneous
|
12,684 | ||||
|
Total
|
$ | 750,000 | |||
We will bear all of the foregoing expenses.
| Item 14. | Indemnification of Directors and Officers. |
Under Section 145 of Delaware General Corporation Law
(“DGCL”), a corporation has the authority to indemnify
any person who was or is a party or is threatened to be made a
party to an action (other than an action by or in the right of
the corporation) by reason of such person’s service as a
director or officer of the corporation, or such person’s
service, at the corporation’s request, as a director,
officer, employee or agent of another corporation or other
enterprise, against amounts paid and expenses incurred in
connection with the defense or settlement of such action, if
such person acted in good faith and in a manner such person
reasonably believed to be in or not opposed to the
corporation’s best interests and, with respect to any
criminal action or proceeding, had no reasonable cause to
believe that such person’s conduct was unlawful. If such
person has been judged liable to the corporation in any action
or proceeding brought by or in the right of the corporation,
however, indemnification is only permitted to the extent that
the adjudicating court (or the court in which the action was
brought) determines, despite the adjudication of liability, that
such indemnification is proper.
As permitted by Section 145 of DGCL, our restated
certificate of incorporation and by-laws authorize us to
indemnify any officer, director and employee of Covanta against
amounts paid or expenses incurred in connection with any action,
suit or proceeding (other than any such action by or in the
right of the corporation) to which such person is or is
threatened to be made a party as a result of such positions if
the Board of Directors or stockholders of or independent legal
counsel to us, in a written opinion, determine that
indemnification is proper.
We have agreed to indemnify and hold KPMG harmless against and
from any and all legal costs and expenses incurred by KPMG in
successful defense of any legal action or proceeding that arises
as a result of KPMG’s consent to the inclusion of its
report on Ref-Fuel’s past financial statements included in
this registration statement.
| Item 15. | Recent Sales of Unregistered Securities. |
None.
II-1
Table of Contents
| Item 16. | Exhibits and Financial Statement Schedules. |
(a) Exhibits.
| Exhibit No. | Description | |||
| 2 | .1† | Investment and Purchase Agreement by and between Covanta Holding Corporation and Covanta Energy Corporation dated as of December 2, 2003 (incorporated herein by reference to Exhibit 2.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003, as amended by Covanta Holding Corporation’s Current Report on Form 8-K/A dated December 2, 2003 and filed with the SEC on January 30, 2004). | ||
| 2 | .2† | Note Purchase Agreement by and between Covanta Holding Corporation and the Purchasers named therein dated as of December 2, 2003 (incorporated herein by reference to Exhibit 2.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003, as amended by Covanta Holding Corporation’s Current Report on Form 8-K/A dated December 2, 2003 and filed with the SEC on January 30, 2004). | ||
| 2 | .3† | Amendment to Investment and Purchase Agreement by and between Covanta Holding Corporation and Covanta Energy Corporation dated February 23, 2004 (incorporated herein by reference to Exhibit 2.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 10, 2004 and filed with the SEC on March 11, 2004). | ||
| 2 | .4† | First Amendment to Note Purchase Agreement and Consent by and among Covanta Holding Corporation and D.E. Shaw Laminar Portfolios, L.L.C., SZ Investments, L.L.C. and Third Avenue Trust, on behalf of The Third Avenue Value Fund Series, dated as of February 23, 2004 (incorporated herein by reference to Exhibit 2.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 10, 2004 and filed with the SEC on March 11, 2004). | ||
| 2 | .5† | Stock Purchase Agreement among Covanta ARC Holdings, Inc., the Sellers party thereto and Covanta Holding Corporation dated as of January 31, 2005 (incorporated herein by reference to Exhibit 2.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 3 | .1† | Amended and Restated Certificate of Incorporation of Covanta Holding Corporation, as amended (incorporated herein by reference to Exhibit 3.1 of Covanta Holding Corporation’s Report on Form 10-Q for the period ended September 30, 2005 and filed with the SEC on November 9, 2005). | ||
| 3 | .2† | Amended and Restated Bylaws of Covanta Holding Corporation, as amended and effective October 5, 2004 (incorporated herein by reference to Exhibit 3.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated September 7, 2004 filed with the SEC on September 9, 2004). | ||
| 4 | .1 | Specimen certificate representing shares of Covanta Holding Corporation’s common stock. | ||
| 4 | .2† | Registration Rights Agreement among Covanta Holding Corporation and the other signatories thereto dated January 31, 2005 (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 4 | .3† | Registration Rights Agreement dated November 8, 2002 among Covanta Holding Corporation and SZ Investments, L.L.C. (incorporated herein by reference to Exhibit 10.6 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 27, 2002 and filed with the SEC on March 27, 2003). | ||
| 4 | .4† | Registration Rights Agreement between Covanta Holding Corporation, D.E. Shaw Laminar Portfolios, L.L.C., SZ Investments, L.L.C., and Third Avenue Trust, on behalf of The Third Avenue Value Fund Series, dated December 2, 2003 (incorporated herein by reference to Exhibit 4.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003). | ||
