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Executives

Marisa Jacobs – VP, IR & Corporate Communications

Tony Orlando – President & CEO

Mark Pytosh – EVP & CFO

Analysts

Paul Clegg – Jefferies

Ron Oster – Broadpoint AmTech

JinMing Liu – Ardour Capital

Dan Mannes – Avondale

Michael Prober – Clovis Capital

Shamo Sadukan – Lotus Partners

Randy Gwirtzman – Baron Capital

Covanta Holding Corporation (CVA) Q4 2008 Earnings Call Transcript February 27, 2009 8:30 AM ET

Operator

Good morning, everyone, and welcome to the Covanta Holding Corporation fourth quarter 2008 financial results conference call and webcast. This call is being taped and a replay will be available to listen to until midnight Eastern Time on March 6th 2009. The playback number is 888-286-8010, for callers in the U.S. and 617-801-6888 from outside of the country. The pass code is 67460754. The webcast will also be archived on www.covantaholding.com and can be replayed or downloaded as an mp3 file.

At this time for opening remarks and introductions, I would like to turn the call over to Marisa Jacobs, Vice President of Investor Relations and Corporate Communications. Please go ahead.

Marisa Jacobs

Thank you. Good morning, everyone. Welcome to Covanta Holding Corporation's fourth quarter 2008 conference call. Before turning to our prepared remarks, I want to advise you that we recently upgraded the investor relations section of the Covanta Web site. You may have trouble accessing the new pages if you bookmark any of the old investor relations pages. To access the new material, please delete your current bookmark and create a new one after accessing the new content directly from your internet server. We hope you find the expanded presentation helpful.

Joining me on the call today will be our President and CEO, Tony Orlando, and Mark Pytosh, Executive Vice President and CFO. We will provide an operational and business update, review our financial results and provide our guidance for 2009 and then take your questions. The following discussion may contain forward-looking statements and our actual results may differ materially from those expectations.

The information concerning factors that could cause such differences can be found in the company's reports and registration statements filed with the Securities and Exchange Commission. A content of this conference call contains time sensitive information that is only accurate as of the date of this live broadcast, February 27, 2009. We do not assume any obligation to update our forward-looking information unless required by law. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Covanta is prohibited.

The information presented includes non-GAAP financial measures, reconciliation to the most directly comparable GAAP measures and management's reasons presenting such information is set forth in the press release that was issued last night. Because these measures are not calculated in accordance with Generally Accepted Accounting Principles, they should not be considered in isolation from our financial statements prepared in accordance with GAAP. It should also be noted that our computation of adjusted EBITDA may differ from similarly titled computations used by other companies.

I will now turn the call over to our President and CEO, Tony Orlando.

Tony Orlando

Thanks, Marisa, and thanks, everyone, for joining us today. We have a lot to cover, so let me jump right in. Notwithstanding the difficult economy, we continued to delever the business and generate significant free cash flow to invest in growth opportunities. We're staying the course and making good progress in that regard.

But before I discuss our growth prospects, let me first review our year end results and 2009 outlook. As you know, market conditions became very challenging late in the third quarter and it's likely to stay that way throughout the year.

Fortunately, the vast majority of Covanta's revenue is under contract to provide essential services to our client communities and we continue to perform at a very high level. During 2008, we achieved record production at our energy from waste facilities. This enabled us to deliver operating cash flow and adjusted EBITDA above the midpoint of guidance first issued by us at this time last year.

Revenues for the year increased 16% to 1.7 billion. Adjusted EBITDA rose 4% to 574 million, and cash flow from operations rose by 11% to 403 million. In light of the economic slow down, I'm pleased with that performance. I'm particularly pleased with our cash generation. The vast majority of which we used to invest in the business and repay debt consistent with our ongoing strategy.

In our domestic business, we are undergoing something of a transition as contracts roll off and more of our revenue is exposed to market conditions. Last year, about 90% of our domestic revenue was contracted. This year it will be about 80% and next year, it's expected to be about 70%.

Looking ahead, our business structure still substantially insulates us from the market downturns. However, we are not immune. And of course, we're in the midst of a severe downturn. During the last several months, we've seen scrap metal prices plummet, energy prices significantly drop and we've seen lower waste generation rates, which have caused our average tip fee to decline modestly. In the face of that challenge, we will continue to generate healthy level of operating cash flow, but for the first time in many years, we're projecting results that are below those of the prior year.

Mark will review guidance in some detail, so let me just give you the bottom line. At the midpoint of our 2009 guidance and after taking into account some unusual benefits in 2008, our adjusted EBITDA and operating cash flow will each be down approximately 40 million. This decline is primarily due to the recession. We'll feel it in 2009, but it also highlights the upside that we have when the economy rebounds. Let me go into a little more detail.

I noted on our last call that recycled metal constitutes about 4% of our revenue. To be exact, in 2008, we generated 54 million in revenue by selling recycled metal. Our fourth quarter metal revenue was 6 million and that's a good run rate at the current market conditions.

We are, of course, working to take advantage of lower metal prices to reduce facility maintenance expense. Price reductions in this area have been stubborn and in any event will experience a time lag because we often buy parts and equipment well in advance of installation. So we don't expect much benefit this year on the expense side. We've assumed a slight price recovery in the second half of the year and if we are right, we'll see a year-over-year net reduction of 15 million to 30 million from recycled metal.

Turning to our domestic energy portfolio, we previously told you approximately 20% of this year's domestic energy revenue would be exposed to market conditions and we also mentioned that would increase if we acquired the main biomass facilities, which we did.

To help you assess the financial impact of rising or falling energy prices, we've converted this into a megawatt equivalent basis, which includes an estimated number to account for our exposed steam sales. For 2009, we anticipate the equivalent of about 1.5 million megawatt hours will be exposed to the market. Due to timing of certain contract expirations, this exposure is somewhat back end loaded.

