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Covanta Holding Corporation (NYSE:CVA)

Q3 2011 Earnings Call

February 9, 2012 8:30 am ET

Executives

Alan Katz - VP of IR

Tony Orlando - President and CEO

Sanjiv Khattri - CFO

Tom Bucks - CAO

Brad Helgelson - Treasurer

Analysts

Al Kaschalk - Wedbush Securities

Michael Hoffman - Wunderlich Securites

Hamzah Mazari - Credit Suisse

Dan Mannes - Avondale

Chris Kovacs - Robert Baird

Peter Christiansen - Merrill Lynch

Operator

Good morning, everyone, and welcome to the Covanta Holding Corporation's fourth quarter and yearend 2011 financial results conference call and webcast. (Operator Instructions) At this time, for opening remarks and introductions, I would like to turn the call over to Alan Katz, Covanta's Vice President of Investor Relations.

Alan Katz

Welcome to Covanta's fourth quarter and full year 2011 conference call. The Investor Relations team has been very busy since our last call. We've been on the road and have attended several conferences since that time. We'll be attending more conferences and meetings over the next several months. So I look forward to seeing many of you. As always, we appreciate your continued support to Covanta.

Joining me today on the call will be Tony Orlando, our President and CEO; Sanjiv Khattri, our CFO; Tom Bucks, our Chief Accounting Officer; and Brad Helgelson, our Treasurer.

We will provide an operational and business update, review of financial results and then take your questions. We will be ending before 9:30 am. During their prepared remarks, Tony and Sanjiv will be referencing certain slides that we prepared to supplement the audio portion of this call. These slides can be accessed now or after the call in the Investor Relations section of covantaenergy.com. These prepared remarks should be listened to in conjunction with those slides.

Today's slide deck is substantial to say the least. We have a number of appendix slides that Tony and Sanjiv will reference throughout their remarks, but might not discuss in detail. We continue to try to improve this level of transparency around our results. You will see additional data and analysis and hopefully will find it useful. As always, we look forward to your input. If you have any additional questions on these slides, we can discuss them during the Q&A portion of the call or offline.

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, February 9, 2012. 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 express 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 reasons for presenting such information is set forth in the press release that was issued last night as well as in 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, which are 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 turn the call over to our President and CEO, Tony Orlando.

Tony Orlando

Thanks, Alan. Good morning, everyone. Let's begin with a quick summary of 2011. For those of you using the web deck, please turn to slide three. We executed on our plan and came in at the midpoint of our guidance. That's a very good performance in the midst of some market ups and downs. Compared to 2010, revenue was up 4%, adjusted EBITDA was up 5%, free cash flow was down 12% and adjusted EPS was up 24%.

I am pleased with these financial results as well as our operating performance, and our disciplined capital allocation. However, I must say, I am not satisfied with the fact that our efforts have not yet rewarded our shareholders. I assure you, our management team is completely focused on the things we can do to create value and provide investors with transparency, so that you can more easily understand the value that we see in the business.

For us, it all starts with world-class facility operations benefit our clients and the communities we serve. Our team is tireless in pursuing innovation that continues improvement. As a result, in 2011, we've recorded our best ever safety record and our highest boiler availability.

That strong performance continued to fill confidence in our clients. That is evidenced by our numerous contract extensions, including several in the last couple of months. In addition, our newest clients Durham and York, in Ontario, demonstrated their confidence in Covanta last year, when they issued us the Notice to Proceed with construction of their showcase energy-from-waste facility.

The combination of our long-term client relationship and our stellar operational performance supports continued earnings growth and predictable cash flow generation, which we're utilizing to deliver on our commitment to return capital to shareholders. We established a regular quarterly dividend and continued to actively repurchase stock. Since the program began in 2010, we have repurchased approximately 14% of the shares outstanding.

Let's move to Slide 4 and discuss this year's guidance. Our 2012 guidance call for continued growth of about 5% in adjusted EBITDA to a range of $500 million to $530 million. Achieving this will not be an easy task in the phase of depressed energy markets and certain contract transition. But I am confident that based on the organic growth initiatives we have underway, our team will get it done.

I'll talk about how we're going to do that over the next few slides. In terms of free cash flow we're guiding slightly down at the midpoint. There are two reasons for cash flow not going up in concert with adjusted EBITDA, working capital swings and anticipated higher corporate interest expense. Our adjusted EPS continues to improve. This is driven by improved operating income and the impact of our share buyback program through the end of 2011.

Now, let me turn to each of our markets to discuss recent trends and our outlook for 2012. We'll start with the waste markets on Slide 5. For the year, our service fee revenue, excluding debt service was up nicely, driven by contract escalation. Our tip fee revenue was also up, that was driven by improved production and approximately 1% improvement in tip fees for the year.

After three consecutive quarters of pricing improvement, tip fee prices were flat in the fourth quarter. This was driven by two things. First, as we increased production, we take in more low-price spot waste, which reduces our per ton fee, but increases our total revenue. And second, we've seen some pricing pressure in the Northeast, primarily driven by landfill operators, who will become a bit more aggressive on price.

Looking ahead to next year, we anticipate our contracted waste pricing will grow at inflationary rates, supported by contract escalations. With respect to spot waste, we're likely to see continued pressure from landfills and thus we expect pricing to be flat.

Let's move on to metals market on Slide 6. Demand remained strong during the second half of the year, notwithstanding much uncertainty surrounding global economic growth. Our metal revenue was $19 million in the fourth quarter compared with $20 million in the third quarter.

