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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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0001261679 MSW Energy Holdings LLC Delaware 14-1873119
0001261680 MSW Energy Finance Co., Delaware 20-0047886
Inc.
Commission File (Exact name of each (State or other (I.R.S. Employer
Number registrant as specified jurisdiction of Identification
in its charter) incorporation or Number)
organization)
c/o American Ref-Fuel Company LLC
155 Chestnut Ridge Road
Montvale , New Jersey 07645
Phone No. 800-727-3835
(Address, including zip code, and telephone number, including area code, of the
registrants' principal executive offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants' knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act):
MSW Energy Holdings LLC: yes [ ] no [X]
MSW Energy Finance Co., Inc: yes [ ] no [X]
Aggregate market value of voting and non-voting common stock held by
nonaffiliates:
MSW Energy Holdings LLC: None
MSW Energy Finance Co., Inc: None
Indicate the number of shares outstanding of each of the registrants' classes of
common stock, as of the latest practicable date.
MSW Energy Holdings LLC: None
MSW Energy Finance Co., Inc: 100 shares of Common Stock
Documents Incorporated by Reference: None
MSW Energy Finance Co., Inc. meets the conditions set forth in General
Instruction I 1(a) and (b) of Form 10-K and is therefore filing this Form 10-K
with the reduced disclosure format.
DEFINITIONS
"Allied" refers to Allied Waste Industries, Inc.
"Acquisition" refers to the agreement by MSW Energy Holdings to acquire Duke's
50% membership interest in Ref-Fuel Holdings.
"AIGGIG" refers to AIG Global Asset Management Holdings Corp.
"American Ref-Fuel" refers to American Ref-Fuel Company LLC.
"ARC" refers to American Ref-Fuel Company LLC.
"ARC operating companies" refers to the subsidiaries of ARC that operate the WTE
facilities.
"BFI" refers to Browning Ferris Industries, Inc.
"CSFB Private Equity" refers to Credit Suisse First Boston Private Equity, Inc.
"Duke" refers to Duke Energy Corporation.
"Duke Capital" refers to Duke Capital LLC.
"Equalization Transactions" refers to the proposed transactions pursuant to
which CSFB Private Equity affiliates will collectively own a 59.88%
indirect interest in Ref-Fuel Holdings and Highstar, Highstar I and
Highstar II will collectively own a 39.92% indirect interest in Ref-Fuel
Holdings.
"Erie" refers to Duke Energy Erie, LLC.
"HENS" refers to Hempstead, Essex, Niagara and Seconn, a series of partnerships
owned by Allied and Ref-Fuel Holdings.
"Highstar" refers to Highstar Renewable Fuels LLC.
"Highstar I" refers to Highstar Renewable Fuels I LLC.
"Highstar II" refers to Highstar Renewable Fuels II LLC.
"Hudson" refers to MSW Energy Hudson LLC.
"Investors" refers to Allied and Ref-Fuel Holdings as investors in the HENS.
"LLC Agreement" refers to the limited liability company agreement of MSW Energy
Holdings, dated June 24, 2003.
"MSW Acquisition" refers to MSW Energy Acquisition LLC.
"MSW Energy II" refers to MSW Energy Holdings II LLC.
"MSW Energy Holdings" refers to MSW Energy Holdings LLC.
"MSW Energy Finance" refers to MSW Energy Finance Co., Inc.
"MSW Merger" refers to MSW Merger LLC.
"MSW Transactions" refers to the June 30, 2003 acquisition by MSW Energy
Holdings of Duke's 49.8% interest in American Ref-Fuel Holdings and the
December 12, 2003 merger of MSW Merger into UAE Holdings, resulting in the
transfer of UAE's 50% interest in Ref-Fuel Holdings LLC being transferred
to MSW Energy II.
"Recapitalization" refers to the recapitalization of the HENS.
"Redemption" refers to the redemption of Allied's interest in the HENS.
"Ref-Fuel Holdings" refers to Ref-Fuel Holdings LLC.
"Senior Notes" refers to the 8 1/2 % Senior Secured Notes due 2010 of MSW Energy
Holdings.
"UAE" refers to United American Energy Corp.
"UAE Holdings" refers to United American Energy Holdings Corp.
"WTE" refers to the waste-to-energy business in which municipal waste is
combusted to produce energy.
Table of Contents
Part I.........................................................................1
Item 1. Business...............................................................1
Item 2. Properties............................................................7
Item 3. Legal Proceedings.....................................................8
Item 4. Submission of Matters to a Vote of Security Holders...................8
PART II........................................................................8
Item 5. Market for Registrants' Common Equity and Related
Stockholder Matters and Purchases of Equity Securities....................8
Item 6. Selected Financial Data...............................................8
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................................11
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk..............................................................29
Item 8. Financial Statements and Supplementary Data...........................30
Item 9. Changes in and Disagreements with Accountants on
Financial Disclosure.....................................................82
Item 9A. Controls and Procedures.............................................82
PART III......................................................................82
Item 10. Directors and Executive Officers of the Registrant..................82
Item 11. Executive Compensation..............................................84
Item 12. Security Ownership of Certain Beneficial Owners
and Management...........................................................84
Item 13. Certain Relationships and Related Transactions......................85
Item 14. Principal Accountant Fees and Services..............................86
Part IV..................................................................86
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K..............................................................86
SIGNATURES
SAFE HARBOR STATEMENT
This Form 10-K contains "forward-looking statements" intended to qualify for
safe harbor from liability established by the Private Securities Litigation
Reform Act of 1995. Forward-looking statements should be read with the
cautionary statements and important factors included in this Form 10-K at Part
II, Item 7- "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Risk Factors." Forward-looking statements are all
statements other than statements of historical fact, including without
limitation those that are identified by the use of the words "anticipates,"
"estimates," "expects," "intends," "plans," "predicts" and similar expressions
Part I
Item 1. Business
COMPANY OVERVIEW
The terms "we," "our," "ours" and "us" refer only to MSW Energy Holdings;
the terms "American Ref-Fuel" and "ARC" refer to American Ref-Fuel Company LLC;
and the term "Ref-Fuel Holdings" refers to Ref-Fuel Holdings LLC.
Overview
We were formed in June 2003 as a Delaware limited liability company for the
purpose of acquiring a 50% indirect membership interest in Ref-Fuel Holdings LLC
(formerly Duke/UAE Ref-Fuel LLC) (the "Acquisition"). At the initial closing on
June 30, 2003, we acquired MSW Energy Hudson LLC (or Hudson), which holds a
49.8% membership interest in Ref-Fuel Holdings. We have agreed to acquire Duke
Energy Erie, LLC (or Erie), a wholly-owned subsidiary of Duke that holds an
additional 0.2% membership interest in Ref-Fuel Holdings within two years and
six months after our purchase of Hudson. We currently own 49.8%, and have voting
control over an additional 0.2%, of Ref-Fuel Holdings, which owns 100% of
American Ref-Fuel. MSW Energy II holds directly and indirectly the other 50%
membership interest in Ref-Fuel Holdings.
Our sole source of operating cash flow relates to our indirect 49.8%
membership interest in Ref-Fuel Holdings. Ref-Fuel Holdings is a holding company
whose sole source of operating cash flow relates to its 100% membership interest
in American Ref-Fuel. As a 49.8% owner that has voting control over an
additional 0.2% interest, we do not have the ability to unilaterally control
Ref-Fuel Holdings or American Ref-Fuel. Given our interest in Ref-Fuel Holdings,
the financial statements and other financial information contained in this
report relating to Ref-Fuel Holdings are not directly comparable to our
financial statements and other financial information.
American Ref-Fuel owns partnerships that develop, own and operate WTE
facilities, which combust municipal solid waste and produce energy in the form
of electricity and steam. American Ref-Fuel owns or controls and operates six
WTE facilities located in the northeastern United States, which we refer to as
the ARC operating facilities. The subsidiaries of American Ref-Fuel that operate
the ARC operating facilities (the ARC operating companies) derive revenues
principally from disposal or tipping fees received by the ARC operating
companies for accepting waste and from the sale of electricity and steam
produced by those facilities.
Each of the ARC operating companies has outstanding indebtedness. The
majority of this indebtedness is evidenced by tax-exempt bonds and is
collateralized by the ARC operating facilities and other assets of the ARC
operating companies. American Ref-Fuel also has outstanding indebtedness.
Substantially all distributions to American Ref-Fuel from the ARC operating
companies, after the payment of expenses and debt service on ARC operating
company-level indebtedness, are subject to the satisfaction of financial tests
such as working capital and debt coverage ratio tests. Distributions from
American Ref-Fuel to Ref-Fuel Holdings, after the payment of expenses and debt
service on American Ref-Fuel indebtedness, are also subject to the satisfaction
of financial tests.
