FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

For the quarterly period ended September 30, 2004

OR

For the transition period from ______________ to ______________

Commission file number 1-6732

Danielson Holding Corporation

40 Lane Road, Fairfield, NJ 07004

(973) 882-9000

Two North Riverside Plaza, Suite 600
Chicago, IL 60606

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x       No o

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes x       No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares of the registrant’s Common Stock outstanding as of the last practicable date.

DANIELSON HOLDING CORPORATION
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTER ENDED SEPTEMBER 30, 2004

DANIELSON HOLDING CORPORATION

The accompanying notes are an integral part of the consolidated financial statements.

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DANIELSON HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS — (Continued)
(Unaudited)
(Dollars in Thousands, Except Per Share Amounts)

The accompanying notes are an integral part of the consolidated financial statements.

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DANIELSON HOLDING CORPORATION

The accompanying notes are an integral part of the consolidated financial statements.

3

DANIELSON HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION — (Continued)
(Dollars in Thousands)

The accompanying notes are an integral part of the consolidated financial statements.

4

DANIELSON HOLDING CORPORATION

The accompanying notes are an integral part of the consolidated financial statements.

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DANIELSON HOLDING CORPORATION

The accompanying notes are an integral part of the consolidated financial statements.

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DANIELSON HOLDING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS — (Continued)
(Unaudited)
(Dollars in Thousands)

The accompanying notes are an integral part of the consolidated financial statements.

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Note 1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Danielson Holding Corporation (“DHC” or the “Company”) have been prepared in accordance with the instructions to Form 10-Q. As permitted by the rules and regulations of the Securities and Exchange Commission (the “SEC”), the financial statements contain certain condensed financial information and exclude certain footnote disclosures normally included in audited consolidated financial statements prepared in accordance with U. S. generally accepted accounting principles (“GAAP”). In the opinion of management, the accompanying financial statements contain all adjustments, including normal recurring accruals, necessary to fairly present the accompanying financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in DHC’s Annual Report on Form 10-K for the year ended December 31, 2003. Operating results for the interim period are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2004.

DHC is a holding company that owns subsidiaries engaged in a number of diverse business activities. The most significant of these is the energy business of Covanta Energy Corporation (“Covanta”) acquired on March 10, 2004 (the “Effective Date”). DHC also has investments in subsidiaries engaged in insurance operations in the western United States, primarily California, and in American Commercial Lines LLC (“ACL”), an integrated marine transportation and service company currently in bankruptcy proceedings under Chapter 11 of the United States Bankruptcy Code (“Chapter 11”).

Covanta is engaged in developing, constructing, owning and operating for others, key infrastructure for the conversion of waste-to-energy, independent power production and the treatment of water and waste water in the United States and abroad. On March 10, 2004, Covanta consummated a plan of reorganization and emerged from its reorganization proceeding under Chapter 11. Pursuant to the plan of reorganization (“Covanta Reorganization Plan”), DHC acquired 100% of the equity in Covanta. This transaction is more fully described in Note 2. Four of Covanta’s subsidiaries, which related to two projects, have not reorganized or filed a liquidation plan under the Bankruptcy Code (the “Remaining Debtors”). While Covanta exercises significant influence over the operating and financial policies of these four subsidiaries, these four subsidiaries will continue to operate as debtors-in-possession in the Chapter 11 cases until they organize or liquidate. Because any plan of reorganization or liquidation relating to these debtors would have to be approved by the Bankruptcy Court, and possibly their respective creditors, neither the Company nor Covanta controls the ultimate outcome of their respective Chapter 11 cases. Accordingly, Covanta no longer includes those four subsidiaries in its consolidated financial statements. Covanta’s investment in these four subsidiaries is recorded using the equity method effective as of March 10, 2004. Unless these subsidiaries emerge from bankruptcy under Covanta’s control, it is unlikely that they will contribute to Covanta’s results of operations.

DHC holds all of the voting stock of Danielson Indemnity Company (“DIND”). DIND owns 100% of the common stock of National American Insurance Company of California, DHC’s principal operating insurance subsidiary, which owns 100% of the common stock of Valor Insurance Company, Incorporated. National American Insurance Company of California and its subsidiaries are collectively referred to herein as “NAICC”. The operations of NAICC are in property and casualty insurance. NAICC writes non-standard private automobile insurance in the western United States, primarily California. Effective September 7, 2003, NAICC discontinued writing all commercial automobile insurance. Effective January, 2002, NAICC discontinued writing all workers’ compensation insurance.

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ACL provides barge transportation and ancillary services throughout the inland United States and Gulf Intracoastal Waterway Systems, which include the Mississippi, Ohio and Illinois Rivers and their tributaries and the Intracoastal canals that parallel the Gulf Coast. In addition, ACL provides barge transportation services on the Orinoco River in Venezuela and the Parana/Paraguay River System serving Argentina, Brazil, Paraguay, Uruguay and Bolivia. As discussed in Note 3, on April 23, 2004, ACL sold it interest in UABL Limited, a South American barging and terminalling company.

DHC acquired a 100% ownership interest in ACL in May, 2002, thereby entering into the marine transportation, construction and related service provider businesses. On January 31, 2003, ACL and many of its subsidiaries and its immediate direct parent entity, American Commercial Lines Holdings, LLC, referred to herein as “ACL Holdings,” filed a petition with the U.S. Bankruptcy Court to reorganize under Chapter 11. Material uncertainty exists as to the impact of the bankruptcy on DHC’s equity interest in ACL upon the conclusion of ACL’s bankruptcy proceeding. While it cannot presently be determined, DHC believes that its investment in ACL is likely to have little or no value upon the completion of that bankruptcy proceeding. (See discussion in Note 3.) Accordingly, DHC attributes no value to its investment in ACL on its financial statements. DHC, its subsidiaries and equity investees, operating in the marine services industries, are not guarantors of ACL’s debt, nor are they contractually liable for any of ACL’s liabilities. In the event of the liquidation and sale of ACL’s assets or other plan terminations, under certain circumstances, statutory obligations for ACL’s ERISA qualified pension plans could be imposed upon us.

As a result of the ACL bankruptcy filing, DHC no longer maintains control of ACL. Accordingly, beginning for the year ended December 31, 2003, DHC has accounted for its investments in ACL, Global Materials Services, LLC (“GMS”) and Vessel Leasing, LLC (“Vessel Leasing”) using the equity method of accounting. GMS is a joint venture of DHC, ACL and a third party in which DHC held a 5.4% interest. It is engaged in the marine terminal business. Both ACL and DHC sold their respective interests in GMS as of October 6, 2004. Vessel Leasing is a joint venture of ACL and DHC which leases barges to ACL. DHC owns a 50% direct interest in Vessel Leasing and ACL holds the remaining 50%. Under the equity method of accounting, DHC reports its share of the equity investees’ income or loss based on its ownership interest. DHC has fully written off its investment in ACL, accordingly DHC ceased recognizing losses on its investment as DHC is not liable either directly or as guarantor for such losses.

SZ Investments, L.L.C., a significant stockholder of DHC, and a company affiliated with Samuel Zell, former Chairman of DHC’s Board of Directors, William Pate, DHC’s current Chairman of the Board of Directors and Philip Tinkler, DHC’s former Chief Financial Officer, is a holder through its affiliate, HY I Investments, L.L.C., of approximately 42% of ACL’s senior notes and payment-in-kind notes. As a result, a special committee of DHC’s Board of Directors was formed in November 2002, composed solely of disinterested directors, to oversee DHC’s investment in ACL and its related Chapter 11 bankruptcy proceedings.

