(EDGAR Online via COMTEX) -- Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ("MD&A")
The following MD&A is intended to help the reader understand the results of operations and financial condition of Covanta for the three and six months ended June 30, 2021. The financial information as of June 30, 2021 should be read in conjunction with the financial statements for the year ended December 31, 2020 contained in our 2020 Annual Report on Form 10-K.
Factors Affecting Business Conditions and Financial Results
Impact of novel coronavirus ("COVID-19") on the United States and the global economy
The COVID-19 pandemic has impacted, and is expected to continue to impact, our employees, our operations, our business and the economy. In early 2020, we began to see impacts from COVID-19 on the economy and commercial activity in the United States, resulting in reduced waste volumes and disruptions in waste markets. We have seen an increase in commercial activity and a stabilization of business conditions from the lows in the second quarter of 2020, but the extent of potential impacts from COVID-19 in the future remains uncertain. We cannot predict the potential future impact of the COVID-19 pandemic with new variants of the virus circulating and delays in distributing and administering the vaccine, and it could materially and adversely affect our business, financial condition and results of operations in the future.
While a limited number of our employees have contracted COVID-19, we have followed recommended protocols and have thus far not experienced material disruptions to our operations as result of workforce availability issues. Depending upon the rate, extent, and location of future COVID-19 infection, more widespread infection of our employees could cause significant increases to operating expenses at specific facilities, or the curtailment of operations at such facilities on a temporary basis.
Our WtE plants and material processing facilities provide a vital service to our municipal and commercial clients. As waste disposal facilities, they have been recognized as part of Critical Infrastructure by the Department of Homeland Security and as essential services by state and local governments. Residential waste represents the substantial majority of our contracted volumes, and there has been limited impact on these volumes to date. We also process commercial waste, including profiled waste, at many facilities, and while overall volumes of these materials for disposal in the market fell during the early stages of the pandemic, volumes have generally returned to pre-pandemic levels, and our average revenue per ton levels have returned as well.
As the COVID-19 pandemic is ongoing with new variants and the near term worldwide economic outlook remains uncertain, we cannot reasonably estimate the length or severity of this pandemic, or the extent to which the disruption may materially impact our consolidated financial statements.
Commodity Markets - Our quarterly results within an operating year may be affected substantially by movements in commodity markets relevant to our business, principally those relating to energy and metals. As noted above, the COVID-19 pandemic has had a dampening effect on prices in these markets in prior periods. Such factors have caused, and may continue to cause, the portion of our energy revenue exposed to the market and/or our materials sales revenue to fluctuate to an extent that may materially affect our quarterly and annual financial results.
Energy Markets - A portion of our energy revenue is sold under short term arrangements at prevailing market prices. Underlying market prices are affected by a variety of factors not within our control such as weather, natural gas supply/demand conditions (including seasonal storage), regional electricity transmission and system conditions, and global demand. We maintain a disciplined program to hedge our exposure to market price volatility, see Item 1. Financial Statements - Note 11. Derivative Instruments. As a result of our hedging program, we have only a limited amount of exposure to market price volatility in the near term, including for the remainder of 2021.
Metals Markets - We sell recycled ferrous and non-ferrous metals under short term arrangements based on prevailing rates that are affected by regional and global demand for specific types of recycled metals. In addition, recycled metal prices for both ferrous and non-ferrous materials are potentially impacted, directly and indirectly, by tariff and trade actions both by the U.S. as well as foreign countries.
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June 30, 2021 June 30, 2020 Consumer Price Index (1) 5.4% 0.6% PJM Pricing (Electricity) (2) $ 24.23 $ 15.69 NE ISO Pricing (Electricity) (3) $ 29.41 $ 18.23 Henry Hub Pricing (Natural Gas) (4) $ 2.94 $ 1.71 #1 HMS Pricing (Ferrous Metals) (5) $ 425 $ 208 Old Sheet & Old Cast (Non-Ferrous Metals) (6) $ 0.71 $ 0.37
(1)Represents the year-over-year percent change in the Headline CPI number. The Consumer Price Index (CPI-U) data is provided by the U.S. Department of Labor Bureau of Labor Statistics.
Seasonal - Our quarterly operating results within the same fiscal year typically differ substantially due to seasonal factors, primarily as a result of the timing of scheduled plant maintenance. We conduct scheduled maintenance periodically each year, which requires that individual boiler and/or turbine units temporarily cease operations. During these scheduled maintenance periods, we incur material repair and maintenance expense and receive less revenue until the boiler and/or turbine units resume operations. This scheduled maintenance usually occurs during periods of off-peak electric demand and/or lower waste volumes, which are our first, second and fourth fiscal quarters. The scheduled maintenance period in the first half of the year (primarily first quarter and early second quarter) is typically the most extensive, while the third quarter scheduled maintenance period is the least extensive. Given these factors, we normally experience our lowest operating income from our projects during the first half of each year.