These were our best back-to-back quarters. This was driven by three things. The biggest factor was strong market pricing, but we also added revenue by recovering more metal and acquiring the Dade shredder, which improves our pricing. We invested a little less than $10 million to buy this shredder, which will pay for itself in three years. Combined, the actions we took contributed 30% of the metal revenue increase.

Our metal revenue is becoming more and more meaningful, so we want to provide some additional transparency. In 2011, we recovered approximately 430,000 tons of metal. About 4% of those tons were high-priced non-ferrous metals, which accounted for almost 20% of our total 2011 metal revenues. The rest was ferrous metal.

I want to point out that we share a lot of metal revenue with our client communities. The tons I'm reporting are gross while the revenues are net.

Looking ahead to 2012, we are assuming pricing will be constant and consistent with the current levels. Ferrous pricing is currently up-rises in line with 2011 and non-ferrous pricing is down just a little bit from last year. As we've said before, the global economic activity will drive metal prices and the recovery seems to be stabilizing, but as we all know much uncertainty remains.

So with all the appropriate caveats, let me give you a rule of thumb regarding our metal revenue. This assumes that ferrous metal and non-ferrous metal prices move in tandem, which is often, but not always the case. Still this is a good proxy. As a rule of thumb for 2012, you can estimate for every $50 move in the annual HMS one index, our adjusted EBITDA will move up and down by $10 million.

Moving on to our energy portfolio. Please turn to Slide 7. Since our last discussion we've seen some dramatic moves in power prices across the country. This was driven by primarily by the increased natural gas production and the very mild winter that we've seen so far this year. The long end of the curve has come down as well due to higher natural gas production and the delay in implementing more stringent coal regulations. We've also seen the market start to respond to these low prices with companies like Chesapeake cutting back on drilling and more generation switching to natural gas, but we know that takes time.

So how are we managing this soft market in 2012? First, we have a great deal of stability because 75% of our anticipated 2012 energy revenue is either under fixed price contract or hedged. The hedges we put in place last year are certainly helping, but we don't plan on hedging much more for 2012, given our limited volatility and current prices.

Second, the remaining 25% that is exposed is not fully exposed to the markets. For example, some of our exposed output is sold under contracts with floating prices that have a floor. We also have a big contract where prices reset periodically. That tends to delay and smooth out the market price.

Another example would be our generation in Hawaii, which is influenced by the oil prices not gas prices. And finally, as we discussed many times we run our biomass facilities only when the bark spread is favorable. That limits our downside while preserving the upside.

Now let me get specific about 2012. I'm going to split our output into energy-from-waster and biomass. The energy-from-waste facilities are profitable no matter how low the energy price goes so they will run full out. We have about 1.6 million megawatt hours of EfW output for the rest of the year that is exposed to market fluctuation.

Based on the current forward curves, we expect an average full year price to be in the low 50s per megawatt hour. That's almost $10 of reduction from 2011. For those of you who follow market prices that 50 price probably sounds high. It is if you compare it to PJM or NEPOOL where we expect to see prices in the high 30s. Fortunately, about 45% of exposed output is sold in premium markets such as Long Island and Hawaii. Our exposed theme also commands a premium price when compared to electricity.

Moving to biomass. Six of already facilities do not have fixed price contracts and we only run them when it's beneficial to do. These six facilities have a total capacity of about 700,000 megawatt hours. Of that we've already shut down 400,000. We're currently running the remaining 300,000, but will probably be taking those offline soon. This will not have a meaningful impact on adjusted EBITDA. Therefore, as we move forward when discussing exposed energy output. I will focus only on our energy-from-waste portfolio.

Let me give you another rule of thumb. Again, let me start with a caveat. A big percentage of our exposed output is sold to Long Island. There rate setting process is somewhat opaque so it's hard to say how and when changes in natural gas will affect our revenue. Having said that, as a rule of thumb for every $1 per MMBtu change in natural gas, our 2012 adjusted EBITDA will move up or down about $10 million to $15 million. We're starting with an estimate of 3-hour average gas for the full year, which is consistent with the current forward curve.

That covers all the key markets that will affect our 2012 results so now want you to turn to slide 8 and talk about what we are doing into drive growth this year and beyond.

I know some of you are worried that our contract transitions might adversely affect our ability to continue growing earnings. It is true. Our debt service pass through revenue is declining as project that is paid off. And we have some attractive energy contracts that will end in the next few years.

These challenges are real, but they are not new for us. The fact is we've been working through contract transitions for several years now and we grew adjusted EBITDA 4% in 2010 and 5% last year. No question, the recent drop in energy prices makes our job harder, yet, I remain confident we'll continue to grow.

Let me explain why. First, we're working successfully to preserve our long-term client partnerships by executing win-win solutions. In just the last few months, we have several good examples of how we do this. At the end of last year, we extended to 231 of waste contract and facility lease with the Union County, New Jersey authority that owns the facility.

As a part of that transaction, the project there was extended at attractive rates, which enabled the authority to lower the fees it charges to member municipalities. And they were also able to increase and extend the waste delivery commitment to us. This in turn enabled Covanta to shares in some of the benefit of lower debt service, plus we extended the time period during which we enjoyed a benefit of the lease. That's a real win-win.

Another lease extension completed last year relates to the Braintree Transfer Station outside Boston, which primarily feeds our SEMASS facility. We agreed to upgrade the transfer station and extend the lease from 2015 to 2030. This will increase our maintenance capital expense this year, but its well worth it to preserve this asset and enhance our community relations.

