UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K/A

Amendment No. 1


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

		For the fiscal year ended December 31, 2004

or

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

		For the transition period from to

Commission file number 1-3122

COVANTA ENERGY CORPORATION

(Exact name of registrant as specified in its charter)


Delaware		13-5549268
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employee Identification No.)

40 Lane Road, Fairfield, N.J. (Address of Principal Executive Offices)		07004 (Zip Code)

Registrant’s telephone number, including area code:

(973) 882-9000

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Each Exchange on Which Registered

None		N/A

Securities registered pursuant to Section 12(g) of the Act:

N/A

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. þ

State the aggregate market value of the voting and non-voting common equity held by nonaffiliates of the registrant computed by reference to the price at which the common equity was last sold, or the average bid and asked prices of such common equity, as the last business day of the registrant’s most recently complete second fiscal quarter. $0

Indicate by check mark whether the registrant is an accelerated filer (as defined by Exchange Act Rule 12b-2). Yes o No þ

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 þ No o

Common Stock, par value $0.01 per share; 200 shares authorized.

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares of the registrant’s common stock outstanding as of March 9, 2005 was 200 shares.

DOCUMENTS INCORPORATED BY REFERENCE:

NONE

EXPLANATORY NOTE

Covanta Energy Corporation (“Covanta”) is filing this Amendment No. 1 to its annual report on Form 10-K for the fiscal year ended December 31, 2004 (this “Amendment No. 1”) to amend its disclosures in Part II, Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations under the sub-headings “Executive Summary,” “Covanta’s Capital Resources and Commitments” and “Material Weaknesses in Internal Controls and Procedures” and Item 9A — Controls and Procedures of its annual report on Form 10-K filed on March 17, 2005, as well as to provide an amended report of its independent auditors, Sycip Gorres Velayo & Co., of its subsidiary Quezon Power, Inc. The purpose of this Amendment No. 1 is to provide (1) an expanded contractual obligations tabular presentation on page 67, (2) an expanded disclosure of management’s conclusions regarding Covanta’s disclosure controls and procedures and changes that had been made in Covanta’s internal controls over financial reporting, and (3) a revised report of its independent auditors, Sycip Gorres Velayo & Co., which has been revised solely for the purpose of referring to “standards of the Public Company Oversight Board (United States)” in lieu of the previous reference to “auditing standards generally accepted in the United States.” The other items of the Annual Report have not been changed by this Amendment No. 1. The complete text of the items amended is included in this Amendment No. 1 pursuant to Rule 12b-15 promulgated under the Securities Exchange Act of 1934. As a result, this Amendment amends and restates in its entirety only Part II, Items 7 and 9A of the Annual Report. References to “Annual Report” and “Form 10-K” in this Amendment No. 1 refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, as amended by this Amendment No. 1.

Except as otherwise expressly stated for the portions of the items amended in this Amendment No. 1, this Amendment No. 1 continues to speak as of the date of the original Annual Report and Covanta has not updated the disclosure contained herein to reflect events that have occurred since the filing of the original Annual Report. Accordingly, this Form 10-K/A should be read in conjunction with Covanta’s other filings made with the Securities and Exchange Commission subsequent to the filing of the original Annual Report, including any amendments to those filings.

TABLE OF CONTENTS


		Page

PART I
Item 1.	Business		3
Item 2.	Properties		41
Item 3.	Legal Proceedings		43
Item 4.	Submission of Matters to a Vote of Security Holders		45

PART II
Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters		46
Item 6.	Selected Financial Data		46
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		48
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk		91
Item 8.	Financial Statements and Supplementary Data Index		93
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		178
Item 9A.	Controls and Procedures		178
Item 9B.	Other Information

PART III
Item 10.	Directors and Executive Officers of the Registrant		180
Item 11.	Executive Compensation		183
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		189
Item 13.	Certain Relationships and Related Transactions		191
Item 14.	Principal Accountant Fees and Services		193

PART IV
Item 15.	Exhibits and Financial Statement Schedules		195
Certification
Certification
Certification
Certification

PART I


Item 1.	*BUSINESS*

INTRODUCTION

Covanta Energy Corporation (“Covanta”) and its subsidiaries (together with Covanta, the “Company”) develop and construct, own and operate for others key infrastructure for the conversion of waste-to-energy and independent power production in the United States and abroad. The Company owns or operates 51 power generation facilities, 38 of which are in the United States and 13 of which are located outside of the United States. The Company’s power generation facilities use a variety of fuels, including municipal solid waste, water (hydroelectric), natural gas, coal, wood waste, landfill gas, heavy fuel oil and diesel fuel. The Company also operates one potable water treatment facility which is located in the United States. Until September 1999, and under prior management, the Company was also actively involved in the entertainment and aviation services industries.

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 Company’s plan of reorganization, 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 pursuant to the Bankruptcy Code. International operations and certain other subsidiaries and joint venture partnerships were not included in the bankruptcy filings.

The subsidiaries of Covanta that own and operate the Warren County, New Jersey waste-to-energy facility (together the “Remaining Debtors”) remain in Chapter 11. The subsidiaries of Covanta that were involved in the Tampa Bay desalination project (“Tampa Bay Facility”) remained in the Chapter 11 proceeding until they emerged on August 6, 2004. These subsidiaries emerged from bankruptcy without material assets or liabilities, and without contractual rights to operate the Tampa Bay Facility. Additionally, the subsidiary of Covanta that operates the waste-to-energy facility in Lake County, Florida (“Covanta Lake”) remained in the Chapter 11 proceeding until emergence on December 12, 2004. Covanta Lake and the County entered into new agreements, releases and financing arrangements contemplated by the Plan of Reorganization described below.

Covanta was known as Ogden Corporation prior to March 13, 2001. The Company was incorporated in Delaware as a public utility holding company on August 4, 1939. In 1948, the Company registered with the Securities and Exchange Commission (the “SEC”) as a closed-end investment company. Following several acquisitions, the Company no longer qualified as an investment company and from 1953 until 1999 operated as a diversified holding company operating through subsidiaries. In May 1966, Ogden Corporation was listed on the New York Stock Exchange (“New York Stock Exchange”).

Prior to September 1999, the Company conducted its business through operating groups in three principal business units: Energy, Entertainment and Aviation. In September 1999, the Company adopted a plan to discontinue its Entertainment and Aviation operations, pursue the sale or other disposition of these businesses, pay down corporate debt and concentrate on businesses previously conducted through its Covanta Energy Group, Inc. (f/k/a Ogden Energy Group, Inc.) subsidiary. As a result of the reorganization proceedings described above, the Company has completed its plan to sell discontinued businesses.

On April 1, 2002, the New York Stock Exchange suspended trading of the Company’s common stock (“Old Common”) and $1.875 cumulative convertible preferred stock (“Old Preferred”) and began processing an application to the SEC to delist the Company from the New York Stock Exchange. By order dated May 16, 2002 the SEC granted the application of the New York Stock Exchange for removal of the Old

Common and Old Preferred of Covanta from listing and registration on the New York Stock Exchange under the Securities Exchange Act of 1934 as amended. The removal from listing and registration on the New York Stock Exchange of these classes of stock became effective at the opening of the trading session of May 17, 2002 pursuant to the order of the SEC.

All of the Company’s outstanding Old Common and Old Preferred were cancelled and extinguished on March 10, 2004, in accordance with the Company’s bankruptcy plan of reorganization. On March 10, 2004 the reorganized Company issued new common stock (“New Common”) to Danielson.

This Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results may differ materially from those contained in such forward-looking statements. See “Forward Looking Statements,” below.

DESCRIPTION OF COVANTA’S BUSINESSES

Set forth below is a description of the Company’s business operations as of December 31, 2004 as presented in the consolidated financial statements included in this report. The Company is engaged in the Energy Services business. The Company’s Business segments are Domestic Energy and International Energy, which described below.

Additional information about the Company’s business segments is included in Item 7, “Management’s, Discussion and Analysis of Financial Condition and Results of Operation.” See Note 27 to the Notes to Consolidated Financial Statements in Item 8 of this Form 10-K for financial information regarding geographic areas.

(A) Domestic Energy Business

The Company’s domestic business is the design, construction and long-term operation of key infrastructure for municipalities and others in waste-to-energy and independent power production. The Company’s largest operations are in waste-to-energy projects, and it currently operates 25 waste-to-energy plants, the majority of which were developed and structured contractually as part of competitive procurements conducted by municipal entities. The waste-to-energy plants combust municipal solid waste as a means of environmentally sound disposal and produce energy that is typically sold as electricity to utilities and other electricity purchasers. The Company processes approximately four percent of the municipal solid waste produced in the United States and therefore represents a vital part of the nation’s solid waste disposal industry.


	*Waste-to-Energy Projects*

The essential purpose of the Company’s waste-to-energy projects is to provide waste disposal services, typically to municipal clients who sponsor the projects (“Client Communities”). Generally, the Company provides these services pursuant to long-term service contracts (“Service Agreements”). The electricity or steam is sold pursuant to long-term power purchase agreements (“Energy Contracts”) with local utilities or industrial customers, with one exception, and most of the resulting revenues reduce the overall cost of waste disposal services to the Client Communities. Each Service Agreement is different to reflect the specific needs and concerns of the Client Community, applicable regulatory requirements and other factors. The original terms of the Service Agreements are each 20 or more years, with the majority now in the second half of the applicable term. Most of the Company’s Service Agreements may be renewed for varying periods of time, at the option of the Client Community.

The Company currently operates the waste-to-energy projects identified below under “Domestic Project Summaries.” Most of the Company’s operating waste-to-energy projects were developed and structured contractually as part of competitive procurements 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 or may be restructured, are described in “Other Waste-to-Energy Project Structures” and “Project Restructuring during 2004” below.

The Company receives its revenue in the form of fees pursuant to Service Agreements, and in some cases Energy Contracts, at facilities it owns. The Company’s Service Agreements begin to expire in 2007, and Energy Contracts at Company-owned projects generally expire at or after the date on which that project’s Service Agreement expires. As the Company’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, the Company intends to seek to enter into renewal or replacement contracts to operate several such facilities. The Company also will seek to bid competitively in the market for additional contracts to operate other facilities as similar contracts of other vendors expire. As the Company’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, the Company expects to be able to offer rates that will attract sufficient quantities of waste while providing acceptable revenues to the Company. At Company-owned facilities, the expiration of existing Energy Contracts will require the Company to sell its output either into the local electricity grid at prevailing rates or pursuant to new contracts. There can be no assurance that the Company 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 the Company.

The Company’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 15 to the Notes to Consolidated Financial Statements.


	*Structurally Similar Waste-to-Energy Projects*

Each Service Agreement is different to reflect the specific needs and concerns of the Client Community, applicable regulatory requirements and other factors. However, the following description sets forth terms that are generally common to these agreements:


	•	The Company designs the facility, helps to arrange for financing and then constructs and equips the facility on a fixed price and schedule basis.

	•	The Company operates the facility and generally guarantees it will meet minimum waste processing capacity and efficiency standards, energy production levels and environmental standards. The Company’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 (“Unforeseen Circumstances”)) may result in liquidated damages charged to the Company or, if the breach is substantial, continuing and unremedied, the termination of the Service Agreement. In the case of such Service Agreement termination, the Company may be obligated to pay material damages, including payments to discharge project indebtedness. The Company or an intermediate holding company typically guarantees performance of the Service Agreement.

	•	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, regardless of whether or not that quantity of waste is delivered to the facility (the “Service Fee”). 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 the Company, 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 the Company.

Financing for the Company’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 Company 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 the Company’s consolidated financial statements. Generally, such debt is secured by the revenues pledged under the respective indentures and is collateralized by the assets of the Company’s subsidiary with the only recourse to the Company being related to construction and operating performance defaults.

The Company has issued instruments to its Client Communities and other parties which guarantee that the Company’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 the Company’s subsidiaries, the Company’s potential maximum liability as of December 31, 2004 associated with the repayment of project debt on such facilities was in excess of $1 billion. If the Company 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, the Company has not incurred material liabilities under such guarantees.


	*Other Waste-to-Energy Project Structures*


	*Haverhill, Massachusetts*

The Company’s Haverhill, Massachusetts waste-to-energy facility is not operated pursuant to a Service Agreement with a Client Community. In this project, the Company 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. The Company retains all of the energy revenues from sales of power and disposal fees for waste accepted at this facility. Accordingly, the Company believes that this project carries both greater risks and greater potential rewards than projects in which there is a Client Community.

During 2003, US Gen New England, Inc. (“USGenNE”), the power purchaser for the Haverhill project, filed a petition under Chapter 11 of the United States Bankruptcy Code. During the pendency of its bankruptcy, on October 8, 2004, the United States Bankruptcy Court for the District of Maryland entered an order approving the sale by USGenNE of certain of its assets, including its contract to purchase power from the Haverhill project, to Dominion Energy New England, Inc. (“Dominion”). As a result of USGenNE’s sale to Dominion, USGenNE assigned and Dominion assumed such contract and the Company was paid all outstanding prepetition cure amounts plus interest.


	*Union, New Jersey*

In Union County, New Jersey, a municipally-owned facility has been leased to the Company, 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 the Company at its risk. The Company 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 part of a restructuring of this project, the Client Community assigned to the Company the long-term power contract with the local utility. As part of this assignment, the power contract was amended to give the Company the right to sell all or a portion of the plant’s output to other purchasers. Since April 2002, the Company 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 the Company may enter into contracts with other purchasers if it believes doing so would enhance this project’s revenues.


	*Alexandria, Virginia*

The Company’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 (the “Virginia Communities”). 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 the Company from private haulers pursuant to short-term contracts or on a spot basis. The Company’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 the Company’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 there are currently no outstanding loans to the Company’s operating subsidiary.


	*Project Restructurings during 2004*


	*Babylon, New York*

The Town of Babylon, New York (“Babylon”) filed a proof of claim against Covanta Babylon, Inc. (“Covanta Babylon”) in its bankruptcy proceeding for approximately $13.4 million in prepetition damages and $5.5 million in postpetition damages, alleging that Covanta Babylon was accepting less waste than required under the Service Agreement between Babylon and Covanta Babylon at the waste-to-energy facility in Babylon and that Covanta Babylon’s Chapter 11 Cases 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 pursuant to which, in part, (i) the parties amended 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 paid 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 may hold against the Company and in satisfaction of Babylon’s administrative expense claims against Covanta Babylon; and (iii) the parties allocated additional costs relating to the project’s swap financing as a result of Covanta Babylon’s Chapter 11 proceedings until such costs are eliminated. Covanta Babylon subsequently emerged from Chapter 11 pursuant to the Reorganization Plan as described below on March 10, 2004, and the restructuring became effective on March 12, 2004.


	*Lake County, Florida*

In late 2000, Lake County, Florida (“Lake County”) commenced a lawsuit in Florida state court against Covanta Lake, Inc. (“Covanta Lake,”) relating to the waste-to-energy facility operated by Covanta Lake 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 the Company.

After months of negotiations that failed to produce a settlement between Covanta Lake and Lake County, 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 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 Debtors and Lake County reached a tentative settlement calling for a new agreement specifying the parties’ obligations and restructuring of the project. That tentative settlement and the proposed restructuring involved, among other things, termination of the existing Service Agreement and the execution of a new waste disposal agreement which provides 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 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 Debtors’ separate 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 August 2004, the Bankruptcy Court ruled on the Debtors’ claims objections, finding in favor of the Debtors. Based on the foregoing, the Debtors determined to propose a plan of reorganization for Covanta Lake.

The Debtors subsequently reached a final settlement with Mr. Gregg, entered into a new long-term waste disposal agreement with Lake County on terms substantially similar to the tentative settlement, refinanced the project debt and confirmed the Covanta Lake plan of reorganization in December 2004. Covanta Lake emerged from bankruptcy on December 12, 2004.


	*Warren County, New Jersey*

The Company 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 for the Warren Facility.

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. Based upon the foregoing, the Company has not yet determined to propose a plan of reorganization or plan of liquidation for Covanta Warren at this time, and instead has determined that Covanta Warren should remain a debtor-in-possession.

In order to emerge from bankruptcy without uncertainty concerning potential claims against the Company related to the Warren Facility, Covanta rejected its guarantees of Covanta Warren’s obligations relating to the operation and maintenance of the Warren Facility. The Company anticipates that if a restructuring is consummated, Covanta may at that time issue a new parent guarantee in connection with that restructuring and emergence from bankruptcy.

reorganization on a non-consensual basis, or liquidate Covanta Warren. In such an event, creditors of Covanta Warren may not receive any recovery on account of their claims.

The Company expects that the outcome of this restructuring will not negatively affect its ability to implement its business plan, or have a material impact on its financial position or results of operations.


	Projects under Development


	*Hillsborough County, Florida*

The Company 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 has informed the Company of its desire to expand the facility’s waste processing and electricity generation capacities, a possibility contemplated by the existing contract between the Company and the County. As part of the proposed agreement to implement this expansion the Company 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, environmental and other project related permits will need to be secured and financing completed. At this time, there can be no assurance that any definitive agreements will be finalized or approved by the parties, the relevant permits will be received or that Hillsborough County will, in fact, expand the facility.


	*Lee County, Florida*

The Company 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 the Company of its desire to enlist the Company to manage the expansion of the facility’s waste processing and electricity generation capacities, a possibility contemplated by the existing contract between the Company and Lee County. As part of the proposed agreement to implement this expansion the Company 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 the Company. Subsequently, the Company purchased the rights to operate and maintain the facility on behalf of the City and County of Honolulu. The City and County of Honolulu have informed the Company of their desire to expand the facility’s waste processing capacity, a possibility contemplated by the existing contract between the Company and the City and the County of Honolulu. As part of the proposed agreement to implement the expansion the Company 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, environmental and other project related permits will need to be secured and financing completed. At this time, there can be no assurance that any definitive agreements will be finalized or approved by the parties, the relevant permits will be received or that the City and the County of Honolulu will, in fact, expand the facility.


	*Independent Power Projects*

Since 1989, the Company has been engaged in developing, owning and/or operating independent power production facilities utilizing a variety of energy sources including water (hydroelectric), natural gas, coal, waste wood (biomass), landfill gas, heavy fuel oil and diesel fuel. The Company currently owns, has ownership in and operates 13 such facilities. The electrical output from each facility, with one exception, is sold to local

utilities. The Company’s revenue from the independent power production facilities is derived primarily from the sale of energy and capacity under energy contracts. During 2003, the Company sold its interests in its Geothermal Energy Projects Business.

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*

The Company 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 the Company provides operation and maintenance services to the Koma Kulshan partnership under a cost plus fixed fee agreement.

During the first quarter of 2004, the Company 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. The Company chose not to renew the lease on the project, the term of which expired in October 2003.


	*Waste Wood*

The Company 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 the Company 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*

The Company 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, the Company 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

The Company designed, built and now continues to operate and maintain a 24 million gallon per day (“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, the Company 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, the Company was awarded contracts to supply its patented DualSand™microfiltration system (“DSS”) 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 (“NYCDEP”), a $1.4 billion program to protect and enhance the drinking water supply, or watershed, for New York City. These DSS contracts for upgrades have been completed and non-material payment issues are currently being discussed by, and may be litigated between, the Company and NYCDEP in order to close out these contracts. The Company 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. (“CTC”) completed construction of a 25 mgd 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 is 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. Under the terms of the plan CTB will not operate the Tampa Water Facility, and the Company will have no continuing obligations with respect to this project.


	*Transfers of Waste Water Project Contracts*

The Company formerly operated and maintained wastewater treatment facilities on behalf of seven small municipal and industrial customers in upstate New York. During 2004, the Company 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 the Company.


