Covanta Holding Corp (CVA) CEO Discusses Q2 2013 Results - Earnings Call Transcript

Jul.18.13 | About: Covanta Holding (CVA)

Covanta Holding Corp (NYSE:CVA)

Q2 2013 Earnings Call

July 18, 2013 8:30 am ET

Executives

Alan Katz - Vice President of Investor Relations

Anthony J. Orlando - Chief Executive Officer, President, Director, Member of Technology Committee and Member of Public Policy Committee

Sanjiv Khattri - Chief Financial Officer and Executive Vice President

Bradford Helgeson - Vice President and Treasurer

Analysts

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Daniel J. Mannes - Avondale Partners, LLC, Research Division

Hamzah Mazari - Crédit Suisse AG, Research Division

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

Aditya Satghare - Lazard Capital Markets LLC, Research Division

Carter W. Driscoll - Ascendiant Capital Markets LLC, Research Division

Barbara Noverini - Morningstar Inc., Research Division

Brendan Naeve

Yilma Abebe - JP Morgan Chase & Co, Research Division

Operator

Good morning, everyone, and welcome to the Covanta Holding Corporation's Second Quarter 2013 Fiscal Results Conference Call and Webcast. This call is being taped, and a replay will be available to listen to later this morning. For the replay, please call (877) 344-7529 and use the replay conference ID number 10029940. The webcast will also be archived on www.covantaenergy.com and can be replayed or downloaded as an MP3 file. [Operator Instructions] Please note this event is being recorded.

At this time, for opening remarks and introductions, I'd like to turn the call over to Alan Katz, Covanta's Vice President of Investor Relations. Please go ahead.

Alan Katz

Thank you, Laura, and good morning. Welcome to Covanta's Second Quarter 2013 Conference Call.

We had a busy quarter in terms of facility tours and meetings throughout the East Coast. We'll be on the West Coast in a few weeks for some meetings and to hold a plant tour at our Stanislaus location. We look forward to seeing many of you then.

Moving on. Joining me on the call today will be Tony Orlando, our President and CEO; Sanjiv Khattri, our CFO; Tom Bucks, our Chief Accounting Officer; and Brad Helgeson, our Treasurer. We will provide an operational and business update, review our financial results and then take your questions.

During their prepared remarks, Tony and Sanjiv will be referencing certain slides that we prepared to supplement the audio portion of this call. Those slides can be accessed now or after the call on the Investor Relations section of the website. These prepared remarks should be listened to in conjunction with these slides.

Before I get into the Safe Harbor, I'd like to remind everyone that we hold regular plant tours every quarter. Our next one will be up in Boston in September. You can sign up for these on the Covanta IR website or by e-mailing ir@covantaenergy.com.

Now on to the Safe Harbor. The following discussion may contain forward-looking statements, and our actual results may differ materially from those expectations. Information regarding factors that could cause such differences can be found in the company's reports and registration statements filed with the SEC. The content of this conference call contains time-sensitive information that is only accurate as of the date of this live broadcast, July 18, 2013. 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 measure, and management's reason for presenting such information is set forth in the press release that was issued last night, as well as the slides posted on our website. Because these measures are not calculated in accordance with U.S. GAAP, they should not be considered in isolation from our financial statements, prepared in accordance with GAAP. It should also be noted that our computations of free cash flow, adjusted EBITDA and adjusted EPS may differ from similarly titled computations used by other companies.

With that, I'd like to now turn the call over to our President and CEO, Tony Orlando. Tony?

Anthony J. Orlando

Thanks, Alan, and good morning, everyone. Let's begin with a quick summary of the quarter. For those of you using the web deck, please turn to Slide 3.

Operationally, the second quarter came in pretty much as we had anticipated. We successfully finished our plants' spring maintenance activity, which puts us in a good position to have a strong second half of the year. This gives us confidence in reaffirming our guidance for the full year. Sanjiv will review the outlook in more detail.

We also continue to make good progress on our organic growth initiatives, which will benefit the second half of this year as well as the years ahead. Furthermore, we continue to secure long-term base revenue by signing a couple of waste contracts.

Our adjusted EBITDA and free cash flow came in a little bit better than expected during the quarter. This was primarily driven by a mutually beneficial power purchase agreement buyout that we completed in June after one of our New England energy customers approached us with a desire to terminate a long-term PPA that was slightly above market. This transaction positively impacted our adjusted EBITDA and free cash flow by $8 million this quarter. Sanjiv will review the financial impact in greater detail. And when I cover energy, I'll also highlight this transaction.

And finally, we've shifted our strategy in the U.K., which resulted in the noncash write-down. I'll also discuss this in more detail later in the call.

Now, let's turn to the business outlook. We'll start with waste on Slide 4.

Our view of the markets remains the same, with our special waste business and contract escalation almost entirely offset by lower year-over-year spot prices and the impact of contract transitions. We have approximately 80% of our waste revenue under fixed price contract for 2013, which provides us a nice base of stability for our waste revenues, and most of our contracts extend well beyond this year.

Growth in our special waste business is on track, and we are now working with a number of well-known companies to dispose of their waste in an environmentally-friendly way. Our client roster includes a number of major auto brands such as Subaru, GM, Chrysler, Toyota and Honda, as well as several industrial and consumer goods companies such as Mary Kay Cosmetics and Sunny Delight, among others. We secured additional contracted waste volumes this quarter by signing a number of agreements with municipalities in Connecticut and Massachusetts for our bundled service offering. Each of these contracts is relatively small. But in total, they represent 400,000 tons of waste and 75,000 tons of recyclables. These are important contracts for us because we're providing what our customers want, an environmentally superior, single-point solution for their waste management. The services include long-term disposal at our Energy-from-Waste facilities, recycling, e-waste and, in some cases, composting and bulky waste. We also signed a 15-year extension of our service fee contract such that we'll continue operating on similar terms the municipally-owned MacArthur facility on Long Island.