And finally, we just signed a contract extension with our Arlington/Alexandria Virginia partners. These host community supply 15% to 20% of the waste for the facility. And the new agreement provides them with attractive rates through 2019, with additional benefit it they extend the agreement to 2038. By sharing the benefit of this debt-free asset with our partners, we secured a long-term future of these projects.

We provided a new chart on Slide 29 in the appendix, which shows just how successful we've been at renewing our major waste contracts over the past few years. And highlights the fact that when you look at or portfolio in its entirety, we have relatively few big municipal waste contracts coming up for renewal in the next five years. These long-term client relationships are the foundation for our organic growth.

We're also continuing to focus on fundamentals, basic blocking and tackling. We continually invest in our people and our plans to ensure reliability and peak performance. We're always working to get a little bit more out of our facilities, just as we did last year with record braking availability, up about 0.5% from 2010. I know that's not a lot, over the portfolio of our size it's meaningful.

We're also doing small things to secure waste supply. For example, we're installing a natural gas fueling station at our Essex, New Jersey facility. And we'll continue to look for tuck-in acquisitions, such as strategic transfer stations. Our successful construction projects are also contributing to our growth. Last year our JV successfully completed two projects in China and will be getting the full year benefit from those projects this year.

Our extension project in Honolulu, Hawaii is progressing nicely. We were more than 80% complete at the end of 2011, and we expect to begin processing waste this spring with full commercial operations later during the year. When this expansion is complete, the facility will produce about 6% of Hawaii's electricity and of course will also earn an operating fee.

We're also well underway with the Durham-York, Canada EfW facility construction. Remember, both the Honolulu extension and the Durham-York facility are owned by our clients. Therefore, we are not investing our capital rather we are being paid to build a facility under a fixed-price contract. When complete, we'll operate the facility for the 20 years. So as Honolulu construction revenue winds down, it is being replaced with the revenue from the Durham project. We expect the Durham project will become operational in late 2014.

Turning to Slide 9. We see some tremendous opportunity in terms of metal recovery. We've made significant headway at pretty new magnets and new or updated non-ferrous systems at several of or plants. These are relatively low cost investments, ranging from a few hundred thousand to a few million dollars each. But the payback is excellent, given the current price levels. It takes about a year to plan, permit and install these projects. We already have several in the works. So we expect to see growth from these investments over the next couple of years.

Special waste is another focus in terms of growing revenue. We get paid a premium for this service, which gives us a higher margin than regular waste disposal. We've doubled our sales team and we've enhance our customer offerings to our Covanta for recovery group to grow this business.

Our three primary offerings are; sustainable solutions, specialty services and assured destruction. Sustainable solutions target the customers, who want to achieve landfill-free status. A great example of this would be our long-standing relationship with (inaudible 2.02). Specialty services target hard-to-handle waste, an example of this would be non-hazardous industrial waste or even liquid waste. And finally, assured destruction targets customers, who need to dispose of outdated, off spec or recalled products. This is a big part of the business and we service many large consumer product and retail companies.

This waste replaces lower price spot waste. So as we see pricing pressure or higher concentration of spot waste at a particular plant, the special waste becomes an even more important revenue stream for us. We've been growing this business for several years and we still have a lot of runway. This will definitely be an important contributor to our total organic growth.

Lastly, we are more focused on productivity and innovation than ever before. We're leveraging technology to squeeze margin out of our assets wherever we can. We've made some great headways and using technology to improve cost structure. For example, we developed a new ash conditioning system to improve metal recovery and lower our ash disposal cost. We're also using innovation in terms of maintenance techniques and process automations to drive down cost.

With few initiatives that we're currently working on, which should add nicely to the bottomline over the next few years. Let me be clear, this cost savings is not coming at the expense of investing in our plants. Keeping our plants running at best-in-class availability is a key focus point for us and we will continue to invest capital that we need in order to keep our availability at high levels.

Before I wrap up, let me spend a minute on our development projects. I have not discussed these, because there isn't much to update at this point. We do however hope to gain clarity this year, in particular with respect to our Merseyside, U.K. bid. We're in the final stages of the biding process. We're going to put our best foot forward and we hope that client will select us as a preferred bidder by the end of the second quarter. We'll update you on this and other bids as events unfold.

Turning to Slide10, let me summaries. I've taken the time to review our organic growth in detail, because these initiatives combined with our strong operating performance, will drive continued earnings growth. Our business is very resilient. We're well-positioned to take advantage if the economy gains strength. And we're prepared if the market move against us, with a very stable base business with over 75% of our waste and energy revenues contracted. Not only is most of our revenue contracted, but just is important for providing essential services at competitive prices.

With respect to our market exposure, our guidance is based on current waste, metal and energy markets. Our organic growth initiatives are low-risk high-return projects. We're moving quickly on these opportunities and are already seeing some of the benefits.

And as a cash-focused company, I know we will continue to generate strong cash flow and we will allocate this capital with a singular purpose of creating shareholder value. As we demonstrated in 2011, we will focus on using our capital wisely and returning excess cash to our shareholders recognizing the benefit of both buybacks and dividends.

To sum up, our team continues to execute our operational and organic growth initiatives. This positions us nicely to deliver earnings growth this year, even in the phase of challenging energy market. Furthermore, we continue to successfully extend our long-term municipal client partnerships to support continued growth for years to come.

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

Sanjiv Khattri

Thanks, Tony. Good morning, everybody. Greetings for 2012 to all of you and a special congratulations to all the Giant's fans, including to my boss Tony, what a game. It's good to speak with all of you again. As Tony said, 2011 was a very good year for Covanta. We finished the year strong and our business continues to do well and we continued to be effective at managing the ups and downs.