	*Sales of Certain Landfill Gas Assets*

During the fourth quarter of 2004, the Company 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 the Company 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.


	*Domestic Project Summaries*

Summary information with respect to the Company’s domestic projects(1) that are currently operating is provided in the following table:


			Waste		Gross			Date of
			Processing		Electric			Acquisition/
			Capacity		Output			Commencement of
		Location	(Ton/Day)		(MW)		Nature of Interest(1)	Operations

	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
		SUBTOTAL		30,925		816.3
B	HYDROELECTRIC
26	Koma Kulshan(8)	Washington				12.0	Part Owner/Operator		1997
27	Weeks Falls(8)	Washington				5.0	Part Owner		1997
		SUBTOTAL				17.0
C	WOOD
28	Burney Mountain	California				11.4	Owner/Operator		1997
29	Pacific Ultrapower	California				25.6	Part Owner		1997
	Chinese Station(8)
30	Mount Lassen	California				11.4	Owner/Operator		1997
31	Pacific Oroville	California				18.7	Owner/Operator		1997
		SUBTOTAL				67.1
D	LANDFILL GAS
32	Gude	Maryland				3.0	Owner/Operator		1997
33	Otay	California				3.7	Owner/Operator		1997
34	Oxnard	California				5.6	Owner/Operator		1997
35	Salinas	California				1.5	Owner/Operator		1997
36	Santa Clara	California				1.5	Owner/Operator		1997
37	Stockton	California				0.8	Owner/Operator		1997
38	Toyon(9)	California				3.8	Operator		1997
		SUBTOTAL				19.9

TOTAL DOMESTIC GROSS MW IN OPERATION						920.3
E	WATER
39	Bessemer	Alabama				24.0 mgd	Design/Build/Operate		2000

NOTES:


(1)	The Company’s ownership and/or operation interest in each facility listed below 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 the Company.

(4)	Operating contracts were acquired after completion. Facility uses a refuse-derived fuel technology and does not employ the Martin technology.

(5)	Company subsidiaries were purchased after construction completion.

(6)	Under contracts with the Connecticut Resource Recovery Authority, the Company operates only the boilers and turbines for this facility.

(7)	The facility is leased to a Company subsidiary.

(8)	The Company has a 50% ownership interest in the project.

(9)	The Company owned this project from 1997 until its sale in the fourth quarter of 2004. The Company continues to operate the project under a operations and maintenance agreement.

(B) International Energy Business

The Company conducts its international energy businesses through Covanta Power International Holdings, Inc. (“CPIH”) and its subsidiaries. Internationally, the largest element of the Company’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. The Company 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 provided under short-term arrangements as well. Similarly, the Company seeks to obtain long-term contracts for fuel supply from reliable sources.

The Company presently has interests in international power projects with an aggregate generating capacity of approximately 1,061 MW (gross). The Company’s ownership in these facilities is approximately 461 MW. In addition to its headquarters in Fairfield, New Jersey, the Company’s international business is facilitated through field offices in Shanghai, China; Chennai, India; Manila, the Philippines; and Bangkok, Thailand.

In August 2004, the Company 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.

In September 2004, the Company solicited bids for the possible sale of its ownership and operating interests in its operating power projects in Bangladesh, China and India. Indicative bids were received in October 2004 and following due diligence final bids were received in February 2005. In light of Danielson’s proposed acquisition of American Ref-Fuel Holdings Corp., and the related repayment in full of the CPIH corporate debt obligations, the Company has determined not to proceed with negotiating definitive agreements for the sale of these projects at this time. See additional information below under “Subsequent Events” regarding such refinancing.


	*General Approach to International Projects*

In developing its international businesses, the Company has employed the same general approach to projects as is described above with respect to domestic projects. Given its plan to refocus its business in domestic markets, no new international project development is anticipated at this time.

The ownership and operation of facilities in foreign countries in connection with the Company’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 the Company, 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 the Company’s international businesses.

Many of the countries in which the Company 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 the Company (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, the Company 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.

The Company’s power projects in particular depend on reliable and predictable delivery of fuel meeting the quantity and quality requirements of the project facilities. The Company 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 the Company 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, the Company 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, the Company has also endeavored to provide on-site storage of fuel in sufficient quantities to address such interruptions.

Payment for services that the Company 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 the Company’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. The Company 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.

The Company 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 the Company participates; and joint ventures with other companies to pursue the development, financing and construction of these projects. The Company determines which mitigation measures to apply based on its balancing of the risk presented, the availability of such measures and their cost.

In addition, the Company 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, the Company 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 the Company’s then-available sources of funds. To date, the Company 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, the Company 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. (“A2000”) an Italian special purpose limited liability company of which the Company 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. (“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 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*

The Company operates the Don Pedro and the Río Volcán facilities in Costa Rica through an operating subsidiary pursuant to long-term contracts. The Company 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 the Company is a 26% member, owns a 510 MW (gross) coal-fired electric generating facility in the Philippines (the “Quezon Project”). 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 Manila Electric Company (“Meralco”), the largest electric distribution company in the Philippines, which serves the area surrounding and including metropolitan Manila. Under an energy contract expiring in 2025, Meralco is obligated to take or pay for stated minimum annual quantities of electricity 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. The Company 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 Item 7, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations.” The Company has obtained political risk insurance for its equity investment in this project.

The Company 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 the Company 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 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, the Company discontinued political risk insurance for its equity investment in these projects.


	*Natural Gas*

In 1998, the Company 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 the Company. The Company 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 (the “BPDB”) 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 (“OPIC”). The Company 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, the Company 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 the Company. The Company 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 (“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. Bharat Petroleum Corporation, Ltd. supplies the oil requirements of the project through a fifteen-year fuel supply agreement based on market prices.

In 2000, the Company 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. The Company 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 a 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 technical 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 (approximately 93%) 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 CPIH’s corporate 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.

The Company owns interests in three diesel fuel facilities in the Philippines.

The Bataan Cogeneration project is an inactive moth-balled 58 MW facility that is owned by the Company (the “Bataan Cogeneration Energy Project”). Due to the inability to obtain a profitable power off-take agreement for this project following the June 2004 expiration of its principal off-take agreement, the project company in August 2004 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 previously wrote off its investment in this project in 2002.

The Company owns a minority interest in the Island Power project, a 7 MW facility that has a long-term power contract with the National Power Corporation. The Company does not believe its equity interest in this

project has any value and in 1998 wrote off its investment. This project is not operated by the Company. The Company is exploring means of divesting its interest in this facility to the holders of the majority interest. It is uncertain at this time whether the Company would realize any value from such a sale.

A subsidiary of the Company owns and operates the Magellan cogeneration project, a 63 MW diesel fired electric generating facility in the province of Cavite, the Philippines (the “Magellan Cogeneration Energy Project”). This project sells a portion of its energy and capacity to the National Power Corporation and a portion to the Philippine Economic Zone Authority (the “Authority”) pursuant to long-term energy contracts. On January 3, 2002, the Authority, the main power off-taker for this project, served the project with notice of termination of the energy contract for alleged non-performance by the project. The Company disagrees with this assertion and has sought a court injunction against termination of the energy contract and to require arbitration of the dispute which involves alleged non-reliable operations and alleged improper substitution of National Power Corporation power for Magellan production. On February 6, 2002, The Regional Trial Court, National Capital Judicial Region, Branch 115, Pasay City issued a temporary restraining order barring the Authority from terminating the energy contract. On April 5, 2002 after a series of hearings, such Court replaced such temporary restraining order with a preliminary injunction. Such preliminary injunction restrains the Authority from terminating the energy contract until such time as the merits of the case are resolved. If such case were ultimately to be decided in favor of the Authority, the project would lose not only the energy contract but also that portion of the plant site under lease from the Authority as such lease is tied to the energy contract. Due to high fuel pricing and low tariff conditions, project revenues were insufficient to cover both operating costs and debt service beyond the second quarter of 2004. As a result, on May 31, 2004, the Magellan project company filed a petition for corporate rehabilitation under Philippine law. On June 3, 2004, the Regional Trial Court, Fourth Judicial Region, Branch 21, Imus, Cavite issued a stay order enjoining creditors from pursuing collection of pre-petition debts and ordering suppliers to continue supplying goods and services in exchange for prompt payment. In addition, a Rehabilitation Receiver was appointed. On August 31, 2004, the same Regional Trial Court issued a due course order finding the rehabilitation petition to have sufficient merit 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 the debt tenor. The Company wrote off its investment in this project in 2002.


	*International Project Dispositions 2004*

On August 12, 2004, the Company sold its 50% ownership interest in an approximately 14 MW industrial cogeneration facility located in Murcia, Spain. The Company received a total of approximately $1.8 million for its interest in the facility.


	*International Project Summaries*

Summary information with respect to the Company’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		2005	(est.)

		SUBTOTAL		28

B.	HYDROELECTRIC

3.	Rio Volcán(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	the Philippines		63	Owner/Operator		1999

12.	Samalpatti(6)	India		106	Part Owner/Operator		2001

13.	Madurai(11)	India		106	Part Owner/Operator		2001

	SUBTOTAL			282

TOTAL INTERNATIONAL MW IN OPERATION				1,061

NOTES:


	(1)	The Company’s ownership and/or operation interest in each facility listed below extends at least into calendar year 2007.

	(2)	The Company has a 13% interest in this project and a 40% interest in the operator A2000.

	(3)	Operation by A2000 begins one year after the project begins commercial operation provided certain criteria are satisfied.

	(4)	The Company has a nominal interest in this project.

	(5)	The Company has an approximate 26% ownership interest in this project.

	(6)	The Company has a 60% ownership interest in these projects.

	(7)	The Company has an approximate 64% interest in this project.

	(8)	The Company has an approximate 96% ownership interest in this project.

	(9)	The Company has an approximate 45% interest in this project. This project is capable of operating through combustion of diesel oil in addition to natural gas.


(10)	The Company has an approximate 19.6% ownership interest in this project.

(11)	The Company has an approximate 77% interest in this project.

(C) Description of Covanta Reorganization and Related Dispositions of Assets

The Company’s domestic and international businesses were reorganized when they emerged from bankruptcy on March 10, 2004 and the Company became a wholly-owned subsidiary of Danielson.

The Company’s Chapter 11 proceedings commenced on April 1, 2002 (the “First Petition Date”), when the Company 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 under the caption “In re Ogden New York Services, Inc., et al., Case Nos. 02-40826 (CB), et al.” As debtors-in-possession, the Company and its subsidiaries that were part of the Chapter 11 Cases (the “Debtors”) were authorized to continue to operate as an ongoing business.

In order to obtain post-petition financing, with the approval of the Bankruptcy Court, the Debtors entered into a Debtor-in-Possession Credit Agreement dated as of April 1, 2002 with several financial institutions (as amended, the “DIP Financing Facility”) with the Debtors’ prepetition bank lenders (the “DIP Lenders”). The DIP Financing Facility is described in Note 14 to the Consolidated Financial Statements.

Over the course of the Chapter 11 Cases, the Debtors disposed of all remaining interests in their entertainment and aviation businesses. The Debtors also held discussions with the Official Committee of Unsecured Creditors (the “Creditors Committee”), representatives of the Debtors’ 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 Covanta’s 9.25% Debentures with respect to possible capital and debt structures for the Debtors and the formulation of a plan of reorganization. In connection with such discussion, it was determined to be in the best interests of the Debtors’ estates to dispose of the Company’s geothermal project businesses, which was effected in December, 2003.

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


	•	Danielson to purchase 100% of the shares of reorganized 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

	•	execution and consummation of a Tax Sharing Agreement between Danielson and reorganized Covanta (the “Tax Sharing Agreement”), pursuant to which the Company’s share of Danielson’s consolidated group tax liability for taxable years ending after consummation of the Danielson Transaction will be computed taking into account Danielson’s net operating losses (“NOLs”) generated before January 1, 2003 to the extent not utilized by any other existing member of the consolidated group, and Danielson will have an obligation to indemnify and hold harmless the Company for certain excess tax liability.

The Debtors determined that the Danielson Transaction was in the best interests of their estates and their creditor, and was preferable to other alternatives under consideration because it provided:


	•	a more favorable capital structure for the Debtors 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 reorganized Debtors’ 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 Debtors’ plans of reorganization premised on the Danielson Transaction and liquidation for certain of those Debtors involved in non-core businesses (the “Liquidation Plan” collectively with the plan of reorganization, the “Reorganization Plan”), and on March 10, 2004 the Reorganization Plans were effected upon the consummation of the Danielson Transaction (the plans of reorganization and liquidation collectively, the “Reorganization Plan”). The Debtors owning or operating Covanta’s Warren County, New Jersey, Lake County, Florida and Tampa Bay, Florida projects initially remained debtors-in-possession (the “Remaining Debtors”), and were not the subject of the Reorganization Plan. During 2004, the Company’s subsidiaries involved with the 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.

The Reorganization Plan provided for, among other things, the following distributions:

(i) Secured Bank Lender and 9.25% Debenture Holder Claims

On account of their allowed secured claims, the Secured Bank Lenders and the 9.25% Debenture holders received, in the aggregate, a distribution consisting of:


	•	the cash available for distribution after payment by the Debtors 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 the Company and guaranteed by its subsidiaries (other than CPIH and its subsidiaries) which are not contractually prohibited from incurring or guaranteeing additional debt (the Company 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 three years.

Additionally, the Reorganization Plan incorporates the terms of a settlement of litigation that had commenced during the Chapter 11 Cases by the Creditors Committee challenging the validity of the lien asserted on behalf of the holders of the 9.25% Debentures (the “9.25% Debenture Adversary Proceeding”). Pursuant to the settlement, holders of general unsecured claims against the Company are entitled to receive 12.5% of the value that would otherwise be distributable to the holders of 9.25% Debenture claims that participate in the settlement.

(ii) Unsecured Claims against Operating Company Subsidiaries

The holders of allowed unsecured claims against any of the Company’s operating subsidiaries will receive new unsecured notes in a principal amount equal to the amount of their allowed unsecured claims with a stated maturity of eight years (the “Unsecured Notes”).

(iii) Unsecured Claims against the Company and Holding Company Subsidiaries

The holders of allowed unsecured claims against the Company or certain of its holding company subsidiaries will receive, in the aggregate, a distribution consisting of (i) $4 million in principal amount of Unsecured Notes, (ii) a participation interest equal to five percent of the first $80 million in net proceeds received in connection with the sale or other disposition of CPIH and its subsidiaries used to paydown CPIH debt, if it were to effect asset sales, and (iii) the recoveries, if any, from avoidance actions not waived under the plan that might be brought on behalf of the Company and its subsidiaries. As described above, pursuant to the Reorganization Plan, each holder of an allowed unsecured claim against the Company or certain of its holding company subsidiaries is entitled to receive its pro-rata share of 12.5% of the value that would otherwise be distributable to the holders of 9.25% debenture claims that participate in the settlement of the 9.25% Debenture Adversary Proceeding pursuant to the Reorganization Plan.

(iv) Subordinated Claims of holders of Convertible Subordinated Debentures

The holders of the Company’s 6% Convertible Subordinated Debentures and its 5.75% Subordinated Debentures (together, the “Convertible Subordinated Debentures”) neither received distributions nor

retained any property pursuant to the Reorganization Plan. The Convertible Subordinated Debentures were cancelled as of March 10, 2004.

(v) Equity interests of Old Common and Old Preferred stockholders

The holders of equity interests of the Company’s Old Preferred and Old Common shares outstanding immediately before consummation of the Danielson Transaction received no distribution and retained no property pursuant to the Reorganization Plan. The Old Preferred and Old Common shares were cancelled as of March 10, 2004.

The Liquidation 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 Liquidation 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 Liquidation Plan and priority claims required to be paid under the Bankruptcy Code.

As further set forth in this Part 1, Item 1, “Business” and Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” there are risks that might affect the Company’s ability to implement its business plan and pay the various debt instruments that were issued pursuant to 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. 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.

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. As of December 31, 2004, the accreted amount of the High Yield Notes was 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 a 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, 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 was 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 the Company and its other domestic subsidiaries. For further discussion, see Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

In addition, in the Chapter 11 cases, the Debtors had the right, 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, each Debtor was required to cure all existing defaults (including payment defaults). The Company paid approximately $9 million in cure amounts in connection with assumed executory contracts and unexpired leases.

(D) Description of Other Business

Since the First Petition Date, the Company, with the approval of the Bankruptcy Court, has sold or otherwise disposed of its interests in Argentina, its interests in the arenas located in Anaheim, California and Ottawa, Canada, its interest in the Ottawa Senators Hockey Club, the remaining aviation fueling and fuel facility management business related to three airports operated by the Port Authority of New York and New Jersey and other miscellaneous assets related to the entertainment businesses.

MARKETS, COMPETITION AND BUSINESS CONDITIONS

General Business Conditions

The Company’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 the Company has no control.

The Company expects in the foreseeable future that competition for new contracts and projects will be intense in all domestic markets in which the Company 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, the Company competes in two principal markets, both of which are highly competitive. The first market in which it competes is the market for waste disposal. While the Company currently processes for disposal approximately four percent 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, the Company 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, the Company 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 the Company’s facility. At all but three of its facilities, the Company 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 three of its facilities, in Haverhill, Massachusetts, Union County, New Jersey and Alexandria, Virginia, the Company 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 these projects are in densely populated areas, with high waste generation rates and numerous large and small participants in the regional market.

Once a long-term contract expires and is not renewed or extended by a Client Community, the Company’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 facilities and other waste disposal technologies that are then offering disposal service in the region. See discussion below, under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and results of Operations,” for additional information concerning the expiration of existing contracts.

The second market in which the Company competes related to its waste-to-energy projects is the market for obtaining new contracts to operate waste-to-energy facilities, either through greenfield development or through competing to be selected by project owners soliciting bids for new operators. In this market, there are fewer competitors than in the broader waste disposal market. This market for new waste-to-energy facilities is anticipated to be very limited with few opportunities for the foreseeable future.

Since before its bankruptcy filing in 2002, it has not engaged in material development activity with respect to its independent power business. The Company 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, the Company primarily sells its output pursuant to long-term contract. Accordingly, it generally does not sell its output into markets where it must compete on price. As these contracts expire, the Company will participate in such markets if it is unable to enter into new or renewed long-term contracts. See discussion below, under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and results of Operation,” for additional information concerning the expiration of existing contracts.

Once a contract is awarded or a project is financed and constructed, the Company’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 the Company’s control, such as successful operation in compliance with law and the presence or absence of labor difficulties or disturbances. Other risk factors, described above, are largely out of the Company’s control and may have an adverse impact on a project over a long-term operation.

Technology

The Company has the exclusive right to market in the United States the proprietary mass-burn technology of Martin GmbH für Umwelt und Energietechnik (“Martin”). All of the waste-to-energy projects that the Company has constructed use the Martin technology, although the Company does own and/or operate some projects using other technologies. 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. The Company believes that it is Martin’s know-how and worldwide reputation in the waste-to-energy field, and the Company’s know-how in designing, constructing and operating waste-to-energy facilities, rather than the use of patented technology, that is important to the Company’s competitive position in the waste-to-energy industry in the United States. The Company 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 the Company’s financial condition or competitive position.

The Company believes that mass-burn technology is now the predominant technology used for the combustion of solid waste. The Company 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 the Company’s domestic waste-to-energy business.

Since 1984, the Company’s rights to the Martin technology have been provided pursuant to a cooperation agreement with Martin which gives the Company 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 the Company 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 10 years after such notice. Any termination would not affect the rights of the Company 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.