II-2
Table of Contents
| Exhibit No. | Description | |||
| 4 | .5† | MSW Energy Holding LLC and MSW Energy Finance Co., Inc., and each of the Guarantors named therein, Series A and Series B 81/2% Senior Secured Note Due 2010 Indenture, dated as of June 25, 2003, by and among MSW Energy Holding LLC, MSW Energy Finance Co., Inc. and Wells Fargo Bank Minnesota, National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 of MSW Energy Holding LLC’s Registration Statement on Form S-4 filed with the SEC on September 23, 2003). | ||
| 4 | .6† | Supplemental Indenture, dated as of July 11, 2003, by and among MSW Energy Hudson LLC, MSW Energy Holding LLC, MSW Energy Finance Co., Inc. and Wells Fargo Bank Minnesota, National Association, as Trustee (incorporated herein by reference to Exhibit 4.2 of MSW Energy Holding LLC’s Registration Statement on Form S-4 filed with the SEC on September 23, 2003). | ||
| 4 | .7† | Form of Series A and Series B 81/2% Senior Secured Note Due 2010 (incorporated herein by reference to Exhibit 4.1 of MSW Energy Holding LLC’s Registration Statement on Form S-4 filed with the SEC on September 23, 2003). | ||
| 4 | .8† | MSW Energy Holding II LLC and MSW Energy Finance Co. II, Inc., and each of the Guarantors named therein, Series A and Series B 73/8% Senior Secured Note Due 2010 Indenture, dated as of November 24, 2003, by and among MSW Energy Holding II LLC, MSW Energy Finance Co. II, Inc. and Wells Fargo Bank Minnesota, National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 of MSW Energy Holding II LLC’s Registration Statement on Form S-4 filed with the SEC on February 10, 2004). | ||
| 4 | .9† | Supplemental Indenture, dated as of December 12, 2003, by and among UAE Ref-Fuel II Corp., MSW Energy Holding II LLC, MSW Energy Finance Co. II, Inc. and Wells Fargo Bank Minnesota, National Association, as Trustee (incorporated herein by reference to Exhibit 4.2 of MSW Energy Holding II LLC’s Registration Statement on Form S-4 filed with the SEC on February 10, 2004). | ||
| 4 | .10 | Form of Series A and Series B 73/8% Senior Secured Note Due 2010. | ||
| 4 | .11 | Form of Warrant Offering Agreement between Wells Fargo Bank, National Association and Covanta Holding Corporation. | ||
| 5 | .1 | Legal Opinion of Neal, Gerber & Eisenberg LLP. | ||
| 10 | .1† | Equity Commitment for Rights Offering between Covanta Holding Corporation and SZ Investments L.L.C. dated February 1, 2005 (incorporated herein by reference to Exhibit 10.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 10 | .2† | Equity Commitment for Rights Offering between Covanta Holding Corporation and EGI-Fund (05-07) Investors, L.L.C. dated February 1, 2005 (incorporated herein by reference to Exhibit 10.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 10 | .3† | Equity Commitment for Rights Offering between Covanta Holding Corporation and Third Avenue Trust, on behalf of The Third Avenue Value Fund Series dated February 1, 2005 (incorporated herein by reference to Exhibit 10.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 10 | .4† | Equity Commitment for Rights Offering between Covanta Holding Corporation and D.E. Shaw Laminar Portfolios, L.L.C. dated February 1, 2005 (incorporated herein by reference to Exhibit 10.5 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 10 | .5† | Letter Agreement between Covanta Holding Corporation and D.E. Shaw Laminar Portfolios, L.L.C. dated January 31, 2005 (incorporated herein by reference to Exhibit 10.6 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
II-3
Table of Contents
| Exhibit No. | Description | |||
| 10 | .6† | Investment and Purchase Agreement by and between Covanta Holding Corporation and Covanta Energy Corporation, dated December 2, 2003 (incorporated herein by reference to Exhibit 2.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003), as amended by that certain Amendment to the Investment and Purchase Agreement, made and entered into on February 23, 2004, by and between the same parties (incorporated herein by reference to Exhibit 2.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 10, 2004 and filed with the SEC on March 11, 2004). | ||
| 10 | .7† | Note Purchase Agreement by and among Covanta Holding Corporation, SZ Investments, L.L.C., Third Avenue Trust, on behalf of The Third Avenue Value Fund Series, and D. E. Shaw Laminar Portfolios, L.L.C. dated December 2, 2003 (incorporated herein by reference to Exhibit 2.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003), as amended by that certain First Amendment to Note Purchase Agreement and Consent, made and entered into as of February 23, 2004, by and among the same parties (incorporated herein by reference to Exhibit 2.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 10, 2004 and filed with the SEC on March 11, 2004) | ||
| 10 | .8† | Letter Agreement by and between Covanta Holding Corporation and D.E. Shaw Laminar Portfolios, L.L.C. dated December 2, 2003 (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003) | ||
| 10 | .9† | Letter Agreement by and between Covanta Holding Corporation and Equity Group Investments, L.L.C. dated December 1, 2003 (incorporated herein by reference to Exhibit 10.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003). | ||
| 10 | .10† | Tax Sharing Agreement, dated as of March 10, 2004, by and between Covanta Holding Corporation, Covanta Energy Corporation, and Covanta Power International Holdings, Inc. (incorporated herein by reference to Exhibit 10.25 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003 and filed with the SEC on March 15, 2004). | ||