The following information relates to the ARC operating facilities:
Capacity Contract Expiration Date
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Date of
Commercial
Waste Operation/
Disposal Service Date
(tons Electric Agreements/Electricity Acquired by
Operating per Generating Disposal Sales American
Facility Location day) (megawatts) Contracts Contracts Ref-Fuel
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Hempstead Hempstead, NY 2,505 72 2009 2009 1989
Essex Newark, NJ 2,700 70 2020 2021 1991
Seconn Preston, CT 689 18 2015 2017 1992
Niagara Falls,
Niagara NY 2,250 50 2007-2012 2014 1980/1993
Semass Rochester, MA 2,700 79 2003-2016 2015 1989/1996
Delaware
Valley Chester, PA 2,688 79 2017 2016 1992/1997(1)
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(1) Date acquired for the Delaware Valley facility refers to the date of
acquisition by BFI. Following that date, the Delaware Valley facility was
managed by a predecessor of American Ref-Fuel until it was acquired by
American Ref-Fuel on April 30, 2001.
1
American Ref-Fuel indirectly owns 100% of the ARC operating companies,
except for Semass Partnership (which owns the Semass facility), of which
American Ref-Fuel indirectly owns 90%. American Ref-Fuel also owns TransRiver
Marketing Co., L.P. (or TransRiver), a waste procurement company. In addition to
providing waste procurement services to American Ref-Fuel, TransRiver owns a
740-ton-per-day transfer station in Lynn, Massachusetts.
American Ref-Fuel's facilities together process a total of approximately
five million tons of waste each year.
Waste Processed ('000 tons/year) 1999(1) 2000 2001 2002 2003
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Hempstead Facility 926 897 915 923 936
Essex Facility 975 916 918 899 937
Seconn Facility 245 241 248 252 258
Niagara Facility 760 782 755 725 755
Semass Facility 978 1,106 1,091 1,056 1,069
Delaware Valley Facility 1,040 1,114 1,151 1,060 1,111
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Total 4,924 5,056 5,078 4,915 5,066
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The ARC operating facilities sell approximately 2.6 million MWH of
electricity each year.
Power Sold ('000 MWH) 1999(1) 2000 2001 2002 2003
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Hempstead Facility 562 537 547 541 557
Essex Facility 514 465 468 465 479
Seconn Facility 129 126 129 137 138
Niagara Facility 301 299 289 278 270
Semass Facility 561 631 612 597 591
Delaware Valley Facility 567 616 618 554 577
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Total 2,634 2,674 2,663 2,572 2,612
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The following table summarizes each ARC operating facility's weighted
average boiler availability levels.
Availability Levels 1999(1) 2000 2001 2002 2003
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Hempstead Facility 95.5% 92.2% 93.8% 93.1% 94.8%
Essex Facility 95.9 90.7 92.5 92.7 92.6
Seconn Facility 96.9 93.9 95.3 96.2 96.3
Niagara Facility 93.4 92.5 90.3 89.8 89.7
Semass Facility 88.0 93.2 91.6 89.6 87.6
Delaware Valley Facility 88.1 92.2 92.1 88.4 88.4
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Weighted Average 92.2% 92.3% 92.5% 91.0% 90.9%
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(1) For the fiscal year ended September 30, 1999.
American Ref-Fuel guarantees or provides support for each of its
subsidiaries that owns an ARC operating facility, in one or more of the
following forms:
-- guarantees of recourse debt;
-- support agreements in connection with service agreement-related
obligations for each of the Hempstead, Semass, Seconn and the Delaware
Valley facilities; and
-- contingent credit support for damages from performance failures,
environmental indemnities, or contingent capital and credit support to
finance costs, in most cases in connection with a corresponding
increase in service fees, relating to uncontrollable circumstances.
In order to provide American Ref-Fuel with an additional source of funds to
meet calls on its project support obligations, each of its members has entered
into the Equity Contribution Agreement pursuant to which each member has agreed
2
to provide up to $50 million in equity capital. Each member's obligation to make
equity capital contributions under the Equity Contribution Agreement is
conditioned upon the other making an equal contribution and is limited to each
making no more than $50 million of aggregate equity contributions. If a member
is not rated at least BBB by S&P, such party is required to provide a letter of
credit from a commercial bank that is rated at least A- by S&P to secure its
obligations under the Equity Contribution Agreement.
Structure and Ownership
CSFB Private Equity and several funds affiliated with it, and Highstar
collectively hold 100% of our membership interests. Highstar is an affiliate of
AIGGIG, a subsidiary of American International Group, Inc. The entities through
which CSFB Private Equity makes its investment in us are sometimes referred to
in this report collectively as the CSFB Private Equity Investor.
Ref-Fuel Holdings is governed by a limited liability company agreement
pursuant to which our consent and that of MSW Energy II is required for certain
shareholder actions, including modifications of the Ref-Fuel Holdings limited
liability company agreement and actions taken by Ref-Fuel Holdings as the 100%
owner of American Ref-Fuel. Therefore, notwithstanding the fact that affiliates
of CSFB Private Equity indirectly own a majority of the membership interests of
Ref-Fuel Holdings, the consent of Highstar is required for certain actions to be
taken with respect to Ref-Fuel Holdings and neither we nor CSFB Private Equity
unilaterally control Ref-Fuel Holdings or American Ref-Fuel.
Management
We are managed by a board of directors, which currently consists of five
representatives: two appointed by Highstar, two appointed by MSW Acquisition
(the entity holding the CSFB Private Equity Investor interest) and one
independent director. Pursuant to the terms of our amended and restated limited
liability company agreement (the LLC Agreement), and so long as our 8 1/2%
Senior Secured Notes due 2010 (the Senior Notes) are outstanding, the consent of
the independent director is required for us to effect any bankruptcy or
insolvency proceeding or to consent to any involuntary bankruptcy proceeding.
Other than consenting to the bankruptcy and insolvency actions, the independent
director is a non-voting director.
Pursuant to the LLC Agreement, each of our two members, and any of our
substitute members, has the right to appoint: (i) two representatives to the
board for so long as such member owns at least 40.1% of our aggregate membership
interests and (ii) one representative to the board for so long as such member
owns at least 20.1% of our aggregate membership interests. All actions by the
board require the affirmative vote of the representatives designated by the
members holding a majority of our membership interests. So long as the CSFB
Private Equity Investor and Highstar each owns at least a 40.1% membership
interest in us, any action of our board requires the affirmative vote of a
representative to the board appointed by each of MSW Acquisition and Highstar.
The representatives to our board, other than our independent director, also
serve as the members of the board of directors of Ref-Fuel Holdings. These
directors vote as one block on the board of Ref-Fuel Holdings. Pursuant to the
terms of the LLC Agreement, our members have agreed to instruct our board to
vote to cause Ref-Fuel Holdings and its subsidiaries, subject to any applicable
contractual restrictions, to distribute available cash on a monthly basis to the
extent practicable, but no less frequently than quarterly. In accordance with
the terms of the LLC Agreement, our members have further agreed that our board
will not vote to permit us or our subsidiaries to consent to (i) any amendments
or modifications to any contractual restrictions on dividends binding on
Ref-Fuel Holdings or its subsidiaries that would make such restrictions more
restrictive or (ii) any new restrictions on dividends from such entities.
MSW Energy Finance Co., Inc.
Our wholly-owned subsidiary, MSW Energy Finance, was formed in June 2003
solely for the purpose of serving as a co-issuer of the Senior Notes. Other than
serving as a co-issuer of our Senior Notes, MSW Energy Finance does not have any
operations or assets and will not have any revenues.
Recent Developments
On January 26, 2004, affiliates of CSFB Private Equity entered into a
securities purchase agreement with Highstar II, an affiliate of AIGGIG, pursuant
3
to which the CSFB Private Equity affiliates agreed to sell to Highstar II 40% of
the outstanding shares of common stock of UAE Holdings. Upon the consummation of
the transactions contemplated by the securities purchase agreement, the CSFB
Private Equity affiliates will collectively own 60% and Highstar II will own 40%
of the outstanding shares of common stock of UAE Holdings. Concurrently with the
execution of the aforementioned purchase agreement, Highstar, MSW Acquisition,
and UAE Holdings entered into a membership interests purchase agreement pursuant
to which Highstar agreed to sell to MSW Acquisition 10% and to UAE Holdings
0.01% of our outstanding membership interests. Prior to such transaction,
Highstar will transfer 39.89% of our membership interests to its wholly-owned
subsidiary, Highstar I. Upon the consummation of the transactions contemplated
by the membership interests purchase agreement, MSW Acquisition will own 60%,
Highstar and Highstar I will own 39.99% and UAE Holdings will own 0.01% of our
outstanding membership interests, and UAE Holdings will be our managing member.