REGULATION OF COVANTA’S BUSINESSES


	Environmental Regulatory Laws Affecting Covanta’s Businesses


	*Domestic*

The Company’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 regulations thereunder, “Environmental Regulatory Laws”).

Other federal, state and local laws, such as the Comprehensive Environmental Response Compensation and Liability Act (“CERCLA”) (collectively, “Environmental Remediation Laws”) make the Company potentially liable on a joint and several basis for any onsite or offsite environmental contamination which may be associated with the Company’s activities and the activities at sites, including but not limited to landfills that the Company’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 some such 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 is and has been a federally-designated “Superfund” site. Each of these leases provide for indemnification of the Company 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 requires that permits be maintained throughout the operating life of the facility. There can be no assurance that all required permits will be issued or re-issued, and the process of obtaining such permits can often cause lengthy delays, including 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. To date, the Company 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 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. The Company 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 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, 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 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 the Company’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 certain Service Agreements require the Company’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, the Company 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, the Company is not responsible for fines and penalties resulting from the delivery to the Company’s treatment facility of water not meeting standards set forth in those contracts.


	*International*

The Company 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 the Company’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 requirements are generally not as rigorous as those applicable in the United States. 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

The Company’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 the Company’s domestic energy businesses impose limitations on the types of fuel used, prescribe the degree to which these businesses are subject to federal and state utility-type regulation and restrict the extent to which these businesses may be owned by one or more electric utilities. 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 the federal Public Utility Regulatory Policies Act (“PURPA”), the Federal Energy Regulatory Commission (the “FERC”) has promulgated regulations that exempt qualifying facilities (“QFs”) (facilities meeting certain size, fuel and ownership requirements) from compliance with certain provisions of the Federal Power Act (the “FPA”), the Public Utility Holding Company Act of 1935 (“PUHCA”), 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 PUHCA and most aspects of state electric utility regulation are of great importance to the Company 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. PURPA requires that electric utilities purchase electric energy produced by QFs at negotiated rates or at a price equal to the incremental or “avoided” cost that would have been incurred by the utility if it were to generate the power itself or purchase it from another source. PURPA does not expressly require public utilities to enter into long-term contracts to purchase the output supplied by QFs. Many state public utility commissions have approved longer-term energy contracts as part of their implementation of PURPA.

Under PUHCA, any entity owning or controlling 10% or more of the voting securities of a “public utility company” or company which is a “holding company” of a public utility company is subject to registration with the SEC and regulation by the SEC unless exempt from registration. Under PURPA, most projects that satisfy the definition of a “qualifying facility” are exempt from regulation under PUHCA. Under the Energy Policy Act of 1992, projects that are not QFs under PURPA but satisfy the definition of an “exempt wholesale generator” are not deemed to be public utility companies under PUHCA. Finally, projects that satisfy the definition of “foreign utility companies” are exempt from regulation under PUHCA. The Company believes that all of its operating projects involved in the generation, transmission and/or distribution of electricity, both domestically and internationally, qualify for an exemption from PUHCA and that it is not and will not be required to register with the SEC under PUHCA.

Congress continues from time to time to consider energy legislation to repeal both PURPA and PUHCA. Repeal of PUHCA would allow both independent power producers and vertically integrated utilities to acquire electric assets throughout the United States that are geographically widespread, eliminating the current requirement that the utility’s electric assets be capable of physical integration. Also, registered holding companies would be free to acquire non-utility businesses, which they may not do now, with certain limited exceptions. With the repeal of PURPA or PUHCA, competition for independent power generators from utilities would likely increase. This is likely to have little or no impact on the Company’s existing projects, but may mean additional competition from highly capitalized companies seeking to develop projects in the U.S.

The Company 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.

RECENT DEVELOPMENTS

Acquisition of American Ref-Fuel Holdings Corp.

On January 31, 2005, Danielson entered into a stock purchase agreement (the “Purchase Agreement”) with American Ref-Fuel Holdings Corp. (“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 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 existing debt service reserves and other restricted funds held in trust to pay 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 and as required by certain governmental authorities such as the Federal Energy Regulatory Commission and other applicable regulatory authorities. Other closing conditions of the transaction include the following: the Company’s completion of debt financing and an equity Ref-Fuel 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. If a required governmental or regulatory approval has not been received by such date, however, 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.

Financing the Ref-Fuel Acquisition

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 in an offering to be registered with the SEC 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. Danielson will file a registration statement with the SEC with respect to such rights offering and the statements contained herein shall not constitute an offer to sell or the solicitation of an offer to buy shares of Danielson’s common stock. Any such offer or solicitation will be made in compliance with all applicable securities laws.

Three of Danielson’s largest stockholders, SZ Investments L.L.C. (collectively 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 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 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. It is currently expected that 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 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 American 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 American 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 Operations.”

There can be no assurance that Danielson will be able to complete the Ref-Fuel Rights Offering or complete the acquisition of Ref-Fuel.

RISK FACTORS

The following risk factors could have a material adverse effect on the Company’s business, financial condition and results of operations.

Covanta-Specific Risks


	*Covanta emerged from bankruptcy with a large amount of domestic debt, and we cannot assure you that its cash flow from domestic operations will be sufficient to pay this debt.*

As of December 31, 2004, Covanta’s outstanding domestic corporate debt was $236 million. Covanta’s ability to service its domestic debt will depend upon:


	•	its ability to continue to operate and maintain its facilities consistent with historical performance levels;

	•	its ability to maintain compliance with its debt covenants;

	•	its ability to avoid increases in overhead and operating expenses in view of the largely fixed nature of its revenues;

	•	its ability to maintain or enhance revenue from renewals or replacement of existing contracts, which begin to expire in October 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 its existing contracts expire.

	•	the continued availability to Covanta of the benefit of Danielson’s net operating losses under the Tax Sharing Agreement; and

	•	its ability to refinance its domestic corporate debt, whether in conjunction with the Ref-Fuel acquisition or otherwise.

The Company is currently in compliance with all of its domestic debt covenants. For a more detailed discussion of Covanta’s domestic debt covenants please see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”


	*The amount of unsecured claims for which Covanta is liable has not been determined and could exceed our estimates.*

In connection with Covanta’s emergence from bankruptcy, Covanta authorized the issuance of $50 million of unsecured notes under an indenture. Although Covanta estimates that it will issue such notes in an amount less than $30 million, the ultimate amount of unsecured notes will not be determined until remaining claims are resolved through settlement or litigation in Bankruptcy Court. We cannot assure you that the final amount of such notes issued will be less than Covanta’s estimate, or that the ultimate resolution of such claims will result in liabilities of less than $50 million.


	*Covanta may not be able to refinance its domestic debt agreements prior to maturity.*

Covanta issued high yield notes, which mature in 2011. Prior to maturity, Covanta is obligated to pay only interest, and no principal, with respect to these notes. Covanta’s cash flow may be insufficient to pay the principal at maturity, which will be $230 million at such time. Consequently, Covanta may be obligated to refinance these notes prior to maturity. Covanta may refinance the notes during the first two years after issuance without paying a premium, and thereafter may refinance these notes but must pay a premium to do so.

Several of Covanta’s contracts require it to provide certain letters of credit to contract counterparties. The aggregate stated amount of these letters declines materially each year, particularly prior to 2010. Covanta’s financing arrangements under which these letters of credit are issued expire in 2009, and so it must refinance

these arrangements in order to allow Covanta to continue to provide the letters of credit beyond the current expiration date.

We cannot assure you that Covanta will be able to obtain refinancing on acceptable terms, or at all, either in conjunction with the Ref-Fuel acquisition or otherwise.


	*Covanta’s ability to grow its business is limited.*

Covanta’s ability to grow its domestic business by investing in new projects will be limited by debt covenants in its principal financing agreements, unless such financing agreements are refinanced, and from potentially fewer market opportunities for new waste-to-energy facilities. Covanta’s business is based upon building and operating municipal solid waste processing and energy generating projects, which are capital intensive businesses that require financing through direct investment and the incurrence of debt. When we acquired Covanta and it emerged from bankruptcy proceedings in March 2004, Covanta entered into financing arrangements with restrictive covenants typical of financings for companies emerging from bankruptcy. These covenants essentially prohibit investments in new projects or acquisitions of new businesses and place restrictions on Covanta’s ability to expand existing projects. The covenants prohibit borrowings to finance new construction, except in limited circumstances related to specifically identified expansions of existing facilities. The covenants also limit spending for new business development and require that excess cash flow be trapped to collateralize outstanding letters of credit.

Although the Company will be negotiating debt covenants for the refinancing of Covanta’s debt in connection with the Ref-Fuel acquisition, such financing is contingent upon consummation of the Ref-Fuel acquisition. We cannot assure you that, when it seeks to refinance its domestic debt agreements, Covanta will be able to negotiate covenants that will provide it with more flexibility to grow its business.


	*Covanta’s liquidity is limited by the amount of domestic debt issued when it emerged from bankruptcy.*

Covanta believes that its cash flow from domestic operations will be sufficient to pay for its domestic cash needs, including debt service on its domestic corporate debt, and that its revolving credit facility will provide a secondary source of liquidity. For the period March 11 through December 31, 2004, Covanta’s cash flow from operating activities for domestic operations was $85.3 million. We cannot assure you, however, that Covanta’s cash flow from domestic operations will not be adversely affected by adverse economic conditions or circumstances specific to one or more projects or that if such conditions or circumstances do occur, its revolving credit facility will provide Covanta with access to sufficient cash for such purposes.


	*Operation of Covanta’s facilities and the construction of new or expanded facilities involve significant risks.*

The operation of Covanta’s facilities and the construction of new or expanded facilities involve many risks, including:


	•	the inaccuracy of Covanta’s assumptions with respect to the timing and amount of anticipated revenues;

	•	supply interruptions;

	•	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; and

	•	performance below expected levels of output or efficiency.

We cannot predict the impact of these risks on Covanta’s business or operations.


	*Expansion of Covanta’s existing plants or construction of new plants may require Covanta to use additional new technology which may increase construction costs.*

Expansions of existing plants and construction of new plants may require that Covanta incorporate recently developed and technologically complex equipment, especially in the case of newer environmental emission control technology. Inclusion of such new technology may materially increase the cost of construction.


	*Covanta’s insurance and contractual protections may not always cover lost revenues, increased expenses or liquidated damages payments.*

Although Covanta maintains insurance, obtains warranties from vendors, obligates contractors to meet certain performance levels and attempts, where feasible, to pass risks Covanta cannot control to the service recipient or output purchaser, the proceeds of such insurance, warranties, performance guarantees or risk sharing arrangements may not be adequate to cover lost revenues, increased expenses or liquidated damages payments.


	*Performance reductions could materially and adversely affect Covanta.*

Any of the risks described in this Annual Report on Form 10-K or unforeseen problems could cause Covanta’s projects to operate below expected levels, which in turn could result in lost revenues, increased expenses, higher maintenance costs and penalties for defaults under Covanta’s service agreements and operating contracts. As a result, a project may operate at less than expected levels of profit or at a loss.

Most of Covanta’s Service Agreements for 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. Such contractual provisions excuse Covanta 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 Covanta from incurring losses upon the occurrence of uncontrollable circumstances or that if Covanta were to incur such losses it would continue to be able to service its debt.

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 water facilities. With respect to its domestic businesses, Covanta has issued guarantees to its 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. The obligations guaranteed will depend upon the contract involved. Many of Covanta’s 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. In its operating history, Covanta has not incurred liability to pay material amounts under these guarantees, and has incurred no liability to repay project debt. 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. Additionally, damages payable under such guarantees on Company-owned waste-to-energy facilities could expose Covanta to recourse liability on project debt. Covanta may not have sufficient sources of cash to pay such damages or other obligations. Although it has not incurred material liability under energy, water and waste-to-energy guarantees previously and has

incurred no liability to repay project debt, we cannot assure you that Covanta will be able to continue to avoid incurring material payment obligations under such guarantees or that if it did incur such obligations that it would have the cash resources to pay them.

With respect to the international projects, CPIH, Covanta and certain of Covanta’s domestic subsidiaries have issued guarantees of CPIH’s operating obligations. The potential damages that may be owed under these guarantees may be material. Covanta is generally entitled to be reimbursed by CPIH for any payments it may make under guarantees related to international projects.


	Covanta generates its revenue primarily under long-term contracts, and must avoid defaults under its contracts in order to service its debt and avoid material liability to contract counterparties.

Covanta must satisfy its performance and other obligations under its contracts to operate waste-to-energy facilities. These contracts typically require Covanta to meet certain performance criteria relating to amounts of waste processed, energy generation rates per ton of waste processed, residue quantity, and environmental standards. Covanta’s failure to satisfy these criteria may subject it to termination of its Operating Contracts. If such a termination were to occur, Covanta would lose the cash flow related to the project, and incur material termination damage liability. In circumstances where the contract of one or more subsidiaries has been terminated due to Covanta’s default, Covanta may not have sufficient sources of cash to pay such damages.

None of Covanta’s operating contracts for its waste-to-energy facilities previously has been terminated for Covanta’s default. We cannot assure you, however, that Covanta will be able to continue to be able to perform its obligations under such contracts in order to avoid such contract terminations, or damages related to any such contract termination, or that if it could not avoid such terminations that it would have the cash resources to pay amounts that may then become due.


	*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 begin to expire in 2007, 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 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. Covanta will seek to bid competitively in the market for additional contracts to operate other facilities as similar contracts of other vendors expire. The expiration of Covanta’s 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 Covanta’s facilities, market conditions may allow Covanta to effect extensions of existing operating contracts along with facility expansions which would increase the waste processing capacity of these projects. 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 and expansions is materially delayed, this may adversely affect Covanta’s cash flow and profitability.

Covanta’s cash flow and profitability may be adversely affected if it is unable to obtain contracts acceptable to it for such renewals, replacements or additional contracts, or extension and expansion contracts. 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 Covanta.


	*Concentration of suppliers and customers may expose Covanta to heightened financial exposure.*

Covanta often relies on single suppliers and single customers at Covanta’s facilities, exposing such facilities to financial risks if any supplier or customer should fail to perform its obligations.

Covanta often relies 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 or capacity. In most cases, Covanta has 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 Covanta is 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 Covanta’s cash flow or profitability.

In addition, for its waste-to-energy facilities, Covanta relies on its municipal clients as a source not only of waste for fuel but also of revenue from fees for disposal services Covanta provides. Because Covanta’s contracts with its municipal clients are generally long term (none expires prior to 2007), Covanta may be adversely affected if the credit quality of one or more of its municipal clients were to decline materially. We cannot assure you that such credit quality will not decline, or that if one or more of Covanta’s municipal clients’ credit quality does decline, that it would not adversely affect Covanta’s domestic cash flow or profitability.


	Covanta’s international businesses emerged from bankruptcy with a large amount of debt, and we cannot assure you that its cash flow from international operations will be sufficient to pay this debt.

Covanta’s subsidiary holding the equity interests in its international businesses, CPIH, is also highly leveraged, and its debt will be serviced solely from the cash generated from the international operations. Cash distributions from international projects are typically less dependable as to timing and amount than distributions from domestic projects, and we cannot assure you that CPIH will have sufficient cash flow from operations or other sources to pay the principal or interest due on its debt. As of December 31, 2004, Covanta’s outstanding international debt was $180 million, consisting of $77 million of CPIH recourse debt and $103 million of project debt.

CPIH’s ability to service its debt will depend upon:


	•	its ability to continue to operate and maintain its facilities consistent with historical performance levels;

	•	stable foreign political environments that do not resort to expropriation, contract renegotiations or currency or exchange changes;

	•	the financial ability of the electric and steam purchasers to pay the full contractual tariffs on a timely basis;

	•	the ability of its international project subsidiaries to maintain compliance with their respective project debt covenants in order to make equity distributions to CPIH; and

	•	its ability to sell existing projects in an amount sufficient to repay CPIH indebtedness at or prior to its maturity in March 2007, or to refinance its indebtedness at or prior to such maturity.


	*CPIH’s debt is due in March 2007, and it will need to refinance its debt or obtain cash from other sources to repay this debt at maturity.*

Covanta believes that cash from CPIH’s operations, together with liquidity available under CPIH’s revolving credit facility, will provide CPIH with sufficient liquidity to meet its needs for cash, including cash to pay debt service on CPIH’s debt prior to maturity in March 2007. Covanta believes that CPIH will not have sufficient cash from its operations and its revolving credit facility to pay off its debt at maturity, and so if it is unable to generate sufficient additional cash from asset sales or other sources, CPIH will need to refinance its debt at or prior to maturity. While CPIH’s debt is non-recourse to Covanta, it is secured by a pledge of Covanta’s stock in CPIH and CPIH’s equity interests in certain of its subsidiaries. While we have financing commitments to refinance Covanta’s debt, and to repay CPIH’s debt entirely, in connection with the

acquisition of Ref-Fuel, such financing is contingent upon consummation of the Ref-Fuel acquisition. We cannot assure you that such additional cash will be available to CPIH, or that it will be able to refinance its debt on acceptable terms, or at all.


	*CPIH’s assets and cash flow will not be available to Covanta.*

Although CPIH’s results of operations are consolidated with Danielson’s and Covanta’s for financial reporting purposes, as long as the existing CPIH term loan and revolver remain outstanding, CPIH is restricted under its existing credit agreements from distributing cash to Covanta. Under these agreements, CPIH’s cash may only be used for CPIH’s purposes and to service CPIH’s debt. Accordingly, although reported on Danielson’s and Covanta’s consolidated financial statements, Covanta does not have access to CPIH’s revenues or cash flows and will have access only to Covanta’s domestically generated cash flows.


	*A sale or transfer of CPIH or its assets may not be sufficient to repay CPIH indebtedness.*

Although CPIH’s results of operations are consolidated with Danielson’s and Covanta’s for financial reporting purposes, due to CPIH’s indebtedness and the terms of Covanta’s credit agreements, CPIH’s cash flow is available only to repay CPIH’s debt. Similarly, in the event that CPIH determines that it is desirable to sell or transfer all or any portion of its assets or business, the proceeds would first be applied to reduce CPIH’s debt. We cannot assure you that the proceeds of any such sale would be sufficient to repay all of CPIH’s debt, consisting of principal and accrued interest or, if sufficient to repay CPIH’s debt, that such proceeds would offset the loss of CPIH’s revenues and earnings as reported by Danielson and Covanta in their respective consolidated financial statements.

Although 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 of Ref-Fuel, as well as to refinance the existing recourse debt of Covanta and repay all of CPIH’s recourse debt, such financing is contingent upon consummation of the Ref-Fuel acquisition. We cannot assure you that this financing will close. In the absence of a successful closing of the Ref-Fuel acquisition and its related financing, we cannot assure you that CPIH will be able to obtain refinancing on acceptable terms, or at all.


	*Exposure to international economic and political factors may materially and adversely affect Covanta’s business.*

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 over the next five years comes from facilities located in countries having sovereign ratings below investment grade, including Bangladesh, the Philippines and India. In addition, Covanta continues to provide operating guarantees and letters of credit for certain of CPIH’s projects, which if drawn upon would require CPIH to reimburse Covanta for any related payments it may be required to make. 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.

The occurrence of any of these risks could substantially delay the receipt of cash distributions from international projects or reduce the value of the project concerned. In addition, the existence of the operating guarantees and letters of credit provided by Covanta for CPIH projects could expose it to any or all of the risks identified above with respect to the CPIH projects, particularly if CPIH’s cash flow or other sources of liquidity are insufficient to reimburse Covanta for amounts due under such instruments. As a result, these risks may have a material adverse effect on Covanta’s business, consolidated financial condition and results of operations and on CPIH’s ability to service its debt.


