FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Commission file number 1-3122

Covanta Energy Corporation

40 Lane Road, Fairfield, NJ 07004

(973) 882-9000

Not Applicable

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [x] No [  ]

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ] No [x]

APPLICABLE ONLY TO ISSUERS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by checkmark whether the registrant has filed all reports required to be filed by Section 12, 13 and 15 (d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan of reorganization confirmed by a court.

Yes [x] No [  ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares of the registrant’s Common Stock outstanding as of August 6, 2004 was 200 shares.

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

STATEMENTS OF CONDENSED CONSOLIDATED OPERATIONS
AND COMPREHENSIVE INCOME

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

STATEMENTS OF CONDENSED CONSOLIDATED OPERATIONS
AND COMPREHENSIVE INCOME

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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Covanta Energy Corporation and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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Covanta Energy Corporation and Subsidiaries

STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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Covanta Energy Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

1. Basis of Presentation:

The accompanying unaudited Condensed Consolidated Financial Statements (“Financial Statements”) include the accounts of Covanta Energy Corporation and its subsidiaries (together, “Covanta” or the “Company”). The financial statements presented reflect the reorganization under which Covanta became a wholly-owned subsidiary of Danielson Holding Corporation as of March 10, 2004 (the “Effective Date”).

Accordingly, the Financial Statements for the period beginning on the day after the Effective Date through June 30, 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” and Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes”. References in these Financial Statements to the “Predecessor” refer to the Company prior to March 10, 2004. References to the “Successor” refer to the Company on and after March 10, 2004.

The accompanying unaudited Financial Statements 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 U.S. 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. 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 and the reported amounts of revenues and expenses. Actual results could differ from those estimates. Significant estimates include useful lives of long-lived assets, cash flows and taxable income from future operations, allowances for doubtful accounts receivable, and liabilities related to pension obligations, and for workers compensation, severance, and certain litigation.

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 equity investments of 20% to 50% are accounted for using the equity method since Covanta has the ability to exercise significant influence over their operations. Those companies in which Covanta owns less than 20% are accounted for using the cost method. Six of the Company’s subsidiaries, which relate to three projects, 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 those subsidiaries, those six subsidiaries will continue to operate as debtors in possession in the Chapter 11 cases 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 cases. Accordingly, Covanta no longer includes those six subsidiaries as consolidated subsidiaries in the Financial Statements. Covanta’s investment in these six 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 among consolidated entities have been eliminated.

2. Reorganization:

On March 10, 2004, the Company consummated a plan of reorganization and, emerged from its reorganization proceeding under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”). As a result of the consummation of the plan, Covanta became a wholly-owned subsidiary of Danielson Holding Corporation, a Delaware corporation (“Danielson”). The Chapter 11 proceedings commenced on April 1, 2002 (the “First Petition Date”), when Covanta and most 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”). All of the bankruptcy cases (the “Chapter 11 Cases”) were jointly administered. During the Chapter 11 Cases, Covanta and its subsidiaries which were part of the Chapter 11 Cases (the “Debtors”) operated their business as debtors-in-possession

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pursuant to the Bankruptcy Code. International operations and certain other subsidiaries and joint venture partnerships were not included in the bankruptcy filings.

The Financial Statements of the Predecessor through March 10, 2004 were prepared in accordance with SOP 90-7. Accordingly, all pre-petition liabilities believed to be subject to compromise were segregated in the Condensed 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 Statements of Condensed Consolidated Cash Flows.

Prior to March 10, 2004, the Debtors acted as debtors-in-possession and were authorized to continue to operate as an ongoing business, but could not engage in transactions outside the ordinary course of business without the approval of the Bankruptcy Court.

Pursuant to the Bankruptcy Code, pre-petition obligations of the Debtors, including obligations under debt instruments, generally could not be enforced against the Debtors, and any actions to collect pre-petition indebtedness were automatically stayed, unless the stay was lifted by the Bankruptcy Court. The obligations of, and the ultimate payments by, the Debtors under pre-petition commitments were substantially altered in the course of the Chapter 11 Cases. This resulted in claims being satisfied in the Chapter 11 Cases at less than their face value or being paid other than in cash.