Now, we know the market prices have dropped 40% to 50% from their highs. In fact, from the time of our last earnings call to January, electricity prices were treated about 20% and just during the last few weeks, we've seen another 10% decline. We're hoping for a modest recovery in the second half of the year to at least get back that last 10% drop.

On that basis, we expect a full year dollar per megawatt hour average price for our energy that's exposed to market to be in the range of the mid 50s to the low 60s. So to help you assess that impact of movements in the energy market, let me just give you a directional calculation.

If the market price is $60 per megawatt hour, you would multiply 60 by estimated output of 1.5 million megawatt hours, which equals 90 million of domestic energy revenue exposed to the market. So, a $10 movement in price will move our revenue about $15 million. However, not all of that will drop to the bottom line.

We're working aggressively to offset the energy revenue decline with lower chemical and fossil fuel related expenses but we're not going to be able to get it all back. We expect the lower energy prices will cause a net year-over-year impact of $15 million to $30 million.

The economic slowdown is also causing reduction in municipal and commercial waste volumes. We're substantially insulated from this because more than 80% of the waste we process is delivered under contract.

Merchant deliveries add approximately 2.5 million tons make up most of the remaining tonnage. That waste is delivered predominantly to our tip fee facilities, where our approach is to ensure ample waste deliveries by clearing the market price.

During the fourth quarter, we experienced modest price declines and we expect that to persist until the economy begins to recover. I'm not happy about forecasting lower numbers, but in light of the difficult economic conditions, I am pleased with how we're managing the business. We're offsetting a portion of these downturns with our typical organic growth.

Our balance sheet is solid. Since 2006, we've reduced debt by over 600 million and at the end of this year we had almost 200 million of unrestricted cash in the balance sheet.

We will pay over 150 million in debt this year after which we expect to generate another 150 million available to invest in growth and that puts us in an excellent position to capitalize on the opportunities presented by these difficult times. And notwithstanding the near-term outlook, we firmly believe that over the long-term, energy and commodity prices will rise faster than inflation, driven by macro trends, and population and per capita income.

Furthermore, much of the legislation taking effect or under consideration to reduce our reliance on fossil fuel to encourage the production of more renewable energy and to tackle climate change here and abroad will ultimately lead to higher prices. And when the economy recovers, I believe we'll see a sharp increase in energy prices, which will generate a big upside for Covanta. Consequently, we're not altering our strategy. 2009 and maybe even 2010 will be challenging, but we'll be in great shape when the market recovers.

In addition, we're making steady progress executing our growth strategy and I remain confident that we're on the right path. In terms of maximizing the value of our current asset base, 2008 was particularly busy and successful. We entered into three contract extensions and completed negotiations on a fourth as the year wrapped up.

In fact, since we began the process of negotiating contract extensions, our team has a perfect track record. We've successfully extended 12 out of 12 contracts. This is a real testament to the Covanta team, which has a well deserved reputation of being the best operators in the business and have an unwavering commitment to work hand in hand with our client communities.

Very briefly, I'll review the four contract extensions recently completed. Our first transition from a service fee contract to a tip fee contract took effect with the city of Indianapolis. The new waste agreement began in December of 2008 and has a ten year term. Under this contract, the city will deliver about half of the plants waste capacity.

A new agreement covering the facility steam sale was also signed. Steam sales under this contract will be adjusted annually based on changes in the CPI and a basket of Fossil fuel indices. We signed a five-year extension of our service fee operating agreement for the Pasco energy from waste facility taking us out to April 2016.

We also signed a 14 year extension of our operating contract with Kent County, Michigan. The Kent agreement was converted from a service fee operated structure to a tip fee structure effective January 1st of this year.

We typically don't have tip fee contracts on facilities we don't own and in some respects, this contract is structured differently than most of our other tip fee agreements, but our client wanted to incentivize us to achieve optimal production by paying us for each ton we process and we're happy to work under that type of arrangement.

And just a few weeks ago, we reached an agreement with respect to our Wallingford facility. We executed a ten year tip fee contracts with five towns, plus a capacity agreement with the Connecticut Resource Recovery Authority. Combined these agreements represent most of the facilities capacity and when they take effect in July of 2010, this facility will be converted from a service fee arrangement to a tip fee arrangement.

Clearly, there's a trend moving toward tip fee agreements. Not that long ago, about one third of our waste disposal capacity was covered by tip fee agreements and two-thirds by service fee agreements. Now it's about 50/50.

Looking ahead to the future contract transitions, only three other service fee arrangements are scheduled to end in the next two years. The Detroit operating contract expires this year.

We're doing everything we can with a reason to extend this contract, but it's an extremely complicated situation and quite challenging and that makes it difficult to predict how this might play out. I'm hopeful it will be extended, but if for some reason that doesn't happen, the termination will not have a material effect on our financial results.

Two other service agreements are scheduled to expire in 2010. Our agreement to operate Honolulu facility and our service agreement at the facility we own in Stanislaus County, California. I'm confident that both of those contracts will be extended.

Progress was also made on the expansion front with the submission of various filings to secure necessary permits to expand the Honolulu and Hamstead facilities. Construction is continuing at our Hillsborough County, Florida facility where we anticipate bringing the new boiler online late this summer.

In terms of our 2008 acquisition activity, we acquired three renewable energy facilities, a 1,100 ton per day facility in Tulsa, Oklahoma that sells steam and electricity, plus two electric generating biomass facilities in Maine with a combined output of 49 megawatts.

All three facilities sell energy at market rates. And because those prices are currently depressed, and as well Tulsa is not yet operating at full capacity, we expect contributions from these three facilities to be quite modest in 2009, but we bought these assets far below replacement costs looking to the future. When renewable energy prices rise, we'll see the full value of these acquisitions.

Internationally, we got some very good news. The Irish EPA issued the last outstanding major license needed with respect to the Dublin facility. This is a big milestone that paves the way for this important $450 million project. We started site preparation work as well as detailed design, everything that must be completed before full scale construction can begin is now being wrapped up including the project financing.