Covanta Energy Corporation is referred to herein as “Energy” or as “Covanta”. “Domestic Covanta” refers to Covanta and its subsidiaries engaged in the waste-to-energy, water and independent power businesses in the United States; and “CPIH” refers to Covanta’s subsidiary, Covanta Power International Holdings, Inc. and its subsidiaries engaged in the independent power business outside the United States. DHC’s insurance subsidiaries are referred to herein as “Insurance Services”. ACL, GMS and Vessel Leasing are together referred to herein as “Marine Services”.

The December 31, 2003 consolidated financial statements include the accounts of DHC and DIND and their consolidated subsidiaries. The September 30, 2004 consolidated financial statements include the accounts of DHC, DIND and Covanta and their consolidated subsidiaries. All intercompany accounts and transactions have been eliminated. As previously mentioned, DHC’s investments in ACL and its consolidated subsidiaries, GMS and Vessel Leasing, are included in the consolidated financial statements using the equity method of accounting.

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The accompanying consolidated statement of financial position at December 31, 2003 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.

Note 2. Covanta Acquisition and Financing Agreements

On December 2, 2003, DHC executed a definitive investment and purchase agreement to acquire Covanta in connection with Covanta’s emergence from Chapter 11 proceedings after the non-core and geothermal assets of Covanta were divested. The primary components of the transaction were: (1) the purchase by DHC of 100% of the equity of Covanta in consideration for a cash purchase price of approximately $30 million, and (2) agreement as to new letter of credit and revolving credit facilities for Covanta’s domestic and international operations, provided by some of the existing Covanta lenders and a group of additional lenders organized by DHC.

This agreement was amended on February 23, 2004 which reduced the purchase price and released from an escrow account $0.2 million to purchase DHC’s equity interest in Covanta Lake, Inc. A limited liability company was formed by DHC and one of Covanta’s subsidiaries and it acquired an equity interest in Covanta Lake II, Inc., an indirect subsidiary of Covanta, in a transaction separate and distinct from the acquisition of Covanta out of bankruptcy.

As required by the investment and purchase agreement, Covanta filed a proposed plan of reorganization, a proposed plan of liquidation for specified non-core businesses, and the related draft disclosure statement, each reflecting the transactions contemplated under the investment and purchase agreement, with the Bankruptcy Court. On March 5, 2004, the Bankruptcy Court confirmed the Covanta Reorganization Plan. On March 10, 2004, DHC acquired 100% of Covanta’s equity in consideration for approximately $30 million.

With the purchase of Covanta, DHC acquired a leading provider of waste-to-energy services and independent power production in the United States and abroad. DHC’s equity investment and ownership provided Covanta’s businesses with improved liquidity and capital resources to finance their business activities and emerge from bankruptcy.

The aggregate purchase price was $47.5 million which included the cash purchase price of $29.8 million, approximately $6.4 million for professional fees and other estimated costs incurred in connection with the acquisition, and an estimated fair value of $11.3 million for DHC’s commitment to sell up to 3 million shares of its common stock at $1.53 per share to certain creditors of Covanta, subject to certain limitations as more fully described below.

The following table summarizes a preliminary allocation of values to the assets acquired and liabilities assumed at the date of acquisition in conformity with Statement of Financial Accounting Standards (“SFAS”) No. 141 “Business Combinations” and SFAS No. 109 “Accounting for Income Taxes”. In addition to the value allocation adjustments, Covanta’s emergence from Chapter 11 proceedings on March 10, 2004 resulted in Covanta becoming a new reporting entity and adoption of fresh start accounting as of that date, in accordance with AICPA Statement of Position (“SOP”) 90-7, “Financial Reporting by Entities in Reorganization Under Bankruptcy Code”. Preliminary fair value determinations of the tangible and intangible assets were made by management based on anticipated discounted cash flows using currently available information. Management’s estimate of the fair value of long term debt was based on the new principal amounts of recourse debt that was part of the reorganized capital structure of Covanta upon emergence. Management’s estimate of the fair value of project debt was based on market information available to the Company. The Company has engaged valuation consultants to review its valuation methodology and their work is ongoing.

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In accordance with SFAS No. 141, the preliminary purchase price allocation is subject to additional adjustment within one year after the acquisition as additional information on asset and liability valuations becomes available. The Company expects that adjustments to recorded fair values may include those relating to:

	•		property, plant, and equipment, intangibles, debt, and equity investments, all of which may change based on consideration of additional analysis by the Company and its valuation consultants;
	•		accrued expenses which may change based on identification of final fees and costs associated with Covanta’s emergence from bankruptcy, resolution of disputed claims, and completion of Chapter 11 cases relating to the Remaining Debtors;
	•		the final principal amount of the unsecured notes (recorded as an estimated principal amount of $28 million, which estimate excludes any notes that may be issued if and when Remaining Debtors emerge from bankruptcy), and which will be adjusted based upon the resolution of claims of creditors entitled to such notes as distributions; and
	•		tax liabilities, which may be adjusted based upon additional information to be received from taxing authorities.

The following depicts the summary balance sheet of Covanta after the purchase price allocation as of March 10, 2004 (in thousands of dollars):

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The acquired intangible assets of $203.0 million primarily relate to service agreements on publicly owned waste-to-energy projects with an approximate 17-year weighted average useful life. However, many such contracts have remaining lives that are significantly shorter.

In its initial purchase price allocation as of March 10, 2004, goodwill of $24.5 million was recorded to reflect the excess of cost over the preliminary fair value of acquired net assets. The Company has subsequently refined various estimates of fair values of the assets acquired and liabilities assumed. The most significant adjustments were decreases of (a) property, plant and equipment — net of $148.5 million, (b) intangible assets of $115.1 million, (c) deferred income tax liabilities of $160.4 million and (d) other liabilities of $128.7 million. Goodwill was eliminated as a result of these fair value adjustments and the resulting excess of fair value over the purchase price paid was allocated on a pro rata basis to reduce the carrying value of the Company’s eligible non-current assets.

The results of operations from Covanta are included in DHC’s consolidated results of operations from March 11, 2004. The following table sets forth certain unaudited consolidated operating results for the quarter and nine months ended September 30, 2004 and 2003, as if the acquisition of Covanta were consummated on the same terms at the beginning of each period (in thousands of dollars, except per share amounts).

As part of the investment and purchase agreement, DHC arranged for a new $118.0 million replacement letter of credit facility for Covanta, secured by a second lien on Covanta’s domestic assets. This financing was provided by SZ Investments, L.L.C., a DHC stockholder (“SZ Investments”), Third Avenue Trust, on behalf of Third Avenue Value Fund Series, a DHC stockholder (“Third Avenue”), and D. E. Shaw Laminar Portfolios, L.L.C., a creditor of Covanta and a DHC stockholder (“Laminar”). Subsequent to the signing of the investment and purchase agreement, each of Third Avenue, Laminar and SZ Investments assigned approximately 30% of their participation in the second lien letter of credit facility to Goldman Sachs Credit Partners, L.P. and Laminar assigned the remainder of its participation in the second lien letter of credit facility to TRS Elara, LLC. In addition, in connection with a note purchase agreement described below, Laminar arranged for a $10.0 million revolving loan facility for CPIH, secured by CPIH’s assets. Covanta also paid an upfront fee of $2.4 million upon entering into the second lien credit agreement, and will pay (i) a commitment fee equal to 0.5% per annum of the daily calculation of available credit, (ii) an annual agency fee of $30,000 and, (iii) with respect to each issued letter of credit an amount equal to 6.5% per annum of the daily amount available to be drawn under such letter of credit.