| 10 | .11† | Corporate Services and Expenses Reimbursement Agreement, dated as of March 10, 2004, by and between Covanta Holding Corporation and Covanta Energy Corporation (incorporated herein by reference to Exhibit 10.26 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003 and filed with the SEC on March 15, 2004). | ||
| 10 | .12† | Corporate Services Agreement, dated as of September 2, 2003, by and between Covanta Holding Corporation and Equity Group Investments, L.L.C. (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Quarterly Report on Form 10-Q for the period ended September 30, 2003 and filed with the SEC on November 7, 2003). | ||
| 10 | .13† | Management Services and Reimbursement Agreement, dated March 10, 2004, among Covanta Energy Corporation, Covanta Energy Group, Inc., Covanta Projects, Inc., Covanta Power International Holdings, Inc., and certain Subsidiaries listed therein (incorporated herein by reference to Exhibit 10.30 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003 and filed with the SEC on March 15, 2004). | ||
| 10 | .14† | Covanta Energy Savings Plan, as amended by December 2003 amendment (incorporated herein by reference to Exhibit 10.25 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 31, 2004 and filed with the SEC on March 16, 2005). | ||
| 10 | .15† | Covanta Holding Corporation Equity Award Plan for Employees and Officers, as amended (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Report on Form 10-Q for the period ended September 30, 2005 and filed with the SEC on November 9, 2005). | ||
| 10 | .16† | Covanta Holding Corporation Equity Award Plan for Directors (incorporated herein by reference to Exhibit 4.3 of Covanta Holding Corporation’s Registration Statement on Form S-8 filed with the SEC on October 7, 2004). | ||
II-4
Table of Contents
| Exhibit No. | Description | |||
| 10 | .17† | Form of Covanta Holding Corporation Stock Option Agreement for Employees and Officers (incorporated herein by reference to Exhibit 10.5 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 and filed with the SEC on October 7, 2004). | ||
| 10 | .18† | Form of Covanta Holding Corporation Restricted Stock Award Agreement (incorporated herein by reference to Exhibit 10.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 and filed with the SEC on October 7, 2004). | ||
| 10 | .19† | Covanta Holding Corporation 1995 Stock and Incentive Plan (as amended effective December 12, 2000 and as further amended effective July 24, 2002) (incorporated herein by reference to Appendix A to Covanta Holding Corporation’s Proxy Statement filed with the SEC on June 24, 2002). | ||
| 10 | .20† | Employment Agreement, dated October 5, 2004, by and between Anthony J. Orlando and Covanta Projects, Inc., Covanta Energy Corporation and Covanta Holding Corporation (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 and filed with the SEC on October 7, 2004). | ||
| 10 | .21† | Employment Agreement, dated October 5, 2004, by and between Craig D. Abolt and Covanta Projects, Inc., Covanta Energy Corporation and Covanta Holding Corporation (incorporated herein by reference to Exhibit 10.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 and filed with the SEC on October 7, 2004). | ||
| 10 | .22† | Employment Agreement, dated October 5, 2004, by and between Timothy J. Simpson and Covanta Projects, Inc., Covanta Energy Corporation and Covanta Holding Corporation (incorporated herein by reference to Exhibit 10.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 filed with the SEC on October 7, 2004). | ||
| 10 | .23† | Employment Agreement, dated as of April 27, 2004, by and between Covanta Holding Corporation and Jeffrey R. Horowitz (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Registration Statement on Form S-3/A filed with the SEC on August 20, 2004). | ||
| 10 | .24† | Form of Covanta Holding Corporation Amendment to Stock Option Agreement for Employees and Officers (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 18, 2005 and filed with the SEC on March 24, 2005). | ||
| 10 | .25† | Covanta Holding Corporation Amendment to Stock Option Agreement (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated May 25, 2005 and filed with the SEC on May 26, 2005). | ||
| 10 | .26† | Credit Agreement, dated as of June 24, 2005, among Covanta Energy Corporation, Covanta Holding Corporation, as a guarantor, certain subsidiaries of Covanta Energy Corporation, as guarantors, various lenders, Credit Suisse, Cayman Islands Branch, as Joint Lead Arranger and Co-Syndication Agent, Goldman Sachs Credit Partners, L.P., as Joint Lead Arranger, Co-Syndication Agent, Administrative Agent and Collateral Agent, JPMorgan Chase Bank, as Co-Documentation Agent, Revolving Issuing Bank and a Funded LC Issuing Bank, UBS Securities LLC, as Co-Documentation Agent, UBS AG, Stamford Branch, as a Funded LC Issuing Bank, and Calyon New York Branch, as Co-Documentation Agent (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .27† | Second Lien Credit and Guaranty Agreement, dated as of June 24, 2005, among Covanta Energy Corporation, Covanta Holding Corporation, as a guarantor, certain subsidiaries of Covanta Energy Corporation, as guarantors, various lenders, Credit Suisse, Cayman Islands Branch, as Joint Lead Arranger, Co-Syndication Agent, Administrative Agent, Collateral Agent and Paying Agent, and Goldman Sachs Credit Partners L.P., as Joint Lead Arranger and Co-Syndication Agent (incorporated herein by reference to Exhibit 10.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
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| Exhibit No. | Description | |||