2011 was my first good year at Covanta. Time flies when you're having fun. It's exciting to be reporting to you versus objectives that we laid out a full-year ago. As you've heard, we finished the year with earnings up and right in line with our guidance. We achieved 5% adjusted EBITDA growth, given the economy we thought this was particularly good. Moreover, our core business continued a solid operating performance. And the good work in 2011 sets us up nicely for 2012.

Let's start with Slide 12, the Q4 financial highlights. We had a good solid quarter, very close to how we laid it out for you on our third quarter call. Slide 12, lays out our key financial highlights and some remarks on our strong performance. As usual, I'll walk through the financial variance waterfalls over the next few slides.

Before we get into the numbers, I wanted to flag a few key charts in the appendix that emphasize, both the overall robustness of our 2011 performance and the strength of our underlying business. Slide 28, gives you a breakdown of our waste and energy revenues. And Slide 29, highlights the amazing job being done by the operating team in renewing municipal waste contracts. Slide 30, has (granted a 9-1.21) P&L walk for both the fourth quarter and the full year. And finally Pages 31 to 34, have the variance waterfall walk for the full year 2011 versus the full year 2010. We are happy to take questions later or offline on any of these slides.

Let's move to Slide 13, for a waterfall on revenue variance. Total revenue in the fourth quarter is up by about $11 million year-over-year to $430 million. The most significant driver was improved waste revenues in the quarter. The $9 million of waste pickup was a result of higher productivity at several plants, due to moving some of the scheduled maintenance and outages into Q2. You'll remember that we had higher Q2 maintenance expense in 2011.

The $6 million of higher construction revenue was related to both our Hawaii expansion project and to the Durham-York project. Recycle metal held-up in the quarter, despite a slight dip in October around the time of our last earnings call.

There were some offset from lower debt service revenues, lower contribution from biomass facilities and weaker energy pricing. Tony took you to what's happening in the metals and energy areas, so I won't dwell on these. Net revenue was up, both in the fourth quarter and for the full year.

Moving on to Slide 14, adjusted EBITDA was up $17 million year-over-year to $146 million. The other bucket includes a $12 million benefit for lower maintenance expense in the quarter, resulting from the acceleration of some scheduled maintenance expenses into Q2 as previously discussed. Another positive driver for adjusted EBITDA was the impact of strong metal pricing and improved waste volumes.

We had a few negatives offsetting some of the pick-ups, primarily a $7 million impact from lower debt service pass through billings, which of course has no impact on net cash. As discussed previously, our debt service pass through revenue and billings are declining overtime as we payoff project debt.

We will continue to see this impact moving forward. This would be an $18 million impact to adjusted EBITDA in 2012, which we have of course factored into our guidance. However, this is one piece of the overall picture of our contract transition. We are confident that we will still growth our adjusted EBITDA despite this impact.

Metals held up this past quarter, but it's important to remember that this is a volatile market. We are doing our best to grow volume and improve the quality of the metal we recycle, but our revenue from this metal could swing dramatically in a relatively short-time due to price changes.

Turning to Slide 15. Let's discuss Q4 free cash flow, which was $65 million, down $17 million from Q4 last year. While we had $17 million of adjusted EBITDA benefit this quarter, this was offset by lower working capital in the quarter, interest payments on our new high yield notes. Since we issued the notes in Q4 of 2010, we didn't have one of the two semi-annual coupon payments in that quarter, but we did so in 2011 and a small increase in maintenance CapEx.

A quick note on maintenance CapEx. We finished at $80 million for the year, right in the middle of our guidance. For 2012, we are looking at maintenance CapEx in the $80 million to $90 million range for the year. The variability will be driven primarily by the timing of some major maintenance projects.

Working capital was a large year-over-year headwind in Q4, almost exclusively due to the timing of construction working capital in 2010. Let me hold off on discussing working capital, until we discuss 2012 cash flow guidance.

Now, turning to Slide 16. Our adjusted EPS is up nicely compared to 2010. The benefit of much higher operating income and a much lower share count as a result of our buyback program were the primary drivers for this 37% improvement.

Turning to our balance sheet, let's move to the very familiar Slide 17. Our balance sheet remains very strong. Our net debt to adjusted EBITDA versus yearend 2010 has improved due to continued debt pay down as well as the proceeds from the Asia asset sales. We are now less than four times leverage in terms of net debt to adjusted EBITDA, which gives us a lot of dry powder to fund new uses of capital.

Capital return continues to be a key point of focus for the entire team. 2011 was a stellar year in terms of returning capital to shareholders. As you can see on Slide 18, we returned $272 million in dividends and buybacks over the year. I think the numbers speak for themselves. During the fourth quarter we purchased 1.8 million at an average cost of $14.22 per share and also paid out the quarterly dividend.

At $230 million or full year stock repurchase was very impressive. Obviously we could have foreseen the more recent stock decline we would have waited to use the Asia IPP asset sales funds that we repatriated to do buy stock in the fourth quarter. However, we don't try to time the market, we believe that our stock has been at an attractive value since we started the buy back program and as a result we used our capital throughout the year for stock repurchases.

Excluding the earned $37 million from the Asia IPP asset sales, we averaged about $25 million of stock repurchases per quarter. All-in-all since we started the buyback program just about a year-and-a-half ago we bought back almost 14% of our outstanding shares. In all, we've returned $6 million of capital. As long as our free cash flow yield remains so high and we are not compromising on high value growth activity, this remains a great use for our free cash flow. We plan to continue buying back shares until further notice.