We plan to begin full scale construction during the second quarter and we're really excited about that. This project will put us on the map in Europe. The UK is also a hot bed of activity. With numerous public/private partnership bids already under way and more slated to begin this year. Most of these bids are expected to be decided in 2010 and one that began sometime ago will be decided this year.

In addition to the competitive procurements, good opportunities for merchant projects exist throughout the UK. Just a few weeks ago, we announced our plan to construct, own and operate a 400 million pound energy from waste facility in Wales. In addition, although it has not yet received much media attention, we are also pursuing a smaller merchant opportunity in Middlewich.

We're optimistic about both projects, but we're very early in the process. We still have many community meetings and permit filings in front of us before construction can begin.

This is a perfect illustration of the long-term nature of our projects. Each one entails uncertainty and requires patients to get to the finish line. But each also holds the potential to make a sizable contribution to our results when ultimately completed and put into operation.

In China, each project will have a smaller financial impact, but development activities move very quickly. As evidence of this speed, we won the Chengdu energy from waste bid less than a year ago and construction is scheduled to begin shortly with a target operation date of 2011.

We also signed definitive agreements to increase our current ownership in the new Fuzhou energy from waste facility from 13% to 71% and will complete that transaction upon the necessary approvals. This facility is located in the prosperous East Coast of China in the Fujian province.

It's currently processing approximately 1,200 metric tons per day and generating 24 megawatt hours. It is our intention to operate this facility as a showcase for perspective clients to help build our reputation and set the stage for more success in China.

All in all, it was a very busy and productive year in terms of advancing our growth initiatives. Of course, these efforts come with a cost and you can see that in our G&A expense line, so I want to spend some time discussing this.

Between 2007 and 2008, G&A expense rose approximately 14 million to 97 million and we plan to increase that another 5 million to 10 million this year. We have an exciting window of opportunity to develop new EFW projects and to advocate for new policies that will help our industry grow.

Contracts awarded over the next several years will create value for several decades. We consider it imperative that we commit resources now to seize these opportunities. We understand the burden this decision places on our near-term financial results. But we have always operated this business with a long-term perspective because we believe it's the most appropriate way of creating shareholder value.

In addition to building excellent development teams and strategic global markets, we've embarked on another initiative that we view as an investment in our future. We've dubbed it our Clean World Initiative or CWI for short.

Our business offers sustainable solutions to energy and environmental problems and our corporate culture is increasingly focused on sustainability, manifested in all aspects of how we operate. The concept of continuous improvement is fundamental to CWI and under this initiative, we are pursuing performance enhancements, not for the sake of mere legal compliance, but to ensure that we operate our business and perform for our clients in an environmentally superior manner.

Our Clean World Initiative is an umbrella program with three key elements. First, we're deploying technology, know-how and processes to continuously improve our environmental performance and increase our energy efficiency.

Second, we're expanding our research into new technologies, having the potential to enhance our existing operations or create new business opportunities. We've begun to break out the capital expense associated with these efforts in Exhibit 6 to our press release.

And finally, we're partnering with governmental agencies, universities and NGOs to implement sustainability programs, reduce society’s use of environmentally harmful products and enhance recycling and promote our industry.

While this initiative began late in 2007, we waited to introduce it formally until we gained some traction. Let me give you a few examples of our progress. Last year, we hired Paul Gilman as Chief Sustainability Officer to lead this initiative.

We're investing our own capital to install the company's proprietary new low NOx systems at tip fee facilities we own and we are also selling these systems and installing them for clients. We're partnering with client communities to sponsor collection, recycling and abatement projects that keep mercury out of the waste stream.

We're working with the National Fish and Wildlife Foundation and NOAA, the National Oceanic and Atmospheric Administration to expand our fishing for energy program. Under this program, dangerous abandoned fishing gear is being removed from fishing ports and processed at our facilities with no cost to the community.

And we're building a pilot waste to diesel fuel facility designed to produce a few thousand gallons per day. We're hoping to have a good indication of commercial viability by the end of this year. I'll be speaking to you more about the Clean World Initiative on future calls.

Let me just wrap up this discussion by stressing the fact that we view CWI as central to Covanta's mission and we also believe that its implementation represents an investment in our future that will enhance shareholder value.

Before wrapping up my remarks, let me spend just one minute on legislative issues. The most significant development since we last spoke is undoubtedly the arrival of the Obama administration and the increased majority the democrats enjoy in congress. The practical impact of this as it relates to our business is still largely unknown, but I'm upbeat about the policies being developed in Washington, DC.

The stimulus bill just signed into law has extended the production tax credits for renewable energy, including energy from waste. That will help us with projects like the planned expansion of our Hempstead facility and hopefully this momentum will carry over into the federal renewable electricity standard and climate change policies now being debated. Both could have a significant benefit for Covanta depending on the final outcomes. When and if legislation is passed, and if it is passed, and how the laws will affect our business, remain open questions.

We are engaged in the process, advocating for energy from waste technology to be included on a level playing field with other renewable technologies. Fortunately we're not alone in our advocacy. Just a few weeks ago at Davos, the World Economic Forum issued a report citing energy from waste as one of the eighth large scale clean energy sectors that governments throughout the world should pursue to address energy security and lower carbon emissions.

We're hopeful the new administration and congress will heed this advice. Each has placed the creation of a federal renewable electricity standard as a high priority item on the respective agendas and I believe we're likely to see that become law sometime this year.

There's also a lot of support for climate change legislation. But the issues are more complicated and it's likely to take longer to establish this policy. Clearly, it's an important time for us in Washington and we'll continue to give you updates on future calls.

Now let me turn the call over to Mark for a review of our fourth quarter and 2008 results and a discussion of 2009 guidance.

Mark Pytosh

Thanks, Tony, and good morning, everyone. Total operating revenues for the fourth quarter of 2008 grew 4.7% to 414 million. Net income was 30 million, or $0.19 per diluted share. Cash flow from operating activities was 135.1 million and adjusted EBITDA was 138.1 million.