| 10 | .28† | First Lien Pledge and Security Agreement between each of Covanta Energy Corporation and the other Grantors Party thereto and Goldman Sachs Credit Partners L.P., as Collateral Agent, dated as of June 24, 2005 (incorporated herein by reference to Exhibit 10.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .29† | Parity Lien Pledge and Security Agreement, dated as of June 24, 2005, between each of Covanta Energy Corporation and the other Grantors Party thereto and Credit Suisse, Cayman Islands Branch, as Collateral Agent (incorporated herein by reference to Exhibit 10.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .30† | First Lien Pledge Agreement, dated as of June 24, 2005, between Covanta Holding Corporation and Goldman Sachs Credit Partners L.P., as Collateral Agent (incorporated herein by reference to Exhibit 10.5 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .31† | Parity Lien Pledge Agreement, dated as of June 24, 2005, between Covanta Holding Corporation and Credit Suisse, Cayman Islands Branch, as Collateral Agent (incorporated herein by reference to Exhibit 10.6 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .32† | Intercreditor Agreement, dated as of June 24, 2005, among Covanta Energy Corporation, Goldman Sachs Credit Partners L.P., as Collateral Agent for the First Lien Claimholders, Credit Suisse, Cayman Islands Branch, as Administrative Agent for the Second Lien Credit Claimholders and as Collateral Agent for the Parity Lien Claimholders (incorporated herein by reference to Exhibit 10.7 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .33† | Amendment No. 1 to Tax Sharing Agreement, dated as of June 24, 2005, by and between Covanta Holding Corporation, Covanta Energy Corporation and Covanta Power International Holdings, Inc., amending Tax Sharing Agreement between Covanta Holding Corporation, Covanta Energy Corporation and Covanta Power International Holdings, Inc. dated as of March 10, 2004 (incorporated herein by reference to Exhibit 10.8 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 21 | .1 | List of Subsidiaries. | ||
| 23 | .1 | Consent of Neal, Gerber & Eisenberg LLP (included as part of Exhibit 5.1). | ||
| 23 | .2 | Consent of Independent Registered Public Accounting Firm of Covanta Holding Corporation and Subsidiaries, dated December 14, 2005, by Ernst & Young LLP. | ||
| 23 | .3 | Consent of Independent Registered Public Accounting Firm of Quezon Power, Inc., dated December 14, 2005, by Sycip Gorres Velayo & Co., a member practice of Ernst & Young Global. | ||
| 23 | .4 | Consent of Independent Registered Public Accounting Firm of Covanta ARC Holdings, Inc. and Subsidiaries, dated December 15, 2005, by PricewaterhouseCoopers LLP for their report dated March 15, 2005. | ||
| 23 | .5 | Consent of Independent Registered Public Accounting Firm of Covanta ARC Holdings, Inc. and Subsidiaries, dated December 15, 2005, by PricewaterhouseCoopers LLP for their report dated June 30, 2004. | ||
| 23 | .6 | Consent of Independent Registered Public Accounting Firm of Covanta ARC Holdings, Inc. and Subsidiaries, dated December 14, 2005, by KPMG LLP. | ||
| 23 | .7 | Consent of Independent Registered Public Accounting Firm of Covanta Ref-Fuel Holdings LLC and Subsidiaries, dated December 15, 2005, by PricewaterhouseCoopers LLP for their report dated March 15, 2005. | ||
| 23 | .8 | Consent of Independent Registered Public Accounting Firm of Covanta Ref-Fuel Holdings LLC and Subsidiaries, dated December 15, 2005, by PricewaterhouseCoopers LLP for their report dated March 29, 2004. | ||
| 23 | .9 | Consent of Independent Registered Public Accounting Firm of Covanta Energy Corporation and Subsidiaries, dated December 14, 2005, by Deloitte & Touche LLP. | ||
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| Exhibit No. | Description | |||
| 23 | .10 | Consent of Independent Registered Public Accounting Firm of Covanta Energy Corporation and Subsidiaries, December 14, 2005, by Ernst & Young LLP. | ||
| 24 | .1† | Power of attorney (included in signature page to Registration Statement on Form S-3 (333-120755) filed with the SEC on November 24, 2004). | ||
| † | Not filed herewith, but incorporated herein by reference. |
Pursuant to paragraph 601(b)(4)(iii)(A) of
Regulation S-K, the registrant has omitted from the
foregoing list of exhibits, and hereby agrees to furnish to the
Securities and Exchange Commission, upon its request, copies of
certain instruments, each relating to long-term debt not
exceeding 10% of the total assets of the registrant and its
subsidiaries on a consolidated basis.
(b) Financial Statement Schedules.
All financial statement schedules for which provision is made in
the applicable accounting regulations of the SEC have been
omitted because they are either: (1) not required or are
inapplicable; (2) the required information has been
provided in the Audited Consolidated Financial Statements of
Covanta Holding Corporation as of December 31, 2004 and
December 31, 2003 and for the years ended December 31,
2004 and 2003 and December 27, 2002 or the notes thereto
which are attached as Appendix A to the prospectus included
in this registration statement; or (3) the required
information has been provided in the Audited Consolidated
Financial Statements of Covanta Energy Corporation and
Subsidiaries as of December 31, 2004 and December 31,
2003 and for the periods January 1, 2004 through
March 10, 2004 and March 11, 2004 through
December 31, 2004 and for the years ended December 31,
2003 and 2002 or the notes thereto which are attached as
Appendix E to the prospectus included in this registration
statement.