With respect to financing during the pendency of the Chapter 11 Cases, the Debtors entered into a debtor-in-possession credit facility (the “DIP Facility”) as of April 1, 2002, which was approved by final order of the Bankruptcy Court on May 15, 2002. The DIP Facility was replaced with new credit and letter of credit facilities as of March 10, 2004 and is no longer in effect.

On December 2, 2003, Covanta and Danielson entered into an Investment and Purchase Agreement (as amended, the “DHC Agreement”). The DHC Agreement provided for:

	•		Danielson to purchase 100% of the equity in Covanta for approximately $30 million as part of a plan of reorganization (the “DHC Transaction”);
	•		agreement as to new revolving credit and letter of credit facilities for the Company’s domestic and international operations, provided by certain of Covanta’s existing lenders under the DIP Facility and a group of additional lenders organized by Danielson; and
	•		execution and consummation of the Tax Sharing Agreement between Danielson and Covanta (the “Tax Sharing Agreement”), pursuant to which (a) Covanta (exclusive of its international holding company), will file a consolidated tax return with Danielson, and (b) Danielson will make up to $572 million, constituting all of Danielson’s net operating loss tax carry-forwards (“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.

On March 5, 2004, the Bankruptcy Court entered an order confirming the Company’s plan of reorganization premised on the DHC Transaction and liquidation for certain of those Debtors involved in non-core businesses (the “Liquidation Plan”). On March 10, 2004 both plans were effected upon the consummation of the DHC Transaction and the reorganization plan (the plans of reorganization and liquidation collectively, the “Reorganization Plan”). The following is a summary of material provisions of the Reorganization Plan. The Debtors owning or operating the Company’s Warren County, New Jersey, Lake County, Florida, and Tampa Bay, Florida projects remained debtors-in-possession (the “Remaining Debtors”), and are not the subject of either plan. 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 Lenders 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:

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	•		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 (the “CPIH Term Loan Facility”) 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”).

     (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, its 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, 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 Convertible Subordinated Debentures did not receive any 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 Common and Preferred Stockholders

The holders of Covanta’s preferred and common stock outstanding immediately before consummation of the DHC Transaction did not receive any distribution or retain any property pursuant to the Reorganization Plan. The preferred stock and common stock were cancelled as of March 10, 2004, the effective date of the Reorganization Plan.

The Reorganization Plan provides 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 has 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 is in 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 2004. In total, approximately 4,700 proofs of claim in aggregate amount of approximately $13.3 billion were filed. The Company believes that many of the proofs of claim are invalid, duplicative, untimely, inaccurate or otherwise objectionable. 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.

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Developments in Project Restructurings

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 and Lake County, Florida waste-to-energy projects and the Tampa Bay water project. As a result, Covanta’s subsidiaries involved in these projects remained in Chapter 11 and are not consolidated in the Company’s consolidated financial statements. The Warren County matter is described below; the Lake County and Tampa Bay matters are described in Note 14. The Company expects that the outcome of the issues described below and in Note 14 relating to these projects will not adversely affect Covanta or CPIH.

Warren County, New Jersey

The Covanta subsidiary (“Covanta Warren”) which operates the Company’s 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 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 the Company’s emergence from bankruptcy, the Company and Covanta Warren entered into several agreements approved by the Bankruptcy Court that permit Covanta Warren to reimburse the Company for employees and employee-related expenses, provide for payment of a monthly allocated overhead expense reimbursement in a fixed amount, and permit the Company 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 June 30, 2004, Covanta Warren owed to the Company $0.4 million under this debtor-in-possession loan facility.

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.

Reorganization Items

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 for the Period January 1, 2004 through March 10, 2004 and the three and six months ended June 30, 2003, (in thousands of dollars):

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Legal and professional fees consist of fees related to professionals for work associated with the bankruptcy of the Company.