Now I would like to discuss the 2008 fourth quarter segment results compared to those of last year's quarter. In the domestic business, total revenues for Q4 declined by 6.4 million or 1.9%. All the domestic revenue comparisons exclude the pickup of $4 million of accelerated debt service revenue related to the pay down of the Stanislaus project debt.

Revenues from our existing business declined by 7.8 million and our new business contributed 1.4 million primarily from Tulsa. Domestic waste and service revenues declined in Q4 by 3.5 million or 1.5% to a total of 230.7 million, which breaks down as follows.

Revenues from service fee plants increased by 2.8 million net due mainly to contractual obligations offset by lower debt service past due revenues of 1.5 million. Revenues from tip fee facilities decreased by 3.1 million. The benefits from higher volumes, including the addition of Tulsa, were offset by lower pricing. We expect market pricing to remain weak in 2009.

Merchant tonnage comprises approximately 15% or 2.5 million tons of our domestic waste volume. Recycled metal revenues declined by 3.2 million to a total of 5.9 for the quarter despite higher recovery volumes. This was 11.4 million lower than the third quarter metal revenues of 17.3 million. Of course, this decline was due to the significant drop in pricing for scrap metal revenue since the summer. For the year, the company had 53.6 million of recycled metals revenue.

Electricity and steam revenues increased by 5.3 million or 6.1%. The increase was due primarily to full fourth quarter production at the Delano biomass facility in California in contrast to last year's fourth quarter when it was being rebuilt. In addition, we had a higher contribution from Indianapolis associated with its December 1 conversion to a tip fee contract and the accompanying increase in energy revenues retained by us.

While electricity rates for the quarter were up slightly from 2007, they were declining during the quarter and the weakness has persisted near the first quarter. Approximately 25% of our domestic energy revenue is exposed to market pricing fluctuations in 2009 after taking into account the recent addition of the two biomass facilities in Maine. As Tony mentioned, this is the equivalent of 1.5 million megawatt hours per year.

Domestic plant operating expenses increased by $12.2 million. The existing business accounted for 8.5 million of the increase and the new business primarily Tulsa accounted for 3.7 million. In the existing business, the incremental expenditures greater than normal escalation primarily relate to the Clean World Initiative, including research and development activities and additional wood costs at the Delano facility. We expect 2009's maintenance cycle to be very similar to 2008 in terms of the quarterly breakdown.

We recorded an insurance recovery for the SEMASS fire of $8.3 million in 2008 versus a recovery of $4.9 million in the fourth quarter of 2007 and we received the cash in the fourth quarter. This finalizes our settlement with the insurance company on the fire.

Now turning to the international business, total international revenues increased by $20 million, driven by increased revenues at our two facilities in India due to higher electricity generation.

International plant operating expenses increased by 31.8 million primarily due to the higher generation of the two facilities in India and higher fuel costs. The two Indian plants utilized diesel fuel to generate electricity and the price of the fuel is a pass-through expense embedded in the contracted electricity price.

During periods when we experienced large increases or decreases in fuel prices, which occurred during 2008, the contract price tends to adjust faster than our costs. Therefore, for short periods of time we are more profitable when oil prices are rising and less profitable when they are declining. Over a normalized cycle fuel price changes have almost no impact on profitability.

For 2008, we were more profitable in the first nine months as oil prices rose, but experienced a slight operating loss in the fourth quarter as oil prices declined significantly in short periods of time. The impact is expected to dissipate in the first few months of 2009, assuming stable oil prices.

Operating income from the international business was down 16.5 million in the fourth quarter of 2008 due to the impact of higher fuel prices at our Indian facilities coupled with the foreign exchange impacts and increased SG&A to pursue growth.

And at the consolidated Covanta Holding level, general and administrative expenses for the company increased 4.4 million to 26.4 million in the fourth quarter 2008, up from 22 million in 2007. Fourth quarter G&A levels represent a good run rate for 2009.

Total debt service decreased by $5.2 million to $21.9 million in the fourth quarter of 2008 primarily due to lower interest rates on our floating rate debt compared to 2007 and lower principle balances offset by lower interest income. Rates declined significantly during the quarter and remain low in the first quarter of 2009.

Reported diluted earnings per share were $0.19 in the fourth quarter of 2008. Utilizing a 40% effective tax rate would result in diluted earnings per share of $0.23 which include the net benefit of $0.03 related to the insurance recoveries for the SEMASS fire.

Looking back to the fourth quarter 2007, if the same adjustments are made, EPS would have been $0.26. Our effective tax rate for the quarter was 52%, which incorporates the final wind down of the former activities of the Grantor Trust under Danielson Holding as a result of the wind down; the NOL increased to $591 million at 12/31/08 and should provide a significant federal tax shield through 2011.

Our cash taxes were 27 million in 2008 and expected to be a similar amount in 2009. We had unrestricted cash of 192 million at December 31. Total corporate debt including the convertible debentures was 1.01 billion. Project debt balances declined by 113.5 million during the quarter to 1.08 billion, which included the early repayment of $21.3 million in debt at our Stanislaus California project made at the client's request.

Total net debt at 12/31 was 1.7 billion. This amount is net of unrestricted cash and restricted funds set aside explicitly for project debt principal repayment in the amount of 195 million.

Now turning to our operating cash flow, cash flow from operating activities for the fourth quarter was 135.1 million, up 15.8 million from 2007. The company's investments of cash in the fourth quarter were 20.6 million, which included maintenance CapEx of 14.5 million. The details of the other investments are described in Exhibit 6 of the press release.

Our maintenance CapEx spending for the year was in line with our expectations at 59.8 million. The company spent approximately 92 million in acquisitions and equity investments for the full year. Even with the significant debt pay down in the fourth quarter and the acquisitions of the two biomass facilities, the company has greater liquidity today than last quarter and is well positioned to confront the difficult economy ahead.