Our 2013 outlook for waste hasn't changed. For your convenience, we've repeated all of the key factors regarding our outlook on this slide.

Moving on to our energy portfolio, please turn to Slide 5.

Natural gas and electricity markets are still up year-over-year, but we've seen a pullback in prices after our last earnings call. Full year average natural gas is now forecasted to be about $3.70. That compares to $3.50 when we initially issued guidance and $4 at our first quarter earnings call. As a reminder, our rough rule of thumb is that for every $1 move in natural gas prices, we'll see a $5 million to $10 million annualized impact to our 2013 adjusted EBITDA. So versus initial guidance, we're up $1 million to $2 million.

The only other noteworthy point relates to the power purchase agreement buyout that I mentioned earlier. The utility that purchased power from us under a long-term PPA approached us about buying out our contract, which was slightly above market. After some negotiations, we agreed to a lump-sum payment of $8 million to terminate the agreement. This will increase our annual exposure to market prices by about 350,000 megawatt hours. We've already hedged the additional exposure for this year, which will result in a net 2013 benefit of $7 million. This transaction is not expected to have a noticeable impact to energy revenue through 2016, and we expect only a small negative impact from 2017 through 2019. And again, that's based on current forward curves.

Let's move on to the metals on Slide 6.

Year-over-year net metal revenue was down $1 million, driven by a 15% decline in ferrous market prices. We were able to offset some of the market price decline by recovering more nonferrous tons. We've made great progress on this front, as our nonferrous tons increased by 40% compared to the same quarter last year. No question, we'll see that improvement accelerate in the second half of the year. However, we still have a lot of work to do to achieve the year-end target run rate we set for ourself, which was approximately 340,000 tons of ferrous and 25,000 tons of nonferrous. Overall, I'm very pleased with our effort to remove -- to improve our recycled metal revenue.

Recovery rates for the new systems have been consistent with our plan, and we continue to gain valuable process knowledge as we focus management attention in this area.

Of course, market prices will continue to be a big driver of metal revenues because, unlike electricity, we have no effective way to hedge this commodity. Recall, our rough rule of thumb states that a full year $50 move in the HMS #1 Index would be a $10 million to $15 million impact in our adjusted EBITDA. Ferrous market prices are slightly down compared to our original guidance, which assumed 2013 HMS price of $350. This compares to the actual year-to-date HMS price of about $340. The July price is also $340. And assuming it stays there for the rest of the year, it would translate to a $2 million to $3 million adverse impact versus original guidance.

Before moving on, let me give you a quick update on the joint venture we formed to mine metal from ash monofills. If you recall, we partnered with a German technology company called Tartech. And when we formed the JV last year, we were hoping to invest in our first project this year, with returns beginning in 2014. So far, so good. We have, in fact, started construction of our first project, and we expect to see this joint venture generating modest equity income next year.

Turning to Slide 7. I want to talk briefly about our change in strategic direction in the U.K. Just after the last earnings call, we reported the Merseyside decision not to select us as a preferred bidder. We've challenged that decision in court because of what we see as irregularities in the award. In any event, though, we've decided to change our approach in the U.K. We've significantly reduced our Birmingham staff and we've ceased pursuing large development projects on our own. In addition, we're exploring all options regarding our U.K. development projects, ranging from monetizing these assets to potentially partnering with someone to grow in the U.K. As a result of this change in strategy, we've recorded an accounting write-down, which Sanjiv will take you through shortly.

I want to point out that our shift in strategy in the U.K. has no impact on our Dublin project. We continue to work on that deal and still see Dublin as a good project if we can complete the project financing. But there's nothing new to report on that front.

Now back to the U.K. Many of you are asking, what does all this mean for our capital allocation plan? In short, our capital allocation plan has not changed. Of course, we're committed to our regular quarterly dividend and we hope to grow it over time. The highest return and best use of the remaining cash is to invest in attractive growth opportunities. To the extent more of these opportunities materialize, we'll invest more. To the extent fewer materialize, we'll buy back more stock. Hopefully, our track record over the last 3 years in making disciplined investments and using the excess cash to buy back shares speaks for itself.

As we've previously noted, we expect to invest $75 million to $100 million this year in organic growth, and we currently think we'll be at the high end of that range. I mentioned last quarter that we have a number of opportunities to grow the business, some smaller, some larger. The timing and likelihood of these is hard to predict, but I'm optimistic that some of these opportunities will come to fruition. The level of success we have in this regard will dictate the amount of growth investments versus share buyback. Maintaining this flexibility allows us to optimize value creation based on the facts we have at the time of the decision.

Overall, the business is on track. Our operating performance is steady. We continue to effectively manage through contract transitions and our organic growth initiatives are making good progress. I remain optimistic that we'll both achieve this year's financial targets and continue to see modest growth in adjusted EBITDA and free cash flow in the years to come. On top of this steady performance, we have upside if we can complete some of our larger growth opportunities.

And now, I'll turn the call over to Sanjiv for his remarks.

Sanjiv Khattri

Thanks, Tony. Good morning, everybody, and good afternoon to those of you calling in from Europe. I hope everyone's summer is off to a good start. I can't believe how hot it's been recently. Unfortunately, it hasn't moved the long-term energy curve. But hopefully, it will.

Before I go to our results, I wanted to give a good shout-out to Tom Bucks, our Chief Accounting Officer, whom many of you have met. His wonderful daughter, Laura, is getting married on Saturday. He made sure we had a smooth earnings process so there was nothing in the way of the celebration. Thank you, Tom, and congratulations to you and the family.

Now back to business. First, I want to spend a minute on some housekeeping. As a reminder, we've included on Slide 21 and 22 our free cash flow walk, which shows how you get from book earnings to our free cash flow. This is an important analysis, especially when our adjusted EPS is so low. We also have our detailed P&L on Slide 18, as well as the usual non-GAAP reconciliations. We're happy to take any questions on these, of course.