	*Exposure to foreign currency fluctuations may affect Covanta’s costs of operations.*

CPIH 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 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 profitability and financial performance.

The market prices and availability of fuel supplies of some of CPIH’s facilities fluctuate. Although CPIH believes that it has adequate and reliable fuel supplies and that its suppliers have adequate production and transportation systems to comply with their contractual requirements to supply CPIH’s facilities, any price increase, delivery disruption or reduction in the availability of such supplies could affect CPIH’s ability to operate CPIH’s facilities and impair its cash flow and profitability. CPIH may be subject to further exposure if any of its future operations are concentrated in facilities using fuel types subject to fluctuating market prices and availability. Covanta may not be successful in its efforts to mitigate its exposure to supply and price swings.


	*Covanta’s inability to obtain resources for operations may adversely affect its ability to effectively compete.*

Covanta’s waste-to-energy facilities depend on solid waste both for fuel and as a source of revenue. For most of Covanta’s facilities, the prices it charges for disposal of solid waste are fixed under long-term contracts and the supply is guaranteed by sponsoring municipalities. However, for some of Covanta’s waste-to-energy facilities, the availability of solid waste to Covanta, as well as the tipping fee that Covanta 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, Covanta may need to obtain waste on a short-term competitive basis as its long-term contracts expire at its owned facilities. There has been and 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 Covanta for disposal at some of Covanta’s waste-to-energy facilities and market pricing.


	*Compliance with environmental laws could adversely affect Covanta’s results of operations.*

Costs of compliance with existing and future environmental regulations by federal, state and local authorities could adversely affect Covanta’s cash flow and profitability. Covanta’s business is subject to extensive environmental regulation by federal, state and local authorities, primarily relating to air, waste (including residual ash from combustion) and water. Covanta is required to comply with numerous environmental laws and regulations and to obtain numerous governmental permits in operating Covanta’s facilities. Covanta may incur significant additional costs to comply with these requirements. Environmental regulations may also limit Covanta’s ability to operate Covanta’s facilities at maximum capacity, or at all. If Covanta fails to comply with these requirements, Covanta 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 Covanta or its facilities, and future changes in environmental laws and regulations could occur. This may materially increase the amount Covanta must invest to bring its facilities into compliance. In addition, lawsuits by the Environmental Protection Agency, commonly referred to as the EPA, and various states highlight the environmental risks faced by generating facilities. Stricter environmental regulation of air emissions, solid waste handling or combustion, residual ash handling and disposal, and waste water discharge could materially affect Covanta’s cash flow and profitability.

Covanta 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 Covanta fails to obtain and comply with them, the operation of Covanta’s facilities could be jeopardized or become subject to additional costs.


	*Federal energy regulation could adversely affect Covanta’s revenues and costs of operations.*

Covanta’s business is subject to extensive energy regulations by federal and state authorities. The economics, including the costs, of operating Covanta’s generating 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 Public Utility Holding Company Act of 1935 and the Federal Power Act regulate public utility holding companies and their subsidiaries and place 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, known as “PURPA,” Covanta’s domestic facilities are qualifying facilities (facilities meeting statutory size, fuel and ownership requirements), which are exempt from regulations under PUHCA, most provisions of the FPA and state rate regulation. Covanta’s foreign projects are exempt from regulation under PUHCA.

If Covanta becomes subject to either the FPA or PUHCA, the economics and operations of Covanta’s energy projects could be adversely affected, including rate regulation by the Federal Energy Regulation Commission, with respect to its output of electricity. If an alternative exemption from PUHCA was not available, Covanta could be subject to regulation by the SEC as a public utility holding company. In addition, depending on the terms of the project’s power purchase agreement, a loss of Covanta’s exemptions could allow the power purchaser to cease taking and paying for electricity or to seek refunds of past amounts paid. 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, Covanta 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 Covanta’s operations.*

Covanta is continually in the process of obtaining or renewing federal, state and local approvals required to operate Covanta’s facilities. While Covanta currently has all necessary operating approvals, Covanta may not always be able to obtain all required regulatory approvals, and Covanta 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 Covanta fails to obtain and comply with any required regulatory approvals, the operation of Covanta’s facilities or the sale of electricity to third parties could be prevented, made subject to additional regulation or subject Covanta to additional costs.


	*The energy industry is becoming increasingly competitive, and Covanta might not successfully respond to these changes.*

Covanta 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 Covanta’s business may come under increasing pressure. Regulatory initiatives in foreign countries where Covanta has 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 Covanta’s business.*

Covanta’s business is highly regulated. Covanta 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 Covanta, 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 Covanta may have a material adverse effect on Covanta’s business, financial condition or results of operations.


	*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 SEC’s rules and forms.

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, (“Section 404”) and the rules and regulations promulgated by the SEC to implement Section 404, we are required to furnish a report to include in our Form 10-K an annual report by our management 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 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 identified errors, principally related to complex manual “fresh start” accounting calculations, predominantly effecting Covanta’s investments in its international businesses. These errors, the net effect of which was immaterial (less than $2 million, pretax), have been corrected in our 2004 consolidated financial statements. 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 Danielson’s internal control over financial reporting was not effective as of December 31, 2004. The Company has identified and undertaken steps necessary in order to address this material weakness, but the effectiveness of our internal control over financial reporting in the future will depend on our effectiveness in fulfilling these steps to address 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 in our stock price.


	*We cannot be certain that Danielson’s net operating loss tax carryforwards will continue to be available to offset our tax liability.*

As described in Danielson’s 2004 Annual Report on Form 10-K, Danielson had approximately $516 million of net operating loss tax carryforwards for Federal income tax purposes, which we refer to as “NOLs.” A portion of the NOLs are made available to us pursuant to the Tax Sharing Agreement. In order to utilize the NOLs, we must generate taxable income which can offset such carryforwards. As described in Danielson’s 2004 Annual Report on Form 10-K, 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 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 order to help us preserve the NOLs, Danielson’s 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 Danielson reports that it expects 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.

The NOLs will expire in various amounts, if not used, between 2005 and 2023. The Internal Revenue Service has not audited any of Danielson’s 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 Danielson would prevail if the IRS were to challenge the availability of the NOLs. If the IRS was successful in challenging our NOLs, all or some portion of the NOLs would not be available to offset our future consolidated income and Danielson may not be able to satisfy its obligations to Covanta under Tax Sharing Agreement described above, or to pay taxes that may be due from our consolidated tax group.

Risks Related to the Ref-Fuel Acquisition


	*We may be unable to integrate the operations of Ref-Fuel and Danielson successfully and may not realize the full anticipated benefits of the acquisition*

Achieving the anticipated benefits of the transaction 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 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 integrate the operations of Ref-Fuel and Danielson successfully could have a material adverse effect on the business and financial condition of Danielson.


	*We will incur significant combination-related costs in connection with the transaction*

If the proposed acquisition with Ref-Fuel closes, we expect that Danielson will be obligated to pay transaction fees and other expenses related to the transaction of approximately $45 million, including financial advisors’ fees, legal and accounting fees, and fees and expenses to refinance the existing Covanta recourse debt. Furthermore, we expect to incur significant costs, which we estimate to be approximately $45 million associated with combining the operations of the two companies. However, we cannot predict the specific size of those charges before we begin the integration process. Although we expect that 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 we expect, or at all.


	*Ref-Fuel’s business model includes greater risk in the waste disposal market than does Covanta’s*

While Covanta and Ref-Fuel both sell energy pursuant to long term contracts, Covanta typically sells a greater proportion of its aggregate waste processing capacity under long-term contracts than does Ref-Fuel. Consequently, more of Ref-Fuel’s revenue from its waste-to-energy facilities is subject to market risk from fluctuations in waste market prices than Covanta’s, and short-term fluctuations in the waste markets may have a greater impact on the combined company’s waste-to energy revenues than on those of Covanta alone.

EMPLOYEES

As of December 31, 2004, the Company employed approximately 1,800 full-time employees worldwide, of which the majority is employed in the United States.

Of the Company’s employees in the United States, approximately 16% are unionized. Currently, the Company is party to seven (7) collective bargaining agreements: one (1) of these agreements is scheduled to expire in 2005, two (2) in 2006, and one (1) in 2008. With respect to the remaining three (3) agreements which have recently expired, the Company is currently in negotiations with the applicable collective bargaining representatives and the Company expects to reach an agreement with such representative to extend such agreement on its current or similar terms.

The Company considers relations with its employees to be good and does not anticipate any significant labor disputes in 2005.

AVAILABILITY OF INFORMATION

The Company files annual reports, quarterly reports, current reports and other information with the Securities and Exchange Commission. Copies of such materials can be read and copied from the Public Reference Room of the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 10549. You may obtain information on the operation of the Public Reference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. You can access our filings electronically by visiting the Securities and Exchange Commission’s website at http://www.sec.gov. Filings are also available on Company’s website at www.covantaenergy.com or free of charge by writing to Lou Walters at 40 Lane Road, Fairfield, N.J. 07004.


Item 2.	*PROPERTIES*

The Company’s 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, the Company closed its office in Fairfax, Virginia and relocated its former Redding, California office to Anderson, California. Additionally, the Company 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 owned or leased by Covanta and its subsidiaries:


		Approximate
		Site Size				Nature of
	Location	(in Acres)(1)			Site Use	Interest(2)

Domestic Energy Services

1.	Fairfield, New Jersey		5.4		Office space	Own

2.	Anderson, California		2,000	sq. ft.	Office space	Lease

3.	City of Industry, California		953	sq. ft.	Office space	Lease

4.	Marion County, Oregon		15.2		Waste-to-energy facility	Own

5.	Alexandria/ Arlington, Virginia		3.3		Waste-to-energy facility	Lease

6.	Bristol, Connecticut		18.2		Waste-to-energy facility	Own

7.	Indianapolis, Indiana		23.5		Waste-to-energy facility	Lease

8.	Stanislaus County, California		16.5		Waste-to-energy facility	Lease

9.	Babylon, New York		9.5		Waste-to-energy facility	Lease

10.	Haverhill, Massachusetts		12.7		Waste-to-energy facility	Lease

11.	Haverhill, Massachusetts		16.8		Landfill Expansion	Lease

12.	Haverhill, Massachusetts		20.2		Landfill	Lease

13.	Lawrence, Massachusetts		11.8		RDF power plant (closed)	Own

14.	Lake County, Florida		15.0		Waste-to-energy facility	Own

15.	Wallingford, Connecticut		10.3		Waste-to-energy facility	Lease

16.	Fairfax County, Virginia		22.9		Waste-to-energy facility	Lease

17.	Union County, New Jersey		20.0		Waste-to-energy facility	Lease

18.	Huntington, New York		13.0		Waste-to-energy facility	Lease

19.	Warren County, New Jersey		19.8		Waste-to-energy facility	Lease

20.	Hennepin County, Minnesota		14.6		Waste-to-energy facility	Lease

21.	Onondaga County, New York		12.0		Waste-to-energy facility	Lease

International Energy Services

22.	Bataan, the Philippines		30,049	sq. m.	Diesel power plant	Lease

23.	Zhejiang Province, People’s Republic of China		33,303	sq. m.	Coal-fired cogeneration facility	Land Use Right reverts to China Joint Venture Partner upon termination of Joint Venture Agreement

24.	Shandong Province, People’s Republic of China		33,303	sq. m.	Coal-fired cogeneration facility	Land Use Right reverts to China Joint Venture Partner upon termination of Joint Venture Agreement


		Approximate
		Site Size				Nature of
	Location	(in Acres)(1)			Site Use	Interest(2)


25.	Jiangsu Province, People’s Republic of China		65,043	sq. m.	Coal-fired co-generation facility	Land Use Right reverts to China Joint Venture Partner upon termination of Joint Venture Agreement

26.	Rockville, Maryland		N/A		Landfill gas project	Lease

27.	San Diego, California		N/A		Landfill gas project	Lease

28.	Oxnard, California		N/A		Landfill gas project	Lease

29.	Salinas, California		N/A		Landfill gas project	Lease

30.	Santa Clara, California		N/A		Landfill gas project	Lease

31.	Stockton, California		N/A		Landfill gas project	Lease

32.	Burney, California		40.0		Wood waste project	Lease

33.	Jamestown, California		26.0		Wood waste project	Own (50%)

34.	Westwood, California		60.0		Wood waste project	Own

35.	Oroville, California		43.0		Wood waste project	Own

36.	Whatcom County, Washington		N/A		Hydroelectric project	Own (50%)

37.	Weeks Falls, Washington		N/A		Hydroelectric project	Lease

38.	Cavite, the Philippines		13,122	sq. m.	Heavy fuel oil project	Lease

39.	Cavite, the Philippines		10,200	sq. m.	Heavy fuel oil project	Lease

40.	Manila, the Philippines		468	sq. m.	Office space	Lease

41.	Bangkok, Thailand		676	sq. m.	Office space	Lease

42.	Chennai, India		1797	sq. ft.	Office space	Lease

43.	Samalpatti, India		2,546	sq. ft.	Office space	Lease

44.	Samayanallur, India		1,300	sq. ft.	Office space	Lease

45.	Samayanallur, India		17.1		Heavy fuel oil project	Lease

46.	Samayanallur, India		2.3		Heavy fuel oil project	Lease

47.	Samalpatti, India		30.3		Heavy fuel oil project	Lease

48.	Shanghai, China		145	sq. m.	Office space	Lease

49.	Imperial County, California		83.0		Undeveloped Desert Land	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 item 9, 22-25 and 26-31. 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.


Item 3.	*LEGAL PROCEEDINGS*

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, record 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.

The Company 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, 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, 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 the Company’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 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. 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 the 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.

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. Subsequent to March 10, 2004 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. 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, the Debtors involved with the Warren County, New Jersey project remain in Chapter 11 and are not consolidated in the Company’s consolidated financial statements. The Company expects that the outcome of the Warren County, New Jersey litigation described below will not adversely affect the Company.

The Company 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 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.

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 Covanta 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 December 31, 2004, Covanta Warren owed the Company $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.


Item 4.	*SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS*

None.

PART II


Item 5.	*MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS*

On March 10, 2004, all then outstanding Old Preferred and Old Common stock of the Company was cancelled and extinguished in accordance with the Reorganization Plan. Holders of Old Preferred and Old Common stock received no distributions or other consideration on account of their securities cancelled and extinguished under the Reorganization Plan.


Item 6.	*SELECTED FINANCIAL DATA*

Covanta Energy Corporation and Subsidiaries


	Successor		Predecessor

	For the Period		For the Period
	March 11,		January 1,
	Through		Through			December 31,
	December 31,		March 10,
	2004(1)		2004(2)			2003(3)			2002(4)			2001(5)			2000(6)

	(In thousands of dollars, except per share amounts)
TOTAL REVENUES FROM CONTINUING OPERATIONS	$	557,202	$	143,232		$	790,468		$	825,781		$	917,646		$	856,434

Income (loss) from continuing operations before cumulative effect of change in accounting principles		31,139		29,563			(26,764	)		(127,698	)		(205,686	)		(103,132	)
Gain (loss) from discontinued operations		—		—			78,814			(43,355	)		(25,341	)		(126,153	)
Cumulative effect of change in accounting principles		—		—			(8,538	)		(7,842	)		—			—

Net income (loss)		31,139		29,563			43,512			(178,895	)		(231,027	)		(229,285	)

BASIC EARNINGS (LOSS) PER SHARE:
Income (loss) from continuing operations before cumulative effect of change in accounting principles			$	0.59		$	(0.54	)	$	(2.56	)	$	(4.14	)	$	(2.08	)
Income (loss) from discontinued operations				—			1.58			(0.88	)		(0.51	)		(2.55	)
Cumulative effect of change in accounting principles				—			(0.17	)		(0.16	)		—			—

Total				0.59			0.87			(3.60	)		(4.65	)		(4.63	)

DILUTED EARNINGS (LOSS) PER SHARE:
Loss from continuing operations before cumulative effect of change in accounting principles			$	0.59		$	(0.54	)	$	(2.56	)	$	(4.14	)	$	(2.08	)
Income (loss) from discontinued operations				—			1.58			(0.88	)		(0.51	)		(2.55	)
Cumulative effect of change in accounting principles				—			(0.17	)		(0.16	)		—			—

Total				0.59			0.87			(3.60	)		(4.65	)		(4.63	)

TOTAL ASSETS	$	1,870,522	$	2,567,570		$	2,613,580		$	2,840,107		$	3,247,152		$	3,298,828

LONG-TERM DEBT (LESS CURRENT PORTION AND LIABILITIES SUBJECT TO COMPROMISE)	$	1,147,820	$	903,703		$	935,335		$	1,151,996		$	1,600,983		$	1,749,164

SHAREHOLDERS’ EQUITY (DEFICIT)	$	79,453	$	(177,915	)	$	(128,034	)	$	(172,313	)	$	6,244		$	231,556

SHAREHOLDERS’ EQUITY (DEFICIT) PER COMMON SHARE		N/A	$	(3.57	)	$	(2.57	)	$	(3.47	)	$	0.11		$	4.65

CASH DIVIDENDS DECLARED PER COMMON SHARE		N/A		—			—			—			—			—


(1)	Successor refers to the Company after March 10, 2004 (“Effective Date”). The financial statements for the period beginning on the day after the Effective Date reflect fresh start accounting and business combination accounting (see Note 1 to the Consolidated Financial Statements).

(2)	The Company emerged from Chapter 11 on March 10, 2004. Predecessor refers to the Company prior to and including March 10, 2004. Income from continuing operations from January 1 through March 10, 2004 includes a pre-tax gain on cancellation of prepetition debt of $399.1 million and pre-tax charges of $510.7 million for fresh start adjustments and $58.3 million for reorganization expenses.

(3)	Net income in 2003 includes net after-tax gain on discontinued operations of $78.8 million or $1.58 per diluted share, $83.3 million or $1.67 per diluted share of reorganization expenses, and $8.5 million or $0.17 per diluted share for the cumulative effect of change in accounting principle related to asset retirement obligations.

(4)	Net loss in 2002 includes net after-tax charges of $84.9 million, or $1.70 per diluted share, reflecting the write-down of and obligations related to assets held for use and $49.1 million, or $1.00 per diluted share, of reorganization costs, both within continuing operations, $43.4 million or $0.88 per diluted share, for discontinued operations and $7.8 million or $0.16 per diluted share for the cumulative effect of change in accounting principle related to the write-off of goodwill.

(5)	Net loss in 2001 includes net after-tax charges of $212.7 million, or $4.28 per diluted share, reflecting the write-down of and obligations related to assets held for sale and loss from discontinued operations of $25.3 million, or $0.51 per diluted share.

(6)	Net loss in 2000 includes net after-tax charges of $56.0 million, or $1.13 per diluted share, reflecting the write-down of assets held for sale and $60.4 million, or $1.22 per diluted share, reflecting costs associated with non-energy businesses, and organizational streamlining costs composed of $45.5 million, or $0.92 per diluted share, for continuing operations and $126.2 million, or $2.55 per diluted share, for loss from discontinued operations.