Free cash flow along with adjusted EBITDA continues to be our primary financial metric. We used these metrics to manage and measure our financial performance. Our free cash flow is currently used primarily in three ways, to funds scheduled project debt repayments which in turn creates long term debt capacity for discretionary growth capital spending and to return cash to shareholders, which we have been actively doing over the past 18 months.

As project debt continues to be paid off the amount of free cash flow available for both growth and shareholders return goes up, this will become meaningful driver of value over the next several years.

Earlier in the year I told you that we wanted to be book kept in terms of our sources and uses of free cash flow. How much cash we generate and where we allocate it.

We are now on Slide 19. Let me take a couple of minutes to explain this new slide. In 2011, Covanta generated $547 million both from free cash flow and assets sales. This total does not include the proceeds from the fourth Asia IPP asset sales that is yet to close. In terms of uses, we allocated $138 million to paid-out debt mostly advertising debt and some prepayment of debt maturing in 2012.

With had a growth capital of $53 million net of project debt that funded a portion of it. We also have $122 million increase in cash overseas primarily from the asset sales which we plan to use for future international development. Finally, $272 million was allocated to shareholders returns using both stock buybacks and dividends.

In fact, net-net we used a bit more cash that we generated as we thought it prudent to continue buying stocks buybacks even as we invested in high-return growth capital. As a quick aside, we expect another $50 million or so of growth capital investment in 2012 as well to support our high return organic growth initiatives.

At this time I also want to mention that on slide 35 of the appendix, we have updated the walk from net income to free cash flow for 2010 and 2011 actual results as well as our 2012 estimates. We have been showing this slide for quarters now and it lays out with actual data how are relatively speaking lower book earnings translates into much higher levels of free cash flow. This chart cements arguments that our free cash flow generation remains sustainable.

To remind you all of our capital allocation policy, we still believe that investing in the business for high term growth is the best use of capital. But we remain disciplined when it comes to our return thresholds. However, as we have said in the past, we also believe in the value of returning capital to shareholders through cash dividends and share repurchases. And we plan to continue actively returning capital not invested in our growth initiatives.

Going forward in 2012 and beyond, we plan to be transparent like this so as to show you clearly where the free cash flow is going. Our strong and consistent free cash flow generation which represents 13% of our market cap at the midpoint of guidance provides us with the number of options to enhance shareholder value.

Slide 20 summarizes 2012 guidance. Let's get into the details in the subsequent charts. Before we go through adjusted EBITDA a quick word on revenue outlook for 2012, we estimate modest topline growth in revenue in the $1.65 billion to $1.7 billion range versus $1.65 billion in 2011. We hope to see a pick up in revenue from our organic growth re-initiatives and from new units coming online.

Energy pricing will negatively impact revenues and as Tony flagged, construction revenues year-over-year should be stable. Now in our business, not all revenues created equal so it's important you factor that in as you generate your models. Organic growth initiatives traditionally result in a high adjusted EBITDA margins but construction and biomass energy which could always be a big variable for revenue have a much more muted impact on profitability.

Moving on to adjusted EBITDA on Slide 21. Our organic growth initiatives will be the biggest drivers of growth in 2012. At the midpoint, we see $25 million of contribution from these initiatives. This number includes metal, special waste, process improvements and assets management as well as a few other smaller contributors.

In terms of new units coming online, we see the benefit of our expanded Hawaii facility and the China facilities. Further, the caption of other improvements includes a number of items such as escalation across our portfolio, various facility improvements including (inaudible 13-0.05) facility, which had a unit shutdown for the better part of last year. Improvements at our biomass facilities, which had losses in 2011, related to taking the facilities offline, and more focused development efforts.

Offsetting these, other improvements are normal cost escalations. This will all offset lower energy pricing at some of our EfW plants, lower debt service pass through billings of $18 million and the loss of alternative fuel tax credits. At the midpoint of 2012 guidance for adjusted EBITDA of $515 million, this will be in two years of back-to-back 5% improvement, impressive performance in light of all the adverse factors.

On Slide 22, you will see that the midpoint of our free cash flow guidance calls for a decline of $15 million. We have the benefit of our adjusted EBITDA growth of about $23 million using midpoint. The majority of the delta between 2011 and 2012 will be lower working capital from our construction projects and higher interest cost.

I'd like to spend a few minutes on working capital. When looking at working capital, I would break it into two components. One relates to the day-to-day operations at facilities, which is fairly predictable. It adds inflows primarily with the seasonality of the business.

The second is the working capital related to our construction projects. In construction, we receive payments for our work from our clients in chunky installments and outflows to our construction vendors can also be chunky. This can make the absolute year-over-year and quarter-over-quarter differences quite dramatic.

So in 2012, we expect working capital from construction to be a big use of cash, about $20 million, which effectively unwinds the pickup we had in 2010. Of course, if you net all the cash flow relating to construction is in a modest, but important net positive cash flow. We have Durham-York coming online as well. So you could see an effect for working capital timing as a result of that project over the next few years.

In our free cash flow guidance, we have also assumed a $15 million to $20 million adverse impact to cash interest. This is a place holder and we are still developing our 2012 capital plans. In 2013 and 2014, we have over $1.6 billion of corporate debt capacity coming due. We are looking at refinancing a lot of it in 2012 to take advantage of the favorable debt market conditions that we enjoy.

However, even though the market conditions are very favorable compared to historical levels, they still represent a premium over the even more benign environment in 2007, when we issued most of this debt. The premium is 100 basis points to 400 basis points more expensive versus current debt, depending on both the type of security we use and the tenure.