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DHC obtained the financing necessary for the Covanta acquisition pursuant to a note purchase agreement dated December 2, 2003, with each of SZ Investments, Third Avenue and Laminar, referred to collectively as the “Bridge Lenders”. Pursuant to the note purchase agreement, the Bridge Lenders severally provided DHC with an aggregate of $40 million of bridge financing in exchange for notes which were convertible under certain circumstances into shares of DHC common stock at a price of $1.53 per share, subject to agreed upon limitations. DHC used $30.0 million of the proceeds from the notes to post an escrow deposit prior to the closing of the transactions contemplated by the investment and purchase agreement with Covanta. At closing, the deposit was used to purchase Covanta. DHC will use the remainder of the proceeds to pay transaction expenses and for general corporate purposes. These notes were repaid on June 11, 2004 from the proceeds of a pro rata rights offering made to all stockholders on May 18, 2004.

DHC issued to the Bridge Lenders an aggregate of 5,120,853 shares of DHC’s common stock in consideration for the $40 million of bridge financing. At the time that DHC entered into the note purchase agreement, agreed to issue the notes convertible into shares of DHC common stock and issued the equity compensation to the Bridge Lenders, the trading price of the DHC common stock was below the $1.53 per share conversion price of the notes. On December 1, 2003, the day prior to the announcement of the Covanta acquisition, the closing price of DHC common stock on the American Stock Exchange was $1.40 per share.

In addition, under the note purchase agreement, Laminar agreed to convert an amount of notes to acquire up to an additional 8.75 million shares of DHC common stock at $1.53 per share based upon the levels of public participation in the May 18, 2004 rights offering. Based upon the public participation in the rights offering, DHC issued the maximum of 8.75 million shares to Laminar pursuant to the conversion of approximately $13.4 million in principal amount of notes. Consequently, the $20.0 million principal amount of notes held by Laminar plus accrued but unpaid interest was repaid in full on June 11, 2004 through the issuance of 8.75 million shares of DHC common stock to Laminar and $7.9 million of the proceeds from the rights offering.

DHC has agreed to commence an offering of shares to a class of creditors of Covanta that are entitled to participate in an offering of up to 3.0 million shares of DHC common stock at a price of $1.53 per share pursuant to the Covanta Reorganization Plan.

As part of DHC’s negotiations with Laminar and its becoming a 5% stockholder, pursuant to a letter agreement dated December 2, 2003, Laminar has agreed to additional restrictions on the transferability of the shares of DHC common stock that Laminar holds or will acquire. Further, in accordance with the transfer restrictions contained in Article Fifth of DHC’s charter restricting the resale of DHC common stock by 5% stockholders, DHC has agreed with Laminar to provide it with limited rights to resell the DHC common stock that it holds. Finally, pursuant to its agreement with the Bridge Lenders on July 28, 2004, DHC has filed a registration statement with the SEC to register the shares of DHC common stock issued to or acquired by them under the note purchase agreement. The registration statement was declared effective on August 24, 2004.

Samuel Zell, DHC’s former Chairman of the Board of Directors, Philip Tinkler, DHC’s former Chief Financial Officer and William Pate, current Chairman of DHC, are affiliated with SZ Investments. David Barse, Director of DHC, is affiliated with Third Avenue. The note purchase agreement and other transactions involving the Bridge Lenders were negotiated, reviewed and approved by a special committee of DHC’s Board of Directors composed solely of disinterested directors and advised by independent legal and financial advisors.

See Notes 7 through 9 for additional information regarding Covanta’s credit and debt arrangements.

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Note 3. ACL Chapter 11 Filing

During 2002, ACL experienced a decline in barging rates, reduced shipping volumes and excess barging capacity during a period of slow economic growth. Due to these factors, ACL’s revenues and earnings did not meet expectations and ACL’s liquidity was significantly impaired. Debt covenant violations occurred and, as a result, ACL was unable to meet its financial obligations as they became due. On January 31, 2003 (the “Petition Date”), ACL filed a petition with the U.S. Bankruptcy Court for the Southern District of Indiana, New Albany Division (the “Bankruptcy Court”) to reorganize under Chapter 11 under case number 03-90305. Included in the filing were ACL, ACL’s direct parent (ACL Holdings), American Commercial Barge Line LLC, Jeffboat LLC, Louisiana Dock Company LLC and ten other U.S. subsidiaries of ACL (collectively with ACL, the “Debtors”) under case numbers 03-90306 through 03-90319. These cases are jointly administered for procedural purposes before the Bankruptcy Court under case number 03-90305. The Chapter 11 petitions do not cover any of ACL’s foreign subsidiaries or certain of its U.S. subsidiaries.

ACL and the other Debtors are continuing to operate their businesses as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of Chapter 11 and orders of the Bankruptcy Court. As debtors-in-possession, the Debtors may not engage in transactions outside of the ordinary course of business without approval, after hearing, of the Bankruptcy Court.

The Debtors’ direct and indirect foreign subsidiaries and foreign joint venture entities did not file petitions under Chapter 11 and are not debtors-in-possession. DHC, GMS and Vessel Leasing also did not file petitions under Chapter 11 and are not debtors-in-possession.

The Debtors have entered into a Revolving Credit and Guaranty Agreement (“DIP Credit Facility”) that provides up to $75 million of financing during ACL’s Chapter 11 proceeding. As of December 26, 2003, participating bank commitments under the DIP Credit Facility totaled $75 million, consisting of a $50 million term loan and a $25 million revolving credit facility. Of this amount, the Debtors had fully drawn the $50 million term loan, which was used to retire ACL’s Pre-Petition Receivables Facility and which continues to be used to fund the Debtors’ day-to-day cash needs. The Debtors have made no draws against the revolving credit facility. In the first quarter of 2004, the Debtors repaid $8 million of the term loan. In the second quarter of 2004, the Debtors repaid $ 25.8 million of the term loan. In the third quarter of 2004, the debtors repaid $4.9 million of the term loan. Each payment permanently reduced the amount available under the DIP Credit Facility. As of September 30, 2004, participating bank commitments remaining under the DIP Credit Facility totaled $36.3 million, consisting of $11.3 million remaining on a fully-drawn term loan and a $25 million revolving credit facility. Total amounts drawn under the DIP Credit Facility are limited by a borrowing base (as defined in the DIP Credit Facility). The borrowing base limit was approximately $69.3 million as of September 30, 2004 and is updated weekly. The DIP Credit Facility is secured by the same and additional assets that collateralized ACL’s Senior Credit Facilities and Pre-Petition Receivables Facility, and bears interest, at ACL’s option, at London Inter Bank Offered Rates (“LIBOR” or “LIBOR” Rates) plus four percent or an Alternate Base Rate (as defined in the DIP Credit Facility) plus three percent. There are also certain interest rates in the event of a default under the facility.