Item 7.	*MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS*

Cautionary Note Regarding Forward-Looking Statements

Certain statements in the Annual Report on Form 10-K may constitute “forward-looking” statements as defined in Section 27A of the Securities Act of 1933 (the “Securities Act”), Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) or in releases made by the Securities and Exchange Commission, all as may be amended from time to time. Such forward looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of Covanta and its 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”, “scheduled to”, or other similar words, or the negative of these terms or other variations of these terms or comparable language, or by discussion of strategy or intentions. These cautionary statements are being made pursuant to the Securities Act, the Exchange Act and the PSLRA with the intention of obtaining the benefits of the “safe harbor” provisions of such laws. The Company cautions investors that any forward-looking statements made by the Company 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 the Company, include, but are not limited to, the risks and uncertainties affecting their businesses described in Item 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and in other securities filings by the Company.

Although the Company believes that its plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, actual results could differ materially from a projection or assumption in any of its forward-looking statements. The Company’s future financial condition and results of operations, as well as any forward-looking statements, are subject to change and inherent risks and uncertainties. The forward-looking statements contained in this Annual Report on Form 10-K are made only as of the date hereof and the Company does not have or undertake any obligation to update or revise any forward-looking statements whether as a result of new information, subsequent events or otherwise, unless otherwise required by law.

REORGANIZATION

On March 10, 2004 (the “Effective Date”), 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 Company’s plan of reorganization, Covanta became a wholly-owned subsidiary of Danielson. The Company’s 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 pursuant to the Bankruptcy Code. International operations and certain other subsidiaries and joint venture partnerships were not included in the bankruptcy filings.

On December 2, 2003, Covanta and Danielson entered into an Investment and Purchase Agreement (as amended). On March 5, 2004, the Bankruptcy Court entered an order confirming the Company’s plan of reorganization premised on the Danielson Agreement 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 Danielson Agreement and the reorganization plan (the plans of reorganization and liquidation collectively, the “Reorganization Plan”).

The 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” and Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes”. 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 was disclosed separately in the Statements of Consolidated Cash Flows.

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.

As used in this Item 7, the term “Covanta” refers to Covanta Energy Corporation; “Company” refers to Covanta and its consolidated subsidiaries; “Domestic Covanta” refers to Covanta and its subsidiaries, other than CPIH, 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.

References contained herein this Annual Report on Form 10-K to the “Predecessor” refer to the Company prior to and including March 10, 2004 and references to the “Successor” refer to the Company after March 10, 2004.

Developments in Project Restructurings

The Company’s subsidiaries involved with the Tampa Bay water project emerged from Chapter 11 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. While Covanta’s investment in these subsidiaries was recorded using the equity method after March 10, 2004, and prior to August 6, 2004, it includes these entities as consolidated subsidiaries in its financial statements after August 6, 2004.

The Company’s subsidiaries involved with the Lake County, Florida waste-to-energy facility emerged from Chapter 11 on December 14, 2004. The Company’s subsidiaries and Lake County entered into the new agreements, releases, and financing arrangements contemplated by the Lake Plan, and Covanta Lake emerged from bankruptcy on that date. While Covanta’s investment in these subsidiaries was recorded using the equity method after March 10, 2004, and prior to December 14, 2004, it includes these entities as consolidated subsidiaries in its financial statements after December 14, 2004.

The Debtors owning and operating the Company’s Warren County, New Jersey and Lake County, Florida waste-to-energy facilities and the Tampa Bay, Florida water project remained debtors-in-possession (the “Remaining Debtors”) after the Effective Date, and were not the subject of either plan. As a result, the Company recorded its investment in the Remaining Debtors using the equity method as of March 10, 2004,

until CTC and CTB and Covanta Lake emerged from bankruptcy as described above. The Warren County matter is more fully described in Note 31 to the Consolidated Financial Statements.

EXECUTIVE SUMMARY


	*The Company’s Business Segments*

The Company has two business segments: (a) Domestic, the businesses of which are owned and/or operated through Domestic Covanta; and (b) International, the businesses of which are owned and/or operated through CPIH. As described below under “Capital Resources and Commitments” and “Liquidity”, Domestic Covanta and CPIH have separate corporate debt.

In its Domestic segment, the Company designs, constructs, and operates key infrastructure for municipalities and others in waste-to-energy and independent power production. Domestic Covanta’s principal business, from which the Company earns most of its revenue, is the 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. Domestic Covanta generally operates waste-to-energy facilities under long term contracts with municipal clients. Some of these facilities are owned by Domestic Covanta, while others are owned by the municipal client or other third parties. For those facilities owned by it, Domestic Covanta retains the ability to operate such projects after current contracts expire. For those facilities not owned by Domestic Covanta, municipal clients generally have the contractual right, but not the obligation, to extend the contract and continue to retain Domestic Covanta’s service after the initial expiration date. For all waste-to-energy projects, Domestic Covanta receives revenue from two primary sources: fees it charges for processing waste received; and payments for electricity and steam.

In addition to its waste-to-energy projects, Domestic Covanta operates, and in some cases has ownership interests in, other renewable energy projects which generate electricity from wood waste, landfill gas, and hydroelectric resources. The electricity from these projects is sold to utilities. For these projects, Domestic Covanta receives revenue from electricity sales, and in some cases cash from equity distributions.

Domestic Covanta also operates one water project which produces potable water that is distributed by a municipal entity. For this project, Domestic Covanta receives revenue from service fees it charges the municipal entity. Domestic Covanta previously had operated several small waste water treatment projects pursuant to contractual arrangements with municipal entities or other customers. During 2004, Domestic Covanta’s operating contracts for these projects were either terminated or transferred to third parties. The termination of these operations did not have a material effect on the Company. The Company does not expect to grow its water business, and may consider further divestitures.

In its International segment as of December 31, 2004, CPIH has ownership interests in, and/or operates, independent power production facilities in the Philippines, China, Bangladesh, India, and Costa Rica, and one waste-to-energy facility in Italy. During the third quarter of 2004, it sold its interest in one project in Spain. 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, CPIH receives revenue from operating fees, electricity and steam sales, and in some cases cash from equity distributions.

In 2003 and 2002, the Company had an “Other” segment which consisted of the Company’s remaining operations in the aviation and entertainment businesses which have been disposed of or which are being liquidated in bankruptcy by a liquidation trustee. The Company expects that it will have no liability or further obligations with respect to its former activities in this segment.


	*Optimizing Cash*

An important objective of management is to provide reliable service to its clients while generating sufficient cash to meet its recourse debt service and liquidity needs. Maintaining historic facility production

and optimizing cash receipts is necessary to assure that the Company has sufficient cash to fund operations, make appropriate and permitted capital expenditures and meet scheduled debt service payments. Under its current principal financing arrangements the Company does not expect to receive any cash contributions from Danielson, and is prohibited, under its principal financing arrangements, from using its cash to issue dividends to Danielson.

The Company believes that when combined with its other sources of liquidity, Domestic Covanta’s operations should generate sufficient cash to meet operational needs, capital expenditures and debt service due prior to maturity on its corporate debt. Therefore in order to optimize cash flows, management believes it must seek to continue to operate and maintain Domestic Covanta’s facilities consistent with historical performance levels, and to avoid increases in overhead and operating expenses in view of the largely fixed nature of Domestic Covanta’s revenues. Management will also seek to maintain or enhance Domestic Covanta’s cash flow from renewals or replacement of existing contracts (which begin to expire in October 2007), and from new contracts to expand existing facilities or operate additional facilities. Domestic Covanta’s ability to grow cash flows by investing in new projects is limited by debt covenants in its principal financing agreements, and by the scarcity of opportunities for developing and constructing new waste-to-energy facilities.

The Company believes that CPIH’s operations should also generate sufficient cash to meet its operational needs, capital expenditures and debt service prior to maturity on its corporate debt. However, due to risks inherent in foreign operations, CPIH’s receipt of cash distributions can be less regular and predictable than that of Domestic Covanta. Management believes that it must continue to operate and maintain CPIH’s facilities consistent with historical performance levels to enable its subsidiaries to comply with respective debt covenants and make cash distributions to CPIH. It will also seek to refinance its corporate indebtedness, or sell existing projects in an amount sufficient to repay such indebtedness, at or prior to its maturity in March 2007. In those jurisdictions where its subsidiaries’ energy purchasers, fuel suppliers or contractors may experience difficulty in meeting payment or performance obligations on a timely basis, CPIH must seek arrangements which permit the subsidiary to meet all of its obligations. CPIH’s ability to grow by investing in new projects is limited by debt covenants in its principal financing agreements.

Domestic Covanta and CPIH each emerged from bankruptcy with material amounts of corporate debt. As of December 31, 2004, Domestic Covanta had outstanding corporate debt in the principal amount of $235.7 million, comprised of (i) secured notes due in 2011 in the amount of $207.7 million (accreting to $230 million at maturity) and (ii) unsecured notes due 2012 in the amount of $24 million (which are estimated to increase to approximately $28 million through the issuance of additional notes). As of December 31, 2004, Domestic Covanta also had credit facilities for liquidity and the issuance of letters of credit in the amount of $240.3 million, which credit facilities expire in 2009. As of December 31, 2004, CPIH had outstanding corporate debt in the principal amount of $76.9 million and credit facilities for liquidity in the amount of $9.1 million. Additional information on Domestic Covanta’s and CPIH’s debt and credit facilities is provided below in “Capital Resources and Commitments” and in “Liquidity.”

Creditors under Domestic Covanta’s debt and credit facilities do not have recourse to CPIH, and creditors under CPIH’s debt and credit facilities do not have recourse to Domestic Covanta. Cash generated by Domestic Covanta businesses is managed and held separately from cash generated by CPIH businesses. Therefore, under current financing arrangements the assets and cash flow of each of Domestic Covanta and CPIH are not available to the other, either to repay the debt or to satisfy other obligations.

Domestic Covanta’s ability to optimize its cash flow should be enhanced under a Tax Sharing Agreement with Danielson. This agreement provides that Danielson will file a federal tax return for its consolidated group of companies, including the subsidiaries which comprise Domestic Covanta, and that certain of Danielson’s NOLs will be available to offset the federal tax liability of Domestic Covanta. Consequently, Domestic Covanta’s federal income tax obligations will be substantially reduced. Covanta is not obligated to make any payments to Danielson with respect to the use of these NOLs. The NOLs will expire in varying amounts from December 31, 2004 through December 31, 2023 if not used. The IRS has not audited Danielson’s tax returns. See Note 26 to the Company’s consolidated financial statements for additional information regarding Danielson’s NOLs and factors which may affect its availability to offset taxable income of Domestic Covanta.

If the NOLs were not available to offset the federal income tax liability of Domestic Covanta, Domestic Covanta may not have sufficient cash flow available to pay debt service on the Domestic Covanta corporate credit facilities. Because CPIH is not included as a member of Danielson’s consolidated taxpayer group, the Tax Sharing Agreement does not benefit it.


	*Refinancing Corporate Debt*

Management believes that demonstrating Domestic Covanta’s ability to maintain consistent and substantial cash available for corporate debt service and letter of credit fees will enable it to refinance its corporate debt, as well as attract alternative sources of credit. Refinancing Domestic Covanta’s credit facilities may enable it to reduce the costs of its indebtedness and letters of credit, remove or relax restrictive covenants and provide Domestic Covanta with the additional flexibility to exploit appropriate growth opportunities in the future. The Company also believes that operating cash flows will not be sufficient to repay the High Yield Notes at maturity in 2011. Accordingly, the Company will have to derive such funds from refinancing, asset sales, or other sources. Domestic Covanta may refinance, without prepayment premium, the High Yield Notes prior to March 10, 2006. In addition, Domestic Covanta has three letter of credit facilities under which it obtained letters of credit required under agreements with customers and others. These facilities are of shorter duration than the related obligation of Domestic Covanta to provide letters of credit. Domestic Covanta will have to renew or replace these facilities in order to meet such obligations.

CPIH’s corporate debt matures in March 2007. CPIH believes that its operating cash flows alone will not be sufficient to repay this debt at maturity. Accordingly, CPIH will have to derive such funds from refinancing, asset sales, or other sources.

As described below in “Proposed Refinancing”, Danielson has received commitments to refinance both Domestic Covanta’s and to repay CPIH’s corporate debt. If it is able to close such refinancing, the Company expects to achieve both a lower overall cost with respect to its existing corporate debt and less restrictive covenants than under its current financing arrangements.


	*Earnings*

The Company’s emergence from bankruptcy did not affect the operating performance of its facilities or their ability to generate cash. However, as a result of the application of fresh start and purchase accounting adjustments required upon the Company’s emergence from bankruptcy and acquisition by Danielson, the carrying value of the Company’s assets was adjusted to reflect their 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, the Company’s consolidated financial statements have been further adjusted to deconsolidate the Remaining Debtors from the consolidated group until they emerged or were disposed after March 10, 2004 as described above in “Developments in Project Restructurings.”

Although management has endeavored to use its best efforts to make appropriate estimates of value, the estimation process is subject to inherent limitations and is based upon the preliminary work of the Company and its valuation consultants. Moreover, under applicable accounting principles to the extent that relevant information remains to be developed and fully evaluated, such preliminary estimates may be adjusted prior to March 10, 2005. The adjusted values assigned to depreciable and amortizable assets may affect the Company’s GAAP earnings. See Note 34 to the Consolidated Financial Statements for additional information on the impact of fresh start adjustments on the Company’s financial statements.

Domestic 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 December 31, 2004 the principal amount of project debt outstanding with respect to these projects was approximately $670 million. In accordance with GAAP, regardless of the actual amounts paid by the

municipal client with respect to this component, the Company 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 the Company’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.

The Company also owns two waste-to-energy projects for which debt service is not expressly included in the fee it is paid. Rather, the Company receives a fee for each ton of waste processed at these projects. As of December 31, 2004, the principal amount of project debt outstanding with respect to these projects was approximately $172 million. Accordingly, Domestic 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.


	*Covanta Operating Performance and Seasonality*

The Company has historically performed its operating obligations without experiencing material unexpected service interruptions or incurring material increases in costs. In addition, in its contracts at domestic projects Domestic Covanta generally has limited its exposure for risks not within its control. For additional information about such risks and damages that Domestic Covanta may owe for its unexcused operating performance failures see, Risk Factors’ included herein Part I, Item 1. In monitoring and assessing the ongoing operating and financial performance of the Company’s domestic businesses, management focuses on certain key factors: tons of waste processed, electricity and steam sold, and boiler availability.

A material portion of the Company’s domestic service revenues and energy revenues is relatively predictable because it is derived from long-term contracts where Domestic Covanta receives a fixed operating fee which escalates over time and a portion (typically 10%) of energy revenues. Domestic Covanta receives these revenues for performing to base contractual standards, including standards for waste processing and energy generation efficiency. These standards vary among contracts, and at three of its domestic waste-to-energy projects Covanta receives service revenue based entirely on the amount of waste processed instead of a fixed operating fee, and retains 100% of energy revenues generated. In addition, Domestic Covanta has benefited during 2004 from historically favorable pricing in energy and scrap metals markets. Domestic Covanta may receive material additional service and energy revenue if its domestic waste-to-energy projects operate at levels exceeding these contractual standards. Its ability to meet or exceed such standards at its domestic 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 Domestic 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 counter parties ability to fulfill their obligations, including the ability of the Company’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 Domestic 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.

The Company’s quarterly income from domestic operations within the same fiscal year typically differs substantially due to seasonal factors, primarily as a result of the timing of scheduled plant maintenance and the receipt of annual incentive fees, at many waste-to-energy facilities.

Domestic Covanta usually conducts scheduled maintenance twice each year at each of its domestic facilities, which requires that individual boiler units temporarily cease operations. During these scheduled maintenance periods, Domestic 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 in the spring and fall. The spring scheduled maintenance period generally occurs during February, March and April and is typically more comprehensive and costly than the work conducted during the fall maintenance period, which usually occurs between mid-September and mid-November. As a result, Domestic Covanta has typically incurred its highest maintenance expense in the first quarter.

Domestic Covanta earns annual incentive revenues at most of its waste-to-energy projects by processing waste during each contract year in excess of certain contractual levels. As a result, such revenues are recognized if and when the annual performance threshold has been achieved, which can occur only near the end of each respective contract year. Many contract years coincide with the applicable municipal client’s fiscal year, and as a result, the majority of this incentive revenue has historically been recognized in the second quarter and to a lesser extent in the fourth quarter.

Given the seasonal factors discussed above relating to its domestic business, Domestic Covanta has typically experienced its highest operating income from its domestic projects during the second quarter and the lowest operating income during the first quarter.

The Company’s cash provided by domestic operating activities also varies seasonally. Generally cash provided by domestic operating activities follows income with a one to two month timing delay for maintenance expense payables and incentive revenue receivables. In addition, most capital expense projects are conducted during the scheduled maintenance periods. Further, certain substantial operating expenses (including annual insurance payments typically due in the fourth quarter) are accrued consistently each month throughout the year while the corresponding cash payments are made only a few times each year. Generally, the first quarter is negatively impacted to some extent as a result of such seasonal payments. These factors typically have caused Domestic Covanta’s operating cash flow from its domestic projects to be the lowest during the first quarter and the highest during the third quarter.

The Company’s annual and quarterly financial performance can be affected by many factors, several of which are outside the Company’s control as are noted above. These factors can overshadow the seasonal dynamics described herein; particularly, with regard to quarterly cash from operations, which can be materially affected by changes in working capital.


	*CPIH Operating Performance and Seasonality*

Management believes that it must continue to operate and maintain CPIH’s facilities consistent with historical performance levels to enable its subsidiaries to comply with respective debt covenants and make cash distributions to CPIH. In monitoring and assessing the ongoing performance of CPIH’s businesses, management focuses primarily on electricity sold and plant availability at its projects. Several of CPIH’s facilities, unlike Covanta’s domestic facilities, generate electricity for sale only during periods when requested by the contract counterparty to the power purchase agreement. At such facilities, CPIH receives payments to compensate it for providing this capacity, whether or not electricity is actually delivered, if and when required. CPIH’s financial performance is also impacted by:


	•	Changes in project efficiency due to equipment performance or auxiliary load;

	•	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;


	•	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;

	•	The financial condition and creditworthiness of purchasers of power and services provided by CPIH;

	•	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;

	•	Restrictions in repatriating dividends from the host country; and

	•	Political risks associated with international projects.

CPIH’s quarterly income from operations and equity income vary based on seasonal factors, primarily as a result of the scheduling of plant maintenance at Quezon and Chinese facilities and lower electricity sales during the Chinese holidays. The annual major scheduled maintenance for the Quezon facility is typically planned for the first or early second quarter of each fiscal year, which reduces CPIH equity in net income of unconsolidated investments during that period. Boiler maintenance at CPIH’s Chinese facilities typically occurs in either the first or second fiscal quarters, which increases expense and reduces revenue. In addition, electricity sales are lower in the first quarter due to lower demand during the Chinese New Year. As a result of these seasonal factors, income from CPIH will typically be higher during the second half of the year compared to the first half.

Cash distributions from operating subsidiaries and partnerships to CPIH also vary seasonally but are generally unrelated to income seasonality. CPIH receives on a monthly basis modest distributions of operating fees. In addition, CPIH 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 and Haripur facilities, which are material, occur during the second and fourth quarters. As a result, CPIH’s cash available to service the CPIH term loan is typically much greater during the second and fourth quarters than during the first and third quarters.

CPIH’s annual and quarterly financial performance can be affected by many factors several of which are outside CPIH’s control as are noted above. These factors can overshadow the seasonal dynamics described herein.


	*Recent Developments — Agreement to Acquire American Ref-Fuel Holdings Corp.*

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. (“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 funds 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 and as required by certain governmental authorities such as the Federal Energy Regulatory Commission 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 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.