Finally, in determining the interest cost, another variable will be the absolute amount of debt to be raised. We may take the opportunity to raise additional corporate debt, which in fact will replace some of our amortizing project debt. Of course, the higher interest will adversely impact free cash flow. Frankly, this is all work in progress. But we didn't want to have guidance out there that does not include some sort of refinancing impact. We will keep you posted as this process unfolds.

Our adjusted EPS, which we show on Slide 23, is up about $0.18 at the midpoint. Obviously, growth in operating performance helps dramatically, but it's also nice to see the benefit of our stock buyback program. Please keep in mind, in order to keep the analysis simple, (inaudible 14-0.33) this is our adjusted EPS guidance, we have assumed no stock buybacks in 2012. Offsetting this pickup is the impact of the increase in book interest expense.

To comment on our tax outlook, on Slide 23. We continue to see the benefit of our NOL. Our cash taxes were only $13 million in 2011, while our book taxes were $28 million. In 2012, we expect our cash taxes to be in the range of $10 million to $15 million, so basically unchanged from 2011. Our federal NOLs at the end of 2011 was $427 million. Our outlook on utilization is unchanged. The NOL should last until the mid-decade. After we utilize the NOL, we will have some AMT and PTC tax assets that we can utilize. So we shouldn't be a full federal tax payer until much later in the decade.

Let's move on to maintenance seasonality and I'll wrap-up with our Q1 outlook. Let's turn to Slide 25. This slide is a repeat from last year, but with 2011 results added in. As many of you know, our maintenance schedule is very seasonal. It is based on optimizing operating performance rather than some quarterly targets. We have much higher maintenance expense in Q1 than in any other quarter and as a result our operating income is typically much lower than other quarters.

In fact, as we showed in the next slide, we will have negative operating income in the first quarter for the past three years as a result of this seasonality. We more than make up for this during the rest of the year, but it's important for those of you building models on us to remember this expected seasonality.

I'll conclude with a quick summary for the outlook for the first quarter on Slide 26. The (blended 2.09) seasonality in 2012 should be very similar to the last couple of years. The waste markets are holding steady. We've seen strong recycle metals pricing so far this quarter and that board well for us in terms of metals revenue.

Our operations are running great. We've just been in the midst of what we call (outed 2.25) season, when we will do a significant portion of our maintenance. This will of course affect quarterly profitability. I did want to note that our free cash flow will be down significantly due to the lower construction-related working capital.

In general, our free cash flow will be rated towards the back half of the year. In this regard, we will keep you updated as the year progresses.

As we've said in the past, growth is a priority for us. Our organic growth opportunities are real and we'll provide meaningful impact in the short term. We are looking forward to discussing progress with you on future calls. We've worked hard to increase our transparency in order to help you understand why we see so much value in our business.

Over the longer term, development is a great option on the business. But in the more immediate term, we'll continue returning capital to shareholders, even as we invest prudent amounts of capital in high return growth.

Before we take Q&A, I wanted to step back and review our progress over the last year-and-a-half, since I had the privilege of joining Covanta and Tony's team. Over these six quarters, we have grown earnings; generated huge amounts of cash flow; articulated and executed a robust capital allocation strategy; focused on developments efforts to increase our chances of success; improved the level and frequency of our investment outreach; and most recently implemented a far reaching organic growth initiative that will allow us to show growth in earnings even as other trend would suggest otherwise. This is a good report card. But we have much too do in order to create more shareholder value for all of you.

Thank you for your continued support. Now, let's move on to some Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Al Kaschalk with Wedbush Securities.

Al Kaschalk - Wedbush Securities

I appreciate the details on Slides 8, 9 on the organic initiatives. Tony, I was hoping maybe you could size some of those specific in terms of the components. In another words, do you think that the metals is the larger contributor there in terms of investments or what else in other improvement area?

And then the second part question would be, on the metals recovery side. I certainly understand that from an operational perspective and your clients interest and your interest in capturing that cash flow, but do you feel like that's more variability or volatility to the cash flow as you provide an outlook?

Tony Orlando

Let me take the first question, which is kind of which are the bigger factors on the organic growth. And as we talked about, there's really kind of three primary areas that we look. And I would tell you that all three are important. The metals, we feel particularly good about, that's really driven largely by investment in capital to recover more metal, the technologies there. And we expect to see some nice improvement really over the next couple of years, because as I mentioned it's going to take some time to put those systems in.

The efficiencies are things that we can drive a little bit faster. For example, I did mention one in particularly, which is just a good example of the technology that we developed and are now installing it at our plants. It's relatively a modest investment, but it delivers very quick returns to reduce our ash disposal cost and that's our ash conditioning system.

The special waste and waste business growth, that probably takes a little longer to generate as we've ramped up our sales team. We're also enhancing with some capital investments. Our capability is to what we can provide to our special waste clients. So that one is probably going to have a little bit of a longer run rate but really all three of these are going to be important to the total organic growth not just in 2012 but as we look beyond 2012 for the next several years. And were you also asking about the other improvements?

Al Kaschalk - Wedbush Securities

But I think that's, thus far as it sounds as if these investments are in place and they're going to contribute '12 and '13 beyond we should expect, kind of that scene, that organic growth is in the business even if it is $30 million?

Tony Orlando

We don't look at this as a one year program. We look at this as a longer term program. Obviously, the plans that we have for 2012 are more well developed than ones that are further out. But some of this is benefited things that we did late in 2011 where we'll get the benefit in full year 2012. Some of the investments may not get installed until late in 2012, when we'll get a little pick this year and we'll get the full benefit next year.

But look, like every business are intent on growing. And we have a number of ways to do that and one of them is to figure out how to best maximize the value of the assets that we have both for creating value for our shareholders but also doing things that help our client community. So we're going to focus on doing that not just this year but for a long time to come.