Bankruptcy exit costs consist primarily of administrative expenses, trustee costs, and directors and officers liability insurance (covering the period prior to emergence).

Pursuant to SOP 90-7, the Company had segregated and classified certain pre-petition obligations as liabilities subject to compromise. Liabilities subject to compromise were 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, (in thousands of dollars):

3. Summary of Significant Accounting Policies

Fresh start accounting requires the selection of appropriate accounting policies for the reorganized Company. The significant accounting policies previously used by the Company will continue to be used by the reorganized Company including the following:

Service and Energy Contracts: As of March 10, 2004, service and energy contracts were recorded at their estimated fair market values 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 remaining weighted average life of the agreements of 17 years. The arithmetic average life is significantly shorter. Estimated amortization over the next five years is as follows (in thousands of dollars):

Debt Issuance Costs: As of March 10, 2004, debt issuance costs with respect to pre-emergence debt were recorded at their fair value of zero. Costs incurred in connection with the successor company’s issuance of bonds are being amortized using the effective interest rate method over the terms of the debt. Prior to March 10, 2004 unamortized bond issuance costs were included in other assets on the Condensed Consolidated Balance Sheets.

Unbilled Service Receivables and Other Receivables

As of March 10, 2004, unbilled service and other accounts receivables were recorded at their estimated fair value based upon discounted cash flows. Unbilled service receivables include 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 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 were discounted in recognizing the present value for services performed currently in order to service the principal component of project debt.

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Treatment of Pass Through Costs

Pass through costs are costs for which the Company receives a direct reimbursement from the municipal client which sponsors a waste to energy project. These costs include utility charges, insurance premiums, ash residue transportation and disposal, and certain chemical costs. These costs are recorded net in the Company’s Financial Statements. Total pass through expenses for the periods March 11, 2004 through June 30, 2004, January 1, 2004 through March 10, 2004, and the first six months of 2003 were $13.6 million, $10.0 million, and $27.9 million, respectively.

Stock Options

On March 10, 2004, the Company had three stock-based employee compensation plans that were terminated upon emergence from bankruptcy and all outstanding options and restricted stock were cancelled. The Company had accounted 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 was reflected in the 2004 and 2003 net income, 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 2004 or 2003. Awards under the Company’s plans vested over periods ranging from three to five years. Therefore, the cost related to stock-based employee compensation included in the determination of net income for 2004 and 2003 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.

The following table summarizes the pro forma impact on net income and income per common share for the period January 1, 2004 through March 10, 2004 and for the three and six months ended June 30, 2003 including the effect on net income and income per share if the fair value based method had been applied to all outstanding and unvested awards in each period (in thousands of dollars, except per share amounts):

New Accounting Pronouncements:

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN No. 46”). FIN No. 46 was developed as an attempt to clarify the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” and applies immediately to any variable interest entities created after January 31, 2003 and to variable interest entities in which an interest is obtained after that date. FIN No. 46 was revised in December 2003 and is applicable for the Company on January 1, 2004 for interests acquired in variable interest entities prior to February 1, 2003. The Company adopted the provisions of FIN No. 46 without impact on its consolidated financial condition or results of operations.

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Reclassification:

Certain prior period amounts, including various revenues and expenses, have been reclassified in the Financial Statements to conform with the current period presentation.

4. 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 the adjustment of 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 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 our 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 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 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 June 30, 2004 and the resulting fresh start consolidated balance sheet as of March 10, 2004:

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Following are footnotes to Pro forma Condensed Consolidated Balance Sheet.

	(a)		Pro Forma Balance Sheet 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)		Includes a decrease of $11.3 million because a tax receivable was netted against the net tax liability included in accrued expenses.
	(g)		Reflects the effect of adjusting receivables to fair value.
	(h)		Includes a $21.8 million write down of unamortized bond issuance costs, exclusive of minority interests, to a fair value of $0 and a write down of $6.2 million in deferred costs related to the Haverhill facility to a fair value of $0.