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The obligations of the Debtors under the DIP Credit Facility, by court order, have super-priority administrative claim status as provided under Chapter 11. Under Chapter 11, a super-priority claim is senior to secured and unsecured pre-petition claims and all administrative expenses incurred in the Chapter 11 case. In addition, with certain exceptions (including a carve-out for unpaid professional fees and disbursements), the DIP Credit Facility obligations are secured by (1) a first-priority lien on all unencumbered pre- and post-petition property of the Debtors, (2) a first-priority priming lien on all property of the Debtors that is encumbered by the existing liens securing the Debtors’ pre-petition secured lenders and (3) a junior lien on all other property of the Debtors that is encumbered by the pre-petition liens.

The DIP Credit Facility also contains certain restrictive covenants that, among other things, restrict the Debtors’ ability to incur additional indebtedness or guarantee the obligations of others. ACL is also required to maintain minimum cumulative EBITDA, as defined in the DIP Credit Facility, limit its capital expenditures to defined levels and restrict advances to certain subsidiaries.

The DIP Credit Facility will terminate and the borrowings thereunder will be due and payable upon the earliest of (i) December 31, 2004, (ii) the date of the substantial consummation of a plan of reorganization that is confirmed pursuant to an order by the Bankruptcy Court, or (iii) the acceleration of the term loans or the revolving credit loans made by any of the banks who are a party to the DIP Credit Facility and the termination of the total commitment under the DIP Credit Facility pursuant to the DIP Credit Facility.

As a result of the Chapter 11 filings, certain events of default under ACL’s Senior Credit Facilities, Senior Notes, PIK Notes and Old Senior Notes have occurred, the effects of which are stayed pursuant to certain provisions of Chapter 11.

Under Chapter 11, actions by creditors to collect claims in existence at the filing date are stayed or deferred absent specific Bankruptcy Court authorization to pay such pre-petition claims while the Debtors continue to manage their businesses as debtors-in-possession and act to develop a plan of reorganization for the purpose of emerging from these proceedings. The Debtors have received approval from the Bankruptcy Court to pay or otherwise honor certain of its pre-petition obligations, including but not limited to employee wages and certain employee benefits, certain critical vendor payments, certain insurance and claim obligations and certain tax obligations as a plan of reorganization is developed. A claims bar date of December 5, 2003 and an administrative bar date of July 9, 2004 were established for all pre-petition and post-petition creditors to file a claim against the estate of the various debtors. The Debtors are currently in the process of reviewing the claims that were filed against the Debtors. The ultimate amount of claims allowed by the Court against the Debtors could be significantly different than the amount of the liabilities recorded by the Debtors.

The Debtors also have numerous executory contracts and other agreements that could be assumed or rejected during the Chapter 11 proceedings. Parties affected by these rejections may file claims with the Bankruptcy Court in accordance with the reorganization process. Under these Chapter 11 proceedings, the rights of and ultimate payments to pre-petition creditors, rejection damage claimants and ACL’s equity investor may be substantially altered. This could result in claims being liquidated in the Chapter 11 proceedings at less (possibly substantially less) than 100% of their face value, and the membership interests of ACL’s equity investor being diluted or cancelled. The Debtors’ pre-petition creditors and ACL’s equity investor will each have a vote to approve or disapprove the plan of reorganization.

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The Chapter 11 process presents inherent material uncertainty; it is not possible to determine the additional amount of claims that may arise or ultimately be filed, or predict the length of time that the Debtors will continue to operate under the protection of Chapter 11, the outcome of the Chapter 11 proceedings in general, whether the Debtors will continue to operate in their present organizational structure, or the effects of the proceedings on the business of ACL, the other Debtors and its non-filing subsidiaries and affiliates, or on the interests of the various creditors and equity holder. The ultimate recovery, if any, by creditors and DHC will not be determined until confirmation of a plan or plans of reorganization. No assurance can be given as to what value, if any, will be ascribed in the bankruptcy proceedings to each of these constituencies. While it cannot be presently determined, DHC believed it will receive little or no value with respect to its equity interest in ACL Holdings or ACL. Accordingly, DHC wrote off its remaining investment in ACL at the end of the first quarter of 2003 as an other than temporary asset impairment. (See Note 5.)

On April 23, 2004, ACL announced the sale of its ownership interest in UABL Limited (“UABL”), a South American barging and terminalling company, and other assets being used by UABL for $24.1 million of cash and other consideration. The sale transaction closed on April 23, 2004. In connection with the UABL sale, ACL recorded a pre-tax loss of $35.2 million.

On June 8, 2004, ACL filed a Motion for Order Approving Sale Procedures, Break-Up Fee and Authorizing the Employment of Environmental Consultants to establish procedures for the sale of its 50% membership interest in GMS, to request approval of a break-up fee for a proposed “stalking horse” bidder for ACL’s membership interest in GMS, to fix procedures for rights of access and due diligence by bidders, and to authorize the employment of a consulting firm to prepare certain environmental reports. The proposal by the stalking horse bidder also included a proposal for the coterminous acquisition of DHC’s 5.4% membership interest in GMS. Midsouth Terminal Company L.P. (“MST”), the holder of the remaining interests in GMS, filed an objection to ACL’s motion and asserted their right of first refusal to acquire ACL’s membership interest in GMS pursuant to GMS’ Amended and Restated Limited Liability Company Operating Agreement dated May 25, 2002. At a hearing of the Bankruptcy Court, an order was issued on June 24, 2004 granting the Motion, as amended, establishing sale procedures, a break-up fee, and authorizing the employment of environmental consultants, and preserving the rights of MST to elect to exercise any right of first refusal it may have, subject to further court review, on the same terms and conditions as the stalking horse bidder, and further provided such exercise occurred on or before July 14, 2004. On July 13, 2004, MST notified ACL that it desired to exercise its right of first refusal to acquire ACL’s membership interest in GMS.

During September, 2004 DHC and MST agreed on terms with respect to the sale of DHC’s membership interest in GMS. On September 29, 2004, the Bankruptcy Court approved the sale to MST of ACL’s membership interest in GMS as well as the sale to MST of DHC’s membership interest in GMS. On October 6, 2004, the parties consummated the sale of ACL’s and DHC’s membership interests in GMS to MST. DHC received approximately $1.5 million in connection with this transaction. DHC does not expect to recognize a significant gain or loss or this transaction.

On September 10, 2004, ACL filed in the Bankruptcy Court a plan of reorganization (the “ACL Plan”) on behalf of itself and the other debtors. The ACL Plan provides for among other things, various distributions to creditors, and provides that 100% of the equity in ACL will be held by a newly-formed holding company owned by certain of ACL’s creditors. DHC’s ownership interest in ACL is expected to be cancelled under the ACL Plan, and DHC is expected to receive warrants entitling it to purchase up to 168,230 shares of such holding company, representing 3% of the total number of issued shares therein.

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Note 4. Summary of Significant Accounting Policies

Parent and Consolidated Entity

Principles of Consolidation

The consolidated financial statements reflect the results of operations, cash flows and financial position of DHC and its majority-owned and controlled subsidiaries. All intercompany accounts and transactions have been eliminated. Investments in companies that are not majority-owned or controlled but in which the Company has significant influence are accounted for under the equity method.

Use of Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Actual results could differ from those estimates. Significant estimates include useful lives of long-lived assets, cash flows and taxable income from future operations, allowances for doubtful accounts receivable, and liabilities related to pension obligations, and for workers’ compensation, severance and certain litigation.