The transactions described above (the Equalization Transactions) will
result in CSFB Private Equity affiliates collectively owning a 59.88% indirect
interest in Ref-Fuel Holdings, and Highstar, Highstar I and Highstar II
collectively owning a 39.92% indirect interest in Ref-Fuel Holdings.
The parties plan to enter into a stockholders' agreement and members'
agreement that will provide for our governance and that of UAE Holdings, and our
respective subsidiaries. The consent of both the CSFB Private Equity affiliates
and an affiliate of AIGGIG will be required for us and UAE Holdings and in many
cases our subsidiaries to take certain significant actions. The agreements will
also provide for transfer restrictions, a right of first offer, tag-along
rights, drag-along rights and participation rights with respect to us and UAE
Holdings. The parties will also enter into a registration rights agreement with
respect to UAE Holdings.
The transactions contemplated by the aforementioned agreement will be
conditioned upon the consummation of each other and will also be subject to
certain closing conditions, including the receipt of all necessary governmental
approvals. These transactions are expected to close in the second quarter of
2004. However, we cannot assure you that the transactions will be consummated.
Energy Regulatory Matters
Federal and state energy laws regulate the development, ownership, business
organization, and operation of generating facilities and the sale of
electricity. The Federal Power Act (FPA) authorizes the Federal Energy
Regulatory Commission (FERC) to regulate the wholesale sale of electric energy
and the transmission of electric energy in interstate commerce. The Public
Utility Holding Company Act of 1935 (PUHCA) provides for regulation of holding
companies that hold ownership interests in companies that own or operate
facilities for the generation, transmission or distribution of electricity for
sale. State laws regulate the activities of utilities which serve retail
electric customers.
The Public Utility Regulatory Policies Act of 1978 (PURPA) was enacted to
encourage the development of generating facilities which conserve fossil fuels,
either by producing electricity using a fuel other than fossil fuel, or by the
cogeneration of electricity and steam or other thermal energy which is useful.
Each ARC operating facility meets the requirements for a qualifying facility
(QF) in accordance with regulations issued by the FERC pursuant to PURPA. One of
the ARC operating facilities, Niagara, qualifies as a cogeneration QF. A
cogeneration QF must produce a certain proportion of its total energy output in
the form of thermal energy that is used for a commercial purpose, and its fossil
fuel input must be in a certain proportion to its electric and thermal output.
The other ARC operating facilities satisfy the requirements for qualifying small
power production facilities which rely primarily on biomass for fuel and have a
net power production capacity no greater than 80 megawatts. All QFs must satisfy
the FERC ownership requirement, which states that no more than 50 percent of the
stream of benefits from ownership in the generating facility can be owned by
electric utilities or electric utility holding companies.
PURPA requires utilities to purchase the electric output of QFs at
negotiated rates or rates up to the incremental or "avoided" cost that the
utility would have incurred if it produced the electricity itself or purchased
it from another source. State public utility commissions must approve the rates,
and in some instances, other contract terms, under which utilities purchase
electricity from QFs. State public utility commissions are responsible for
determining the avoided cost rates for utilities subject to their jurisdiction,
although QFs and utilities may negotiate outside of this framework. Some state
public utility commissions require utilities to file their agreements under
which utilities purchase electricity from QFs.
4
Under PURPA and FERC regulations, QFs also are entitled to certain
exemptions from the FPA, PUHCA and state utility regulation. Two of the ARC
operating facilities, Seconn and Niagara, are exempt from all relevant
provisions of the FPA. The other four ARC operating facilities, the Hempstead
facility, the Essex facility, the Semass facility and the Delaware Valley
facility (collectively, the FPA Facilities) are not fully exempt from the FPA
because they are WTE facilities with a net power production capacity larger than
30 megawatts. Companies subject to the FPA must obtain FERC approval for rates
and terms for the sale of electric energy at wholesale and must comply with
other requirements of the FPA and FERC regulations.
Each of the FPA Facilities has filed rate schedules with the FERC in
compliance with the FPA, so that its power purchase agreement (PPA) with the
power-purchasing utility is deemed effective under the FPA. In addition, two of
the FPA Facilities, namely the Essex and the Delaware Valley facilities, have
received FERC authorization to sell electricity at wholesale at market-based or
negotiated rates to any unaffiliated purchaser or into a regional energy market.
The other two FPA Facilities, namely the Hempstead and Semass facilities, do not
sell electricity at market-based rates and therefore do not have or need FERC
market-based rate authority. In connection with their market-based rate
authorizations, each of Essex and Delaware Valley has received a blanket
authorization to issue securities or assume liabilities without further FERC
approval, and has received waivers of other FPA regulations which apply to
traditional utilities selling electricity at cost-based rates. Each of the FPA
Facilities must file quarterly reports providing certain details concerning
wholesale power transactions during the prior calendar quarter. The FPA
Facilities must obtain the prior authorization of the FERC for change-of-control
transactions and for the sale or other transfer of jurisdictional facilities,
including wholesale power sale contracts and interconnection facilities
connecting a generating facility to the transmission grid. Each of the Hempstead
and Semass facilities requires the FERC's prior approval to issue securities or
assume obligations with respect to any other person's securities.
As QFs, all of the ARC operating facilities are exempt from regulation as
"electric utility companies" under PUHCA, and ownership of equity interests in
the ARC operating facilities is likewise not subject to PUHCA regulation, unless
the owner is otherwise independently subject to PUHCA regulation. Thus, no
entity would become subject to regulation under PUHCA solely as a result of
holding an ownership interest in one or more of the ARC operating facilities.
Each of the ARC operating facilities also has been determined to be an exempt
wholesale generator (EWG) which is exempt from regulation under PUHCA. An EWG
must be engaged exclusively in the business of owning and/or operating an
eligible facility and selling electricity at wholesale. An eligible facility is
a generating facility that is used solely to produce electricity for sale at
wholesale. If any ARC operating facilities ceases to meet the requirements for
either QF or EWG status, American Ref-Fuel could remain exempt from PUHCA,
provided that the requirements for the other exemption continue to be satisfied.
In addition, as QFs, all of the ARC operating facilities are exempt from state
laws regulating the rates charged by, or the financial and organizational
activities of, electric utilities. Loss of QF status, which could only occur if
an ARC operating facility were to no longer comply with the FERC's QF
requirements, would terminate the non-PUHCA regulatory benefits and exemptions
that all of the ARC operating facilities currently enjoy.
All of the ARC operating facilities are located within a region served by a
FERC-regulated independent system organization (ISO) or regional transmission
organization (RTO). An ISO or RTO is a FERC-regulated entity responsible for
controlling the transmission system and scheduling transmission service within
its region and between regions on an open access basis. ISOs or RTOs also
administer regional energy sales markets. The Niagara facility and Hempstead
facility are within the New York ISO region; the Semass facility and the Seconn
facility are within the New England ISO region; and the Essex facility and the
Delaware Valley facility are within the PJM RTO region. The price for electric
energy and other electric products sold in these markets other than through
bilateral contracts between sellers and purchasers is set by competitive bids to
supply and offers to purchase, subject to FERC-approved rules. At this time, the
Essex facility and the Delaware Valley facility frequently sell electricity into
the PJM spot market, but the output of the other ARC operating facilities
generally is fully committed under their respective PPAs.
Environmental Matters
American Ref-Fuel conducts operations that require compliance with
environmental provisions of federal, state and local laws, regulations and
standards related to protection of human health and the natural environment.
Specific rules contained in these laws and regulations address air and water
emissions, as well as waste management and disposal. Other provisions of such
environmental laws and regulations address rare unplanned events, such as
5
spills, releases and emergency response. Permitting, record-keeping, reporting
and periodic certifications, along with routine and periodic inspections and
audits are also managed according to applicable laws and regulations.
American Ref-Fuel has indicated that compliance with such laws and
regulations is a major focus for it. According to American Ref-Fuel, its
philosophy with regard to environmental matters at American Ref-Fuel and each of
the ARC operating facilities includes operating within permit limits and
continually striving to improve environmental performance. American Ref-Fuel
reports that it believes that all of its operations are compliant in all
material respects with the requirements of environmental laws and regulations.