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	(i)		Includes a $10.2 million write down 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 on the fair market value premium on waste-to-energy project debt.
	(j)		Includes a write down of $11.0 million in the MCI facility accrued expenses to a fair value of $0 and a reduction of $6.0 million to reclassify pension liabilities to long-term liabilities.
	(k)		Reflects an $18.3 million write down of the long-term portion of the MCI facility project debt to a fair value of $0 and an increase of $34.4 million for the long-term portion of the fair market value premium on waste-to-energy project debt.
	(l)		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..
	(m)		Deferred income related to a power contract restructuring at the Haverhill facility was fair valued at $0.
	(n)		Reflects a decrease of $15.6 million to fair value tax reserves at $22.6 million, an increase of $6.0 million for the reclassification of pension liabilities from current liabilities, an increase of $18.4 million for additional pension liabilities, 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.
	(o)		As of March 10, 2004, goodwill of $24.5 million was recorded to reflect the excess of the estimated fair value of liabilities and equity over identifiable assets. Subsequent to March 10, 2004, the Company recorded additional adjustments to assets and liabilities at fair value in millions:

5. Credit Arrangements

In connection with the Bankruptcy Cases, Covanta and most of its subsidiaries entered into the DIP Facility. The DIP 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. All claims relating to the DIP Facility were discharged upon the effectiveness of the Reorganization Plan (see Note 2).

In connection with the effectiveness of the Reorganization Plan and the consummation of the DHC Transaction, the Company emerged from bankruptcy with a new debt structure. Domestic Borrowers have two facilities which provide letters of credit and liquidity; the First Lien Facility and the Second Lien Facility.

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•

The First Lien Facility provides commitments for the issuance of letters of credit contractually required in connection with one waste-to-energy facility. These letters of credit are currently required in the aggregate amount of approximately $128.0 million as of June 30, 2004, and the contractually required amount decreases semi-annually. The First Lien Facility has a term of five years, and requires 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 (approximately $1.38 million) 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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The Second Lien Facility provides commitments in the aggregate amount of $118 million, up to $10 million of which shall also be available for cash borrowings on a revolving basis and the balance for letters of credit supporting the Company’s domestic and international businesses. This Second Lien Facility has a term of five years. The Second Lien Facility requires cash collateral to be posted for issued letters of credit if Covanta has cash in excess of specified amounts. 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 $2.36 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. As of June 30, 2004, letters of credit in the approximate aggregate amount of $70.9 million had been issued under the Second Lien Facility, and the Company had not sought to make draws against the $10 million liquidity facility of the Second Lien Facility.

Total fees of $11.6 million in connection with the above two facilities paid on March 10, 2004 have been capitalized and are being amortized over the life of the credit facilities on a straight line basis. Both facilities are secured by the assets of the Domestic Borrowers not subject to security interests existing as of the Effective Date. The lien of the Second Lien Facility is junior to that of the First Lien Facility. The First Lien Facility and the Second Lien Facility are non-recourse to CPIH and its subsidiaries.

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 one secured liquidity facility (the “CPIH Revolving Credit 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. 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 June 30, 2004, CPIH had not sought to make draws on this facility.

The CPIH Revolving Credit Facility is non-recourse to Covanta and its other domestic subsidiaries.

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 6 below.

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6. Other Long-Term Debt

Long-term debt (in thousands of dollars) consisted of the following:

Covanta also issued the High Yield Notes and issued or will issue the Unsecured Notes. The High Yield Notes and the Unsecured Notes are non-recourse to CPIH and its subsidiaries.

	•		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 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, and the Company had as of June 30, 2004 issued Unsecured Notes in the aggregate amount of approximately $12.3 million. The Company expects to issue additional Unsecured Notes in a principal amount of approximately $16 million. 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.

Also, the CPIH Borrowers entered into the CPIH Term Loan Facility in the principal amount of up to $95 million, of which approximately $87 million was outstanding as of June 30, 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 three years. The CPIH Term Loan Facility is non-recourse to Covanta and its other domestic subsidiaries.