Now on to the main deck. Slide 9 lays out our Q2 2013 financial highlights. Very briefly, as Tony described, this quarter came in a bit better than expected from a financial results perspective, but we were right on target operationally. The mutually beneficial PPA buyout was an $8 million positive factor on both of our adjusted EBITDA and free cash flow lines in the quarter, and our organic growth initiatives are really gaining traction.

In case you're wondering why I said this is an $8 million impact but Tony said $7 million, this is an $8 million benefit in the quarter but a $1 million negative for the rest of the year, netting to $7 million. For those of you bookkeeping us, the $8 million is in the P&L as a contract expense in the Other Operating Expenses line this quarter.

Before we go to the waterfalls, let's turn to Slide 10, where I'd like to spend a few minutes on the impairments and restructuring charges that we took this quarter. As you all know, we lost the Merseyside contract award in the U.K. And as Tony discussed, this precipitated a rethink of our strategy there. From a financial point of view, the immediate impact of this is a noncash write-off of $46 million for our capitalized development costs in the U.K. If you recall, we discussed this earlier -- disclosed this earlier, excuse me, in July. We looked at the assets that we had on the books and decided that, given the Merseyside decision and the fact that we would no longer be pursuing other projects in the U.K. in the same format that we had in the past, this was the appropriate action to take. This write-down represents our full investment in the U.K., net of any estimated recoverable amounts.

In addition, the downsizing of our office in the U.K. resulted in severance and additional cash costs of about $3 million. I'll note that there was virtually no tax benefit associated with these charges, so there will be a bigger drag than normal on GAAP EPS and our effective GAAP tax rate. I'll get into this in a bit more detail in a moment. Though in any event, we exclude the impact of the impairment and restructuring charges from our calculation of adjusted EPS, so there is no impact on that guidance metric.

We also had some developments in the capital loan outstanding related to the Harrisburg EfW facility. The state-appointed receiver is making progress in resolving the whole situation there, and we want to be a constructive part of the whole solution. While nothing formal has happened, based on the latest development, we have written down our loan another $4 million to -- down to $9 million. This debt was originally $20 million, which we had written down to $13 million in 2010. We continue to operate this plant really well, and the client has always remained up-to-date on their monthly O&M agreement. Remember, we got involved in the facility in 2007 and completely turned it around. Our current contract runs through 2018. And as part of any overall solution, we'd fully expect to continue performing under that contract in a way that is beneficial to both us and the community that we so proudly serve.

As I've mentioned, net-net, the impairment and restructuring charges totaling $53 million pretax impacted reported GAAP EPS by $0.40 for the second quarter.

A quick comment on taxes. Our second quarter year-to-date 2013 GAAP effective tax rate was 13%, driven -- lowered by the impact of foreign losses without any resulting tax benefits, including the write-off of U.K. development costs for the quarter. The GAAP effective tax rate, excluding the write-off of U.K. development costs and restructuring charges, would have been approximately 48%, in line with the range we had discussed at the start of the year. The GAAP effective tax rate for the whole year is now estimated at 94%. This increase from our forecasted range is a result of the write-off of U.K. development costs. Exhibit 4-A in our press release goes through this in greater detail.

However, our full year 2013 effective tax rate, excluding the impact of the adjusted earning write-downs, is expected to be approximately 46%, so unchanged from earlier guidance. I know this is not easy to follow. But if you look at our adjusted EPS, which eliminates the impact of these onetime items, our effective tax rate for the full year is unchanged and still in the original 45% zip code.

Notwithstanding all this activity in book taxes, more importantly, total net cash taxes to be paid in 2013 are still expected to be in the $10 million to $15 million range, representing the continued optimal use of our NOL and other tax planning initiatives. Consistent with the importance of free cash flow, this is what we really focus on.

Stepping back at this time, I also have no change to report on the company's overall tax outlook, which we have been discussing over the past few quarters.

Moving on, we've included our usual waterfalls again this quarter on Slides 11 to 14. I know you find them useful. And over time, they have become quite self-explanatory. Therefore, in an effort to be succinct -- I know, me being succinct -- gives us a bit more for Q&A. So I won't go through them in detail. However, there are a few key items that I wanted to address. And of course, as usual, we are happy to take questions on them later.

First, looking at adjusted EBITDA. Note that maintenance timing continues to be a negative year-over-year driver this quarter. This will reverse in the back half of the year, and we'll see the benefit in terms of lower maintenance expense in Q3 and Q4. I'm sure you remember the decision we -- a discussion we had over the last 2 quarters on maintenance spend seasonality. You may also be wondering why our organic growth and other bucket is positive in our revenue waterfall but negative in our adjusted EBITDA waterfall. There are 2 primary reasons. First, water maintenance timing that I just discussed, that was worth $7 million. Second, we had a few things that boosted Q2 2012 and did not happen in Q2 2013. We had a higher insurance reimbursement in Q2 2012. We also had a higher construction profit last year versus 2013. And finally, we had some benefit last year relating to the close-out of an operating contract.

In terms of free cash flow, working capital and other improved by $16 million versus second quarter of last year related to the ups and downs of construction-related working capital. During this past quarter, construction working capital was negative, but it was even a larger negative last year. This will reverse itself in the second half of the year. I will discuss that more when we talk outlook for the rest of the year.

One last point on the waterfalls before moving on. On our adjusted EPS, you will remember that last year in Q2, we had a onetime benefit from the equity swap that we completed in our China operations, which positively impacted equity income in 2012. We obviously didn't have a similar benefit in this quarter, so we will have a year-over-year decline on that line.

Now, let's move to Slide 15 to discuss our capital returns. In the quarter, we paid out our March dividend in April and announced another dividend in June, which we just paid out earlier this month. We are now back on our regular dividend cycle of making our dividend announcements in the last month of the quarter and paying out the following month. As I've mentioned in the past, we see this dividend as being both very meaningful now and also as having room for growth over time, especially as we aim to grow our free cash flow.