Our operating results may also be affected by seasonal weather extremes during summers and winters. Increased demand for electricity and natural gas during unusually hot or cold periods may affect certain operating expenses and may trigger material price increases for a portion of the electricity and steam we sell.
Brexit Implications - In March, 2017, the United Kingdom formally notified the European Union ("EU") of its intention to leave the EU (so-called "Brexit"), and on January 31, 2020, the UK formally severed political ties and left the EU. The UK's economic ties to the EU and its existing trading arrangements with both the EU and countries outside the EU remained in place pending trade agreement renegotiations during a "standstill" transition period through December 31, 2020. The COVID-19 pandemic has created additional challenges in finalizing these trade agreements, but the UK reached a trade deal with the EU on December 24, 2020 ahead of the UK leaving the EU's single market and customs union on December 31, 2020. As there are ongoing matters which remain to be agreed to, and the legislative frameworks of both UK and EU law continue to develop (and potentially further diverge), there remains ongoing uncertainty as to the implications of Brexit. The UK is also now negotiating and renegotiating its trade arrangements with non-EU countries. We have studied and consulted with local experts regarding the potential market and economic impacts of Brexit on the UK, with a particular focus on potential impacts to the waste and energy markets as they might affect our plans to expand our business with Green Investment Group Limited ("GIG"). The government of the UK has shown no indication of an intention to rollback or reverse its policy support for environmental protection generally, the renewables market, or for WtE specifically. As such, while Brexit may have some impact on construction costs and schedule for both existing and potential new UK WtE projects, we do not believe that Brexit will materially impact the key market and economic drivers for investment in the combined pipeline of WtE projects we are pursuing jointly with GIG.
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Our key capital allocation activities for the three months ended June 30, 2021 included the following:
$11 million declared in dividends to stockholders; and
Completion of Strategic Review
In October 2020, we announced the launch of a comprehensive strategic review of our assets, operations, growth priorities, and capital structure. This review was an opportunity to explore all options to enhance stockholder value, including assessing plans for each of our business lines and geographies. The board of directors appointed Michael Ranger as President and Chief Executive Officer to lead this review and its subsequent execution.
In April 2021, we announced that, in connection with the strategic review, we were implementing an overhead cost rationalization program with a target to reduce costs by $30 million on a run rate basis by the end of 2022. Initial efforts on this program have begun, including a voluntary early retirement program.
On July 14, 2021, we announced that we had entered into a definitive agreement with EQT Infrastructure ("EQT") whereby EQT will acquire all shares of Covanta common stock for $20.25 per share. The acquisition is subject to Covanta shareholder approval, as well as customary government approvals, and is expected to close in the fourth quarter of this year. The agreement resulted from a competitive sale process and is not subject to a financing condition. This transaction represents the conclusion of the strategic review.
CONSOLIDATED RESULTS OF OPERATIONS
The following general discussions should be read in conjunction with the condensed consolidated financial statements, the notes to the condensed consolidated financial statements and other financial information appearing and referred to elsewhere in this report. We have one reportable segment which comprises our entire operating business.
The comparability of the information provided below with respect to our revenue, expense and certain other items for the periods presented was affected by several factors. As outlined in Item 1. Financial Statements - Note 1. Organization and Basis of Presentation in this quarterly report on Form 10-Q and in Item 8. Financial Statements And Supplementary Data - Note 1. Organization and Summary of Significant Accounting Policies and Note 3. New Business and Asset Management of our 2020 Annual Report on Form 10-K, our business development initiatives, contract transitions, and acquisitions resulted in various transactions, which are reflected in comparative revenue and expense.
Certain reclassifications of the prior years' amounts have been made to conform to the current year's presentation. The change in presentation did not affect our total operating revenue, total operating expense or operating loss. For further information on the reclassifications, see Item 1. Financial Statements - Note 1. Organization and Basis of Presentation. In addition, comparability of our results was affected by the COVID-19 pandemic as discussed above under Impact of COVID-19 on the U.S. and the global economy. These factors must be taken into account in developing meaningful comparisons between the periods compared below.
The following terms used within the Results of Operations discussion are defined as follows:
"Organic growth": reflects the performance of the business on a comparable period-over-period basis, excluding the impacts of transactions and contract transitions.
Certain amounts in our Consolidated Results of Operations may not total due to rounding.
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Jul 28, 2021
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