The ARC operating facilities are subject to numerous federal, state and
local environmental permitting and licensing requirements related to the
protection of human health and natural resources. American Ref-Fuel reports that
it believes that each of the ARC operating facilities has in place all of the
material environmental permits and licenses necessary to operate as planned. In
addition, several of the ARC operating facilities from time to time operate
pursuant to various orders issued by, and various agreements with, federal,
state and/or local environmental regulatory agencies. American Ref-Fuel reports
that it believes that each of the ARC operating facilities is compliant in all
material respects with all such applicable orders and agreements.
Certain environmental permits for the ARC operating facilities are subject
to periodic renewal or reissuance. There is no assurance that such renewal or
reissuance will be granted by regulatory authorities or that any renewed or
reissued environmental permit will not contain new, more stringent requirements
resulting in the need for additional capital expenditures for modifications to
the ARC operating facilities in order to bring the ARC operating facilities into
compliance. Any failure or delay in renewing or reissuing environmental permits
or any increase in costs resulting from any renewed or reissued environmental
permits could adversely effect the operation of the ARC operating facilities. In
addition, certain environmental permits contain terms that can result in
periodic adjustment of operating limits, which can result in reduced revenue.
Under various federal, state and local environmental laws and regulations,
a current or previous owner or operator of any facility may be required to
investigate and remediate past releases or threatened releases of hazardous or
toxic substances or petroleum products generated, managed or located at the
facility, and may be held liable to a governmental entity or to third parties
for property damage, personal injury and investigation and remediation costs
incurred by a party in connection with any releases or threatened releases. An
operator may also be liable for costs of remediation at a third party's site to
which the operator has sent waste for disposal. These laws, including, but not
limited to, the Comprehensive Environmental Response, Compensation and Liability
Act of 1980, as amended, impose liability without regard to whether the owner
knew of or caused the presence of the hazardous substances or whether the owner
owned the property where the release occurred. Courts have interpreted liability
under such laws to be strict and joint and several. The cost of investigation,
remediation or removal of substances may be substantial. In connection with
American Ref-Fuel's ownership and operation of the ARC operating facilities,
American Ref-Fuel may become liable for such costs. Although American Ref-Fuel
reports that it is not presently aware of any such condition expected to
materially affect the ARC operating facilities, it is possible that such
conditions impacting the ARC operating facilities could be discovered in the
future or that such conditions could be created by future spills or releases. As
a result, it is possible that American Ref-Fuel may become liable for
remediation costs.
Several major pieces of environmental legislation are periodically
considered for reauthorization or amendment by the United States Congress. These
include, among others: the Clean Air Act; the Clean Water Act; the Comprehensive
Environmental Response, Compensation and Liability Act; and the Endangered
Species Act. Changes to these laws could adversely affect many areas of the
operations of the ARC operating facilities.
We are unable to predict at this time what additional steps American
Ref-Fuel may be required to take as a result of the implementation of future
environmental protection requirements for air or water and regulation of
hazardous or toxic materials, but such steps could adversely affect operations
and result in substantial additional costs. Failure to comply with such
requirements could result in the complete shutdown of one or more of the ARC
operating facilities not in compliance as well as the imposition of civil and/or
criminal penalties.
Delaware Valley Facility Continuous Emissions Monitoring Systems Issues. In
2002 the Delaware Valley facility experienced deterioration of hydrochloric acid
(HCl) monitors and related components due to corrosive flue gases leaking from
damaged stack breachings. Some or all of the monitors were out of service for
periods of time in 2002 and 2003.
American Ref-Fuel has repaired the stack breachings and is replacing major
components of the CEMS system, including installing new multi-component monitors
6
for HCl. The capital cost of these upgrades is estimated to be $1.75 million.
For three of the six monitors, installation is complete and certification test
reports have been submitted to the Pennsylvania Department of Environmental
Protection (PADEP). For the other three monitors, installation and verification
test are expected to be completed by June 2004. ARC expects to incur additional
CEMS availability fines until these remaining monitors are installed.
Certification of the monitors is subject to PADEP approval. It is possible that
PADEP will impose requirements involving additional capital and operating costs
above those projected by American Ref-Fuel.
Future Mercury Regulation at the Essex Facility. On January 5, 2004 the New
Jersey Department of Environmental Protection (NJDEP) proposed regulations
applicable to the Essex facility that will make mercury emission requirements
more stringent. Specifically, the proposed requirement will increase the
required removal efficiency to 85% removal after one year and 95% removal after
seven years versus the current 80% removal, while retaining the alternative
limit of 28 micrograms per cubic meter. Assuming the regulations are promulgated
in this form, there would be an increased risk that emission exceedances would
occur and therefore an increased probability that additional controls would
ultimately be required to prevent such exceedances. ARC believes that the new
requirements would at a minimum result in increased operating costs due to
increased use of activated carbon in the current control equipment. It is also
possible that the more stringent requirements could require the installation of
additional pollution control equipment such as compact hybrid particulate
collector units, a device similar to a baghouse. American Ref-Fuel reports that
it estimates that the cost of the installation of such additional pollution
control equipment, if required, would be approximately $38 million. The Essex
service agreement provides a mechanism for a pass-through to the Port Authority
of New York and New Jersey of the majority of any additional capital and
operating costs that may be required. American Ref-Fuel reports that it cannot
currently determine the likelihood of additional and operating capital costs
being incurred in connection with these potential changes in regulation, or the
total of any such costs.
Title V Air Permit for the Essex Facility. On September 9, 2003, NJDEP
issued a pre-draft Title V air permit which contained new operating limitations
and conditions. Many of the new conditions would require Essex to monitor
emission sources and operating conditions not currently required to be monitored
under the existing air permits or which are monitored or controlled under other
permits. Through subsequent comments and negotiations, American Ref-Fuel has
negotiated removal or mitigation of the majority of those requirements which had
the potential to increase operating costs or result in new or reduced emission
limits or reductions in allowed operating rates. Increased monitoring also can
increase the risk of non-compliance and the imposition of fines and penalties. A
draft permit was issued for public comment in early March 2004, with comments
due by April 2, 2004. American Ref-Fuel will continue to work to mitigate
similar impacts of remaining permit conditions.
Possible Changes to Pennsylvania Oxides of Nitrogen Regulations. The PADEP
has proposed a regulation that would lower the existing emission limits for
oxides of nitrogen to a standard lower than what has been achieved by existing
technology on waste-to-energy facilities. If the regulation were promulgated in
the form proposed, American Ref-Fuel would evaluate the Delaware Valley
facility's ability to comply using selective non-catalytic reduction technology.
If that is not feasible, American Ref-Fuel may be required to retrofit the
Delaware Valley facility with selective catalytic reduction at an approximate
cost of $30 million. The Delaware Valley service agreement provides a mechanism
for a pass-through to Delaware County, Pennsylvania, American Ref-Fuel's primary
customer at the Delaware Valley facility, of approximately 56% of the additional
costs of any such retrofit. American Ref-Fuel and Delaware County, Pennsylvania
are vigorously opposing the proposed regulation through available avenues for
public comment, hearings and education of the relevant regulatory agency
representatives. The Independent Regulatory Review Commission (IRRC), which is a
regulatory oversight committee of the Pennsylvania State Legislature, has
responded to the PADEP with objections and recommendations regarding the
proposed regulation. Certain of the objections of the IRRC relate to the lack of
demonstrated cost-effective, achievable technology that would enable waste to
energy facilities to achieve the proposed levels of oxides of nitrogen.
Employees
ARC Management Company runs the day-to-day operations of American Ref-Fuel.
Collectively, ARC Management Company and the other subsidiaries of American
Ref-Fuel have approximately 720 employees. Neither MSW Energy Holdings nor MSW
Energy Finance has any employees. See "Management--MSW Energy Holdings."
Item 2. Properties
Neither MSW Energy Holdings nor MSW Energy Finance leases or owns any
physical property or office space.
7
Item 3. Legal Proceedings
Neither MSW Energy Holdings nor MSW Energy Finance is currently involved in
any litigation, other than routine, ongoing disclosure proceedings before the
FERC that under current law do not create any risk related to the regulatory
status or exemptions of the ARC operating companies.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5. Market for Registrants' Common Equity and Related Stockholder Matters
and Purchases of Equity Securities
There is no trading market for the equity interests in MSW Energy Holdings
or MSW Energy Finance. CSFB Private Equity and several funds affiliated with it,
and Highstar, collectively hold 100% of the membership interests in MSW Energy
Holdings. MSW Energy Holdings owns 100% of the equity interests in MSW Energy
Finance.