| Item 17. | Undertakings. |
(a) The undersigned registrant hereby undertakes:
| (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement: |
| (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; | |
| (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20 percent change in the maximum aggregate offering price set forth in the “Calculation of Registration Fee” table in the effective registration statement; | |
| (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement. | |
| (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. | |
| (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. | |
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(b) Insofar as indemnification for liabilities arising
under the Securities Act of 1933 may be permitted to directors,
officers and controlling persons of the registrant pursuant to
the foregoing provisions, or otherwise, the registrant has been
advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities
(other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the
registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in
the Act and will be governed by the final adjudication of such
issue.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant has duly caused this registration statement to be
signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Fairfield, State of New Jersey, on
December 16, 2005.
| COVANTA HOLDING CORPORATION | |
| (Registrant) |
| By: | /s/ ANTHONY J. ORLANDO |
|
|
|
| Anthony J. Orlando | |
| President and Chief Executive Officer |
Pursuant to the requirements of the Securities Act of 1933, as
amended, this amendment to the Registration Statement on
Form S-1 has been signed on December 16, 2005 by the
following persons in the capacities indicated:
| Signature | Title | |||
|
/s/ SAMUEL ZELL |
Chairman of the Board | |||
|
/s/ ANTHONY J. ORLANDO |
President and Chief Executive Officer and Director (Principal Executive Officer) | |||
|
/s/ CRAIG D. ABOLT |
Senior Vice President and Chief Financial Officer (Principal Financial Officer) | |||
|
/s/ THOMAS E. BUCKS |
Vice President and Chief Accounting Officer (Principal Accounting Officer) |
|||
|
/s/ DAVID M. BARSE* |
Director | |||
|
/s/ RONALD J. BROGLIO* |
Director | |||
|
/s/ PETER C.B. BYNOE* |
Director | |||
|
/s/ RICHARD L. HUBER* |
Director | |||
|
/s/ WILLIAM C. PATE* |
Director | |||
|
/s/ ROBERT S. SILBERMAN |
Director | |||
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| Signature | Title | |||
|
/s/ JEAN SMITH* |
Director | |||
|
/s/ CLAYTON YEUTTER* |
Director | |||
|
*/s/ ANTHONY J. ORLANDO |
||||
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EXHIBIT INDEX
| Exhibit No. | Description | |||
| 2 | .1† | Investment and Purchase Agreement by and between Covanta Holding Corporation and Covanta Energy Corporation dated as of December 2, 2003 (incorporated herein by reference to Exhibit 2.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003, as amended by Covanta Holding Corporation’s Current Report on Form 8-K/A dated December 2, 2003 and filed with the SEC on January 30, 2004). | ||
| 2 | .2† | Note Purchase Agreement by and between Covanta Holding Corporation and the Purchasers named therein dated as of December 2, 2003 (incorporated herein by reference to Exhibit 2.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003, as amended by Covanta Holding Corporation’s Current Report on Form 8-K/A dated December 2, 2003 and filed with the SEC on January 30, 2004). | ||
| 2 | .3† | Amendment to Investment and Purchase Agreement by and between Covanta Holding Corporation and Covanta Energy Corporation dated February 23, 2004 (incorporated herein by reference to Exhibit 2.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 10, 2004 and filed with the SEC on March 11, 2004). | ||
| 2 | .4† | First Amendment to Note Purchase Agreement and Consent by and among Covanta Holding Corporation and D.E. Shaw Laminar Portfolios, L.L.C., SZ Investments, L.L.C. and Third Avenue Trust, on behalf of The Third Avenue Value Fund Series, dated as of February 23, 2004 (incorporated herein by reference to Exhibit 2.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 10, 2004 and filed with the SEC on March 11, 2004). | ||
| 2 | .5† | Stock Purchase Agreement among Covanta ARC Holdings, Inc., the Sellers party thereto and Covanta Holding Corporation dated as of January 31, 2005 (incorporated herein by reference to Exhibit 2.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 3 | .1† | Amended and Restated Certificate of Incorporation of Covanta Holding Corporation, as amended (incorporated herein by reference to Exhibit 3.1 of Covanta Holding Corporation’s Report on Form 10-Q for the period ended September 30, 2005 and filed with the SEC on November 9, 2005). | ||
| 3 | .2† | Amended and Restated Bylaws of Covanta Holding Corporation, as amended and effective October 5, 2004 (incorporated herein by reference to Exhibit 3.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated September 7, 2004 filed with the SEC on September 9, 2004). | ||
| 4 | .1 | Specimen certificate representing shares of Covanta Holding Corporation’s common stock. | ||
| 4 | .2† | Registration Rights Agreement among Covanta Holding Corporation and the other signatories thereto dated January 31, 2005 (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 4 | .3† | Registration Rights Agreement dated November 8, 2002 among Covanta Holding Corporation and SZ Investments, L.L.C. (incorporated herein by reference to Exhibit 10.6 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 27, 2002 and filed with the SEC on March 27, 2003). | ||