So let me summarize the key drivers for fourth quarter results. Cost to grow the business including the startup of Tulsa, expenses associated with the Clean World Initiative and increased SG&A cost us about $7 million in adjusted EBITDA. The economic slow down, which caused a sharp decline in recycled metal revenues and slightly lower tip fees cost us about 6 million in adjusted EBITDA.

And finally, fuel oil price fluctuations and exchange rates related to our international business were offset by the positive impacts from the Stanislaus debt repayment and the SEMAAS fire recovery.

Notwithstanding the lower adjusted EBITDA, we were able to increase our operating cash flow by $16 million; we manage to do this because the fuel oil timing and foreign exchange do not significantly affect cash flow. Our interest expense was lower and we generated cash from working capital, which is part of the normal cash cycle of the company.

While the economy was challenging in my view, this is a positive quarter. We continued to generate substantial free cash flow. We continued to invest in the future growth of the company and we continued to strengthen our balance sheet. We maintain excess liquidity and increased our NOL significantly, which will benefit future free cash generation.

Now I would like to turn to 2009 guidance. The company is instituting guidance for the following key metrics. Cash flow from operations in the range of 325 million to 375 million. Adjusted EBITDA in the range of 500 million to 540 million and diluted earnings per share in the range of $0.75 to $0.90. As Tony said, we, like many businesses are facing economic headwinds.

So let me review each of the key drivers affecting adjusted EBITDA for 2009 over 2008. 2008 adjusted EBITDA was $574 million, which included the one-time benefit of the Stanislaus early debt redemption and the SEMAAS fire recovery. Excluding these two items, 2008 adjusted EBITDA would have been $558 million. The existing business excluding the impact of lower metal and the energy prices is expected to be about flat.

Typical organic growth in the domestic business is being offset by three things. The international business will decline due to the remaining expected negative fuel margin in India and expected foreign exchange impacts. Weakness in waste volume that we expect to result in lower pricing would be the second issue and third, higher overhead to pursue growth and our clean world initiative.

The incremental contribution from acquisitions completed in 2008 is expected to be a contribution of approximately $5 million to $10 million. That leaves two big headwinds. Lower metal and energy prices. As Tony described, we expect a decline in adjusted EBITDA of 15 million to 30 million from both metals and energy prices in 2009.

At the midpoint of guidance, diluted earnings per share expected to fall less than EBITDA, as lower interest expense is expected to somewhat offset lower operating earnings. The reported earnings per share will be further reduced by $0.02 of noncash interest expense due to the company's adoption of APB 14-1 for treatment of the company's convertible subordinated notes. Our effective tax rate assumption is approximately 40%.

Cash flow from operating activities is expected to decline by approximately $50 million from 2008 to the midpoint of the guidance range of $350 million. The decrease is driven by the decline in adjusted EBITDA and the requirement to make an additional lease payment of $16 million for our Delaware Valley facility in 2009 that will not be repeated in the future. These declines are expected to be somewhat offset by lower interest expense.

Maintenance CapEx is expected to be approximately 60 million in 2009 essentially versus 2008. Therefore cash flow available to fund growth or pay down debt is expected to be almost $300 million in 2009 at the midpoint of guidance. Gross project debt pay down is expected to be approximately 170 million in 2009.

Restricted cash of approximately $35 million is expected to be utilized to pay part of the project debt maturities and the parent company is expected to utilize $135 million of its free cash flow for scheduled project debt payment and $7 million for term loan repayments, leaving approximately $150 million available reinvest in the business.

While we face headwinds through the course of '09, our core business will generate significant free cash flow. This allows us to continue investing where we see opportunities to create long-term value. Good opportunities like the Dublin project, the Hempstead expansion, environmental initiatives and strategic acquisitions.

We expect this environment to provide additional external growth opportunities for Covanta and we intend to take advantage of those opportunities. With that, we look forward to answering your questions. Operator, can you open up the line?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And your first question will come from the line of Paul Clegg from Jefferies. Please proceed.

Paul Clegg – Jefferies

Hi, guys. Thanks for all the detail. Thanks for taking my question. You went through a lot of metrics here on the sensitivities on '09 guidance. Can we safely assume then that it's really – it's primarily energy pricing and metals pricing that bracket the upper and lower end of that, that caused the widespread?

Tony Orlando

Well, certainly those are the biggest two without question. The other factor will be how things play out on the waste market. We feel pretty good about the waste market. There tends to be little volatility there. And as we noted, we've got about 15% of our waste that's coming into merchant volume. So we'll have to see how that plays out. But yes, the big two items are clearly the energy price and the scrap metal.

Paul Clegg – Jefferies

Okay. And can you also comment on what you're seeing in terms of M&A opportunities with the downturn, are there opportunities to get more attractive assets at reasonable multiples, are people being more realistic about what they can get?

Tony Orlando

Short answer is, yes. There's definitely better opportunities than there were previously and more sellers and fewer buyers.

Paul Clegg – Jefferies

Okay. And particularly which – is it waste energy facilities particularly or what other types of assets do you think that you might be looking around at over the next year?

Tony Orlando

Well, as we've said in the past, the focus internationally will be on building out a platform that is focused on energy from waste whereas here in the U.S., of course, we'll look for waste energy opportunities, although there aren't all that many available. So we'll look where there are opportunities in the U.S. for waste energy, but we'll also look at other renewable energy facilities like the biomass that we pursued and maybe kind of branch out to try to leverage our existing platform in the U.S., whereas we're really trying to develop a platform in Europe and Asia.

Paul Clegg – Jefferies

Okay. Thanks very much.

Mark Pytosh

Thanks, Paul.

Operator

Your next question will come from the line of Ron Oster from Broadpoint AmTech.

Ron Oster – Broadpoint AmTech

Good morning. I was wondering if you could comment, I think in the beginning of your prepared remarks, you mentioned that 70% of your 2010 electricity sales were under contract. Is that – has that been – I believe that's changed from the 50% we've heard previously. Am I remembering that correctly or has there been some changes there?