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. Danielson will file a registration statement with the SEC with respect to such rights offering and the statements contained herein shall not constitute an offer to sell or the solicitation of an offer to buy shares of Danielson’s common stock. Any such offer or solicitation will be made in compliance with all applicable securities laws.

Three of Danielson’s largest stockholders, SZ Investments, TAVF and Laminar, representing ownership of approximately 40% of Danielson’s outstanding common stock, have each severally committed to participate in the Ref-Fuel Rights Offering and to 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 outstanding 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 term loan facility, a $100 million revolving credit facility and a $340 million letter of credit facility. 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 million term loan facility.

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 American Ref-Fuel following the acquisition, see Liquidity, and Capital Resources and Commitments, below.

There can be no assurance that Danielson will be able to complete the acquisition of Ref-Fuel.

OPERATING RESULTS

2004 vs. 2003

The discussion below provides comparative information regarding the Company’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 the Company’s emergence from bankruptcy, which are described in Note 34 to the Consolidated 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 Philippines Magellan Cogeneration Project (“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; and

	•	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.

The factors noted above must be taken into account in developing meaningful comparisons between the periods compared below.

The 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.

Consolidated Results

The following table summarizes the historical consolidated results of operations of the Company for the years ended December 31, 2004 and 2003 (in thousands of dollars):


			For the Period			For the Period			Combined Results
			January 1,			March 11,			for the Year			Results for the
			Through			Through			Ended			Year Ended
			March 10, 2004			December 31, 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 and referred to elsewhere in this report. Additional detail on comparable revenues, costs and expenses, and operating income of the Company is provided in the Domestic Segment and International Segment discussions below.

Consolidated revenues for 2004 decreased $90.0 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. 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.

Consolidated 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 the Company’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 the Company’s assets and liabilities to fair value in accordance with the provisions of SOP 90-7. See Note 34 to the Consolidated 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.


	*Domestic Segment*

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
		January 1,		March 11,		for the Year		Results for the
		Through		Through		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

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 the Company’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 the Company’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) 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 Segment*

The following table summarizes the historical results of operations of the International segment for the years ended December 31, 2004 and 2003 (in thousands of dollars):


		For the Period		For the Period		Combined Results
		January 1,		March 11,		for the Year		Results for the
		Through		Through		Ended		Year Ended
		March 10, 2004		December 31, 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 $12.0 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 of contracts at one of the CPIH facilities in the Philippines. These decreases were offset by a $3.0 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 $8.0 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.

2003 vs. 2002

Consolidated Results

The following table summarizes the historical consolidated results of operations of the Company for the years ended December 31, 2003 and 2002 (in thousands of dollars):


		Results for the			Results for the
		Year Ended			Year Ended
		December 31, 2003			December 31, 2002

Service revenues		$	499,245		$	493,960
Electricity and steam sales			277,766			289,281
Construction revenues			13,448			42,277
Other revenues			9			263

	Total revenues		790,468			825,781

Plant operating expenses			500,627			496,443
Construction costs			20,479			42,698
Depreciation and amortization			71,932			77,368
Net interest on project debt			76,770			86,365
Other operating costs and expense			2,209			15,163
Net loss on sale of businesses and equity investments			7,246			1,943
Selling, general, and administrative expenses			35,639			54,329
Project development costs			—			3,844
Other (income) expenses-net			(1,119	)		16,008
Write-down of and obligations related to assets held for use			16,704			84,863

	Total costs and expenses		730,487			879,024

	Operating income (loss)		59,981			(53,243	)
Interest income			2,948			2,472
Interest expense			(39,938	)		(44,059	)
Reorganization items-expense			(83,346	)		(49,106	)

	Loss from continuing operations before income taxes, minority interests and equity in net income from unconsolidated investments		(60,355	)		(143,936	)
Income tax benefit			18,096			986
Minority interests			(8,905	)		(9,104	)
Equity in net income from unconsolidated investments			24,400			24,356
Gain (loss) from discontinued operations			78,814			(43,355	)
Cumulative effect of change in accounting principle			(8,538	)		(7,842	)

	Net income (loss)	$	43,512		$	(178,895	)

to elsewhere in this report. Additional detail on comparable revenues, costs and expenses, and operating income of the Company is provided in the Domestic Segment and International Segment discussions below.

Service revenues for 2003 were $499.2 million, an increase of $5.2 million compared to $494.0 million in 2002. The increase was due to a $14.6 million increase in Domestic energy and water segment service revenue primarily related to annual contractual service fee escalations and increased waste tonnage processed, and a $2.4 million increase in the International segment primarily related to an increase in operator bonuses earned by an operations and maintenance company, partially offset by a $11.8 million decrease in service revenues related to the wind-down and sale of non-energy businesses.

Electricity and steam sales revenues for 2003 were $277.8 million, a decrease of $11.5 million compared to $289.3 million in 2002. The decrease was primarily due to a $14.5 million decrease in electricity sales at the Company’s two plants in India combined with a reduction in electricity sales of $1.5 million at two of the Company’s energy facilities in the Philippines resulting from rate reductions. These decreases were partially offset by a $4.8 million increase in electricity and steam sales in Domestic energy and water, primarily related to higher electric rates received by two plants due to increased market rates.

Construction revenues for 2003 were $13.4 million, a decrease of $28.9 million compared to $42.3 million in 2002 primarily due to a $28.8 million decrease as a result of the Company’s substantial completion of construction of the desalination project in Tampa, Florida.

Plant operating expenses were $500.6 million for 2003, an increase of $4.2 million compared to $496.4 million in 2002 primarily due to a $7.0 million increase in parts and labor related to pay increases and higher costs for routine maintenance and overhaul at several domestic energy facilities. In addition, plant operating expenses were reduced in 2002 by a $4.4 million adjustment to operating accruals in 2002. These changes were partially offset by a $6.4 million reversal of bad debt reserves related to two Indian facilities.

Construction costs for 2003 were $20.5 million, a decrease of $22.2 million compared to $42.7 million in 2002. The decrease was primarily attributable to the Company’s substantial completion of the desalination project in Tampa, Florida. A charge of $9.1 million is included in 2003 consisting of $5.0 million for reserve against retainage receivables and $4.1 million in additional costs associated with termination of the Company’s activities relating to the Tampa Bay desalination project. (See Note 2 to Consolidated Financial Statements for further discussion).

Net interest on Project Debt for 2003 was $76.8 million, a decrease of $9.6 million compared to $86.4 million in 2002. The decrease is primarily the result of a reduction in project debt and the restructuring of Hennepin County, Minnesota.

Depreciation and amortization was $71.9 million for 2003, a decrease of $5.5 million compared to $77.4 million for 2002. The decrease was primarily related to the Hennepin restructuring in 2003, and an asset impairment adjustment at two international facilities in 2002.

Other operating costs and expenses were $2.2 million for 2003, a decrease of $13.0 million compared to $15.2 million in 2002 primarily due to the wind-down of many non-energy businesses.

Net loss on sale of businesses in 2003 of $7.2 million is primarily related to the sale of the equity investee included in the geothermal business offset by additional proceeds received from businesses sold in prior years. The remaining geothermal businesses disposed of in 2003 have been recorded as discontinued operations, in accordance with generally accepted accounting principles. See further discussion below. Net loss on sale of businesses in 2002 of $1.9 million was primarily related to a loss on the sale of an investment in an energy project in Thailand of $6.5 million in 2002, and a $4.6 million gain on the sale of assets in 2002. (See Note 4 to the Consolidated Financial Statements for further discussion.)

Selling, general and administrative expenses were $35.6 million for 2003, a decrease of $18.7 million compared to $54.3 million in 2002 primarily due to a $8.3 million reduction in professional fees, and $7.4 million in reduced costs related to headquarter staff reductions.

Project development costs for 2003 were zero, a decrease of $3.8 million compared to $3.8 million in 2002, due to no new project development in 2003.

Other (income) expenses — net for 2003 were $(1.1) million, a decrease of $17.1 million compared to $16.0 in 2002 primarily due to a reversal of a pre-petition severance accrual of $24 million during 2002.

The write-downs of and obligations related to assets held for use of $16.7 million in 2003 related to an increase in the Ottawa obligations (Note 4 to Consolidated Financial Statements) and in 2002 the $84.9 million consisted of a $6.0 million pre-tax charge related to Ottawa obligations and a $78.9 million pre-tax impairment charge related to two international energy projects. The charges were the result of a 2002 review.

Interest expense for 2003 was $39.9 million, a decrease of $4.1 million from $44 million in 2002 primarily due to contract restructuring at two domestic energy projects. See Note 2 to Consolidated Financial Statements for further discussion.

Reorganization items for 2003 were $83.3 million, an increase of $34.2 million compared to $49.1 million in 2002. In accordance with SOP 90-7, certain income and expenses were classified as reorganization items. The 2003 amount primarily consists of legal and professional fees and charges for the Hennepin restructuring and worker’s compensation insurance. The 2002 amount primarily consists of legal and professional fees, severance, retention and office closure costs, and bank fees. See Note 2 to the Consolidated Financial Statements for further discussion.

The effective tax rate in 2003 was 30.0% compared to 0.7% for 2002. This increase in the effective rate was primarily due to deductions and foreign losses included in the pre-tax book loss in the prior year period for which certain tax benefits were not recognized compared to pre-tax book loss in the current period for which certain tax benefits were recorded.

DISCONTINUED OPERATIONS: For 2003, the gain from discontinued operations totaled $78.8 million, due to the sale of the Geothermal Business, the rejection of a waste-to-energy lease, and the final disposition of the Arrowhead Pond interests. The gain before income taxes and minority interests from discontinued operations was $95.0 million. For 2002, the loss from discontinued operations totaled $43.4 million. The loss before income taxes and minority interests from discontinued operations was $56.7 million, due to the sale of two international energy subsidiaries in 2002 and reclassification of operations of the businesses disposed of in 2003 discussed above. See Note 4 to the Consolidated Financial Statements for further discussion.

Cumulative effect of change in accounting principles was $8.5 million in 2003, an increase of $0.7 million compared to $7.8 million in 2002. The Company adopted Statement of Financial Accounting Standard (“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 adoption of SFAS No. 143 resulted in the cumulative effect of a change in accounting principle of $8.5 million. The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”) in 2002. In connection with its adoption of SFAS No. 142, the Company completed the required impairment evaluation of goodwill, which resulted in a cumulative effect of a change in accounting principle of $7.8 million at January 1, 2002. See Note 3 and 11 to the Notes to the Consolidated Financial Statements for further discussion.

Property, plant and equipment — net: A decrease of $208.5 million for 2003 was due mainly to depreciation expense of $68.0 million for the year, a reduction of $69.7 million for the sale of the Geothermal Business, and a reduction of $84.2 million for the Hennepin restructuring (See Note 2 to the Notes to the Consolidated Financial Statements for further discussion) offset by capital additions of $22.1 million and $3.6 million related to amounts capitalized upon the adoption of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations”.


	*Domestic Segment*

The following table summarizes the historical results of operations of the Domestic segment for the years ended December 31, 2003 and 2002 (in thousands of dollars):


		Results for the		Results for the
		Year Ended		Year Ended
		December 31, 2003		December 31, 2002

Service revenues		$	492,065	$	489,181
Electric and steam sales			113,584		108,748
Construction revenues			13,448		42,277
Other revenues			4		211

	Total revenues	$	619,101	$	640,417

Operating income		$	35,846	$	11,695

Total revenues for 2003 for the Domestic energy and water segment were $619.1 million, a decrease of $21.3 million compared to $640.4 million in 2002. This decline resulted primarily from the reduction in construction revenue of $28.8 million primarily due to the Company’s substantial completion of construction of the desalination project in Tampa, Florida. Service revenues increased by $2.9 million as a result of annual contractual service fee escalations, and increased tonnage processed, offset by a decrease of $11.7 million due to the wind-down and sale of non-energy businesses. In addition, there was a $4.8 million increase in electricity and steam sales, primarily related to higher electric rates received by two plants from local electricity purchasers at which the output was sold at market rates.

Income from operations for 2003 for the Domestic energy and water segment was $35.8 million, an increase of $24.2 million compared to $11.7 million for 2002 primarily due to a decrease in total costs and expenses of $45.5 million offset by the $21.3 million decrease in revenue discussed above. The decrease in total costs and expenses consisted of the $22.2 million decrease in construction expenses resulting primarily from the Company’s substantial completion of construction of the desalination project in Tampa, Florida, a reduction in other operating costs of $12.9 million and a reduction of selling, general and administrative expenses of $20.2 million due to the wind-down and sale on non-energy businesses and the $11.8 million increase in loss on sale of businesses, which included the loss on the sale of the equity investee included in the geothermal business. These decreases were partially offset by a $7.0 million increase in parts and labor related to pay increases and higher costs for routine maintenance and overhaul at several domestic energy facilities. Furthermore, there was an additional provision of $10.7 million in 2003 related to the Ottawa commitments. In addition, plant operating expenses were reduced in 2002 by a $4.4 million adjustment to operating accruals. Construction expense in 2003 included a charge of $9.1 million consisting of $5.0 million for reserve against retainage receivables and $4.1 million in additional costs associated with completion of the desalination project.


	*International Segment*

The following table summarizes the historical results of operations of the International segment for the years ended December 31, 2003 and 2002 (in thousands of dollars):


		Results for the		Results for the
		Year Ended		Year Ended
		December 31, 2003		December 31, 2002

Service revenues		$	7,180	$	4,779
Electric and steam sales			164,182		180,533
Other revenues			5		52

	Total revenues	$	171,367	$	185,364

Operating income (loss)		$	24,135	$	(64,938	)

Total revenues for 2003 for the International energy segment were $171.4 million, a decrease of $14.0 million compared to $185.4 million in 2002, primarily due to a $14.5 million decrease in electricity sales at the Company’s two plants in India resulting from reduced demand from the contractual purchaser, combined with a reduction in electricity sales of $1.5 million at two of the Company’s energy facilities in the Philippines as a result of government imposed rate reductions.

Income from operations for 2003 for the International energy segment was $24.1 million, an increase of $89.1 million compared to a loss of $64.9 million in 2002 primarily due to a $78.9 million pre-tax impairment charge in 2002 related to two Philippine energy projects. The decrease in revenue of $14.0 million discussed above was offset by a $12.1 million decrease in plant operating costs. The increase in income from operations in 2003 was also due to a loss on the sale of an equity investment in an energy project in Thailand of $6.5 million in 2002.

CAPITAL RESOURCES AND COMMITMENTS

The following chart summarizes the various components and amounts of Domestic Covanta and CPIH project and recourse debt as of December 31, 2004. Danielson has no obligations with respect to any of the project or recourse debt of the Company, CPIH, or their respective subsidiaries.

COVANTA CAPITAL STRUCTURE

(Dollars in millions)

The following table summarizes the Company’s gross contractual obligations including: project debt, corporate debt, leases and other contractual obligations as of December 31, 2004. (Amounts expressed in thousands of dollars. Note references are to the Notes to the Consolidated Financial Statements):


					Payments Due by Period

					Less than									After
		Total			One Year			1 to 3 Years			4 to 5 Years			5 Years

Domestic Covanta project debt (Note 17)(1)		$	842,154		$	84,718		$	269,019		$	144,213		$	344,204
CPIH project debt (Note 17)			102,583			24,983			43,839			28,543			5,218

Total project debt (Note 17)			944,737			109,701			312,858			172,756			349,422
Domestic Covanta high yield notes (Note 16)			207,736			—			—			—			207,736
Domestic Covanta unsecured notes (Note 16)			28,000			—			11,700			7,800			8,500
CPIH term loan (Note 16)			76,852			—			76,852			—			—
Other recourse debt (Note 16)			308			112			196			—			—

Total debt obligations of Covanta			1,257,633			109,813			401,606			180,556			565,658
Less:
	Non-recourse project debt		(944,737	)		(109,701	)		(312,858	)		(172,756	)		(349,422	)
	Non-recourse CPIH term debt (Note 16)		(76,852	)		—			(76,852	)		—			—

Covanta recourse debt		$	236,044		$	112		$	11,896		$	7,800		$	216,236
Covanta operating leases (Note 27)		$	312,961		$	18,950		$	57,850		$	24,716		$	211,445
Less: Non-recourse rental payments (Note 27)			(279,696	)		(15,392	)		(50,582	)		(23,062	)		(190,660	)

Covanta recourse leases		$	33,265		$	3,558		$	7,268		$	1,654		$	20,785
Interest payments		$	428,651		$	71,113		$	167,522		$	81,995		$	108,021
Less: Non-recourse interest payments			(277,006	)		(50,013	)		(104,280	)		(39,846	)		(82,867	)

Covanta recourse interest(3)		$	151,645		$	21,100		$	63,242		$	42,149		$	25,154
Pension plans obligations (Note 24)(4)		$	3,100		$	3,100			—			—			—
Post-retirement plans obligations (Note 24)		$	18,059		$	1,744		$	5,283		$	3,670		$	7,362

Total Covanta contractual obligations		$	442,113		$	29,614		$	87,689		$	55,273		$	269,537

Notes to table:


(1)	Includes $38 million of Domestic Covanta’s unamortized project debt premiums.

(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)	Includes letter of credit fees through the year Covanta anticipates they will no longer be required.

(4)	Covanta expects to make minimum contributions of $3.1 million to its defined benefit plans in 2005. Pension contribution information for other years presented in the table is not available.

Domestic Project Debt. Financing for Domestic 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 Domestic 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 the Company’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 Domestic Covanta subsidiaries is

described in the table above as non-recourse project debt. The only potential recourse to Covanta with respect to project debt arises under the operating performance guarantees described below.

With respect to such facilities, debt service is in most instances 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 the Company’s consolidated balance sheet. These funds are not generally available to the Company.

International Project Debt. Financing for projects in which CPIH 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 Domestic Covanta. Project debt relating to two CPIH projects in India is included as “Project debt (short- and long-term)” in the Company’s 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.

Corporate Debt. Domestic Covanta’s and CPIH’s corporate debt obligations arise from its Chapter 11 proceeding and are outlined on the following table:

Domestic Covanta Debt


Designation	Principal Amount	Interest	Principal Payments	Security

High Yield Notes	$207.7 million (as of December 31, 2004) accreting to an aggregate principal amount of $230 million	Payable semi-annually in arrears at 8.25% per annum on $230 million	Due on maturity in March 2011	Third priority lien in substantially all of the assets of the domestic borrowers (including Covanta) not subject to prior liens. Guaranteed by Covanta’s domestic subsidiaries which are borrowers.


Designation	Principal Amount	Interest	Principal Payments	Security

Unsecured Notes	$28 million (est.), based on determination of allowed pre-petition unsecured obligations	Payable semi-annually in arrears at 7.5% per annum	Annual amortization payments of $3.9 million beginning March 2006 with the remaining balance due at maturity in March 2012	Unsecured and subordinated in right of payment to all senior indebtedness of Covanta including, the First Lien Facility and the Second Lien Facility, the High Yield Notes; will otherwise rank equal with, or be senior to, all other indebtedness of Covanta.

CPIH Debt


Designation	Principal Amount	Interest	Principal Payments	Security

Term Loan Facility	$76.9 million (as of December 31, 2004)	Payable monthly in arrears 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 as increase to the principal amount of the loan	Due on maturity in March 2007	Second priority lien on substantially all of the CPIH borrowers’ assets not otherwise pledged.

The First Lien Facility, the Second Lien Facility, the High Yield Notes and Unsecured Notes provide that Domestic Borrowers must comply with certain affirmative and negative covenants. In addition, the CPIH Term Loan Facility and the CPIH Revolving Credit Facility provide that CPIH Borrowers must comply with certain affirmative and negative covenants. Below are descriptions of such covenants as well as other material terms and conditions of such agreements.