Item 6. Selected Financial Data
Because MSW Energy Holdings has only been in existence since June 2003 and
has only held its interest in Ref-Fuel Holdings since June 2003, the Selected
Financial Data provided below for prior periods is for informational and
comparative purposes only. Because MSW Energy Holdings holds only a 49.8%
indirect membership interest in Ref-Fuel Holdings, the Selected Financial Data
provided for Ref-Fuel Holdings is not directly comparable to MSW Energy Holdings
financial information. Combined information is provided for the year ended
December 31, 2003 for informational and comparative purposes only.
Prior to June 30, 2003, Ref-Fuel Holdings was owned 50 percent by United
American Energy Corp. (UAE) and 50 percent by Duke Energy Corporation (Duke).
Effective June 30, 2003, Duke sold its membership interests representing 49.8%
of Ref-Fuel Holdings to MSW Energy Holdings LLC (MSW Energy), which is jointly
owned by (a) Highstar Renewable Fuels LLC (Highstar), which is affiliated with
AIG Global Asset Management Holdings Corp., (AIGGIG), a subsidiary of American
International Group, Inc.; and (b) MSW Acquisition LLC (MSW Acquisition) which
is owned by several funds affiliated with Credit Suisse First Boston Private
Equity, Inc. (CSFB Private Equity), the global private equity arm of Credit
Suisse First Boston.
On December 12, 2003, MSW Merger II, an affiliate of CSFB Private Equity,
merged with and into United American Energy Holdings Corp. (UAE Holdings) a
Delaware corporation, which continued as the surviving corporation in the
merger. UAE Holdings is the direct parent of UAE. As a result of this merger,
UAE's 50 percent ownership in American Ref-Fuel was transferred to MSW Energy
Holdings II LLC (MSW Energy II).
Upon consummation of the change in ownership and taking into account the
June 30, 2003 acquisition by MSW Energy I of Duke's membership interest in
Ref-Fuel Holdings (the MSW Transactions), affiliates of CSFB Private Equity and
AIGGIG (the Control Group) own, directly and indirectly, 99.8% of the membership
interests in Ref-Fuel Holdings (and will exercise voting power with respect to
Duke's remaining 0.2% interest). As a result, and in accordance with Emerging
Issues Task Force (EITF) Topic D-97, "Push-Down Accounting," Ref-Fuel Holdings'
financial statements will reflect the effects of its change in ownership and the
new owners' basis in the net assets and liabilities acquired. As a result, the
statement of operations and the statement of cash flows for the eleven and a
half months ended December 12, 2003 and the years ended December 31, 2002 and
2001 reflect the results of Ref-Fuel Holdings prior to purchase accounting
adjustments and the statement of operations of statement of cash flows for the
period ended December 31, 2003, reflect the impact of purchase accounting
adjustments arising from the MSW Transactions.
Prior to the MSW Transactions, profits and losses of Ref-Fuel Holdings were
allocated among its members based on ownership percentages. Subsequent to the
MSW Transactions profits and losses are allocated based upon the members'
ownership percentages except for the amortization of the variances in purchase
price. All significant intercompany accounts and transactions have been
eliminated in consolidation.
8
The table includes certain items that are not measures under generally
accepted accounting principles and are not intended to supplant the information
provided in accordance with generally accepted accounting principles.
Furthermore, these measures may not be comparable to those used by other
companies.
MSW Energy Holdings
Historical
From Inception
(June 30, 2003) to
December 31,
2003
----------------------
(in thousands)
Statement of Operations Data:
Equity in net earnings of Ref-Fuel Holdings $21,603
Interest income 91
Interest expense (8,500)
Accretion of Duke Agreement obligation (993)
Amortization of deferred financing fees (561)
Other expenses (1,029)
----------------------
Net income $10,611
----------------------
Cash Flow Data:
Cash provided by operating activities $10,409
Cash used in investing activities (346,014)
Cash provided by financing activities 341,118
Balance Sheet Data (at December 31, 2003):
Investment in Ref-Fuel Holdings $372,672
Total assets 391,647
Total debt 200,000
Total members' equity 160,111
Ref-Fuel Holdings
| Period from Combined
Period from | January 1, Results for
December 12, | 2003 the Year
2003 through | through Ended
December 31, | December December 31,For the Year
2003 | 12, 2003 2003 Ended 2002
---------------|---------------------------------------
Statement of Operations Data: | (in thousands)
Total Net Revenues $24,847 | $444,461 $469,308 $438,542
Operating and other expenses 8,417 | 183,822 192,239 171,752
Depreciation and amortization 3,391 | 55,838 59,229 67,249
General and administrative expenses 2,184 | 42,118 44,302 43,642
---------------|--------------------------------------
Operating income 10,855 | 162,683 173,538 155,899
Interest income 275 | 2,956 3,231 3,740
Interest expense (2,954)| (59,189) (62,143) (60,893)
Loss on early extinguishment of |
debt - | (3,191) (3,191) -
Equity in earnings of |
unconsolidated affiliates - | - - 15,500
Other expenses, net (94)| (188) (282) (757)
Minority interests in net income |
of subsidiaries - | - - (4,885)
---------------|-------------------------------------
Net income $8,082 | $103,071 $111,153 $108,604
---------------|-------------------------------------
Cash Flow and Other Data: |
EBITDA(1) $14,246 | $220,728 $234,974 $230,445
Adjusted EBITDA(1) 18,050 | 249,596 267,646 256,858
Cash flows from operating |
activities 14,870 | 171,034 185,904 198,651
Cash flows from investing |
activities 36,314 | (70,554) (34,240) (69,536)
Cash flows from financing |
activities (16,124)| (109,202) (125,326) (110,685)
9
Capital expenditures - | 33,780 33,780 35,727
Balance Sheet (as of end of period) |
Total cash and cash equivalents and |
reserves(2) | $233,973 $201,594
PP&E | 1,220,949 1,103,072
Total assets | 2,127,908 1,756,824
Total debt | 1,142,687 1,156,396
Total liabilities | 1,386,608 1,462,368
Total members' equity | 741,300 294,456
(1) "EBITDA" means, for any period, the (a) operating income (or loss),
plus (b) to the extent deducted in determining such income (or loss),
depreciation and amortization, plus, (c) loss on retirements and
relocation expenses. EBITDA is not a measurement of financial
performance under generally accepted accounting principles and should
not be considered as an alternative to cash flow from operating
activities or as a measure of liquidity or an alternative to net
income as indicators of our operating performance or any other
measures of performance derived in accordance with generally accepted
accounting principles.
"Adjusted EBITDA" means, for any period, EBITDA plus fair value
adjustment amortization and revenue levelization adjustments. Adjusted
EBITDA is not a measurement of financial performance under generally
accepted accounting principles and should not be considered as an
alternative to cash flow from operating activities or as a measure of
liquidity or an alternative to net income as indicators of our
operating performance or any other measures of performance derived in
accordance with generally accepted accounting principles.
(2) Total cash and cash equivalents and reserves includes, in addition to
cash and cash equivalents, both restricted cash and short-term
investments and restricted cash and long-term investments. Ref-Fuel
Holdings is required to maintain cash and investment balances that are
restricted by provisions of its debt agreements and lease agreements.
The presentation of these non GAAP measures is intended to enhance the
usefulness of financial information by providing measures which are indicators
of Ref-Fuel Holdings' performance. Ref-Fuel Holdings' management uses these non
GAAP measures internally to evaluate its business.