Operator

Your next question comes from Michael Hoffman with Wunderlich Securites.

Michael Hoffman - Wunderlich Securites

Couple of questions, just wanted a clarification on slide 6, thanks for the clarity on the metals leverage, what's the average price like you gave us, that $3 gas number, what's the average price of you're using in your guidance, so I understand how that $50 is reflective?

Tony Orlando

Last year's average number was right about $400 on the HMS. And we're basically right on top of that now.

Michael Hoffman - Wunderlich Securites

And then, when I look at 21 and at the waterfall and I see the three green areas. Help me understand, what part of the $38 million in your growth capital spending is influencing those green areas. So I can get a feel for the leverage of this growth capital?

Sanjiv Khattri

A lot of the investment of that is going to happen in 2012. We're really going to payoff in 2013 and beyond. Our net growth CapEx last year was $53 million. And we actually what I called it, the foundation, and the primary bucket that you should see that overtime is what we are calling the organic growth initiatives. And it's all the things Tony talked about.

These are very high return (for the channel 17-0.32), we've beaten this to death. But a good example of that would be the shredder at Dade, Miami, that's very tangible. A lot of the others are a lot less exotic, they are much smaller, whether it's a small system to puts a non-ferrous line on a small plant or whether that's using some online technology to improve our procurement. So this is a small little example of that.

Tony Orlando

But just to put a fine point on it, much of the investment that we're making this year, which as Sanjiv mentioned, is roughly $50 million. It's going to deliver results in 2013 and some of it will come online in the third quarter or possibly earlier than that. But most of the benefit for the investment that we're making this year is actually going to show up in 2013.

Michael Hoffman - Wunderlich Securites

I'm actually trying to look at in a sense of just pure growth capital spending, and you know it was $22 million in '09, $41 million in '10, $38 million in '11. And I'm trying to understand that's approximately $100 million over three years. What I am hearing is some or all of that $20 million to $30 million is the benefit of that, that's the way I am so to think about?

Sanjiv Khattri

I think you should. But I would emphasize the lag issue, the capital goes and now it takes a while. And also you're already seeing, I mean a lot of the work and we were obviously careful about not talking much about it until we were sure. But a lot of the foundation for our growth in 2012 was put in 2011. And that's how you should see it being used.

Michael Hoffman - Wunderlich Securites

Now if I wanted to extrapolate $21 million this table out, how should I think about what that part of the waterfall chart looks like in '13, I mean?

Sanjiv Khattri

But we would be speculating there so many variables. And I think I want to specifically focus on 2012, Michael, but there are so many variables. But I do it exactly the way you always do it in your write-ups, I'd go by bucket-by-bucket. However, I think the thing you have to take confidence in is, that the team can deliver on these growth initiatives and the rest will be based on what's happening in the market, and contractual nature of our business. And you know to how to do this a lot better than I do.

Michael Hoffman - Wunderlich Securites

Tony, can you help us just frame, I'm assuming it's in tip fee revenues. What's percentage of the tip fee revenues is now made up of special waste?

Tony Orlando

It's still a relatively small percent of our total revenue. It's in the few percent range of the total waste revenue. But again, we see some nice opportunity to grow. And the key to that is, not even so much or the total revenue is that we're bringing in, but where and how we bring it in. In another words, if we're bringing it into a facility that's displacing particularly low price spot waste.

It's more valuable revenue than if we're displacing higher price waste in maybe a more attractive market. So you might imagine if some of the larger facilities that we would have in this arena would be in the Midwest and not necessarily in the Northeast. But it's in that couple percent range.

Operator

(Operator Instructions) Our next question comes from Hamzah Mazari with Credit Suisse.

Hamzah Mazari - Credit Suisse

A question on just the competitive bidding environment for some of the large projects. Maybe if you could just give some color? How competitive is that right now relative to last year? Are you seeing any change there, particularly from some of your European competitors like Veolia, are they getting more competitive, given the internal issues that they're going through or how you approaching bidding? Is any change there?

Tony Orlando

The nature of the bidding in the U.K. has been competitive for quite some time and it's still competitive. There's a lot of companies there. I think that as we see it as an attractive market, given the regulatory framework. So our competitors see that same attractive market. And it's been competitive, it's still competitive. And obviously, we are doing everything we can to sharpen our pencil and put the best foot forward and do what we can to win. And we expect to, (18-2.08) we'll know where we stand on this key bid in the second quarter.

Hamzah Mazari - Credit Suisse

And then just my last question follow-up is on, you layout some of the contract transitions and you've had a good track record on renewing those contracts. Maybe if you could just add some color, on what circumstances do you guys not renew contracts? In some of these contracts when are you not successful in renewing them essentially?

Tony Orlando

Well, we've got a tremendous track record on renewing our municipal waste contracts. I forgot whatever slide it is. It essentially shows how many of them we've renewed over the years and of course it's our hope to renew all of them.

The one exception that we've had to that thus far is in Hartford, Connecticut, where the client decided to hire another company to operate their facility on a cost-plus fee basis. That's not the business we're in. We're in the business to provide our customers with stability. And we expect to get paid 60 for that. So that's one instance, where we haven't been successful. But it's relatively a small contract.

Sanjiv Khattri

Hamzah, I wanted to do use the opportunity to plug this slide that we did in chart 29, it highlights the amazing job that Tony and (inaudible 19-0.41) operating teams have done in renewing the contracts.

Operator

Your next question comes from Dan Mannes with Avondale.