Material Terms of High Yield Notes: Interest is due semi-annually in arrears on the principal amount of the outstanding High Yield Notes at a rate of 8.25% per annum. The High Yield Notes are secured by a third priority lien on Covanta’s domestic assets. In addition, all or part of the High Yield Notes are pre-payable by Covanta at par of 100% of the accreted value prior to March 15, 2006 and thereafter at a premium starting at 104.625% of par and decreasing during the remainder of the term of the High Yield Notes. There are no mandatory sinking fund provisions. Upon the occurrence of a change of control event and certain sales of assets, Covanta is obligated to offer to repurchase all or any part of the High Yield Notes at 101% of par on the accreted value.

Covanta must comply with certain covenants, including among others:


	•	restrictions on the payment of dividends, the repurchase of stock, the incurrence of indebtedness and liens and the repayment of subordinated debt, unless certain specified financial and other conditions are met;

	•	restrictions on the sale of certain material amounts of assets or securities, unless specified conditions are met;

	•	restrictions on material transactions with affiliates;

	•	limitations on engaging in new lines of business; and

	•	preserving its corporate existence and its material rights and franchises.

The High Yield Notes shall become immediately due and payable in the event that Covanta or certain of its affiliates become subject to specified events of bankruptcy or insolvency, and shall become immediately due and payable upon action taken by the trustee under the indenture or holders of a certain specified percentage of principal under outstanding High Yield Notes, in the event that any of the following occurs after expiration of applicable cure periods:


	•	a failure by Covanta to pay amounts due under the High Yield Notes or certain other debt instruments;

	•	a judgment or judgments are rendered against Covanta that involve an amount in excess of $10 million, to the extent not covered by insurance; and


	•	a failure by Covanta to comply with its obligations under the indenture relating to the High Yield Notes.

Material Terms of Unsecured Notes: Covanta has authorized the issuance of up to $50 million in principal amount of Unsecured Notes as distributions to certain creditors in its bankruptcy proceeding, of which it expects to issue approximately $28 million. Interest will be payable semi-annually at a rate of 7.5%. Annual amortization payments of approximately $3.9 million will be paid beginning in 2006, with the balance due on maturity in March 2012. There are no mandatory sinking fund provisions and Covanta may redeem the Unsecured Notes at any time without penalty or premium. Upon the occurrence of a change of control event and certain sales of assets, Covanta is obligated to offer to repurchase all or any part of the Unsecured Notes at 101% of par value.

Covanta must comply with certain covenants, including among others:


	•	restrictions on the payment of dividends, the repurchase of stock, the incurrence of indebtedness and liens and the repayment of subordinated debt, unless certain specified financial and other conditions are met;

	•	restrictions on the sale of certain material amounts of assets or securities, unless specified conditions are met;

	•	restrictions on material transactions with affiliates; and

	•	preserving its corporate existence and its material rights and franchises.

The Unsecured Notes shall become immediately due and payable in the event that Covanta or certain of its affiliates become subject to specified events of bankruptcy or insolvency, and shall become immediately due and payable, upon action taken by the trustee under the indenture of holders of a certain specified percentage of principal under outstanding Unsecured Notes, in the event that any of the following occurs after expiration of applicable cure periods:


	•	a failure by Covanta to pay amounts due under the High Yield Notes or certain other debt instruments; and

	•	a failure by Covanta to comply with its obligations under the indenture pertaining to the Unsecured Notes.

Material Terms of CPIH Term Loan Facility: CPIH’s term loan facility is secured by a second priority lien on the same collateral, junior only to the lien with respect to the CPIH revolver described in Liquidity below. The principal amount of the CPIH term debt, as of December 31, 2004, was $76.9 million. The CPIH term debt matures in March 2007 and bears interest at the rate per annum of 10.5% (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 such interest shall be paid in kind by adding it to the outstanding principal balance).

The mandatory prepayment provisions, affirmative covenants, negative covenants and events of default under the CPIH Term Loan Facility are similar to those found in the First Lien Facility and the Second Lien Facility described below.


	*Other Commitments.*

The Company’s other commitments as of December 31, 2004 were as follows (in thousands of dollars):


	Commitments Expiring by Period

			Less Than		More Than
	Total		One Year		One Year

Letters of credit	$	192,946	$	21,463	$	171,483
Surety bonds		19,444		—		19,444

Total other commitments — net	$	212,390	$	21,463	$	190,927

The letters of credit were issued pursuant to the facilities described below under “Liquidity” to secure the Company’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.

Two of these letters of credit relate to a waste-to-energy project and are provided under the First Lien Facility. This facility currently provides for letters of credit in the amount of approximately $120 million and generally reduces semi-annually as the related contractual requirement reduces until 2009, when the letters of credit are no longer contractually required to be maintained. The other letters of credit are provided under the Second Lien Facility and one unsecured letter of credit facility, in support of Domestic Covanta’s businesses and to continue existing letters of credit required by CPIH’s businesses. Some of these letters of credit reduce over time as well, and one of such reducing letters of credit may be cancelled if Covanta receives an investment grade rating from both Moody’s Investors Service and Standard & Poor’s. As of December 31, 2004, Domestic Covanta had approximately $47 million in available capacity for additional letters of credit under the Second Lien Facility.

The following table describes the reduction in letter of credit requirements, through 2010, for all existing letters of credit; the table does not include amounts with respect to new letters of credit that may be issued. All amounts are stated as of December 31 of year noted.


	2005		2006		2007		2008		2009

Total First Lien LCs	$	108,967	$	89,775	$	90,918	$	44,466	$	—
Total Second Lien LCs		60,487		60,487		55,487		50,487		50,487
Total Other LCs		2,029		1,728		1,500		1,500		1,500

Total Combined LCs	$	171,483	$	151,990	$	147,905	$	96,453	$	51,987

The Company believes that it will be able to fully perform its contracts to which these 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 the Company’s letters of credit were to be drawn under its current debt facilities, the amount drawn would be immediately repayable to the issuing bank.

The surety bonds listed on the table above relate to performance under its former waste water treatment operating contracts ($8.5 million) and possible closure costs for various energy projects when such projects cease operating ($10.9 million). Were these bonds to be drawn upon, the Company would ordinarily have a contractual obligation to indemnify the surety company. However, since these indemnity obligations arose prior to the Company’s bankruptcy filing, the surety companies’ indemnity claims would entitle them to share only in a limited distribution along with other unsecured creditors under the Reorganization Plan. Because such claims share in a fixed distribution under the Reorganization Plan, the Company expects that any such distribution will not affect the obligations of Domestic Covanta or CPIH. The sureties may have additional rights to make claims against retainage or other funds owed to the Company with respect to projects for which surety bonds were issued. The Company expects that enforcement of such rights will not have any material impact upon results of operations and financial condition of Domestic Covanta or CPIH.

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 Company-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. 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 the Company’s then-available sources of funds. To date, the Company has not incurred material liabilities under its guarantees, either on domestic or international projects.

LIQUIDITY

An important objective of management is to provide reliable service to its clients while generating sufficient cash to meet its liquidity needs. Maintaining historic facility production and optimizing cash receipts is necessary to assure that the Company has sufficient cash to fund operations, make appropriate and permitted capital expenditures and meet scheduled debt service payments. Under its current principal financing arrangements the Company does not expect to receive any cash contributions from Danielson, and is prohibited, under its principal financing arrangements, from using its cash to issue dividends to Danielson.

At December 31, 2004, Domestic Covanta had $63.1 million in unrestricted cash. Restricted funds held in trust largely reflects payments from municipal clients under Service Agreements as the 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. The Company does not have access to these funds. In addition, as of December 31, 2004 Domestic Covanta had $32.8 million in cash held in restricted accounts to pay for additional emergence expenses that are estimated to be paid after emergence. Cash held in such reserve accounts is not available for general corporate purposes.

During the year, CPIH made payments of $19.6 million to reduce outstanding principal on its term loan, a portion of which was funded by the sale of its interest in an energy facility in Spain. At December 31, 2004, CPIH had $3.8 million in its domestic accounts. CPIH also had $11.1 million related to cash held in foreign bank accounts that could be difficult to transfer to the U.S. due to the: (i) requirements of the relevant project financing documents; (ii) applicable laws affecting the foreign project; (iii) contractual obligations; and (iv) prevention of material adverse tax liabilities to the Company and subsidiaries. While CPIH’s existing term loan and revolver remain outstanding, CPIH’s cash balance is not available to be transferred to Domestic Covanta.

CPIH’s receipt of cash distributions can be less consistent and predictable than that of Domestic Covanta because of restrictions associated with project financing arrangements at the project level and other risks inherent with foreign operations. As a result of these factors, CPIH may have sufficient cash during some months to pay principal on its corporate debt, but have insufficient cash to pay principal during other months. To the extent that CPIH has insufficient cash in a given month to pay the full amount of interest then due on its term loan facility at the rate of 10.5%, it is permitted to pay up to 4.5% of such interest in kind, which amount is added to the principal amount outstanding.

Domestic Covanta and CPIH have entered into the following credit facilities which provide liquidity and letters of credit relating to their respective businesses. As of December 31, 2004, neither Domestic Covanta nor CPIH had made any borrowings under their respective revolving liquidity facilities.


Designation	Purpose	Term	Security

Domestic Covanta Facilities
First Lien Facility	To provide for letter of credit required for a Covanta waste-to- energy facility	Expires March 2009	First priority lien in substantially all of the assets of the domestic borrowers (including Covanta) not subject to prior liens. Guaranteed by Covanta’s subsidiaries which are domestic borrowers. Also, 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.
Second Lien Facility	To provide for certain existing and new letters of credit and up to $10 million in revolving credit for general corporate purposes	Expires March 2009	Second priority lien in substantially all of the assets of the domestic borrowers not subject to prior liens. Guaranteed by domestic borrowers. Also, 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.
CPIH Facility
Revolving Loan Facility	Up to $9.1 million	Expires March 2007	First priority lien on the stock of CPIH and substantially all of the CPIH borrowers’ assets not otherwise pledged.

See Note 15 to Notes to the Consolidated Financial Statements.

All obligations under the Company’s financing arrangements which existed prior to and during its bankruptcy proceeding were discharged on March 10, 2004, the effective date of the Reorganization Plan. On the same date and pursuant to the Reorganization Plan, the Company entered into new credit facilities, as described below.

The Domestic Borrowers entered into two credit facilities to provide letters of credit and liquidity in support of the Company’s domestic operations and to maintain existing letters of credit in support of its international operations. The Domestic Borrowers entered into the First Lien Facility, secured by a first priority lien on substantially all of the assets of the Domestic Borrowers not subject to prior liens (the “Collateral”). The First Lien Facility provides commitments for the issuance of letters of credit with respect to one waste-to-energy facility. The First Lien Facility reduces semi-annually as the contractually-required letter of credit for this facility reduces. As of December 31, 2004, this requirement was approximately $119.7 million. 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 in the 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. Among other things, the Second Lien Facility will provide the Company with the ability to obtain new letters of credit as may be required with respect to various domestic waste-to-energy facilities, as well as to maintain existing letters of credit with respect to international projects. Both the First Lien Facility and the Second Lien expire in March 2009.

The Domestic Borrowers also entered into the Domestic Intercreditor Agreement with the respective lenders under the First Lien Facility and Second Lien Facility and the trustee under the indenture for the High Yield Notes. It provides for certain provisions regarding the application of payments made by the Domestic Borrowers among the respective creditors and certain matters relating to priorities upon the exercise of remedies with respect to the Collateral.

Under these facilities, as described below, 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 it refinances is current corporate debt.

Material Terms of First and Second Lien Facilities: Both the First Lien Facility and the Second Lien Facility 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 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 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 a 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;

	•	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 NOLs.

Material Terms of CPIH Revolving Loan Facility: CPIH Borrowers entered a revolving credit facility, which is secured by a pledge of the stock of CPIH and a first priority lien on substantially all of the CPIH Borrowers’ assets not otherwise pledged. The revolver provided an initial commitment for cash borrowings of up to $10 million for purposes of supporting the international independent power business. The amount of the commitment reduces per formula in the event of asset sales, receipt of insurance or condemnation proceeds, issuance of new CPIH indebtedness, receipt of tax refunds and/or cash on hand in excess of stated liquidity requirements. Since securing the facility 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 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.

The CPIH Borrowers also entered into the International Intercreditor Agreement, with the respective lenders under the revolver and the term debt, and Reorganized Covanta, that sets forth, among other things, certain provisions regarding the application of payments made by the CPIH Borrowers among the respective lenders and Reorganized Covanta and certain matters relating to the exercise of remedies with respect to the collateral pledged under the loan documents.

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. The International Intercreditor Agreement provides that the Domestic Borrowers will be 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.

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 First Lien Facility and the Second Lien Facility.

The Company believes cash available to CPIH and its subsidiaries, together with borrowing under the CPIH revolver will provide CPIH with sufficient liquidity to meet its operational needs and pay required debt service due prior to maturity. The Company believes that CPIH will need to refinance its indebtedness at or prior to maturity in March 2007 unless asset sales affected prior to such time are sufficient to repay all CPIH indebtedness. Although Danielson has received a commitment to refinance the CPIH recourse debt, there can be no assurance that CPIH will be able to refinance such indebtedness at maturity or that such assets sales will be sufficient to repay CPIH indebtedness prior to its maturity.

Non-GAAP Financial Measures

The following summarizes unaudited non-GAAP financial information for the Company. Certain items are included that are not measured under U.S. generally accepted accounting principles (“GAAP”) and are not intended to supplant the information provided in accordance with GAAP. Furthermore, these measures may not be comparable to those used by other companies. The following information should be read in conjunction with the financial statements and footnotes included herein.

Domestic Covanta and CPIH must each generate substantial cash flow from operations, upon which they depend as an important source of liquidity to pay project operating and capital expenditures, project debt, taxes, corporate operating expenses, and corporate debt and letter of credit fees. Management believes that a useful measure of the sufficiency of Domestic Covanta’s and CPIH’s respective cash generated from operations is that amount available to pay corporate debt service and letter of credit fees after all other obligations are paid.

The following table provides additional information with respect to cash available to pay Domestic Covanta’s and CPIH’s corporate debt and letter of credit fees, for the period March 11, through December 31, 2004 in thousands of dollars.


		Domestic			CPIH			Consolidated

Operating Income		$	62,232		$	14,776		$	77,008
Depreciation and amortization			48,805			7,016			55,821
Change in unbilled service receivables			11,221			—			11,221
Project debt principal repaid			(42,535	)		(25,408	)		(67,943	)
Borrowings for facilities			—			14,488			14,488
Change in restricted funds held in trust			(7,871	)		(5,968	)		(13,839	)
Change in restricted funds for emergence costs			65,681			—			65,681
Change in accrued emergence costs			(65,681	)		—			(65,681	)
Change in other liabilities			(2,545	)		(459	)		(3,004	)
Distributions to minority partners			(5,272	)		(2,989	)		(8,261	)
Distributions from investees and joint ventures			—			14,705			14,705
Dividends from equity investees			—			3,106			3,106
Amortization of premium and discount			(10,457	)		—			(10,457	)
Proceeds from sale of businesses			—			1,799			1,799
Investments in facilities			(10,083	)		(1,794	)		(11,877	)
Change in other assets			(3,947	)		12,636			8,689

Cash generated for recourse debt and letter of credit fees, pre-tax			39,548			31,908			71,456
Corporate income taxes paid:
	Foreign		—			(2,779	)		(2,779	)
	State		(2,926	)		—			(2,926	)
	Federal		(1,000	)		(1,100	)		(2,100	)

Cash generated for recourse debt and letter of credit fees, after taxes			35,622			28,029			63,651
	Cash balance, beginning of period		45,307			12,488			57,795

Cash available for corporate debt and letter of credit fees			80,929			40,517			121,446
	Recourse debt service and letter of credit fees paid-net		(17,759	)		(5,902	)		(23,661	)
	Payment of principal recourse debt		(47	)		(19,626	)		(19,673	)

	Cash balance, end of period	$	63,123		$	14,989		$	78,112

Reconciliation of cash generated for corporate debt and letter of credit fees after taxes to cash provided by operating activities for the period March 11, 2004 through December 31, 2004 (in thousands of dollars):


Cash generated for recourse debt and letter of credit fees	$	63,651
Investment in facilities		11,877
Borrowing for facilities		(14,488	)
Distributions from investees and joint ventures		(14,705	)
Distribution to minority partners		8,261
Change in restricted funds held in trust		13,839
Payment of project debt		67,943
Recourse debt service and letter of credit fees paid — net		(23,661	)
Other cash provided in investing activities		1,114

Cash provided by operating activities for the period March 11, 2004 to December, 2004	$	113,831

PROPOSED REFINANCING OF DEBT, LIQUIDITY AND LETTER OF CREDIT FACILITIES

In connection with the proposed acquisition of Ref-Fuel, Danielson has received commitments to finance the acquisition and to refinance all of Domestic Covanta’s and CPIH’s recourse debt. The financing is not expected to alter the project debt of Covanta’s subsidiaries, or the existing corporate and project debt of Ref-Fuel’s subsidiaries other than a revolving loan facility being replaced. The following chart indicates the anticipated combined debt capital structure of Covanta and its subsidiaries following the proposed acquisition. Amounts shown below are as of December 31, 2004 unless otherwise indicated (in millions).

Many of the material terms of Covanta’s proposed new debt and refinanced debt, including interest rates, security and covenants, have not been finalized. Such proposed debt will consist of first and second lien secured facilities. The first lien facilities is expected to consist of:


	•	$100 million revolving loan facility expiring 2011;

	•	$340 million letter of credit facility expiring 2011; and

	•	$250 million variable rate term loan facility due 2012.

The second lien facility will consist of a $450 million variable rate term loan facility due 2012, a portion of which may be converted to fixed rate notes, at no premium or penalty.

Covanta will incur no cost or obligation if the financing or refinancing does not occur.

There can be no assurance that the acquisition, or the related refinancings of Domestic Covanta’s and CPIH’s corporate debt, will successfully close.

OTHER

Quezon Power

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 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.

Insurance

The Company has obtained insurance for its assets and operations that provide coverage for what the Company believes are probable maximum losses, subject to self-insured retentions, policy limits and premium costs which the Company believes to be appropriate. However, the insurance obtained does not cover the Company for all possible losses.

Off Balance Sheet Arrangements

During 2004, subsidiaries of Covanta were parties to lease arrangements with Covanta’s municipal clients at its Union County, New Jersey and its Alexandria, Virginia waste-to-energy facilities. At its Union County facility, Covanta’s operating subsidiary leases the facility from the Union County Utilities Authority (the “UCUA”) under a lease that expires in 2023, which Covanta may extend for an additional five years. 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.

Covanta is also 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 the Company’s financial condition.

Covanta generally uses operating lease treatment for all of the foregoing arrangements. A summary of the Company’s operating lease obligations is contained in Note 27 to the consolidated financial statements.

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 water 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, in excess of $1 billion. This amount was not recorded as a liability in the Company’s 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 17 to the Notes to Consolidated 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 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. The Company 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 6 to the Notes to the Consolidated Financial Statements for additional information regarding these leases.)

Discussion of Critical Accounting Policies

In preparing its consolidated financial statements in accordance with U.S. generally accepted accounting principles the Company is required to use its judgment in making estimates and assumptions that affect the amounts reported in its financial statements and related notes. Management bases its estimates on historical experience and on various other assumptions that are 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 the Company’s 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.