Covanta may issue tax notes in an aggregate principal amount equal to the aggregate amount of allowed priority tax claims with a maturity six years after the date of assessment. Interest will be payable semi-annually at the rate of 4% per annum. Under the Reorganization Plan, the Company may pay some of these claims in cash. The Company does not expect the amount of such allowed priority tax claims to negatively affect its ability to implement its business plan.

The maturities on long-term debt including capital lease obligations, (in thousands of dollars) at June 30, 2004 were as follows:

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7. Project Debt

Project debt (in thousands of dollars) consisted of the following:

The amounts reflected in the table above for the various series of revenue bonds comprising project debt reflect the Company’s estimate of the fair value of such project debt under fresh start accounting.

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 client community 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 of the project 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 municipally sponsored 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 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 facilities owned by the Company are limited recourse to the operating subsidiary and non-recourse to the Company, subject to construction and 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 facilities and related assets.

The maturities on long-term project debt (in thousands of dollars) at June 30, 2004 were as follows:

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8. Income taxes

Predecessor Company

The provision for income taxes of $215.4 million for the period January 1, 2004 through March 10, 2004 consists of an income tax provision of $229.3 million related to the increase in carrying value of certain assets to fair value recorded in connection with the Company’s adoption of fresh start accounting, and the gain on cancellation of pre-petition debt.

The effective tax rate for the period January 1, 2004 through March 10, 2004 differs from the federal statutory rate as the Company has established a valuation allowance against certain foreign net operating loss carry-forwards and certain other fresh start adjustments to reduce them to the amounts that will more likely than not be realized.

Successor Company

Included in the net deferred tax liability of the Successor Company is a deferred tax asset of $107.2 million related to Danielson NOLs that will be available to offset Covanta’s taxable income.

Danielson reported in its Form 10-K for the fiscal year ended December 31, 2003 filed with the SEC, that it expected to have NOLs estimated to be approximately $652 million for federal income tax purposes as of the end of 2003. Under a Tax Sharing Agreement between Covanta and Danielson, up to $572 million of Danielson’s NOLs will be made available to offset the income tax liability of Covanta and its domestic subsidiaries (other than CPIH and its domestic subsidiaries, which are not consolidated for tax purposes). The NOLs will expire in various amounts beginning on December 31, 2004 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 Danielson’s tax consolidated group. The Internal Revenue Service (“IRS”) has not audited any of Danielson’s tax returns with respect to years in which the losses giving rise to the NOLs were reported.

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”. 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.

Bankruptcy Effect

In connection with the Debtors’ emergence from bankruptcy, the Company realized a gain on the extinguishment of debt of $510.7 million. This gain will not be taxable since the gain resulted from the Company’s reorganization under the Bankruptcy Code. However, for U.S. income tax reporting purposes, as of the beginning of its short taxable period ending December 31, 2004, the Company will be required to reduce certain tax attributes, including (a) net operating loss carry-forwards and (b) certain tax credit carry-forwards, 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 Company’s net operating loss 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. However it has been accounted for assuming that the Company’s available net operating loss carry forwards and tax credit carry forwards will be reduced to $0 as a result of the extinguishment of debt.

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9. Pension and Post Retirement Benefits

Net periodic defined benefit pension and post-retirement expense were as follows (in thousands of dollars):

The Company 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 Statement of Financial Accounting Standards No. 141 “Business Combinations”. The Company made contributions of $6.1 million to the plan in the six months ended June 30, 2004.

In accordance with SFAS No. 141, on March 10, 2004 the company 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.

10. Business Segments

The Company’s reportable segments are: Domestic and International. The segment information for the prior year has been restated to conform with the current segments.

Covanta’s two segments develop, operate and in some cases own, energy generating facilities. The Company also operates certain water and wastewater facilities which serve communities.

Revenues and income from continuing operations by segment for the periods from March 11, 2004 through June 30, 2004, January 1, 2004 through March 10, 2004 and the six months ended June 30, 2003 and for the three months ended June 30, 2004 and June 30, 2003 (in thousands of dollars) were as follows:

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