During the quarter, we repurchased $10 million of stock, reducing our share count to 130 million shares outstanding at quarter-end. We have now bought back almost 18% of the company since we started the buyback program about 3 years ago. While our buyback activity was a bit lower this quarter, in the context of our calendar year free cash flow generation, our regular dividend payout and our planned growth investments for the year, I expect that in 2013, like 2012, we will end up using all of our free cash flow to fund these 3 activities.

As Tony mentioned, and I know I'm repeating myself here, our overall capital return policy remains unchanged. We plan on using our cash to grow the business by investing in high-return projects. We have a strong, stable dividend, which we hope to grow over time. And absent large growth investments, we will continue to buy back stock with our strong free cash flow.

I'm confident by the time the year is over, you will be satisfied with how we have allocated our cash flow.

Before I wrap up, I'll quickly talk about where we stand on guidance and how the third quarter is shaping up. I'm on Slide 16.

As Tony mentioned, we are reaffirming our guidance for 2013. No change there. This means that a couple of strong quarters are ahead of us. For the third quarter, specifically, adjusted EBITDA should be higher versus Q3 2012. As discussed earlier, our 2013 maintenance spend was more weighted towards the first half of the year, so you'll see the benefit of maintenance timing in our year-over-year comparisons for the remainder of this year. In addition, the organic growth initiative will benefit the second half earnings. These benefits will be partially offset by the year-over-year decline in debt service pass through billings.

Also recall, we had a $9 million impact from Sandy in Q4 2012.

Cash flow continues to be steady on an annual basis, but a challenge to provide an outlook from a quarter-to-quarter basis. Again, this is a function of the timing of working capital related to our construction projects. The core operating business is stable as a rock, and we have good handle on our day-to-day working capital and maintenance CapEx.

By the way, our maintenance CapEx outlook for the year is unchanged at $80 million to $90 million, as is core operating cash flow trends. The big variable for free cash flow remains the timing of construction working capital. The third quarter is a stark case-in-point. Remember that our third quarter is generally our highest in terms of free cash flow generation. It's when most of our maintenance activity is behind us and most, if not all, of our facilities are running at full capacity to take advantage of the hot summer and generally higher power prices. However, this year, there is a large payment that we expect relating to our construction work. If the payment comes in the third quarter, then our free cash flow for Q3 will be up significantly versus Q3 2012. If instead the payment comes in the fourth quarter, then the opposite will be true. We will see a meaningful decline in the third quarter year-over-year free cash flow.

The important takeaway here is, when the year is over, we expect free cash flow to be strong in the $250 million to $280 million range for the year, regardless of the Q3 and Q4 volatility.

Lastly, as we did for the first half of the year, we will see the impact of interest and depreciation from the Del Valley acquisition, but this should be more than offset by the growth in our core business. As a result, adjusted EPS should increase in the third quarter related to Q3 of 2012, as a result of the forecast higher adjusted EBITDA.

Before we move to Q&A, I'd like to discuss our growth investments and give a bit of color on how I feel we are positioned for the rest of this year in this important category.

We see a number of solid growth opportunities for the remainder of the year in our metals, special waste and energy areas. Therefore, we are investing to take advantage of these opportunities as soon as possible. As Tony mentioned, we expect to be at the high end of the $75 million to $100 million range that we had discussed at the start of this year. We have included a chart on this in the appendix, I believe it's Slide 19, to lay it out in detail what's in it and how that compares to last year. These growth investments are for a few larger, chunkier projects and a number of smaller ones. The larger ones include a new railhead at our Niagara facilities. This will allow us to take in special waste and services, other contracts that may need disposal capacity. It will also help ease truck congestion around the facility. We are also investing in the installation of a new steam line and natural gas package boiler in our Niagara plant, where we have a 10-year steam offtake contract with a nice collar price. This investment will increase the energy capacity of the plant by the equivalent of 150,000 megawatt hours. We had discussed this investment in Niagara in late 2012.

We are upgrading our boiler system in one of our Chinese plants. This will allow us to take advantage of the strong energy markets there. We also have fairly significant investments in upgrading the emission systems at our Essex facility. We spent a bunch of time on it when we announced that deal last year. In total, we'll invest $75 million to $100 million through 2016, and we'll start spending this year.

Tony also alluded to the progress on our first project in the Tartech joint venture, so we are investing in that as well this year.

Lastly, we have a number of special waste investments and new metal systems, which add up to a sizable investment in total.

As you can see, we spent $125 million last year on growth investments, with approximately $40 million of that on what we call organic growth. We're on track to spend in the $100-million range on our organic growth, as well. These are attractive investments with nice return profiles. This will help us address the contractual headwinds that we have on the horizon and allow us to continue to grow our financial metrics this year and beyond. In many ways, these investments manifest the creative ways the operating teams are thinking of increasing the value of our core portfolio.

Our operations team is executing well and keeping our facilities up and running, and our asset management team continues to improve their already stellar track record. We have now completed 24 out of 25 contract renewals. That's an impressive record by any stretch of the imagination.

One more small but notable example of innovation is the $21 million junior 30-year debt issuance done in early July by the treasury team. Great optionality and very cheap. Over the past year, we've increased our focus on innovation to squeeze more from the existing business. I can honestly say that it's been a great experience watching the cross-pollination between our teams and the results that are starting to come from this.

CFOs measure their tenure by the number of earnings calls. By that measure, this is already my 12th earnings call. It's amazing how time flies when you are having fun. We have gotten a lot done. And while there have for sure been more than a setback or 2, I like how well we are positioned to continue to grow the baseline business over the next few years, even assuming no big-G Growth or positive energy optionality. Of course, we are working hard for you to deliver even more. So here's to another exciting 12 quarters.

Now, let's take some questions. Laura, please open up the phone lines. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Al Kaschalk of Wedbush Securities.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Tony, if I could start. First part of my question here would be on the larger projects and -- in assessing the similar approach to the U.K. Should we read anything into what sounds like you're going to go more JV-oriented, partner with others, as opposed to making individual investments on your own, as to the quality of the U.K. project pipeline? And then if you could maybe just lift off from that, maybe talk about the broader view on the larger project pipeline?