	*Fresh Start and Purchase Accounting*

The Company is required to apply fresh start accounting upon its emergence from bankruptcy. Also, on the Effective Date, the Company experienced a change in control 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 estimates of fair value used by the Company reflect its best estimate based on the work of independent valuation consultants and, where such work has not been completed, such estimates are based on the Company’s experience and relevant information available to the Company. These estimates, and the assumptions used by the Company and by its valuation consultants, are subject to inherent uncertainties and contingencies beyond the Company’s control. For example, the Company used the discounted cash flow method to estimate value of many of its assets. This entailed developing projections about future cash flows and adopting an appropriate discount rate. The Company 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 a different discount rate was used, the fair values of the Company’s assets and liabilities could be materially increased or decreased. Also as described in Note 4, estimates of asset and liability values may be adjusted further if and when additional information regarding such values is developed and evaluated. 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 the Company therefore have substantial effect on the Company’s balance sheet. In addition because the valuations impact depreciation and amortization, changes in such assumptions and estimates may affect earnings in the future.


	*Long-lived Assets*

The Company has estimated the useful lives over which it depreciates its long-lived assets. Such estimates are based on the Company’s experience and management’s expectations as to the useful lives of the various categories of assets it owns, as well as practices in industries the Company believes are comparable. Estimates of useful lives determine the rate at which the Company depreciates such assets and utilizing other estimates could impact both the Company’s balance sheet and earnings statements.

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 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.

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 the value of the Company’s consolidated financial statements.


	*Net Operating Loss Carryforwards — Deferred Tax Assets*

As described in Note 26 to the Consolidated Financial Statements, the Company has recorded a deferred tax asset related to the NOLs made available to Covanta through the Tax Sharing Agreement with Danielson. 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 the Company’s domestic business, to the extent it is reasonably predictable.

CPIH and its subsidiaries and Covanta Lake will not be consolidated with the balance of the Company for federal income tax purposes and therefore will not benefit from the NOLs.

Danielson expects, based on the Danielson Form 10-K for the fiscal year ended December 31, 2004 filed with the SEC, to have 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 beginning on 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 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 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 Danielson’s 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 Danielson’s stock. Danielson’s Certificate of Incorporation contains stock transfer restrictions that were designed to help preserve Danielson’s NOLs by avoiding such an ownership change. Danielson expects that the restrictions will remain in-force as long as Danielson has NOLs. There can be no assurance, however, that these restrictions will prevent such an ownership change.


	*Loss Contingencies*

As described in Note 31, 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 assesses the likelihood of potential losses with respect to these matters 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 and disclosure is made regarding the possibility of additional losses. The Company reviews 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 the Company’s initial or adjusted estimates of losses will reflect the ultimate loss the Company may experience regarding such matters. Any inaccuracies could potentially have a material effect on the Company’s consolidated financial statements.


	*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 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 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, 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; 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 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. The Company anticipates the contracts will be finalized in 2005 at which time it expects to be fully reimbursed for such costs.

Contract Structures and Duration

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, Domestic Covanta today operates many publicly owned facilities, and owns and operates many others. In addition, as a result of acquisitions of additional projects originally owned or operated by another vendor, Domestic Covanta operates several projects under a lease structure where a third party lessor owns the project. In all cases, Domestic Covanta operates each facility pursuant to a long-term contract, and provides the same service in consideration of a monthly service fee paid by the municipal client.

Under both 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 Domestic Covanta’s project subsidiary, and the facility is recorded as an asset, and the project debt is recorded as a liability, on Covanta’s consolidated balance sheet. In a public ownership structure, the municipality would pay for construction without loaning the bond proceeds to Domestic Covanta, and Covanta records as an asset the value of its relationship with its municipal client.

Regardless of whether a project was owned by Domestic Covanta or its municipal client, 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 most projects where Domestic Covanta owns the facility, the municipal client pays debt service as a component of its monthly service fee payment to Domestic Covanta. As of December 31, 2004, the principal amount of project debt outstanding with respect to these projects was approximately $670 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, Covanta records on its 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.

Domestic Covanta also owns two waste-to-energy projects for which debt service is not expressly included in the fee it is paid. Rather, Domestic Covanta receives a fee for each ton of waste processed at these projects.

As of December 31, 2004, the principal amount of project debt outstanding with respect to these projects was approximately $172 million. Accordingly, Domestic 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.

For Domestic Covanta-owned projects, all cash held by trustees is recorded as restricted funds held in trust. For facilities not owned by Domestic Covanta, Covanta does not incur, nor does it record project debt service obligations, project debt service revenue or project debt service expense.

Domestic 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 with 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 Domestic 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 Domestic 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, Domestic Covanta’s role, and its revenue, with respect to that project would cease. If a contract is not extended on a Domestic 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. Domestic 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.

Material Weakness in Internal Controls and Procedures

As set forth in Item 9A — Controls and Procedures, Covanta reported that management had identified a material weakness in its internal controls and procedures over financial reporting. Specifically, during the course of its audit of Covanta’s 2004 financial statements, Ernst & Young LLP, Covanta’s 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 Statement of Financial Position (SOP) 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code.” These errors, the net effect of which was immaterial (less than $2 million in pretax income) were corrected in Covanta’s 2004 Consolidated Financial Statements prior to their issuance. However, management has 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.

While the errors in financial reporting that related to the material weakness were corrected and had an immaterial net effect on Covanta’s Consolidated Financial Statements, Covanta’s management intends to correct the material weakness as soon as possible. Because a material weakness is defined as a control deficiency, or combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of annual or interim financial statements will not be prevented or detected, Covanta’s management believes that prompt remediation of the material weakness will mitigate the uncertainty presented by the possibility of material misstatements in Covanta’s reported financial information and in the accuracy and completeness of its financial reports. If Covanta is again unable to assert that its internal control over financial reporting is effective in any future period, the existence of the reported material weakness could represent a trend or uncertainty affecting the accuracy of Covanta’s consolidated financial statements. Although the material weakness reported related primarily to complicated “fresh start” accounting calculations, which will no longer be applicable after March 10, 2005, similarly complicated accounting calculations may be required in connection with CPIH’s international operations and Danielson’s pending acquisition of Ref-Fuel. As a result, as of the date of this Agreement Covanta has identified and undertaken several actions to remediate the reported material weakness in internal controls over financial reporting. Due to the nature of the control deficiency related to this material weakness, and pending completion of its review process for its

first quarter 2005 interim financial statements, Covanta believes it is premature, as of the date of this Amendment, to determine whether it has effectively corrected the reported material weakness. See also “Risk Factors — failure to maintain an effective system of internal controls 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 Covanta to regulatory sanctions and a loss of investor confidence in Covanta and its parent, Danielson.

Supplemental Financial Information About Domestic Covanta and CPIH

The following condensed consolidating balance sheets, statements of operations and statements of cash flow provide additional financial information for Domestic Covanta and CPIH. Because Domestic Covanta and CPIH have had separate capital structures and cash management systems only since the Company emerged from bankruptcy on March 10, 2004, therefore comparable information did not exist prior to the Company’s emergence from bankruptcy. For this reason, this supplemental information covers the period March 11, 2004 through December 31, 2004.

CONDENSED CONSOLIDATING BALANCE SHEETS

For the Period Ended December 31, 2004


		Domestic		CPIH		Consolidated

		(In thousands of dollars)
Assets
Current Assets:
Cash and cash equivalents		$	63,123	$	14,989	$	78,112
Marketable securities available for sale			3,100		—		3,100
Restricted funds for emergence costs			32,805		—		32,805
Restricted funds held in trust			92,829		23,263		116,092
Unbilled service receivable			58,206		—		58,206
Other current assets			156,995		44,067		201,062

	Total current assets		407,058		82,319		489,377
Property, plant and equipment—net			758,727		101,246		859,973
Restricted funds held in trust			104,580		19,246		123,826
Service and energy contracts and other intangible assets			187,932		705		188,637
Unbilled service receivable			107,894		4,152		112,046
Other assets			36,159		60,504		96,663

	Total assets		1,602,350		268,172		1,870,522

Liabilities and Shareholders’ Equity:
Current liabilities:
Current portion of long-term debt			112		—		112
Current portion of project debt			84,719		24,982		109,701
Accrued emergence costs			32,805		—		32,805
Other current liabilities			126,142		25,035		151,177

	Total current liabilities		243,778		50,017		293,795
Long-term debt			235,932		76,852		312,784
Project debt			757,435		77,601		835,036
Deferred income taxes			156,326		9,860		166,186
Other liabilities			95,460		2,388		97,848

Total liabilities			1,488,931		216,718		1,705,649

Minority interests			45,940		39,480		85,420
Total shareholders’ equity			67,479		11,974		79,453

Total liabilities, minority interests and shareholders’ equity		$	1,602,350	$	268,172	$	1,870,522

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

For the Period March 11, through December 31, 2004


	Domestic			CPIH			Consolidated

	(In thousands of dollars)
Total revenues	$	452,931		$	104,271		$	557,202

Depreciation and amortization		48,805			7,016			55,821
Net interest on project debt		23,786			8,800			32,586
Plant operating and other costs and expenses		318,108			73,679			391,787

Total costs and expenses		390,699			89,495			480,194

Operating income		62,232			14,776			77,008
Interest expense (net of interest income of $518 and $1,340)		(26,911	)		(5,937	)		(32,848	)
Income tax expense		(15,381	)		(8,256	)		(23,637	)
Minority interests		(3,966	)		(2,953	)		(6,919	)
Equity in net income from unconsolidated investments		1,216			16,319			17,535

Net income	$	17,190		$	13,949		$	31,139

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

For the Period March 11, through December 31, 2004


		Domestic			CPIH			Consolidated

		(In thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	17,190		$	13,949		$	31,139
Adjustments to Reconcile Net income to Net Cash Provided by Operating Activities:
	Depreciation and amortization		48,805			7,016			55,821
	Deferred income taxes		10,202			2,133			12,335
	Equity in income from unconsolidated investments		(1,216	)		(16,319	)		(17,535	)
	Dividends from equity investees		—			3,106			3,106
	Accretion of principal on Senior Secured Notes		2,736			—			2,736
	Amortization of premium and discount		(10,457	)		—			(10,457	)
	Minority interests		3,966			2,953			6,919
	Other		4,007			(119	)		3,888
Management of Operating Assets and Liabilities:
	Unbilled service receivables		11,221			—			11,221
	Restricted funds held in trust for emergence costs		65,681			—			65,681
	Other assets		(6,321	)		14,003			7,682
	Accrued emergence costs		(65,681	)		—			(65,681	)
	Other liabilities		5,156			1,820			6,976

Net cash provided by operating activities			85,289			28,542			113,831

CASH FLOWS FROM INVESTING ACTIVITIES
Investments in facilities			(10,083	)		(1,794	)		(11,877	)
Proceeds from sale of business			—			1,799			1,799
Distributions from investees			—			14,705			14,705
Other			(1,665	)		(1,248	)		(2,913	)

Net cash (used in) provided by investing activities			(11,748	)		13,462			1,714

CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings for facilities			—			14,488			14,488
(Increase) decrease in restricted funds held in trust			(7,871	)		(5,968	)		(13,839	)
Payment of project debt			(42,535	)		(25,408	)		(67,943	)
Payment of corporate debt			(47	)		(19,626	)		(19,673	)
Other			(5,272	)		(2,989	)		(8,261	)

NET CASH USED IN FINANCING ACTIVITIES			(55,725	)		(39,503	)		(95,228	)

NET DECREASE IN CASH AND CASH EQUIVALENTS			17,816			2,501			20,317
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			45,307			12,488			57,795

CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	63,123		$	14,989		$	78,112


Item 7A.	*QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK*

In the normal course of business, the Company is party to financial instruments that are subject to market risks arising from changes in interest rates, foreign currency exchange rates, and commodity prices. The Company’s use of derivative instruments is very limited and it does not enter into derivative instruments for trading purposes. The following analysis provides quantitative information regarding the Company’s exposure to financial instruments with market risks. The Company uses a sensitivity model to evaluate the fair value or cash flows of financial instruments with exposure to market risk that assumes instantaneous, parallel shifts in exchange rates and interest rate yield curves. There are certain limitations inherent in the sensitivity analysis presented, primarily due to the assumption that exchange rates change in a parallel manner and that interest rates change instantaneously. In addition, the fair value estimates presented herein are based on pertinent information available to management as of December 31, 2004. Further information is included in Note 33 to the Consolidated Financial Statements.

Interest Rate Risk

The Company has 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. The Company 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 percent 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 percent hypothetical increase in the underlying December 31, 2003 market interest rates would be approximately $32.5 million. The fair value of the Company’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.

Foreign Currency Exchange Rate Risk

The Company 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. The Company does not enter into currency transactions to hedge its exposure to fluctuations in currency exchange rates. Instead, the Company attempts to mitigate its currency risks by structuring its project contracts so that its revenues and fuel costs are denominated in the same currency. 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 Danielson’s 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.

Under CPIH’s current financing arrangements, these risks are borne primarily by the CPIH Borrowers to the extent they affect the cash flow available to the CPIH Borrowers to repay CPIH indebtedness. These risks will continue to affect items reflected on the Company’s consolidated financial statements.

At December 31, 2004, the Company also had net investments in unconsolidated foreign subsidiaries and projects. See Note 6 to the Consolidated Financial Statements for further discussion.

Commodity Price Risk and Contract Revenue Risk

The Company has not entered into futures, forward contracts, swaps or options to hedge purchase and sale commitments, fuel requirements, inventories or other commodities. Alternatively, the Company attempts to mitigate the risk of energy and fuel market fluctuations by structuring contracts related to its energy projects in the manner described above under Management’s Discussion and Analysis, Contract Structures and Duration.

Generally, the Company is protected against fluctuations in the waste disposal market, and thus its ability to charge acceptable fees for its services, through existing long-term disposal contracts (“Service Agreements”) at its waste-to-energy facilities. At three of its waste-to-energy facilities, differing amounts of waste disposal capacity are not subject to long-term contracts and, therefore, the Company is partially exposed to the risk of market fluctuations in the waste disposal fees it may charge. The Company’s Service Agreements begin to expire in 2007, and energy contracts at Company-owned projects generally expire, at or after, the date on which that project’s Service Agreement expires. Expiration of these contracts will subject the Company to greater market risk in maintaining and enhancing its revenues. As its Service Agreements at municipally-owned projects expire, the Company will seek to enter into renewal or replacement contracts to continue operating such projects. As the Company’s Service Agreements at facilities it owns begin to expire, the Company intends to seek replacement or additional contracts for waste supplies, and because project debt on these facilities will be paid off at such time, the Company expects to be able to offer disposal services at rates that will attract sufficient quantities of waste and provide acceptable revenues. The Company will seek to bid competitively in the market for additional contracts to operate other facilities as similar contracts of other vendors expire. At Company-owned facilities, the expiration of existing energy sales contracts will require the Company to sell its output either into the local electricity grid or pursuant to new contracts. There can be no assurance that the Company 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 the Company.

The Company’s opportunities for growth by investing in new projects will be limited by existing debt covenants, as well as by competition from other companies in the waste disposal business. Because its 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. When Covanta was acquired by Danielson and emerged from its bankruptcy proceeding in March 2004, it entered into financing arrangements with restrictive covenants typical of financings of companies emerging from bankruptcy. These covenants essentially prohibit investments in new projects or acquisitions of new businesses, and place restrictions on Covanta’s ability to expand existing projects. The covenants also prohibit borrowings to finance new construction, except in limited circumstances related to specifically identified expansions of existing facilities. In addition, the covenants limit spending for new business development and require that excess cash flow be trapped to collateralize outstanding letters of credit.

Covanta intends to pursue opportunities to expand the processing capacity where Client Communities have encountered significantly increased waste volumes without corresponding competitively-priced landfill availability. Other than expansions at existing waste-to-energy projects, Covanta does not expect to engage in material development activity which will require significant equity investment. There can be no assurance that Covanta will be able to implement expansions at existing facilities.


Item 8.	*FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX*


Management Report on Internal Control over Financial Reporting		94
Reports of Independent Registered Public Accounting Firms		95
Consolidated Statements of Operations and Comprehensive Income (Loss) for the Years ended December 31, 2004, 2003 and 2002		100
Consolidated Balance Sheets — December 31, 2004 and 2003 (Restated)		101
Statements of Shareholders’ Equity (Deficit) for the Years ended December 31, 2004, 2003 and 2002		102
Consolidated Statements of Cash Flows for the Years ended December 31, 2004, 2003 (Restated) and 2002 (Restated)		103
Notes to Consolidated Financial Statements		104
Quarterly Results of Operations		175
Financial Statement Schedules
	Schedule II: Valuation and Qualifying Accounts	176

MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Covanta Energy Corporation (“Covanta”) is responsible for establishing and maintaining adequate internal control over financial reporting for Covanta. Covanta’s internal control system was designed to provide reasonable assurance to its Board of Directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations including the possibility of human error and the circumvention or overriding of controls. Further, because of changes in conditions, the effectiveness of internal controls may vary over time. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Accordingly, even those systems determined to be effective can provide us only with reasonable assurance with respect to financial statement preparation and presentation.

Covanta’s management has assessed the effectiveness of internal control over financial reporting as of December 31, 2004. In making this assessment, we followed the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework.

A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of our annual or interim financial statements will not be prevented or detected. We identified the following material weakness in our assessment of internal control over financial reporting as of December 31, 2004. During the course of its audit of our 2004 financial statements, our independent auditors, Ernst & Young LLP 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 Statement of Financial Position (SOP) 90-7, “Financial Reporting by Entities in Reorganization under the Bankruptcy Code.” These errors, the net effect of which was immaterial (less than $2 million in pretax income) have been corrected in our 2004 consolidated financial statements. Management has 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 Covanta’s internal control over financial reporting was not effective as of December 31, 2004.

Our independent auditors, Ernst & Young LLP, have issued an audit report on our assessment of internal control over financial reporting. This report appears on page 94 of this report on Form 10-K for the year ended December 31, 2004.

March 14, 2005

Anthony J. Orlando

President and Chief Executive Officer

Craig D. Abolt

Senior Vice President and Chief Financial Officer

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 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

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholder of Covanta Energy Corporation

We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that Covanta Energy Corporation (the “Company”) did not maintain effective internal control over financial reporting as of December 31, 2004 because of insufficiently rigorous reviews of complex calculations, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s assessment. During the course of the audit of the Company’s 2004 financial statements, errors were identified, principally related to complex manual “fresh start” accounting calculations predominantly affecting the Company’s investments in its international businesses. These errors, the net effect of which was immaterial (less than $2 million, pretax) have been corrected in the Company’s 2004 consolidated financial statements. Management has 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 the Company’s internal control over financial reporting was not effective as of December 31, 2004. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 financial statements, and this report does not affect our report dated March 14, 2005 on those financial statements.

In our opinion, management’s assessment that Covanta Energy Corporation did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO control criteria. Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Covanta Energy Corporation has not maintained effective internal control over financial reporting as of December 31, 2004, based on the COSO control criteria.


	/s/ Ernst & Young LLP

MetroPark, New Jersey

March 14, 2005

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

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)

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.

100

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.

101

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.

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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.

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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

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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

105

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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”).

106

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.

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.

107

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.


	•	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.

108

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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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

110

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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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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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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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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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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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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Notes to the Consolidated Financial Statements — (Continued)


	Electricity and Steam Sales


	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.

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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.

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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

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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.

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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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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

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	*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.

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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

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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.

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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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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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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.

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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.

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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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

COVANTA ENERGY CORP 10-K/A