Dan Mannes - Avondale

Two quick questions, first, you guys are talking about 5% growth from '11 to '12. Realistically, if you exclude headwinds and not including any benefit from either pricing, from either scrap or obviously with a headwind from power, you actually have about 10% EBITDA uplift. And I guess, I'm thinking as we look forward and you don't have some of these contract transitions over the next couple of year. How do you think about your organic growth initiatives? And what's a more realistic longer-term rate, is that sustainable or what sort of the rate we're to think about that?

Sanjiv Khattri

I think the issue there is really what assumptions do you make regarding some of the macro things. You are right. In looking at, if you assume that and take a couple of things, our actual growth is a lot higher, no questions. Having said that, some of these macro issues are for real and energy is going to take a while to correct itself. Overtime we are very bullish on energy, but short time it's pretty oblique.

And metals is one year at a time. So I think it really in terms of real tailwinds, you are looking at two or three more years at least before we get those, because there'll still be stuff in 2013, 2015, and then things start really hopping.

Tony Orlando

And I think that every business has challenges. As you know, we have a lot of contract transitions yet in front of us. As we've been saying for quite some time, we start to see some tailwinds in the mid-decade. But we still have things to work through and we're confident we can work through those and continue growing the business.

Dan Mannes - Avondale

Real quick, one follow-up. As you look at 2012 capital allocation, you are free cash down a little bit year-over-year. I don't want to say committing, but it sounds like you're locking an incremental $50 million for growth CapEx. I guess I'm just trying to think through, where does that lead in terms of allocation and potential buybacks? And with the knowledge, that you don't have the (ITP 2.52) proceeds this year that you had in '11?

Sanjiv Khattri

Clearly the $137 million from last year won't be repeated, having said that, we are still sort of finalizing our plan. My hope is that we continued to have a very robust dividend and meaningful stock buyback activity.

Operator

Your next question comes from Chris Kovacs with Robert Baird.

Chris Kovacs - Robert Baird

Most of my questions have been answered. I read an article coming out of Dublin that, I guess, more discussions have kind of picked up around that (inaudible 20-0.41) and you can reach by the end of this months to start construction. Can you maybe comment on that?

Tony Orlando

We continue to believe the project make sense to reduce landfilling. And we are working cooperatively with the Dublin City Council in the hopes of making this a successful project for everyone involved. When something definitive get to that point, we'll be sure to let it rain out. But we don't have anything definitive at this time, but we do continue to work cooperatively with our clients.

Opetarot

Your next question comes from Gregg Orill with Barclays Capital.

Gregg Orill - Barclays Capital

Just following-up on the discussion around capital allocation and buyback in dividend. So how do you (waive 1.36) the options there maybe dividend, you get more banks that have bought, but the buyback is accretive to earnings? How do you think about that?

Sanjiv Khattri

When the Board came up with our capital plan for 2011, it was very clear that they viewed that good mix of stock buyback and dividend was a good idea. The dividend is kind of a floor that would be a base return that we would offer to shareholders under all circumstances.

And the level of dividend was such that also there is a potential to grow the dividend overtime. This is still work in progress. But I expect the same sort of capital planning philosophy to drive our decisions for 2012. Dividend is very important and overtime we'd like to grow it. And then stock buyback is the variable that's also important and gives us a bit more capital flexibility.

Operator

Your next question comes from Peter Christiansen with Merrill Lynch.

Peter Christiansen - Merrill Lynch

This is Peter in for Steven Milunovich. My first question really is, if you could just remind us on what portion of the 3.8 million megawatts are hedged and how long do those hedges typically go out? And with Long Island, how often is that (about a 21-0.05) cross contract reset?

Tony Orlando

Sure, let me see if I can do a recap there. As I mentioned we've got roughly $1.6 million of exposed output this year. The Long Island output is included in that $1.6 million. And if you reset periodically, we actually expect them to be resetting the price in April. So we'll get some more clarity on what kind of pricing we'll see moving forward. But they may reset a couple times a year.

With respect to how much is hedged, of our contracted and hedge total, it's roughly 0.5 million megawatt that are hedged and those are hedged through 2012. So we don't have any hedges in place for 2013 at this point.

Peter Christiansen - Merrill Lynch

And then, just a little bit more on the working cap situation there. I guess last quarter you expected it to draw in Q4 tied mostly I assume to the Honolulu expansion. And I guess it's safe to assume that's been pushed out to this quarter. Should we assume that when it comes to construction that a lot of the impact in working cap really occurs later in the development stage?

Sanjiv Khattri

It really depends. There is no single rule. As I said in my comments, both the inflow i.e., from the client and the outflows are chunky. And now we want to get our world-class project done on time within budget. And that's sort of driving it and the working capital will be what it will be.

I think as you will see, when the H-Power Project finishes we will be left with a small modest but important profit. And then the same will how the Durham-York will play out. So it's very difficult. We do our best trying to mange the timing, but it's difficult to exactly get it right.

We do expect a big unwind in 2012. And I think what that will do is the second half of the year should be a better year for working capital than the first half. And you are right, the main reason is construction working capital.

Operator

I will now turn the call over to Tony Orlando, Covanta's CEO and President.

Tony Orlando

Well, thanks everybody. We wanted to try to be (cognizant every time 2.33), so we want to wrap up here in about an hour. We are looking forward to 2012. Clearly we've got some challenges, but we're really excited about our organic growth initiatives and we'll focus on executing that and delivering value to our shareholders. Look forward to talking to you in a few months. Take care.

Operator

Thank you, ladies and gentlemen, for joining today's presentation. Thank you for your participation. You may now disconnect.

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