Tony Orlando

Let me clarify. 70% of our total domestic revenue will be under contract. So if we break that down, it would continue to be roughly 15% of our waste revenue exposed and 85% of our waste revenue under contract for 2010 and roughly it's probably going to be a little bit less than half of the energy revenue in 2010 we'll be exposed to market. So maybe taking a step back on the energy side, this year we gave you a number of 1.5 million megawatt hours exposed to market. In 2010, that numbers going to be approximately 2.5 million.

So you can see how we've got that exposure and as we look long-term, we like that. Because when the market rebounds we're in the substantial position to gain some upside there. A $10 per megawatt hour price move is going to benefit us in 2010. I will say it's important to note when you're thinking about 2010 that the reason that we're – that we have two contracts today that are above market that will end late this year. Those two contracts were both at market in the summer, today's prices, and this is our Hempstead contract in Union County PPA, combined, they're about $25 million above market today. And again, we don't look at that in a negative fashion at all. We look at a $10 move in prices would completely offset that. And long-term we feel really good about having that position with these debt-free assets in great markets.

Ron Oster – Broadpoint AmTech

Okay. And then also on the – we heard a lot about the M&A opportunities. Your balance sheet continues to strengthen, cash position continues to grow. At what point might you consider share buybacks or dividend with the share price being where it is today? Is that under consideration as well as the M&A opportunities?

Mark Pytosh

Well, I would say that we've got an active pipeline on the M&A side, so we'd like to see that play out further before we take a look at the – what we're going to do with the capital. Our hope this year, I think as Tony mentioned that we'd like to spend all of our free cash flow and reinvest it in the business. We also have investments coming up in Dublin, so we I think our feeling is first we like to reinvest in the business and then we'll see kind of how we go through the pipeline.

Ron Oster – Broadpoint AmTech

Okay. And then last one for me. You mentioned some progress at your expansions and some ongoing progress at Hempstead. Can you just kind of expand on that and if there is any other facilities in your fleet that are also candidates for expansion currently?

Tony Orlando

Sure. Well, we have a number of facilities that are candidates for expansions and a number that we're looking at. We have two though that are in more advanced stages. The Hempstead facility on Long Island, we filed permit applications for that. We've already begun various hearing processes, so, we're moving forward. We're probably about maybe one year into a two year permit process. Now, it's always a little bit hard to predict how long the permit process takes, but if we typically would target about two years we maybe are a year, a year into that. So we've got at least another year to go on the permit at Hempstead, but our target there is to be able to begin construction in 2010.

With respect to the Honolulu facility, this is one driven by our client community, they own the facility. We are in the final stages of working with them to finalize the plans and the permit process has already begun. In fact, that begun – began sometime ago as well. That's in a similar stage. We're hoping to be in a position to begin construction there possibly at the end of this year, but more likely in 2010. So those two projects are pretty far down the road in terms of their process. Others are much earlier stages of development.

Ron Oster – Broadpoint AmTech

Great. Thank you.

Operator

Your next question will come from the line of JinMing Liu from Ardour Capital.

JinMing Liu – Ardour Capital

Good morning, gentlemen.

Tony Orlando

Good morning.

JinMing Liu – Ardour Capital

Thanks for taking my question. My first question is, can you give me – give us more color about the project financing for the Dublin project?

Mark Pytosh

Sure. We, we are in discussions or negotiations with the group of banks to provide that financing and as Tony mentioned, we've received the final permit and so we're now working aggressively to get to the finish line on that project finance. What I would tell you is that the – that probably only – and I think I mentioned this somewhat on the last call, but the market is I think for these types of projects continues to be available and we will probably end up putting a little more equity in that project. But the– in terms of the rates, with interest rates having declined, we expect the terms to be very similar to what we've always expected on that project financing. So the market is – it's more difficult than it was back in the fall, but it's still available and we expect to be able to wrap up that here in the next two months or three months. And so we're working aggressively to do that.

JinMing Liu – Ardour Capital

Okay. Switching back to the domestic segments, do you see any of your local municipality clients having trouble to pay your service fee or any of them want to accelerate there the debt repayment?

Tony Orlando

No. Clearly the economies affecting municipalities across the board, but we have the luxury and benefit of really – with providing an essential service. I mean one of the things – municipalities need to take care of water and waste removal and things that just have to be done. We haven't seen any indication by any clients with an inability to pay at all. We have seen slightly lower volumes, which at our service fee agreements is the responsibility of our clients to deliver. And so it does have some influence on kind of our incentive revenue. But it's really quite modest for us and we're working with our client communities to do everything we can to help them manage through these challenges, but fundamentally everything is very sound there.

Mark Pytosh

But on – and then on the debt side the Stanislaus situation was a relatively unique situation where that debt financing was a variable rate financing and so we don't expect to see if any dramatic shifts in the debt portfolio.

JinMing Liu – Ardour Capital

Okay. Glad to hear that. My last question, on the legislation front, say, if the variable RPS legislation passes at least later this year, what kind of impact will that have on your business?

Tony Orlando

Well, it depends of course on what policy is ultimately adopted. As I noted, we're advocating that energy from waste be included in the standards and we're hopeful that's what's going to happen. But until there is actual legislation passed, I don't want to really try to predict on how that could play out. But clearly to the extent we are included there is a significant upside both for our existing facilities as well as for the potential to really spur new growth in this industry, which I think ultimately is something that is appropriate for this country to take 250 million tons of waste that's being buried in the ground today and use it as an energy resource to enhance energy security and reduce greenhouse gas emissions. So we're hopeful that that's the policy that will be adopted.

JinMing Liu – Ardour Capital

Okay. Thanks.

Operator

Your next question will come from the line of Dan Mannes from Avondale.

Dan Mannes – Avondale

Good morning, everybody.

Tony Orlando

Hey, Dan.