Anthony J. Orlando

Sure. Sure, Al. The U.K., obviously, has been a focus for us in the past, and we had a setback there. And so we've adjusted our thinking and our strategy. We are really looking at all the options as to how to best approach that. But I think the key takeaway is that we have significantly reduced our staff there. We'll see some benefit later in this year, in terms of spending. And I would expect, as we're thinking about that next year, that we'll see very little, if any, spending in the U.K. in terms of our staff. There may still be opportunities for us, and we'll evaluate those opportunities as we go forward. But the approach that we've taken, where we had a large staff, going it by ourselves and pursuing large projects, we've decided to change that strategy, given the results that we've had to date.

So I -- hopefully, that's clear. To the extent that opportunities arise, we'll obviously get into those in the future. With respect to the larger pipeline, I had mentioned on the last call that we have a number of opportunities, some small, some large. We obviously have 1 less large opportunity now than we did when we spoke last quarter, but we still have other opportunities. So just -- it's just premature, though, to get into the specifics of those. As we said before, the timing, particularly of the large projects and large opportunities that we have, it's very difficult to predict the timing. And so what we're doing is maintaining a capital structure that gives us the flexibility to make smart decisions when we know where those deals play out.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Would you say then that the structure or your approach to the U.K. is germane only to that market and not necessarily other markets outside of the U.K.? In other words, are you...

Anthony J. Orlando

Well, I would say that -- I'd have to say, when we approached international markets, and certainly China is a case-in-point, but we've done this on other transactions over the years, we have typically approached it with joint ventures outside the U.S., or in some way, shape or form of partnership. Our approach to the U.K., we thought we could be successful focusing with our expertise, without necessarily those partnerships. In hindsight, maybe that wasn't the best call. But I think what is consistent across the board is that when we're looking at making the decision to make the investment, we've been disciplined. And we want to make sure that we get a good return and effectively deploy the capital when it's time to move into whether it's an acquisition or a development project. And we want to maintain that discipline, and we'll continue to look at what's the most effective approach for each different market we're pursuing. But no question, our focus now is much more on the North American market than it was in the past.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Okay. And then finally, Sanjiv, could you comment on the senior note that's I think due early '14? Maybe it's second quarter, I believe. But what -- either the timing is on a -- either a refinancing or conversion, et cetera?

Sanjiv Khattri

Sure. Sure, Al. For everybody's benefit, second quarter of next year, $460 million, give or take, of that convert is due. Obviously, we have been very prudent and measured in how we have refinanced any of our maturing securities. Still a full year to go. We obviously know that we have a nice revolver. So in the appropriate time, based on market conditions and all the opportunities that Tony talked about, we will make a decision on how and when to finance it. So I expect this to be fairly good. We've -- our credit continues to receive great appetite. I think in the appendix, we actually have a capitalized summary that shows the balance sheet. So we're in pretty, pretty good shape and I'm not concerned at all about that. It's a full 1 year to go.

Operator

[Operator Instructions] And our next question will come from Dan Mannes from Avondale.

Daniel J. Mannes - Avondale Partners, LLC, Research Division

Wanted to follow back up on sort of the capital allocation in the large projects side. With the retrenchment from the U.K. and with the acknowledgment that you still have some cash overseas that could be used to fund Dublin, I guess I'm a little bit interested in what else is out there in the pipeline of large projects that would constrain you from, perhaps, being a little bit more aggressive with your balance sheet currently? Because I know you've kind of restrained your willingness to lever up a bit, given the prospect of big spending out there. And I guess, I just -- I'm not sure what the outlook is for that now.

Sanjiv Khattri

Well, Dan, we've been fairly transparent in terms of what's been in the hopper, and maybe more so than we should have been. And unfortunately, we've shared the failures with you with the successes. But through all this process, as Tony mentioned and I articulated, we -- again, we have been very disciplined with the capital. Whatever we've generated has gone back to 3 uses. I think we've been pleasantly surprised at how many good opportunities we have within our U.S. core portfolio in order to leverage it more and generate even more cash from it. So in the near term, I mean, unless we decide to massively lever up the company, we actually have good uses for the capital. Over time, we will follow a very disciplined process with the board where we look at our 5-year plan and we look at our 1-year plan, and we look at what's happening to cash flow. And to the extent that we see limited opportunities, then consistent with our policy, you will see some movement both either in dividend or in stock buyback. But in the meantime, I mean, we have $250 million to $300 million -- $280 million of free cash flow this year. And you look at all the stuff we have going on. So we have been pretty prudent. With respect to the overseas cash, again, right now, it would incur a massive economic penalty to bring it home, so we are sitting tight on it. We've got some few ideas in China. And obviously, we are on standby for Dublin. But again, that will -- we will be very transparent to you in terms of what and how we manage that, if that happens. So I think, Dan, we are sort of working prudently. But over time, we'll figure out what to do.

Daniel J. Mannes - Avondale Partners, LLC, Research Division

All right, and I guess the follow-up here, and this would be in terms of a U.S. opportunity. I know you haven't wanted to talk about it much publicly, but as it relates to New York City, can you at least talk about maybe where you are in the process of getting a final contract there, to maybe just frame what that opportunity is?

Anthony J. Orlando

Sure, Dan, I'll take that one. I think, again, there has been a fair bit of information out there publicly. This is a process that's been going on for a very long time. It relates to a bid for New York City to transport and dispose of some of the waste from the -- that the city generates via marine transfer stations. We have been selected by New York City for a portion of that waste, but that does not mean that this is a final decision. The city has a very long and thorough and time-consuming approval process. And so if the city approves the contract and in fact awards it to us, we'll be excited to talk about it at that time. But it's just premature to get into it at any level of detail at this time. And again, this process has been going on for a long time. So at the end of the day, it's the city's decision as to what to do. It's the city's decision as to when to do it. And when they make those decisions, then we'll be happy to kind of fill in the details.