EBITDA and Adjusted EBITDA are calculated and reconciled to cash provided by
operating activities as follows:
| Combined
Period from | Period from Results for
December 12, | January 1, the Year
2003 through | 2003 through Ended
December 31, | December 12, December 31,For the Year
2003 | 2003 2003 Ended 2002
---------------|----------------------------------------
| (in thousands)
Operating income $10,855 | $162,683 $173,538 $155,899
Depreciation and amortization 3,391 | 55,838 59,229 67,249
Loss on asset retirements - | 2,207 2,207 1,886
Relocation expenses - | - - 5,411
---------------|----------------------------------------
EBITDA 14,246 | 220,728 234,974 230,445
Amortization of long term waste |
contracts (477)| (7,454) (7,931) (8,453)
Amortization of deferred revenue - | (909) (909) (198)
Amortization of energy contracts 3,286 | 27,293 30,579 25,984
Energy contract levelization 995 | 14,947 15,942 14,359
Amortization of lease - | (5,009) (5,009) (5,279)
---------------|---------------------------------------
Total fair value adjustment |
amortization and revenue |
levelization adjustments 3,804 | 28,868 32,672 26,413
---------------|---------------------------------------
Adjusted EBITDA $18,050 | $249,596 $267,646 $256,858
---------------|---------------------------------------
|
Reconciliation of Adjusted EBITDA to |
cash provided by operating |
activities |
Adjusted EBITDA $18,050 | $249,596 $267,646 $256,858
Less relocation expenses - | - - (5,411)
Less other expense, net (94)| (188) (282) (757)
Amortization of debt (494)| (4,097) (4,591) (4,608)
Interest expense (2,954)| (59,189) (62,143) (60,893)
Interest income 275 | 2,956 3,231 3,740
Interest on loss contracts - | 1,863 1,863 2,051
Changes in assets and liabilities |
Accounts receivable, net 2,890 | (6,337) (3,447) (437)
Prepaid expenses and other |
current assets 3,255 | (2,731) 524 (7,933)
10
Other long-term assets 562 | (2,971) (2,409) 3,567
Accounts payable and other |
current liabilities 1,886 | (21,202) (19,316) 19,314
Accrued interest payable (7,775)| 6,762 (1,013) 6,138
Other long-term liabilities (731)| 6,572 5,841 (12,978)
---------------|---------------------------------------
Cash provided by operating activities $14,870 | $171,034 $185,904 $198,651
===============|=======================================
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
The following discussion contains forward-looking statements. These
statements are based on current plans and expectations and involve risks and
uncertainties that could cause actual future activities and results of
operations to be materially different from those set forth in the
forward-looking statements. Important factors that could cause actual results to
differ include risks set forth in ''Risk Factors.'' The following should be read
in conjunction with the financial statements and related notes included
elsewhere in this report. We hold a 49.8% indirect membership interest in
Ref-Fuel Holdings. The financial statements and other financial information
contained in this report relating to Ref-Fuel Holdings are not directly
comparable to our financial statements and other financial information.
MSW ENERGY HOLDINGS
Results of Operations
From Inception to December 31, 2003
Equity in net earnings of Ref-Fuel Holdings. Equity in net earnings of
Ref-Fuel Holdings of $21.6 million from Inception (June 30, 2003) to December
31, 2003 represents our share (49.8%) of the net earnings of Ref-Fuel Holdings
of $34.7 million offset by amortization expense of $13.1 million associated with
the amortization of the amount of our excess purchase price over our share of
the net assets of Ref-Fuel Holdings at the date of acquisition. We acquired our
interest in Ref-Fuel Holdings on June 30, 2003. Effective December 12, 2003, as
a result of push-down accounting, we ceased amortization of the excess of our
purchase price over the net assets acquired of Ref-Fuel Holdings, as the cost of
our investment has been reflected on the books of Ref-Fuel Holdings.
Interest income. Interest income for the period from Inception (June 30,
2003) to December 31, 2003 represents interest on cash and cash equivalents at
rates ranging from 0.5% to 1.5%.
Interest expense. Interest expense of $8.5 million for the period from
Inception (June 30, 2003) to December 31, 2003 represents 8.5% annual interest
on our Senior Notes.
Accretion of Duke Agreement obligation. Accretion of Duke Agreement
obligation of $1.0 million for the period from Inception (June 30, 2003) to
December 31, 2003 represents accretion of interest on the amounts due under the
Duke Agreement (see ''Contractual Obligations and Commercial Commitments''
below) using the effective interest method.
Amortization of deferred financing fees. Amortization of deferred financing
fees of $0.6 million for the period from Inception (June 30, 2003) to December
31, 2003 represents amortization of direct costs associated with financing the
Senior Notes over the seven-year life of the Senior Notes.
Other expenses. Other operating expenses of $1.0 million for the period
from Inception (June 30, 2003) to December 31, 2003 represent expenses incurred
for a letter of credit and our operations and administration.
Liquidity and Capital Resources
At December 31, 2003, our assets related primarily to our 49.8% indirect
membership interest in Ref-Fuel Holdings. Accordingly, our performance and
significant source of future liquidity will depend solely on cash distributions,
if any, from Ref-Fuel Holdings. We will need to receive sufficient ongoing cash
11
distribution from Ref-Fuel Holdings in order to pay principal and interest on
our Senior Notes, however such distributions from Ref-Fuel Holdings are not
assured. Interest only is payable throughout the term of the Senior Notes with
principal and unpaid interest payable at maturity on September 1, 2010.
Debt Covenant
The indenture under which our Senior Notes were issued requires, among
other things, but subject to certain exceptions, that we not permit any
restricted payment unless certain ratio covenants based on our proportionate
ownership of Ref-Fuel Holdings have been met. We are presenting proportionate
adjusted data, including proportionate total cash and cash equivalents and
reserves, proportionate total debt, proportionate interest expense and
proportionate Adjusted EBITDA because these are used in the calculation of the
restrictive covenants contained in the indenture governing our Senior Notes.
The unaudited summary pro forma condensed consolidated statements of
operations data, pro forma MSW Energy Holdings other data and pro forma
proportionate other data for the year ended December 31, 2003, have been
prepared as if the Acquisition, the UAE Transactions and issuance of the Senior
Notes had occurred on January 1, 2003. Accordingly, the following table includes
the effects of push-down accounting on Ref-Fuel Holdings as if the Acquisition
and the UAE Transactions had occurred on January 1, 2003.
The following table includes certain items that are not measures under
generally accepted accounting principles and are not intended to supplant the
information provided in accordance with generally accepted accounting
principles. Furthermore, these measures may not be comparable to those used by
other companies. The following table should be read in conjunction with our
historical financial statements and related notes, the historical financial
statements and related notes of Ref-Fuel Holdings and the "Supplemental
Discussion and Analysis of Ref-Fuel Holdings".
Pro Forma
Year
Ended
December 31,
2003
-----------------
(in thousands)
Pro Forma MSW Energy Holdings other data
Dividends received (1) $36,130
Cash flow available for debt service (2) 35,880
Ratio of cash flows available for debt service to
interest 2.1x
Pro Forma Proportionate other data
Proportionate total cash and cash equivalents and
reserves (3) $127,597
Proportionate total debt (4) 733,999
Proportionate Adjusted EBITDA (5) 133,288
Proportionate interest expense (6) 44,938
Proportionate net leverage ratio (7) 4.5x
Ratio of proportionate Adjusted EBITDA to proportionate
interest expense (8) 3.0x
(1) Dividends received calculated as if we owned 49.8% of Ref-Fuel Holdings as
of January 1, 2003:
Pro Forma Year Ended
December 31,
2003
-------------------------
(in thousands)
Ref-Fuel Holdings dividends paid $72,550
MSW Energy Holdings ownership percentage 49.8%
-------------------------
Pro Forma distributions received $36,130
-------------------------
12
(2) Cash flow available for debt service is based on distributions received by
us less letter of credit fees payable in connection with the equity
contribution agreement.
(3) Total Ref-Fuel Holdings and MSW Energy Holdings cash and cash equivalents
and reserves include, in addition to cash and cash equivalents, both
restricted cash and short-term investments and restricted cash and
long-term investments.
Proportionate Total Cash and Cash Equivalents and Reserves is calculated as
follows:
Pro Forma
December 31,
2003
-----------------------
(in thousands)
Ref-Fuel Holdings cash and cash equivalents $96,511
Ref-Fuel Holdings restricted cash and short-term investments 52,753
Ref-Fuel Holdings restricted cash and long-term investments 84,709
-----------------------
Total Ref-Fuel Holdings cash and cash equivalents and reserves 233,973
MSW Energy Holdings ownership percentage 49.8%
-----------------------
Ref-Fuel Holdings proportionate total cash and cash
equivalents and reserves 116,519
MSW Energy Holdings total cash and cash equivalents 11,078
-----------------------
MSW Energy Holdings proportionate consolidated total cash and
cash equivalents and reserves $127,597
-----------------------
(4) MSW Energy Holdings Proportionate Total Debt is defined as 49.8% of the
total debt for Ref-Fuel Holdings (excluding unamortized debt premium) plus
our total debt.
Proportionate total debt is calculated as follows:
Pro Forma
December 31,
2003
----------------------
(in thousands)
Ref-Fuel Holdings current portion of long-term debt $81,907
Ref-Fuel Holdings long-term debt (excluding net unamortized debt
premium of $70.4 million) 990,380
----------------------
Total Ref-Fuel Holdings debt (excluding net unamortized debt
premium of $70.4 million) 1,072,287
MSW Energy Holdings ownership percentage 49.8%
----------------------
Ref-Fuel Holdings proportionate total debt 533,999
MSW Energy Holdings total debt 200,000
----------------------
Proportionate total debt $733,999
----------------------
(5) Proportionate Adjusted EBITDA is defined as 49.8% of the pro forma Adjusted
EBITDA of Ref-Fuel Holdings. Adjusted EBITDA (as calculated below) is not a
measurement of financial performance under generally accepted accounting
principles and should not be considered as an alternative to cash flow from
operating activities or as a measure of liquidity or an alternative to net
income as indicators of our operating performance or any other measures of
performance derived in accordance with generally accepted accounting
principles.