Cash and Cash Equivalents

Cash and cash equivalents include short-term investments with an original maturity of less than three months when purchased. DHC, from time to time, has cash in banks in excess of federally insured limits. Cash and cash equivalents are stated at cost, which approximates fair value.

Deferred Financing Costs

At September 30, 2004 and 2003, the Company had $5.4 million and $0, respectively of net deferred financing costs recorded on the condensed consolidated balance sheet.

These costs were incurred in connection with arranging its various financing arrangements. These costs are being amortized over the expected period that the related financing will be outstanding. Amortization for three and nine months ended September 30, 2004 were $0.2 million and $7.6 million, respectively, and was included in interest expense on the condensed consolidated statements of operations.

Pension and Postretirement Plans

The Company has pension and post-retirement obligations and costs that are developed from actuarial valuations. Inherent in these valuations are key assumptions including discount rates, expected return on plan assets and medical trend rates. Changes in these assumptions are primarily influenced by factors outside the Company’s control and can have a significant effect on the amounts reported in the financial statements.

Incentive Compensation Plans

Stock-based compensation cost is measured using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” for the Company’s directors and employees. Pro forma net income (loss) and income (loss) per share are disclosed below as if the fair value based method of accounting under SFAS No. 123 had been applied to all stock-based compensation awards.

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Note: Pro Forma compensation expense for the quarter and nine months ended September 30, 2004 includes adjustments for forfeitures of unvested options. Such adjustments exceeded compensation expense disclosed for outstanding unvested options for the quarter and nine months ended September 30, 2004.

Energy

Service Revenues

Covanta’s revenues are generally earned under contractual arrangements. Service revenues include:

	•		Fees earned under contract to operate and maintain waste-to-energy, independent power and water facilities
	•		Fees earned to service project debt (principal and interest) where such fees are expressly included as a component of the service fee paid by the municipal client pursuant to applicable service agreements. Regardless of the timing of amounts paid by the municipal client relating to project debt principal, Covanta records service revenue with respect to this principal component on a levelized basis over the term of the agreement. Long term unbilled service receivable related to waste-to-energy operations are discounted in recognizing the present value for services performed currently in order to service the principal component of the project debt;
	•		Fees earned for processing waste in excess of service agreement requirements;
	•		Tipping fees earned under waste disposal agreements; and
	•		Other miscellaneous fees such as revenue for scrap metal recovered and sold.

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Electricity and Steam Sales

Revenue from the sale of electricity and steam are earned at energy facilities and are recorded based upon output delivered and capacity provided at rates specified under contract terms or prevailing market rates net of amounts due to client communities under applicable service agreements.

Construction Revenues

Revenues under fixed-price contracts, including construction, are recognized on the basis of the estimated percentage of completion of services rendered. Anticipated losses are recognized as soon as they become known.

Pass Through Costs

Pass through costs are costs for which Covanta receives a direct contractually committed reimbursement from the client who sponsors the project. These costs generally include utility charges, insurance premiums, ash residue transportation and disposal, and certain chemical costs. These costs are recorded net in Covanta’s financial statements. Total pass through expenses for the periods March 11, 2004 through September 30, 2004, January 1, 2004 through March 10, 2004, and the first nine months of 2003 were $25.5 million, $10.0 million, and $39.9 million, respectively.

Property, Plant and Equipment

As of March 10, 2004, the assets and liabilities of Covanta’s energy business including property, plant, and equipment were recorded at management’s estimate of their fair values. For financial reporting purposes, depreciation is calculated by the straight-line method over the estimated remaining useful lives of the assets, which range up to 41 years for waste-to-energy facilities. The original useful lives generally range from three years for computer equipment to 50 years for waste-to-energy facilities.

Service and Energy Contracts

As of March 10, 2004, service and energy contracts were recorded at their estimated fair values based upon discounted cash flows from the service contracts on publicly owned projects and the above market portion of the energy contracts on Covanta owned projects using currently available information. Amortization is calculated by the straight-line method over the estimated remaining weighted average life of the agreements of 17 years. However, many of such contracts have remaining lives that are significantly shorter.

Estimated amortization over the next five years is as follows (in thousands of dollars):

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Service Revenues and Unbilled Service Receivables

The following table summarized the components of Service Revenues for the nine months and three months ended September 30, 2004 (in thousands of dollars):

As of March 10, 2004, unbilled service receivables were recorded at their estimated fair value based upon discounted cash flows. Unbilled service receivables include fees earned to service project debt (principal and interest) where such fees are expressly included as a component on the service fee paid by the municipality pursuant to applicable waste-to-energy service agreements. Regardless of the timing of amounts paid by municipalities relating to project debt principal, the Company records service revenue with respect to this principal component on a levelized basis over the term of the service agreement. Long-term unbilled service receivables related to waste-to-energy operations were discounted in recognizing the present value for services performed currently in order to service the principal component of project debt.

Restricted Funds

Restricted funds held in trust are primarily amounts received by third party trustees relating to projects owned by Covanta, and which may be used only for specified purposes. Covanta generally does not control these accounts. They include debt service reserves for payment of principal and interest on project debt, deposits of funds received with respect to projects prior to their disbursement as provided in the relevant indenture or other agreements, lease reserves for lease payments under operating leases, and proceeds received from financing the construction of energy facilities. Such funds are invested principally in United States Treasury bills and notes and United States government agency securities.

Project Development Costs

Covanta capitalizes project development costs once it is determined that it is probable that such costs will be realized through the ultimate construction of a plant. These costs include outside professional services, permitting expense and other third party costs directly related to the development of a specific new project. Upon the start-up of plant operations or the completion of an acquisition, these costs are generally transferred to property, plant and equipment and are amortized over the estimated useful life of the related project or charged to construction costs in the case of a construction contract for a facility owned by a municipality. Capitalized project development costs are charged to expense when it is determined that the related project is impaired. In purchase accounting, no separate value was assigned to project development costs as economically they are reflected in the fair values assigned to property, plant and equipment and to service and energy contracts.

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Interest Rate Swap Agreements

The fair value of interest rate swap agreements are recorded as assets and liabilities, with changes in fair value during the year credited or charged to debt service revenue or debt service charges, as appropriate.

Long-Lived Assets

Covanta assesses the potential for the impairment of long-lived assets to be held and used by evaluating the carrying value of its long-lived assets in relation to the operating performance and future undiscounted cash flows of the underlying businesses when indications of impairment are present. If the carrying value of such assets is greater than the anticipated future undiscounted cash flows of those assets, Covanta would measure and record the impairment amount, if any, as the difference between the carrying value of the assets and the fair value of those assets.

Foreign Currency Translation

For foreign operations, assets and liabilities are translated at year-end exchange rates and revenues and expenses are translated at the average exchange rates during the year. For subsidiaries whose functional currency is deemed to be other than the U.S. dollar, translation adjustments are included as a separate component of other comprehensive income (loss) and shareholders’ equity. Currency transaction gains and losses are recorded in Other-net in the Statements of Consolidated Operations and Comprehensive Income (Loss).

Insurance Services

Investments

Insurance Services’ fixed maturity debt and equity securities portfolio are classified as “available for sale” and are carried at fair value. Changes in fair value are credited or charged directly to stockholders’ equity as unrealized gains or losses, respectively. “Other than temporary” declines in fair value are recorded as realized losses in the statement of operations and the cost basis of the security is reduced.