Daniel J. Mannes - Avondale Partners, LLC, Research Division

Okay. And that's perhaps one of the areas where you might have some capital spend. I think you've even been on record as applying for potentially $100-plus million of funding to build that infrastructure in support of it.

Sanjiv Khattri

Yes, totally. That's one of many things, Dan. Again, without being too specific, obviously, that's in the hopper. But to speculate on when and how much is premature. We will be very transparent when and if that happens.

Operator

And the next question will be from Hamzah Mazari of Crédit Suisse.

Hamzah Mazari - Crédit Suisse AG, Research Division

The first question is just on some of these large CapEx investments that you're making, maybe $100 million this year, $125 million last year, could you give us a sense of the return criteria, the payback criteria? And maybe how investors should think about the contribution to organic growth and the ramp-up on the revenue profile of the company going forward?

Sanjiv Khattri

So good question, Hamzah. So basically, first of all, overall, we are quite disciplined about these investments. We typically look at cash flow, and we do look at IRRs of the investment. A lot of these metal projects and some of these add-ons that we are doing in the plants, they typically have very high return because they are already adding on to a current infrastructure that we have. So the marginal investment is a good payoff. In some cases where it's a stand-alone investment, the returns are lower but still in -- significantly in excess of our cost of capital. So we follow a fairly rigorous process. Some of these, of course, unfortunately, are -- we can't control the timing of which because some of them require regulatory approvals in timing. And as it happens, we have a flurry of activity going on this year, which is adding up to the $100 million level. And I took you through certain returns. This will allow us to do 2 things. We always, always talk about -- we always talk about the fact that it will allow us to grow. I mean, Tony, when we talked at the start of the year how we expect to grow our earnings over the next several years of free cash flow. So that's sort of one, but the other thing, the reality is, we have some secular headwinds as a result of our contract transitions. If you just look at the EBITDA level, how much debt service revenue we have lost, you look at all the PPAs go from contract to exposed and you look at some of the more secular trends in waste, the fact that we have offset all of those and we expect to offset all of them in the future is as a result of these great investments that the team is making at the plant level. On top of that, versus the grain we are still expecting to grow. So that's sort of how you should see it in the context. As some of these transitions start to stabilize, then obviously, the pickup will be more magnified. But that's -- when we see that, we'll obviously talk about it. Does that answer your question, Hamzah?

Hamzah Mazari - Crédit Suisse AG, Research Division

Yes, that's great. And just a follow-up, maybe for Tony. You talked about the U.K. strategy quite a bit. Maybe if you want to just touch on what you're looking for a partner? You've clearly partnered up in other regions. What are you looking for in a partner? And has your past experience changed maybe what you're looking for going forward?

Anthony J. Orlando

Well, I guess in the simplest context of a partner, we always like to say that the partnership has got to be 1 plus 1 equals 3. And that can come in a lot of different forms, based on the location, what we bring to the table, what the partner brings to the table. Certainly, companies that are in the waste business and have waste supply can be attractive. But there's a number of different partners that could be attractive in the U.K. I think right now, we're going to evaluate all of those options, but the key for us here in the near term is to look at what we can do with the assets that we do have as we really kind of transition to a very small staff in the U.K. And we'll look at all those different options.

Operator

The next question comes from Ben Kallo of Robert W. Baird.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

First question's on the PPA. Do you guys have other opportunities like this, where we could see some kind of similar transaction? And should we take away from this that you guys are bullish on electricity prices going forward? That's my first question. And then my follow-up is, we're approaching mid-part of the century here, 2015, and NOLs are going to become a question mark and your cash tax rate. What kind of planning are you guys doing now? And how should we think about that as we get closer to 2015?

Anthony J. Orlando

Ben, I'll take the PPA and then let Sanjiv handle the tax. I think with respect to the PPAs, I think in many respects, we're opportunistic there. The counterparty has a desire to get out of that contract for whatever their reasons were. They approached us and we did something that we thought made sense for both of us. It's a pretty small difference between the current market and that particular contract. As we said, we're really expecting kind of a -- not even to notice the revenue impact for the next several years. And so we thought it was a good deal for us. Now to the extent somebody else is interested in that, that would be fine. But I don't really expect that we're going to see other transitions -- other transactions, rather. We don't see any on the near-term horizon, but you never know. I think probably the bigger point there is that we -- whether or not we do any terminations, we have a lot of contracts that come to an end in the next few years. So our energy market exposure is going to increase fairly significantly. We've reviewed that and laid it out on a couple of occasions. We didn't update it, but we gave you the number. There's an extra 350,000 megawatt hours on top of what it was the last time we updated it. So we're going to see a pretty big increase in our exposure there. We continue to manage that, I think, very methodically as we look at what kind of volatility that we will take. We're hedging for 2014 now, just as we -- last year, we hedged for 2013 at this time. And so we'll continue to do that methodically so that our near-term volatility is minimized. But look, I think we're in a good position because of where our assets are located. We're not paying for energy. Natural gas, we'll have to see where that plays out. I think certainly the conventional wisdom is, right now, it's going to go up modestly but not dramatically. But we'll see how that plays out, as people continue to convert, whether that's coal or for power generation or transportation or LNG export. I think that, given the prices, the demand for natural gas is just going to continue to go up. And long-term, I think that's going to push up energy prices where we've got our facilities.

Benjamin J. Kallo - Robert W. Baird & Co. Incorporated, Research Division

Sanjiv, I guess that's mid-decade I was saying.