| 4 | .4† | Registration Rights Agreement between Covanta Holding Corporation, D.E. Shaw Laminar Portfolios, L.L.C., SZ Investments, L.L.C., and Third Avenue Trust, on behalf of The Third Avenue Value Fund Series, dated December 2, 2003 (incorporated herein by reference to Exhibit 4.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003). | ||
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| Exhibit No. | Description | |||
| 4 | .5† | MSW Energy Holding LLC and MSW Energy Finance Co., Inc., and each of the Guarantors named therein, Series A and Series B 81/2% Senior Secured Note Due 2010 Indenture, dated as of June 25, 2003, by and among MSW Energy Holding LLC, MSW Energy Finance Co., Inc. and Wells Fargo Bank Minnesota, National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 of MSW Energy Holding LLC’s Registration Statement on Form S-4 filed with the SEC on September 23, 2003). | ||
| 4 | .6† | Supplemental Indenture, dated as of July 11, 2003, by and among MSW Energy Hudson LLC, MSW Energy Holding LLC, MSW Energy Finance Co., Inc. and Wells Fargo Bank Minnesota, National Association, as Trustee (incorporated herein by reference to Exhibit 4.2 of MSW Energy Holding LLC’s Registration Statement on Form S-4 filed with the SEC on September 23, 2003). | ||
| 4 | .7† | Form of Series A and Series B 81/2% Senior Secured Note Due 2010 (incorporated herein by reference to Exhibit 4.1 of MSW Energy Holding LLC’s Registration Statement on Form S-4 filed with the SEC on September 23, 2003). | ||
| 4 | .8† | MSW Energy Holding II LLC and MSW Energy Finance Co. II, Inc., and each of the Guarantors named therein, Series A and Series B 73/8% Senior Secured Note Due 2010 Indenture, dated as of November 24, 2003, by and among MSW Energy Holding II LLC, MSW Energy Finance Co. II, Inc. and Wells Fargo Bank Minnesota, National Association, as Trustee (incorporated herein by reference to Exhibit 4.1 of MSW Energy Holding II LLC’s Registration Statement on Form S-4 filed with the SEC on February 10, 2004). | ||
| 4 | .9† | Supplemental Indenture, dated as of December 12, 2003, by and among UAE Ref-Fuel II Corp., MSW Energy Holding II LLC, MSW Energy Finance Co. II, Inc. and Wells Fargo Bank Minnesota, National Association, as Trustee (incorporated herein by reference to Exhibit 4.2 of MSW Energy Holding II LLC’s Registration Statement on Form S-4 filed with the SEC on February 10, 2004). | ||
| 4 | .10 | Form of Series A and Series B 73/8% Senior Secured Note Due 2010. | ||
| 4 | .11 | Form of Warrant Offering Agreement between Wells Fargo Bank, National Association and Covanta Holding Corporation. | ||
| 5 | .1 | Legal Opinion of Neal, Gerber & Eisenberg LLP. | ||
| 10 | .1† | Equity Commitment for Rights Offering between Covanta Holding Corporation and SZ Investments L.L.C. dated February 1, 2005 (incorporated herein by reference to Exhibit 10.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 10 | .2† | Equity Commitment for Rights Offering between Covanta Holding Corporation and EGI-Fund (05-07) Investors, L.L.C. dated February 1, 2005 (incorporated herein by reference to Exhibit 10.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 10 | .3† | Equity Commitment for Rights Offering between Covanta Holding Corporation and Third Avenue Trust, on behalf of The Third Avenue Value Fund Series dated February 1, 2005 (incorporated herein by reference to Exhibit 10.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 10 | .4† | Equity Commitment for Rights Offering between Covanta Holding Corporation and D.E. Shaw Laminar Portfolios, L.L.C. dated February 1, 2005 (incorporated herein by reference to Exhibit 10.5 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
| 10 | .5† | Letter Agreement between Covanta Holding Corporation and D.E. Shaw Laminar Portfolios, L.L.C. dated January 31, 2005 (incorporated herein by reference to Exhibit 10.6 of Covanta Holding Corporation’s Current Report on Form 8-K dated January 31, 2005 and filed with the SEC on February 2, 2005). | ||
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| Exhibit No. | Description | |||
| 10 | .6† | Investment and Purchase Agreement by and between Covanta Holding Corporation and Covanta Energy Corporation, dated December 2, 2003 (incorporated herein by reference to Exhibit 2.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003), as amended by that certain Amendment to the Investment and Purchase Agreement, made and entered into on February 23, 2004, by and between the same parties (incorporated herein by reference to Exhibit 2.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 10, 2004 and filed with the SEC on March 11, 2004). | ||
| 10 | .7† | Note Purchase Agreement by and among Covanta Holding Corporation, SZ Investments, L.L.C., Third Avenue Trust, on behalf of The Third Avenue Value Fund Series, and D. E. Shaw Laminar Portfolios, L.L.C. dated December 2, 2003 (incorporated herein by reference to Exhibit 2.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003), as amended by that certain First Amendment to Note Purchase Agreement and Consent, made and entered into as of February 23, 2004, by and among the same parties (incorporated herein by reference to Exhibit 2.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 10, 2004 and filed with the SEC on March 11, 2004) | ||
| 10 | .8† | Letter Agreement by and between Covanta Holding Corporation and D.E. Shaw Laminar Portfolios, L.L.C. dated December 2, 2003 (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003) | ||