Deferred Policy Acquisition Costs

Insurance Services’ deferred policy acquisition costs, consisting principally of commissions and premium taxes paid at the time of issuance of the insurance policy, are deferred and amortized over the period during which the related insurance premiums are earned. Deferred policy acquisition costs are limited to the estimated future profit after anticipated losses and loss adjustment expenses (“LAE”) (based on historical experience), maintenance costs, policyholder dividends, and anticipated investment income. Deferred policy acquisition costs were $0.2 million and $1.4 million at September 30, 2004 and September 30, 2003, respectively.

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Unpaid Losses and Loss Adjustment Expenses

Unpaid losses and LAE are based on estimates of reported losses and historical experience for incurred but unreported claims, including losses reported by other insurance companies for reinsurance assumed, and estimates of expenses for investigating and adjusting all incurred and unadjusted claims. Management believes that the provisions for unpaid losses and LAE are adequate to cover the cost of losses and LAE incurred to date. However, such liability is, by necessity, based upon estimates, which may change in the near term, and there can be no assurance that the ultimate liability will not exceed, or even materially exceed, such estimates. Unpaid losses and LAE are continually monitored and reviewed, and as settlements are made or reserves adjusted, differences are included in current operations.

Reinsurance

In the normal course of business, Insurance Services seeks to reduce the loss it may incur on the policies it writes by reinsuring certain portions of the insured benefit with other insurance enterprises or reinsurers.

Insurance Services cedes reinsurance on an excess of loss basis for workers’ compensation risks in excess of $0.5 million per occurrence prior to April 2000 and $0.2 million per occurrence thereafter. For commercial automobile lines, NAICC ceded reinsurance on an excess of loss basis for exposure in excess of $0.25 million per occurrence. Various quota share treaties had been in place for non-standard automobile prior to 2002 as well as property and casualty business incepting prior to 1978.

Insurance Services accounts for its reinsurance contracts which provide indemnification by reducing earned premiums for the amounts ceded to the reinsurer and establishing recoverable amounts for paid and unpaid losses and LAE ceded to the reinsurer. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Contracts that do not result in the reasonable possibility that the reinsurer may realize a significant loss from the insurance risk generally do not meet conditions for reinsurance accounting and are accounted for as deposits. For the three and nine months ended September 30, 2004 and 2003, Insurance Services had no reinsurance contracts which were accounted for as deposits.

Earned Premiums

Insurance Services’ earned premium income is recognized ratably over the contract period of an insurance policy. A liability is established for unearned insurance premiums that represent the portion of premium received which is applicable to the remaining portion of the unexpired terms of the related policies. Reinsurance premiums are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts.

Insurance Services establishes an allowance for premium receivables and reinsurance recoverables through a charge to general and administrative expenses based on historical experience. After all collection efforts have been exhausted, Insurance Services writes off the receivable balances and reduces the previously established reserve.

New Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN No. 46”). FIN No. 46 was intended to clarify the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” and applies immediately to any variable interest entities created after January 31, 2003 and to variable interest entities in which an interest is obtained after that date. FIN No. 46 was revised in December 2003 and is applicable for the Company on January 1, 2004 for interests acquired in variable interest entities prior to February 1, 2003. The Company adopted the provisions of FIN No. 46 without impact on its consolidated financial condition or results of operations.

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Reclassification

Certain prior period amounts, including various revenues and expenses, have been reclassified in the Financial Statements to conform with the current period presentation.

Note 5. Equity in Net Income and Losses of Unconsolidated Subsidiaries

DHC wrote off its investment in ACL during the quarter ended March 28, 2003. The GMS and Vessel Leasing investments were not considered by DHC to be impaired. The reported net income (loss) for the quarters and nine months ended September 30, 2004 and 2003, included, under the caption “Equity in Net Income Loss of Unconsolidated Investments”, the following components (in thousands of dollars):

Activity in the equity investees for the three and nine months ended September 30, 2004 and September 30, 2003 was as follows (in thousands of dollars):

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*Before ACL Reorganization Expenses

The following table summarizes the results of operations for the Remaining Debtors for the period March 11, 2004 through September 30, 2004, and for the three months ended September 30, 2004. Due to uncertainty regarding the realizability of earnings of the Remaining Debtors, Covanta has not recognized the earnings set forth below (in thousands of dollars):

Note 6. Per Share Data

Per share data is based on the weighted average number of shares of common stock of DHC, par value $0.10 per share (“Common Stock”), outstanding during the relevant period. Basic earnings per share are calculated using only the average number of outstanding shares of Common Stock. Such average shares were

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72,757,890 and 47,413,289 for the three months ended September 30, 2004 and 2003, respectively, and 60,336,791 and 47,413,986 for the nine months ended September 30, 2004 and 2003, respectively. Diluted earnings per share computations, as calculated under the treasury stock method, include the average number of shares of additional outstanding Common Stock issuable for nonvested restricted stock, stock options, warrants, rights and convertible notes whether or not currently exercisable. Such average shares were 75,266,029 and 62,670,780 for the three and nine months ended September 30, 2004, respectively. Diluted earnings per share for the three and nine months ended September 30, 2003 do not include shares related to stock options and warrants because their effect was anti-dilutive.

5,120,853 shares of Common stock issued on December 2, 2003 pursuant to the note purchase agreement were included in the weighted average outstanding shares calculation as of March 10, 2004, the date on which certain conditions upon which the shares were contingently returnable were satisfied. The weighted average number of such shares included in the basic and diluted earnings per share calculation was 5,120,853 and 3,831,295 for the three and nine months ended September 30, 2004, respectively.

Options to purchase 145,000 shares of Common Stock at exercise prices ranging from $6.6875 to $7.0625 per share and options to purchase 2,887,043 shares of Common Stock at exercise prices ranging from $1.45 to $7.0625 per share were outstanding during the quarters ended September 30, 2004, and September 30, 2003, respectively. These options were not included in the computation of diluted earning per share because the options’ exercise price was greater than the average market price of the Common Stock. Options of 137,500 and 2,887,043 were outstanding as of September 30, 2004, and September 30, 2003, respectively.

Basic and diluted earnings per share and the average shares used in the calculation of basic and diluted earnings per share for all periods have been adjusted retroactively to reflect the bonus element contained in the rights offering issued on May 18, 2004.

Note 7. Credit Arrangements

In connection with the effectiveness of the Covanta Reorganization Plan and the consummation of the DHC acquisition, Covanta emerged from bankruptcy with a new debt structure. Domestic Covanta has two facilities which provide letters of credit and liquidity; the First Lien Facility and the Second Lien Facility.

	•		The First Lien Facility provides commitments for the issuance of letters of credit contractually required in connection with one waste-to-energy facility. These letters of credit are currently required in the aggregate amount of approximately $128.0 million as of September 30, 2004, and the contractually required amount generally decreases semi-annually. The First Lien Facility has a term of five years, and requires cash collateral to be posted for issued letters of credit if Covanta has cash in excess of specified amounts. Covanta paid a 2% upfront fee (approximately $2.8 million) upon entering into the First Lien Facility, and will pay with respect to each issued letter of credit (i) a fronting fee equal to the greater of $500 or 0.25% per annum of the daily amount available to be drawn under such letter of credit, (ii) a letter of credit fee equal to 2.5% per annum of the daily amount available to be drawn under such letter of credit, and (iii) an annual fee of $1,500.
	•		The Second Lien Facility provides commitments in the aggregate amount of $118 million, up to $10 million of which shall also be available for cash borrowings on a revolving basis and the balance for letters of credit supporting Covanta’s domestic and international businesses.