Dan Mannes – Avondale

Couple follow-up questions. Obviously you gave guidance on maintenance capital. Given what's going on at Dublin and some of the other – and this is just for known items, can you give us at least some color on what your CapEx budget is for growth? And that would include also expenditures for instance on the waste to diesel technology, et cetera.

Mark Pytosh

Well the – again, I think our hope is and our goal is to invest the free cash flow which as I said for the midpoint of guidance, about $150 million. And so it's possible depending on what the size of the Dublin investment is, it's possible that that – we would go to the north of there certainly if the opportunities presented themselves. But I – I think that where we stand today, investing the free cash flow and maybe greater than that is, is really what we see today. On the diesel side, that will be a several million dollar investment. It's not a large investment, because we're really the smaller stage at this point.

Dan Mannes – Avondale

And again, this is all discretionary except for I mean with Dublin, is there any discretion to it or – I mean at this point, are you contractually obligated to build the plant?

Mark Pytosh

At this – we're not contractually obligated to build the plant, but –

Tony Orlando

We're going to build the plant.

Mark Pytosh

We're going to build it.

Dan Mannes – Avondale

Right.

Mark Pytosh

And the only question is just working out with the lenders the timing of the investment dollars. So it's not really the – the issue is really what's going to be the final understanding with the lenders and our investments. So we will start to invest in the second quarter on the Dublin project and we'll obviously will be breaking that out and disclosing it as we're investing money. But that's going to come together here in the not too distant future and we intend to start spending money once we have the financing wrapped up.

Tony Orlando

Yes, I mean we're going to build the project there, we've already started spending money, we're on the site now. We're doing detailed design work, so we're already spending money on that and ultimately the amount of cash that we are going to use will depend on how much equity versus debt on the project financing. But the construction there is a three-year period. So it's spread out. Our equity contribution will be spread out over that three year construction period and as Mark said, we'll kind of nail down how much that will be when the financing is finalized.

Dan Mannes – Avondale

Understood. And I wasn't implying that you shouldn't build the plant, more just the timing of it relative to when financing become available. Just on Hempstead real quick, you mentioned all the contract renegotiations and Hempstead wasn't one of the four you mentioned. Can you talk to us a little bit about the waste side I guess of Hempstead?

Tony Orlando

Well, Hempstead, we really wrapped that one up the prior year. We had done a 25 year extension with the town of Hempstead. It was, if I'm remembering it right, it was late 2007 that we wrapped that up. So I didn't have that on the list of the recent ones. We have subsequently signed some additional contracts for other towns. The Hempstead community itself delivers roughly half of the waste to that plant and we have signed up additional contracts to fill up. I think over the course of the next three years to five years, most of the facilities capacity is committed. There is still maybe a small percentage that's open to the market. But that's a particularly attractive market on Long Island, limited disposal capacity on island, and so we feel really good about our position there.

Dan Mannes – Avondale

Okay. Briefly, on the hedge positions, I appreciate the detail in terms of the, sort of the open megawatt hour equivalent positions. Can you give any color on the portion that is hedged, what is the average price it's hedged at, for instance, for 2009 versus 2010?

Tony Orlando

Yes, and I guess I would tend to not use the word hedge. These are contract – they're basically forward contracts. They're contracts to sell all of what we produce at a specified price so there is no exposure there in terms of trading or what not. The contracted price that we have for the facilities at our fixed price are now in the mid-70s.

Dan Mannes – Avondale

Okay.

Tony Orlando

Where it's funny, I mean we look back a year ago, I think on many of these calls, folks were urging me to say that that was below market and it probably was a little below market and it definitely became below market by the summer, while now it's above market. But I think the other important point on that is that those contracts tend to run for quite some time with the two exceptions that I already noted, the Hempstead contract and the Union contract. Once we get beyond that, we have a couple more years for those contracts to run.

Dan Mannes – Avondale

So – but is it fair to assume that the contracted price for 2010 will be lower given the roll off of Union and Hempstead? And does that go from a contracted price of mid 70s, contract price of 70, given that those two are both large and relatively high priced?

Tony Orlando

It – I mean those two, those two facilities alone, if we were to reprice at today's market, it's going to be about a $25 million hit.

Dan Mannes – Avondale

Okay.

Tony Orlando

Right, so that because today's market is below what those contracts are priced at. And I mentioned earlier, as I look at that, with 2.5 million megawatt hours exposed, it only takes a $10 per megawatt move to recapture all of that $25 million.

Dan Mannes – Avondale

Right.

Tony Orlando

So we still feel pretty good about – in fact, we feel very good about where we are, particularly given the location of those facilities, when we're focusing long-term. And that's what we're focused on, because even with that $25 million hit, we're still generating great cash flow next year. Our interest continues to decline. So our cash position next year is going to be, continue to be in very good shape with the ability to invest and try to take advantage of the low prices today and capitalize on that now for the long-term.

Dan Mannes – Avondale

Understood. And just one final question. On the waste side, I mean you mentioned on the open position on your waste, or we'll call it the merchant position on your waste, you'd seen some price declines and that was going to offset some of the contractual escalators. Is there also a bit of an issue on the escalators where we're seeing some lower input costs? Are the contractual escalators also going to moderate in 2009? Are those things both sort of working against you a little bit?

Tony Orlando

We certainly – we have seen a little bit lower in terms of our escalation provisions, but we also, we look at that as neutral because we should also be able to control our costs similarly. So the fact that we're going to have a little bit lower revenue because the escalations are a little lower, we should also be able to pick that up on the cost side.

Dan Mannes – Avondale

Understood. Makes sense. Thank you.

Operator

Your next question will come from the line of Michael Prober from Clovis Capital.

Michael Prober – Clovis Capital

Hi. I just wanted to ask you a quick question on the '09 guidance. You said that the prices declined an additional 10% I think from year-to-date until now. I just want to make sure that you've included that 10% in the guidance or you haven't included that in the guidance?

Mark Pytosh

The guidance range incorporates that movement.