Sanjiv Khattri

Yes, exactly. I was -- I thought you were talking about the hot weather here. It's going to be 100 degrees today. So talking about summer. But very briefly, just for some of those who are new to the story, if you go to the IR section of our website, you will see a nice little chart that lays out how our exposure plays out over the next several years. And then depending on your view on energy, whether it's bullish, bearish or whatever it is, you can make your own assessments. Very briefly on the tax issue, we expect at this time -- at the year end 2012 when we last updated the number, we had a protection of about $400 million of federal income against the NOL. And we thought that -- we expect, based on our current outlook, we expect that to survive until about the mid-decade, which, you are right, is 2015 or so. After that, we still have a fair amount of unused PPC and AMT credits that would continue to bring the tax rate down to below the statutory 35% tax rate. And then, of course, later in the decade, and if absent anything else happening, we would be fully tax-paying. Clearly, of course, there are 4 variables that could affect this outlook, and then I'll talk to the one you specifically alluded to, Ben. So the 4 variables are our operating performance, of course. Up or down, it will do better, it grows sooner. If we do worse, then it takes longer. This is on our tax books, remember. The second is, if there is any tax reform -- there's always a discussion of our tax reform. If that does happen, that will actually be helpful to us. And then you do know that we have an IRS audit going on right now. That's the normal cycle audit from 2004 to 2009. And as a result of that, that could create some use of the NOL. And then finally, we have -- we are looking at various tax planning ideas. Clearly, as we've got a good tax team and myself, we are very focused on reducing our cash taxes. So that has priority right now. But the outlook that I gave you right now is the right outlook, mid-decade and then late into the decade, before we become fully tax-paying.

Operator

And the next question will be from Sanjay Shrestha of Lazard.

Aditya Satghare - Lazard Capital Markets LLC, Research Division

It's Aditya Satghare from Lazard Capital Markets. First question is that, so we've seen some good traction on special waste, bundled services and recycling. Could you elaborate a little bit more on how we should think about the growth opportunity here? And I mean, what's the best way to think about how large this opportunity could be?

Anthony J. Orlando

Sure. This is Tony. I'll take that question. Again, I think -- we first talked about this, it was probably -- I think maybe it was 9 months ago. And at the time, we said we'd been working on it for about a year. Really, we're responding to what our customers want to see. I would say that it does tend to be a little bit more regional, so in Connecticut and Massachusetts, where we've had success, and generally, I think, in the Northeast, where you tend to have smaller municipalities as opposed to other parts of the country where you have large counties that handle waste. It's more attractive to those smaller communities to eliminate the administrative expense and the other burdens of having to deal with so many different waste disposals, to kind of pool that all together with one provider that provides that service. And so we're pleased with how it's grown. We hope to see it continue to grow. We have taken an approach with this where we have partnered with recycling providers. So I will say that we, at least to date, have not taken commodity risk with respect to the recycling. And we'll continue to see where this grows. But clearly, the customers like the administrative savings and the simplicity, but they also like the fact that we're providing e-waste recycling services, and municipalities want to continue to find a way to be more environmentally-friendly with their overall waste management, and we want to try to service those clients so that we can kind of expand the business there as well.

Aditya Satghare - Lazard Capital Markets LLC, Research Division

Got it. My follow-up question is that, Sanjiv, you mentioned that free cash flow in the third quarter depends upon the timing of the construction payment. What are some of the factors impacting that? Is it sort of just sort of meeting construction guidelines and milestone payments? Or is there -- what's the best way to think about that?

Sanjiv Khattri

So Aditya, good to hear from you. And Sanjay is -- correct name is Sanjay Shrestha, for everybody's benefit. Aditya, you're exactly right. There are certain milestones in an agreement. And while the overall construction is going really well, the way the milestones work, the cutoff could actually be right between a quarter. And that's sort of primary driving it. So -- and one unique thing about this project that I did mention a year ago or so when we were starting the real work on it, it's a $250-million project. And once you start the construction work, the disbursements are fairly smooth because you have a full team there, you are buying, stuff is going on. However, the receipts are very lumpy. And that's how our client negotiated it. So the client waits for a bunch of activity and then makes us a big payment. As it turned out, as some of the milestones have worked out, the payment is fairly significant. I think an important point to remember though is, number one, that the core operating cash flow continues to be very strong; number two, the full year is still very robust at $250 million to $280 million; and finally, these construction projects, in the end after everything is said and done, generates a modest profit, very modest profit. But in this case, the end result after finishing the project is a 20-year O&M contract in which we serve the community and make a decent amount of money. So net-net, it's a good thing to do, and we take these lumps and we have the financial flexibility to handle the ups and downs.

Operator

Next, we have a question from Carter Driscoll of Ascendiant Capital Markets.

Carter W. Driscoll - Ascendiant Capital Markets LLC, Research Division

I want to talk maybe just about the implementation of the metals recovery and what you -- as you've gone through this implementation and, obviously, corrected some of the early problems you had last year, what you've learned both positively and negatively to help assist you in either accelerating or maybe even potentially extracting more valuable metal content. If you could just elaborate there, I'd appreciate it.

Sanjiv Khattri

Sure. Currently, the metals projects are -- it's an ongoing learning. We obviously have been recovering and recycling metal for a long time, but we had a very audacious plan, candidly. I think -- I mean, Tony is a tough driver and he's been pushing the team to go, go, go. And as a result, we had a lot of things going on. And as we put more and more new systems and more sophisticated magnets, and magnets for smaller metal, nonferrous systems, obviously there are learnings along the way. And I need to...

Anthony J. Orlando

Maybe just to add a couple of points on that. I think that there were -- there's 2 general areas both for recovering ferrous metal and nonferrous metal. I think that we are -- we've been focused, really, with most of our investments have been in the area of nonferrous metal recovery because many of our plants did not previously recover nonferrous metal. And secondly, about this time last year, we started up our first -- what we called our small nonferrous recovery, where we were going after very small pieces of nonferrous. I think we continue to learn how to optimize the value of that smaller -- it's a slightly different market for the small. So we're continuing to kind of work to find ways to optimize the value and what the best way to market that material is. So we're continuing to get smarter there as we bring more and more systems on with the nonferrous, and again, we were very happy with the 40% increase this quarter, but we also expect that increase to accelerate in the back half of the year. The other thing that we're focused on, and I'd say we continue to get -- I don't think we're where we want to be at -- we're looking at how to optimize the value. We're trying different techniques with cleaning the metal. We have seen that, that actually reduced the tonnage a little bit. Net-net, we got a little bit of pickup in revenue from that. So we're continuing to kind of tweak how we can create the most value. We're also looking at new types of magnets to see if we can recover a little bit more ferrous. We just installed some new -- what's known as rare earth magnets. They have a slightly stronger field, and how can we get every last little bit of value out of that ash? And so I think we're going to continue to get smarter. We've focused a lot of attention on it, and we're looking forward to that as a nice part of our organic growth plan overall.