Proportionate Adjusted EBITDA is calculated as follows:
13
Pro Forma
Year Ended
December 31,
2003
-------------------
(in thousands)
Pro forma Ref-Fuel Holdings operating income $127,737
Pro forma Ref-Fuel Holdings depreciation and amortization 68,094
Pro forma Ref-Fuel Holdings loss on retirements 2,207
-------------------
Pro forma Ref-Fuel Holdings EBITDA 198,038
Pro forma Ref-Fuel Holdings fair value adjustment amortization
and revenue levelization adjustments 69,608
-------------------
Pro forma Ref-Fuel Holdings adjusted EBITDA 267,646
MSW Energy Holdings ownership percentage 49.8%
-------------------
Proportionate Adjusted EBITDA $133,288
-------------------
(6) Proportionate interest expense is defined as 49.8% of the pro forma
interest expense for American Ref-Fuel plus 100% of our pro forma interest
expense.
The following table reconciles MSW Energy Holdings Proportionate Interest
Expense:
Pro Forma
Year Ended
December 31,
2003
-------------------
(in thousands)
Pro Forma Ref-Fuel Holdings interest expense $56,101
MSW Energy Holdings ownership percentage 49.8%
-------------------
Ref-Fuel Holdings proportionate interest expense 27,938
MSW Energy Holdings pro forma interest expense 17,000
-------------------
MSW Energy Holdings proportionate interest expense $44,938
-------------------
(7) Proportionate net leverage ratio is defined as the quotient of
proportionate total debt less proportionate total cash divided by
proportionate Adjusted EBITDA.
(8) Proportionate Adjusted EBITDA to proportionate interest expense is defined
as the quotient of proportionate Adjusted EBITDA divided by proportionate
interest expense.
Operating Activities
Our net cash provided by operating activities of $10.4 million for the
period from Inception (June 30, 2003) to December 31, 2003 relates primarily to
the distributions received from Ref-Fuel Holdings of $13.7 million in 2003
offset by the payment of $3.1 million of interest on our Senior Notes, $0.5
million paid at closing relating to our obligation under the Duke Agreement and
payments for our operating costs.
Investing Activities
Our net cash used in investing activities of $346.0 million for the period
from Inception (June 30, 2003) to December 31, 2003 relates primarily to amounts
paid relating to the Acquisition consisting of $304.8 million paid to Duke at
the initial closing, $20.7 million paid to Duke in September 2003 related to a
purchase price adjustment, and $15.0 million paid for Acquisition related costs.
In August 2003, as required under the terms of the deposit agreement for
the Senior Notes, we deposited $5.6 million into a restricted cash account.
14
Financing Activities
Our net cash provided by financing activities of $341.1 million for the
period from Inception (June 30, 2003) to December 31, 2003 relates primarily to
$150.0 million of proceeds from member contributions and $200.0 million from
proceeds of the Senior Notes, offset by cash paid for debt financing costs of
$8.4 million and a distribution we made to our owners of $0.5 million.
Critical Accounting Policies
Our management is responsible for our consolidated financial statements and
has evaluated the accounting policies to be used in their preparation. Our
management believes these policies to be reasonable and appropriate. The
following discussion identifies those accounting policies that we believe will
be critical in the preparation of our consolidated financial statements, the
judgments and uncertainties affecting the application of those policies, and the
possibility that materially different amounts will be reported under different
conditions or using different assumptions.
Use of Estimates in Preparing Financial Statements. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and
assumptions that affect: (a) the reported amounts of assets and liabilities at
the date of the financial statements; (b) the disclosures of contingent assets
and liabilities at the date of the financial statements; and (c) the reported
amounts of revenues and expenses recognized during the reporting period. Such
estimates may be subsequently revised as necessary when additional information
becomes available. Actual results could differ from those estimates.
Equity Method Investment. Investments are accounted for using the equity
method of accounting if the investment gives us the ability to exercise
significant influence, but not control, over an investee. Significant influence
is generally deemed to exist if we have an ownership interest in the voting
stock of the investee of between 20% and 50%, although other factors, such as
representation on the investee's board of directors, are considered in
determining whether the equity method of accounting is appropriate.
We have recorded our investment in Ref-Fuel Holdings as an equity-method
investment whereby our ownership percentage of 49.8% of Ref-Fuel Holdings is
reflected on our consolidated balance sheets as ''Investment in Ref-Fuel
Holdings.'' We will record our share of Ref-Fuel Holdings' earnings or losses as
''Equity in net earnings (loss) of Ref-Fuel Holdings'' on our consolidated
statement of operations cash distributions received from Ref-Fuel Holdings are
included in the accompanying consolidated statement of cash flows as
''Distributions from Ref-Fuel Holdings.''
Push-Down Accounting. On December 12, 2003, MSW Merger, an affiliate of
CSFB Private Equity, merged with and into UAE Holdings which continues as the
surviving corporation in the merger. UAE Holdings is the direct parent of UAE.
As a result of this merger, UAE's 50 percent ownership interest in Ref-Fuel
Holdings was transferred to MSW Energy II, an affiliate of MSW Merger (the UAE
Transactions). Upon consummation of the UAE Transactions between MSW Merger and
UAE Holdings on December 12, 2003 and taking into account the June 30, 2003
acquisition by us of Duke's membership interest in Ref-Fuel Holdings, affiliates
of CSFB Private Equity and AIGGIG (the ''control group'') will own, directly and
indirectly, 99.8% of the membership interests in Ref-Fuel Holdings (and will
exercise voting power with respect to the remaining 0.2% interest). Emerging
Issues Task Force (EITF) Topic D-97, "Push-Down Accounting,'' requires that
Ref-Fuel Holdings financial statements reflect this change in ownership.
Accordingly, the aggregate excess of purchase price over the net assets acquired
by us on June 30, 2003 was pushed-down to Ref-Fuel Holdings and its subsidiaries
on December 12, 2003.
Prior to push-down on December 12, 2003 identifiable intangible assets were
included in included in ''Investment in Ref-Fuel Holdings'' on the Company's
consolidated balance sheet and were amortized on a straight-line basis over
their estimated useful lives.
Effect of New Accounting Standard
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities," and a revised interpretation of FIN 46 (FIN 46R) in December
2003 (collectively FIN 46). FIN 46 addresses consolidation of variable interest
entities. FIN 46 provides guidance for determining when a primary beneficiary
should consolidate a variable interest entity or equivalent structure that
15
functions to support the activities of the primary beneficiary. The provisions
of FIN 46 are effective immediately for all variable interest entities created
after January 31, 2003. It appears in the first year or interim period ending
after December 15, 2003 to variable interest entities in which enterprise holds
a variable interest that it acquired before February 1, 2003. Management has
evaluated FIN 46 and its related guidance and believes it will not have any
impact on our consolidated financial statements.
Contractual Obligations and Commercial Commitments
The following table sets forth our contractual obligations outstanding as
of December 31, 2003:
Less than 1 More than 5
Contractual Obligations Total Year 1-3 Years 3-5 Years Years
-----------------------------------------------------------------
(in thousands)
Long-Term Debt Obligations $200,000 $- $- $- $200,000
Unconditional Purchase
Obligations 1,307(1) - 1,307 - -
Other Long-Term Obligations 49,500(2) 500 7,500 7,500 34,000
-----------------------------------------------------------------
Total $250,807 $500 $8,807 $7,500 $234,000
=================================================================
(1) Represents unconditional purchase obligation associated with the
Acquisition of $1,307 due at the second closing.
(2) Represents amounts due under the Duke Agreement.
In connection with the Acquisition, we entered into an agreement with Duke
Capital, which we refer to as the Duke Agreement, under which we agreed to pay
Duke Capital certain fees in exchange for Duke Capital's agreement to remain
obligated under a support agreement related to Ref-Fuel Holdings. The fees
payable under the Duke Agreement are subordinate to the Company's Senior Notes.
The fees payable under the Duke Agreement escalate over time, and a portion of
the fees have been deposited into an escrow account for the benefit of Duke
Capital.