| 10 | .9† | Letter Agreement by and between Covanta Holding Corporation and Equity Group Investments, L.L.C. dated December 1, 2003 (incorporated herein by reference to Exhibit 10.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated December 2, 2003 and filed with the SEC on December 5, 2003). | ||
| 10 | .10† | Tax Sharing Agreement, dated as of March 10, 2004, by and between Covanta Holding Corporation, Covanta Energy Corporation, and Covanta Power International Holdings, Inc. (incorporated herein by reference to Exhibit 10.25 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003 and filed with the SEC on March 15, 2004). | ||
| 10 | .11† | Corporate Services and Expenses Reimbursement Agreement, dated as of March 10, 2004, by and between Covanta Holding Corporation and Covanta Energy Corporation (incorporated herein by reference to Exhibit 10.26 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003 and filed with the SEC on March 15, 2004). | ||
| 10 | .12† | Corporate Services Agreement, dated as of September 2, 2003, by and between Covanta Holding Corporation and Equity Group Investments, L.L.C. (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Quarterly Report on Form 10-Q for the period ended September 30, 2003 and filed with the SEC on November 7, 2003). | ||
| 10 | .13† | Management Services and Reimbursement Agreement, dated March 10, 2004, among Covanta Energy Corporation, Covanta Energy Group, Inc., Covanta Projects, Inc., Covanta Power International Holdings, Inc., and certain Subsidiaries listed therein (incorporated herein by reference to Exhibit 10.30 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003 and filed with the SEC on March 15, 2004). | ||
| 10 | .14† | Covanta Energy Savings Plan, as amended by December 2003 amendment (incorporated herein by reference to Exhibit 10.25 of Covanta Holding Corporation’s Annual Report on Form 10-K for the year ended December 31, 2004 and filed with the SEC on March 16, 2005). | ||
| 10 | .15† | Covanta Holding Corporation Equity Award Plan for Employees and Officers, as amended (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Report on Form 10-Q for the period ended September 30, 2005 and filed with the SEC on November 9, 2005). | ||
| 10 | .16† | Covanta Holding Corporation Equity Award Plan for Directors (incorporated herein by reference to Exhibit 4.3 of Covanta Holding Corporation’s Registration Statement on Form S-8 filed with the SEC on October 7, 2004). | ||
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| Exhibit No. | Description | |||
| 10 | .17† | Form of Covanta Holding Corporation Stock Option Agreement for Employees and Officers (incorporated herein by reference to Exhibit 10.5 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 and filed with the SEC on October 7, 2004). | ||
| 10 | .18† | Form of Covanta Holding Corporation Restricted Stock Award Agreement (incorporated herein by reference to Exhibit 10.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 and filed with the SEC on October 7, 2004). | ||
| 10 | .19† | Covanta Holding Corporation 1995 Stock and Incentive Plan (as amended effective December 12, 2000 and as further amended effective July 24, 2002) (incorporated herein by reference to Appendix A to Covanta Holding Corporation’s Proxy Statement filed with the SEC on June 24, 2002). | ||
| 10 | .20† | Employment Agreement, dated October 5, 2004, by and between Anthony J. Orlando and Covanta Projects, Inc., Covanta Energy Corporation and Covanta Holding Corporation (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 and filed with the SEC on October 7, 2004). | ||
| 10 | .21† | Employment Agreement, dated October 5, 2004, by and between Craig D. Abolt and Covanta Projects, Inc., Covanta Energy Corporation and Covanta Holding Corporation (incorporated herein by reference to Exhibit 10.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 and filed with the SEC on October 7, 2004). | ||
| 10 | .22† | Employment Agreement, dated October 5, 2004, by and between Timothy J. Simpson and Covanta Projects, Inc., Covanta Energy Corporation and Covanta Holding Corporation (incorporated herein by reference to Exhibit 10.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated October 5, 2004 filed with the SEC on October 7, 2004). | ||
| 10 | .23† | Employment Agreement, dated as of April 27, 2004, by and between Covanta Holding Corporation and Jeffrey R. Horowitz (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Registration Statement on Form S-3/A filed with the SEC on August 20, 2004). | ||
| 10 | .24† | Form of Covanta Holding Corporation Amendment to Stock Option Agreement for Employees and Officers (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated March 18, 2005 and filed with the SEC on March 24, 2005). | ||
| 10 | .25† | Covanta Holding Corporation Amendment to Stock Option Agreement (incorporated herein by reference to Exhibit 10 .1 of Covanta Holding Corporation’s Current Report on Form 8-K dated May 25, 2005 and filed with the SEC on May 26, 2005). | ||