Carter W. Driscoll - Ascendiant Capital Markets LLC, Research Division

Okay, I appreciate that. And if I could just, as a follow-up, shift gears a little bit back to the bundled contracts. Could you maybe just talk a little bit about the potential for this being an opportunity to make customers stickier versus maybe some competitive displacement of -- and potential maybe metal market share gains from being able to offer these services? Or just lay out the competitive landscape. Is this really in a competitive advantage, or more of just the customer is coming to you, saying like, "We want one operator to provide these services." And since you're able to do it, it helps retain, maybe, when the contract's up, retain you with the customer?

Anthony J. Orlando

It certainly is -- securing the long-term contract and preserving that long-term relationship with clients is very important for us. And that's a big, big aspect of this. But it's also, as we think about the trends in the industry, which clearly are towards more recycling, finding ways to reduce waste, finding ways to have a more sustainable program. And ultimately, for many of our customers, be they municipalities or businesses, trying to find ways to get to 0 landfill. I think there's an opportunity for us to continue servicing customers, finding ways to grow our business by satisfying those demands of customers. So this is a way for us to get into it in a relatively small way to start. And we'll see where it takes us.

Operator

Our next question is from Barbara Noverini of Morningstar.

Barbara Noverini - Morningstar Inc., Research Division

So this question is related a little bit to the last question that was just asked. But I just -- I understand that your current efforts in metals recycling involve extracting what remains from a post-recycling or post-sorted waste stream that's sent through the incinerator. So with these bundled services agreements in place, which address recycling and provide incentive for diversion, can we expect to see more metals revenue flow through your recycled metal line as your customers increase their diversion rates over time? Or in other words, with these agreements in place, do you have the capability to grab these recyclable metals before they reach the incinerator? Or does a third-party MRF operator like clean them first?

Anthony J. Orlando

Yes, so the contracts that we have thus far are -- we're handling presorted recyclable material on behalf of our client communities. And the metal recycling that we're doing, of course, is in the unsorted waste that comes to us for disposal. And we believe, really, at the end of the day with our process, we're going to get, frankly, virtually all the metal out of the waste that comes to us and recycle it. So today, at this point, the recycling work that we're doing on these bundled services is not part of those recycled tons. But we're going to continue to look to see -- at the end of the day, again, our goal is to create the most value out of the waste that's delivered and to do it in a way that's environmentally-friendly and that satisfies our customers. So we're going to continue to look at ways that we can maximize that value.

Barbara Noverini - Morningstar Inc., Research Division

Would you say that it's fair to say that now that you're involved in the process of getting that waste at its source, if you will, because you're the point of contact, maybe longer term, you'll be able to cherry-pick that metal and whatever other material you can process first? Is that a fair way to look at it?

Anthony J. Orlando

I think we're at the early stage of this. At this point, we're really handling -- we have service providers that handle the recycling for us, and we're providing this as a service to our customers. But it also allows us to kind of move up the learning curve. So I think we'll have to see where it plays out.

Operator

And the next question is from Brendan Naeve of Levin Capital.

Brendan Naeve

Just this week, there was another New Jersey-based company who IPO-ed a new security, which is kind of holding some long-term contracted power assets. And there's some, maybe like 90%, of the cash flows being paid out to the investors in the security. I understand there's quite a bit of demand for this yield vehicle, and it was a nice value creation event for this other New Jersey company. I was just curious if you guys have any thoughts on something like that or how that might play for Covanta in the future?

Anthony J. Orlando

So it's certainly hard not to miss how the demand from investors came out on that. So Sanjiv, why don't you comment?

Sanjiv Khattri

We obviously saw it, and then it all played out in the last couple of days, so it's hard to miss. We are looking at different ways all the time, Brendan, to see how we can maximize the value for our shareholders. And we look at it hard. And if that's something that we think is -- has potential, we look at it. But this is sort of -- in the meantime, things that we do totally control right now, we are really focused on. But we'll definitely look at it. I was just intrigued at how they've done it, and I need to understand it a bit more before I can have an informed opinion.

Operator

And the next question is from Yilma Abebe of JPMorgan.

Yilma Abebe - JP Morgan Chase & Co, Research Division

As you show on Slide 20, your leverage on the net debt-to-adjusted EBITDA basis has ticked up. What's the outlook there for the balance of the year? What should we expect that metric to look like?

Sanjiv Khattri

Well, we don't give specific outlook. We sort of create like a solid BB, and we think that's appropriate. And we will continue to protect that. If it does go up, it really depends on why it's gone up, frankly. And it's been thought of in the 4 zip code. The reason you see it a bit higher the rest of the year than right now is because of, first of all, used cash is down a bit. That's sort of the construction working capital. But also because our last 12 month EBITDA is down a bit. So with the higher EBITDA we have forecasted for the rest of the year, it will go back to -- but it's all within the range. There's no specific target. I don't know, Brad, anything you want to add or here on any -- our Treasurer keeps on top of it all the time. We are very comfortable.

Anthony J. Orlando

Any other questions?

Operator

No. That does conclude our question-and-answer session, so I'll turn it back over to management for closing remarks.

Anthony J. Orlando

Well, thank you, everybody. I hope you find a way to stay cool and enjoy the rest of the summer. We'll talk to you in a few months.

Sanjiv Khattri

Thanks, everyone.

Bradford Helgeson

Thanks, everyone.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!