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The Second Lien Facility has a term of five years and requires cash collateral to be posted for issued letters of credit if Covanta has cash in excess of specified amounts. The revolving loan component of the Second Lien Facility bears interest at either (i) 4.5% over a base rate with reference to either the Federal Funds rate of the Federal Reserve System or Bank One’s prime rate, or (ii) 6.5% over a formula Eurodollar rate, the applicable rate to be determined by Covanta (increasing by 2% over the then applicable rate in specified default situations). Covanta also paid an upfront fee of $2.4 million upon entering into the Second Lien Facility, and will pay (i) a commitment fee equal to 0.5% per annum of the daily calculation of available credit, (ii) an annual agency fee of $30,000, and (iii) with respect to each issued letter of credit an amount equal to 6.5% per annum of the daily amount available to be drawn under such letter of credit. As of September 30, 2004, letters of credit in the approximate aggregate amount of $70.9 million had been issued under the Second Lien Facility, and Covanta had not sought to make draws against the $10 million liquidity facility of the Second Lien Facility.

As of September 30, 2004, no cash collateral was required to be posted under the First and Second Lien Facilities.

Total fees of $6.3 million in connection with the above two facilities paid on March 10, 2004 have been capitalized and are being amortized over the life of the credit facilities on a straight line basis. Both facilities are secured by the assets of Covanta and certain of its domestic subsidiaries not subject to security interests existing at the Effective Date. The lien of the Second Lien Facility is junior to that of the First Lien Facility. The First Lien Facility and the Second Lien Facility are non-recourse to CPIH and its subsidiaries.

Also, CPIH and each of its domestic subsidiaries, which hold all of the assets and operations of Covanta’s international businesses (the “CPIH Borrowers”) entered into one secured liquidity facility (the “CPIH Revolving Credit Facility”).

The CPIH Revolving Credit Facility is secured by a first priority lien on the CPIH stock and substantially all of the CPIH Borrowers’ assets not otherwise subject to security interests existing as of the Effective Date, and consists of commitments for cash borrowings of up to $10 million for purposes of supporting the international businesses. This $10 million commitment however is subject to permanent reductions as CPIH asset sales occur. Permanent reductions to the original commitment are determined by applying 50% of all net asset sales proceeds as they occur subject to certain specified limits. The CPIH revolving credit facility has a maturity date of three years and to the extent drawn upon bears interest at the rate of either (i) 7% over a base rate with reference to either the Federal Funds rate, of the Federal Reserve System or Deutsche Bank’s prime rate, or (ii) 8% over a formula Eurodollar rate, the applicable rate to be determined by CPIH (increasing by 2% over the then applicable rate in specified default situations). CPIH also paid a 2% upfront fee of $0.2 million, and will pay (i) a commitment fee equal to 0.5% per annum of the average daily calculation of available credit, and (ii) an annual agency fee of $30,000. As of September 30, 2004, CPIH had not sought to make draws on this facility and the outstanding commitment amount has been reduced to $9.1 million.

The CPIH Revolving Credit Facility is non-recourse to Covanta and its other domestic subsidiaries.

Covanta and/or certain of its domestic subsidiaries are guarantors of performance obligations of some international projects or are the reimbursement parties with respect to letters of credit issued to secure obligations relating to some international projects. Covanta is entitled to reimbursements by CPIH of

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operating expenses incurred on behalf of the CPIH Borrowers and payments, if any, made with respect to the above mentioned guarantees and reimbursement obligations. Any such obligation to reimburse Covanta , should it arise, would be senior to the repayment of principal on the CPIH Term Loan.

Note 8. Long-Term Debt

Long-term debt (in thousands) consisted of the following:

	•		Covanta also issued the High Yield Notes and issued or will issue the Unsecured Notes. The High Yield Notes and the Unsecured Notes are non-recourse to CPIH.
	•		The High Yield Notes are secured by a third priority lien in the same collateral securing the First Lien Facility and the Second Lien Facility. The High Yield Notes were issued in the initial principal amount of $205 million, which will accrete to $230 million at maturity in seven years. Interest is payable at a rate of 8.25% per annum, semi-annually on the basis of the principal at final maturity; no principal is due prior to maturity of the High Yield Notes.
	•		Unsecured Notes in a principal amount of $4 million were issued on the effective date of the Covanta Reorganization Plan, and Covanta had issued Unsecured Notes in the aggregate amount of approximately $12.3 million as of September 30, 2004. An additional $11 million in Unsecured Notes were issued on October 4, 2004. Covanta expects to issue additional Unsecured Notes in a principal amount of approximately $5 million. Additional Unsecured Notes also may be issued to holders of allowed claims against the Remaining Debtors if and when they emerge from bankruptcy, and if the issuance of such notes is contemplated by the terms of any plan of reorganization confirmed with respect to such Remaining Debtors. The final principal amount of all Unsecured Notes will be equal to the amount of allowed unsecured claims against Covanta’s operating subsidiaries which were reorganizing Debtors, and such amount will be determined when such claims are resolved through settlement or further proceedings in the Bankruptcy Court. The principal amount of Unsecured Notes indicated in the table above represents the expected liability upon completion of the claims process, excluding any additional Unsecured Notes that may be issued if and when the Remaining Debtors reorganize and emerge from bankruptcy. Notwithstanding the date on which Unsecured Notes are issued, interest on the Unsecured Notes accrues from March 10, 2004. Interest is payable semi-annually on the Unsecured Notes at a rate of 7.5% per annum; principal is paid annually in equal installment beginning in March, 2006. The Unsecured Notes mature in eight years.

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Also, the CPIH Borrowers entered into the CPIH Term Loan Facility in the principal amount of up to $95 million, of which approximately $83 million was outstanding as of September 30, 2004. The CPIH Term Loan Facility is secured by a second priority lien on the same collateral as the CPIH Revolving Credit Facility, and bears interest at 10.5% per annum, 6.0% of such interest to be paid in cash and the remaining 4.5% to be paid in cash to the extent available and otherwise payable by adding it to the outstanding principal balance. The interest rate increases to 12.5% per annum in specified default situations. The CPIH Term Loan Facility matures in three years. The CPIH Term Loan Facility is non-recourse to Covanta and its other domestic subsidiaries. While CPIH’s term loan is outstanding CPIH’s cash balance is not available to be transferred to Domestic Covanta.

Covanta may issue tax notes in an aggregate principal amount equal to the aggregate amount of allowed priority tax claims with a maturity six years after the date of assessment. Interest will be payable semi-annually at the rate of 4% per annum. Under the Covanta Reorganization Plan, Covanta may pay some of these claims in cash. Covanta does not expect the amount of such allowed priority tax claims to negatively affect its ability to implement its business plan.

The maturities on long-term debt including capital lease obligations, (in thousands) at September 30, 2004 were as follows:

Note 9. Project Debt

Project debt (in thousands) consisted of the following :

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The amounts reflected in the table above from the various series of revenue bonds comprising project debt reflect the Company’s estimate of the fair value of such project debt under purchase accounting.