| 10 | .26† | Credit Agreement, dated as of June 24, 2005, among Covanta Energy Corporation, Covanta Holding Corporation, as a guarantor, certain subsidiaries of Covanta Energy Corporation, as guarantors, various lenders, Credit Suisse, Cayman Islands Branch, as Joint Lead Arranger and Co-Syndication Agent, Goldman Sachs Credit Partners, L.P., as Joint Lead Arranger, Co-Syndication Agent, Administrative Agent and Collateral Agent, JPMorgan Chase Bank, as Co-Documentation Agent, Revolving Issuing Bank and a Funded LC Issuing Bank, UBS Securities LLC, as Co-Documentation Agent, UBS AG, Stamford Branch, as a Funded LC Issuing Bank, and Calyon New York Branch, as Co-Documentation Agent (incorporated herein by reference to Exhibit 10.1 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .27† | Second Lien Credit and Guaranty Agreement, dated as of June 24, 2005, among Covanta Energy Corporation, Covanta Holding Corporation, as a guarantor, certain subsidiaries of Covanta Energy Corporation, as guarantors, various lenders, Credit Suisse, Cayman Islands Branch, as Joint Lead Arranger, Co-Syndication Agent, Administrative Agent, Collateral Agent and Paying Agent, and Goldman Sachs Credit Partners L.P., as Joint Lead Arranger and Co-Syndication Agent (incorporated herein by reference to Exhibit 10.2 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
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| Exhibit No. | Description | |||
| 10 | .28† | First Lien Pledge and Security Agreement between each of Covanta Energy Corporation and the other Grantors Party thereto and Goldman Sachs Credit Partners L.P., as Collateral Agent, dated as of June 24, 2005 (incorporated herein by reference to Exhibit 10.3 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .29† | Parity Lien Pledge and Security Agreement, dated as of June 24, 2005, between each of Covanta Energy Corporation and the other Grantors Party thereto and Credit Suisse, Cayman Islands Branch, as Collateral Agent (incorporated herein by reference to Exhibit 10.4 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .30† | First Lien Pledge Agreement, dated as of June 24, 2005, between Covanta Holding Corporation and Goldman Sachs Credit Partners L.P., as Collateral Agent (incorporated herein by reference to Exhibit 10.5 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .31† | Parity Lien Pledge Agreement, dated as of June 24, 2005, between Covanta Holding Corporation and Credit Suisse, Cayman Islands Branch, as Collateral Agent (incorporated herein by reference to Exhibit 10.6 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .32† | Intercreditor Agreement, dated as of June 24, 2005, among Covanta Energy Corporation, Goldman Sachs Credit Partners L.P., as Collateral Agent for the First Lien Claimholders, Credit Suisse, Cayman Islands Branch, as Administrative Agent for the Second Lien Credit Claimholders and as Collateral Agent for the Parity Lien Claimholders (incorporated herein by reference to Exhibit 10.7 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 10 | .33† | Amendment No. 1 to Tax Sharing Agreement, dated as of June 24, 2005, by and between Covanta Holding Corporation, Covanta Energy Corporation and Covanta Power International Holdings, Inc., amending Tax Sharing Agreement between Covanta Holding Corporation, Covanta Energy Corporation and Covanta Power International Holdings, Inc. dated as of March 10, 2004 (incorporated herein by reference to Exhibit 10.8 of Covanta Holding Corporation’s Current Report on Form 8-K dated June 24, 2005 and filed with the SEC on June 30, 2005). | ||
| 21 | .1 | List of Subsidiaries. | ||
| 23 | .1 | Consent of Neal, Gerber & Eisenberg LLP (included as part of Exhibit 5.1). | ||
| 23 | .2 | Consent of Independent Registered Public Accounting Firm of Covanta Holding Corporation and Subsidiaries, dated December 14, 2005, by Ernst & Young LLP. | ||
| 23 | .3 | Consent of Independent Registered Public Accounting Firm of Quezon Power, Inc., dated December 14, 2005, by Sycip Gorres Velayo & Co., a member practice of Ernst & Young Global. | ||
| 23 | .4 | Consent of Independent Registered Public Accounting Firm of Covanta ARC Holdings, Inc. and Subsidiaries, dated December 15, 2005, by PricewaterhouseCoopers LLP for their report dated March 15, 2005. | ||
| 23 | .5 | Consent of Independent Registered Public Accounting Firm of Covanta ARC Holdings, Inc. and Subsidiaries, dated December 15, 2005, by PricewaterhouseCoopers LLP for their report dated June 30, 2004. | ||
| 23 | .6 | Consent of Independent Registered Public Accounting Firm of Covanta ARC Holdings, Inc. and Subsidiaries, dated December 14, 2005, by KPMG LLP. | ||
| 23 | .7 | Consent of Independent Registered Public Accounting Firm of Covanta Ref-Fuel Holdings LLC and Subsidiaries, dated December 15, 2005, by PricewaterhouseCoopers LLP for their report dated March 15, 2005. | ||
| 23 | .8 | Consent of Independent Registered Public Accounting Firm of Covanta Ref-Fuel Holdings LLC and Subsidiaries, dated December 15, 2005, by PricewaterhouseCoopers LLP for their report dated March 29, 2004. | ||
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Table of Contents
| Exhibit No. | Description | |||
| 23 | .9 | Consent of Independent Registered Public Accounting Firm of Covanta Energy Corporation and Subsidiaries, dated December 14, 2005, by Deloitte & Touche LLP. | ||
| 23 | .10 | Consent of Independent Registered Public Accounting Firm of Covanta Energy Corporation and Subsidiaries, December 14, 2005, by Ernst & Young LLP. | ||
| 24 | .1† | Power of attorney (included in signature page to Registration Statement on Form S-3 (333-120755) filed with the SEC on November 24, 2004). | ||
| † | Not filed herewith, but incorporated herein by reference. |
Pursuant to paragraph 601(b)(4)(iii)(A) of
Regulation S-K, the registrant has omitted from the
foregoing list of exhibits, and hereby agrees to furnish to the
Securities and Exchange Commission, upon its request, copies of
certain instruments, each relating to long-term debt not
exceeding 10% of the total assets of the registrant and its
subsidiaries on a consolidated basis.
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