Michael Prober – Clovis Capital

Okay. Thanks very much.

Operator

Your next question will come from the line of Shamo Sadukan from Lotus Partners.

Shamo Sadukan – Lotus Partners

Yes, hi, good morning. I'm trying to understand in the guidance for 2009, you should have some offsets in plant operating expenses because of lower commodity costs. How much benefit are you getting in 2009 from that?

Mark Pytosh

The – what we've assumed in the guidance is that – and if you look at sort of the 2009, we're offsetting about 30% of the decline in energy through lower hydrocarbon costs.

Tony Orlando

It's really – it's certainly one of the beauties of our business, is that we don't have to pay for fossil fuel, of course to run our facilities. We have some fossil fuel costs for equipment that runs around the site and for startup and shutdown of the facilities, but the beauty is that we pay very little bit for fossil fuel, so we have some ability to offset, but not – we can't get it all.

Mark Pytosh

Yes and I think as Tony said, on the metal side, we're not assuming a significant pickup there, although we're hopeful that we're going to see ultimately declines in our maintenance costs, which embed a fair amount of metals of materials in there. So we're not assuming that for purposes of guidance, but we're hopeful that we'll be able to find that during the course of the year.

Shamo Sadukan – Lotus Partners

And so in the 15 to 30 number that you give for energy prices, that's net of the lower plant operating expense you should get from lower commodity prices?

Mark Pytosh

That's correct. That's net of the hydrocarbon.

Tony Orlando

Yes, they're both net numbers.

Shamo Sadukan – Lotus Partners

Okay. And where are your current – if we look at your waste, your waste prices, either contracted waste prices versus market, where are you overall in terms of where your contracts are versus the market rates that you're getting right now?

Tony Orlando

I'd say that we're about at market. I mean our contracted prices are higher than the spot rate prices, but that's typical. I mean when we offer a long-term contract, that provides security and that provides value to our customer, so it's fairly typical for the contracted long-term rate to be a little bit higher than the spot rate. So we have some, some that might be a little high, some that might be a little low, but on balance, we're about at market.

Shamo Sadukan – Lotus Partners

And does the contracted position stay at about 85% in 2010 or does more come off contract in 2010?

Tony Orlando

It's going to stay right around that 80% to 85% contracted level.

Shamo Sadukan – Lotus Partners

Okay. Thank you. I appreciate the help.

Tony Orlando

Thank you.

Operator

Your next question will come from the line of Randy Gwirtzman from Baron Capital.

Randy Gwirtzman – Baron Capital

Hey, guys, good morning.

Tony Orlando

Good morning, Randy.

Randy Gwirtzman – Baron Capital

Quick question, just on, as you guys reconcile the 2008 adjusted EBITDA, taking out the insurance recovery and the debt issue, you get $558 million. You're going to take in $5 million to $10 million you think from new revenues from the acquisitions or new EBITDA (inaudible) from the acquisitions, lose $15 million to $30 million on metal and energy pricing and then the rest of the delta was what – you have somewhat higher overhead, which is how much?

Mark Pytosh

We didn't break that out exactly, but if you added the international business, the overhead and – can't remember the third point, but we basically – the escalation and those costs would offset each other. So it's really add $5 million to $10 million, subtract the – those two bigger items.

Randy Gwirtzman – Baron Capital

But that doesn't get you down to the $500 million range. I guess – right? If you're adding $5 million to $10 million off the negative $15 million to $30 million –

Mark Pytosh

If you took the extreme cases of $30 million and $30 million, you would get to that range.

Randy Gwirtzman – Baron Capital

What's the other $30 million? I know the worst –

Mark Pytosh

Metals and electricity. So $30 million in metals, $30 million in electricity.

Randy Gwirtzman – Baron Capital

It could be $30 million each in metals and electricity?

Mark Pytosh

Yes, yes, yes, $30 million each.

Randy Gwirtzman – Baron Capital

I'm sorry. I misunderstood that point. Okay. And the last question I had was the – when exactly do the Hempstead and union renegotiations occur during 2009?

Mark Pytosh

Well, the Hempstead contract ends in October –

Tony Orlando

October 31st.

Mark Pytosh

October 31st of this year. The union contract runs till the end of this year and I would say it's not a renegotiation per se. It's going to be, it's going to be sold into the market. Of course we might decide to contract it for a year out or we might decide to hedge the position, but there's not a negotiation per se. It's really driven by the market.

Tony Orlando

But those –

Randy Gwirtzman – Baron Capital

Okay so –

Tony Orlando

To your point, Randy, those are back end.

Randy Gwirtzman – Baron Capital

Right. So you'll have contract pricing until the end of the year. And you basically have until the end of the year to see how electricity pricing either stabilizes or changes.

Tony Orlando

Yes, exactly.

Mark Pytosh

Fortunately we have some time to see how this plays out.

Randy Gwirtzman – Baron Capital

And in terms of the negative impact that you factored into EBITDA, how have you looked at that – how does that factor into the minus $15 million to $30 million? It's – worst case scenario is down $30 million where you're kind of lower than expected electricity rates?

Mark Pytosh

Yes, that's – what we – based on kind of where the – what we've seen in the market, we try to put a range that we think based on where things are on the extreme side. If we got – if we added metals and electricity, it'd be $30 million each.

Tony Orlando

And we looked at specifically at the pricing range on electricity was in the mid $50 per megawatt hour for our exposed portfolio up to the low 60s. So that's actually a relatively tight band. It's really based on what we're seeing today that that's what we would expect.

Randy Gwirtzman – Baron Capital

Got it. Thank you very much, guys.

Operator

That concludes the Q&A session of today's conference call. I'd like to turn it over to Tony for closing comments.

Tony Orlando

Great. Well, thank you, everybody. We appreciate the time. We're looking forward to our next call when we can give you an update on some of our projects like Dublin and some of the other growth initiatives we've got going on. Thanks, everybody.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.

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