Project debt associated with the financing of waste-to-energy facilities is generally arranged by municipalities through the issuance of tax-exempt and taxable revenue bonds. The category, “Revenue Bonds Issued by and Prime Responsibility of Municipalities,” includes bonds issued with respect to projects owned by Domestic Covanta for which debt service is an explicit component of the client community’s obligation under the related service agreement. In the event that a client community is unable to satisfy its payment obligations, the bondholders’ recourse with respect to Domestic Covanta is limited to the waste-to-energy facilities and restricted funds of the project pledged to secure such obligations.

The category “Revenue Bonds Issued by Municipal Agencies with Sufficient Service Revenues Guaranteed by Third Parties” includes municipal bonds issued to finance one municipally sponsored facility for which contractual obligations of third parties to deliver waste provide sufficient revenues to pay debt service, although such debt service is not an explicit component of the third parties’ service fee obligations.

The category “Other Revenue Bonds” includes bonds issued to finance one facility for which current contractual obligations of third parties to deliver waste provide sufficient revenues to pay debt service related to that facility through 2011, although such debt service is not an explicit component of the third parties’ service fee obligations. Domestic Covanta anticipates renewing such contracts prior to 2011.

Payment obligations for the project debt associated with facilities owned by Domestic Covanta are limited recourse to the operating subsidiary and non-recourse to Covanta, subject to construction and operating performance guarantees and commitments. These obligations are secured by the revenues pledged under various indentures and are collateralized principally by a mortgage lien and a security interest in each of the respective facilities and related assets.

The maturities on long-term project debt (in thousands) at September 30, 2004 were as follows:

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Note 10. Income Taxes

DHC files a Federal consolidated income tax return with its subsidiaries. DHC’s Federal consolidated return includes the taxable results of certain grantor trusts established pursuant to a prior court approved reorganization to assume various liabilities of certain present and former insurance subsidiaries of DHC. These trusts are not consolidated with DHC for financial statement purposes.

DHC’s Federal consolidated tax return will exclude the results of CPIH since its operations do not qualify for consolidation under the applicable tax laws. DHC records its interim tax provisions based upon estimated effective tax rates for the year.

DHC’s provision for income taxes in the condensed consolidated statements of operations consists of certain state and other taxes. Tax filings for these jurisdictions do not consolidate the activity of the trusts referred to above, and reflect preparation on a separate company basis. For further information, reference is made to Note 13 of the Notes to the Consolidated Financial Statements included in DHC’s Annual Report on Form 10-K for the year ended December 31, 2003.

DHC had NOLs estimated to be approximately $680 million for Federal income tax purposes as of the end of 2003. The NOLs will expire in various amounts from December 31, 2004 through December 31, 2023, if not used. In connection with the purchase of Covanta, the Company reassessed its valuation allowance on deferred tax benefits associated with its NOLs. A deferred tax asset of $145.6 million associated with the reduction in the valuation allowance is included in the consolidated financial statements to reflect the estimated future NOL utilization from the inclusion of Covanta (exclusive of CPIH) in DHC’s consolidated Federal income tax group. The Internal Revenue Service (“IRS’”) has not audited any of DHC’s tax returns. There can be no assurance that DHC would prevail if the IRS were to challenge the use of the NOLs.

If DHC were to undergo, an “ownership change” as such term is used in Section 382 of the Internal Revenue Code, the use of its NOLs would be limited. DHC will be treated as having had an “ownership change” if there is a more than 50% increase in stock ownership during a 3-year “testing period” by “5% stockholders”. DHC’s Certificate of Incorporation contains stock transfer restrictions that were designed to help preserve DHC’s NOLs by avoiding an ownership change. The transfer restrictions were implemented in 1990, and DHC expects that they will remain in-force as long as DHC has NOLs. DHC cannot be certain, however, that these restrictions will prevent an ownership change.

In connection with ACL’s bankruptcy proceedings and its anticipated emergence from such proceedings under the ACL Plan (as described in Note 3 above), a portion of DHC’s NOLs will be utilized in 2004. While DHC cannot currently predict the amount of taxable income that it will recognize in 2004 in connection with ACL, Covanta’s operations, or certain grantor trusts relating to DHC’s historic insurance business (as described above in this Note 10), DHC has approximately $70 million of NOLs available to use that would otherwise expire in 2004.

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Note 11. Stockholders’ Equity

In connection with a pro rata rights offering to all stockholders on May 18, 2004, the Company issued 27,438,118 additional shares of Common Stock for approximately $42.0 million of gross proceeds. In addition, the Company issued the maximum 8,750,000 shares to Laminar pursuant to the conversion of approximately $13.4 million in principal amount of notes, as more fully described in Note 2. As of September 30, 2004, there were 72,824,307 shares of Common Stock issued of which 72,813,511 were outstanding; the remaining 10,796 shares of Common Stock issued but not outstanding are held as treasury stock.

DHC adopted the Danielson Holding Corporation Equity Award Plan for Employees and Officers (the “Employees Plan”) and the Danielson Holding Corporation Equity Award Plan for Directors (the “Directors Plan”), collectively (the “Award Plans”), effective with stockholder approval on October 5, 2004. The 1995 Stock and Incentive Plan (the “1995 Plan”) was terminated with respect to any future awards under such plan on October 5, 2004 upon stockholder approval of the Award Plans. As of October 5, 2004, awards covering an aggregate of 918,177 shares of common stock were outstanding.

The purpose of the Award Plans is to promote the interests of the Company (including its subsidiaries and affiliates) and its stockholders by using equity interests in the Company to attract, retain and motivate its management, non-employee directors and other eligible persons and to encourage and reward their contributions to the Company’s performance and profitability. Both Award Plans provide for awards to be made in the form of (a) incentive stock options, (b) non-qualified stock options, (c) shares of restricted stock, (d) stock appreciation rights, (e) performance awards, or (f) other stock-based awards which relate to or serve a similar function to the awards described above. Awards may be made on a stand alone, combination or tandem basis. The maximum aggregate number of shares of Common Stock available for issuance is 4,000,000 under the Employees Plan and 400,000 under the Directors Plan.

On October 5, 2004 the Company granted options to purchase an aggregate of 1,000,000 shares of Common Stock and 654,355 shares of restricted stock under the Employees Plan. The options have an exercise price of $7.43 per share and expire 10 years from the date of grant and vest over three years commencing on February 28, 2006. Restrictions upon 50% of the restricted stock shall lapse on a pro rata basis over three years commencing on February 28, 2005 and the restrictions upon the remaining 50% of the restricted stock shall lapse over the same three year period based upon the satisfaction of performance-based metrics of operating cash flow or such other performance measures as may be determined by the Compensation Committee of the Board of Directors.

On October 5, 2004 the Company granted options to purchase an aggregate of 106,672 shares of Common Stock and 12,000 shares of restricted stock under the Directors Plan. The options have an exercise price of $7.43 per share and expire 10 years from the date of grant and vest upon the date of grant. Restrictions on the restricted stock shall lapse on a pro rata basis over three years commencing on the date of grant.

Note 12. Business Segments

DHC has two reportable business segments — energy and insurance. Energy develops, constructs, owns and operates for others key infrastructure for the conversion of waste-to-energy and independent power production in the United States and abroad. The Insurance segment writes property and casualty insurance in the western United States, primarily in California.

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The accounting policies of the reportable segments are consistent with those described in the summary of significant accounting policies, unless otherwise noted.