Our ability to satisfy all of these obligations is entirely dependent on
the generation of cash distributions by Ref-Fuel Holdings. The business of
Ref-Fuel Holdings is subject to a variety of risks, many of which are outside
the control of Ref-Fuel Holdings. Any of these risks could affect Ref-Fuel
Holding's ability to generate cash flow. In addition, the ARC operating
companies and American Ref-Fuel must satisfy covenants imposed by their debt
agreements as well as other legal restrictions before making distributions to
their owners, including Ref-Fuel Holdings, and, ultimately, us. Finally, we do
not unilaterally control the board of directors of Ref-Fuel Holdings and cannot
unilaterally determine the amount of cash distributions.
16
Supplemental Discussion and Analysis of Ref-Fuel Holdings
History and Organization
Ref-Fuel Holdings LLC (Ref-Fuel or Ref-Fuel Holdings), which was formerly
known as Duke/UAE Ref-Fuel LLC, is a Delaware limited liability company that was
formed in 1997, for the purpose of obtaining 50 percent ownership of the
following partnerships:(a) American Ref-Fuel Company (Ref-Fuel Management),
which owned 98 percent of TransRiver Marketing Company, L.P. (TransRiver); (b)
American Ref-Fuel Company of Hempstead (Hempstead); (c) American Ref-Fuel
Company of Essex County (Essex); (d) American Ref-Fuel Company of Southeastern
Connecticut (Seconn); (e) American Ref-Fuel Company of Niagara, L.P. (Niagara);
(f) American Ref-Fuel Company of Semass, L.P. (Ref-Fuel Semass); (g) American
Ref-Fuel Operations of Semass, L.P. (Semass Operator); (h) American Ref-Fuel
Company of the Capital District, L.P. These companies, along with American
Ref-Fuel Company of Delaware Valley, L.P. (Delaware Valley) are collectively
referred to as the American Ref-Fuel Partnerships). The American Ref-Fuel
Partnerships, except for Delaware Valley, were a series of general and limited
partnerships 50 percent owned by Ref-Fuel Holdings and 50 percent indirectly by
subsidiaries wholly owned by Allied Waste Industries, Inc. (Allied), who also
owned the remaining 2 percent of TransRiver and 100 percent of Delaware Valley.
Prior to April 30, 2001, Hempstead, Essex, Niagara and Seconn
(collectively, the HENS) were a series of partnerships that were equally owned
by Allied Waste Industries, Inc. (Allied) and Ref-Fuel Holdings (the Investors).
On April 30, 2001 the Investors recapitalized their partnership interests in the
HENS (the Recapitalization). The terms of the Recapitalization provided that
indirect subsidiaries of Ref-Fuel Management became the managing general
partners of the HENS. The interest held by Ref-Fuel in the HENS converted to a
Class A interest, and the interest held by Allied converted to a Class B
interest. In conjunction with the Recapitalization, the HENS contributed $163.5
million to obtain 99 percent noncontrolling interests in equipment leasing
entities controlled by Allied. ARC LLC also agreed to substitute as guarantor
for guarantees previously furnished by Duke and Allied, less certain liabilities
retained by Allied and Duke pursuant to credit backstop agreements.
The Class A and Class B partners were both general partners in the HENS;
however, the Class B partners had limited involvement in the HENS' management
and had limited participation in partnership distributions, except as expressly
agreed. Among other limitations, the Class A partners were restricted from the
following actions without the written consent of the Class B partners: voluntary
dissolution of the HENS, sale or abandonment of a substantial portion of the
HENS' assets, disposition of any of the HENS' interests in the equipment leasing
entities, and certain other activities.
From April 30, 2001 through April 30, 2002, the profits and losses of the
HENS were allocated as follows: (a) depreciation expense allocated to the HENS
from the equipment leasing entities was allocated to the Class A partner only;
(b) net income and loss before depreciation of the equipment leasing entities
allocated to the HENS was allocated between the Class A and Class B partners
based on certain defined earnings tranches; and (c) all other net income or loss
of the HENS was allocated between the Class A and Class B partners based on
certain defined earnings tranches which differ from the tranches used to
allocate the earnings of the equipment leasing entities. Both Allied and
Ref-Fuel Holdings had separate, nonconcurrent rights to cause the HENS to redeem
Allied's Class B interests in the HENS for the HENS' interest in the equipment
leasing entities (Redemption).
In January 2002, Allied announced its intention to exercise that right and
completed the Redemption on April 30, 2002. The Redemption of the HENS resulted
in the following: (a) gross income for the period from January 1, 2002, through
the Redemption date, was reallocated first to the Class A partners in an amount
equal to the difference between the Class A partners' share of economic
depreciation and prior special allocations of depreciation expense to the Class
A partners with all remaining profits and losses allocated consistent with
profit and loss allocations described above; (b) the HENS' interests in the
equipment leasing entities were distributed to Allied in redemption of Allied's
Class B interests in the HENS; and (c) the $2.6 million difference between the
fair value of Allied's interest in the HENS and the fair value received by
Allied in redemption of those interests was paid by Allied to the HENS.
The Redemption of Allied's Class B interest in the HENS resulted in the
application of purchase accounting to the HENS in accordance with Statement of
Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and
adjusted the assets and liabilities of the HENS to fair value.
17
Prior to June 30, 2003, Ref-Fuel Holdings was owned 50 percent by United
American Energy Corp. (UAE) and 50 percent by Duke Energy Corporation (Duke).
Effective June 30, 2003, Duke sold its membership interests representing 49.8%
of Ref-Fuel Holdings to MSW Energy Holdings LLC (MSW Energy I), which is jointly
owned by (a) Highstar Renewable Fuels LLC (Highstar), which is affiliated with
AIG Global Asset Management Holdings Corp., (AIGGIG), a subsidiary of American
International Group, Inc.; and (b) MSW Acquisition LLC (MSW Acquisition) which
is owned by several funds affiliated with Credit Suisse First Boston Private
Equity, Inc. (CSFB Private Equity), the global private equity arm of Credit
Suisse First Boston.
On December 12, 2003, MSW Merger II, an affiliate of CSFB Private Equity,
merged with and into United American Energy Holdings Corp. (UAE Holdings) a
Delaware corporation, which continued as the surviving corporation in the
merger. UAE Holdings is the direct parent of UAE. As a result of this merger,
UAE's 50 percent ownership in American Ref-Fuel was transferred to MSW Energy
Holdings II LLC (MSW Energy II).
Upon consummation of the change in ownership and taking into account the
June 30, 2003 acquisition by MSW Energy I of Duke's membership interest in
Ref-Fuel Holdings (the MSW Transactions), affiliates of CSFB Private Equity and
AIGGIG (the Control Group) own, directly and indirectly, 99.8% of the membership
interests in Ref-Fuel Holdings (and will exercise voting power with respect to
Duke's remaining 0.2% interest). As a result, and in accordance with Emerging
Issues Task Force (EITF) Topic D-97, "Push-Down Accounting," Ref-Fuel Holdings'
financial statements will reflect the effects of its change in ownership and the
new owners' basis in the net assets and liabilities acquired. As a result, the
statement of operations and the statement of cash flows for the eleven and a
half months ended December 12, 2003 and the years ended December 31, 2002 and
2001 reflect the results of Ref-Fuel Holdings prior to purchase accounting
adjustments and the statement of operations of statement of cash flows for the
period ended December 31, 2003, reflect the impact of purchase accounting
adjustments arising from the MSW Transactions.
Prior to the MSW Transactions, profits and losses of Ref-Fuel Holdings were
allocated among its members based on ownership percentages. Subsequent to the
MSW Transactions profits and losses are allocated based upon the members'
ownership percentages except for the amortization of the variances in purchase
price. All significant intercompany accounts and transactions have been
eliminated in consolidation.
All of the American Ref Fuel Partnerships are indirect wholly owned
subsidiaries or controlled subsidiaries of American Ref-Fuel. The consolidated
financial statements of Ref-Fuel Holdings include the accounts of Ref-Fuel
Holdings, its controlled subsidiaries and certain investments.
Results of Operations
Comparison of the Combined Results for the Year Ended December 31, 2003 and for
the Year Ended December 31, 2002
Total Net Revenues. Total net revenues were $469.3 million for the year
ended December 31, 2003, an increase of $30.8 million, or 7%, over the prior
year. Net revenues increased mainly as a result of improved pricing;
approximately $4.3 million due to waste pricing increases, $10.4 million due to
energy pricing improvements and $2.0 million from higher prices for recovered
metals. Other drivers of the increase related to increased production and
volumes; $6.0 million resulting from increased hauling and transfer station
operations, $2.4 million due to increased steam production at the Niagara
facility, $7.4 million due to an increase in ash disposal volumes, and $5.5
million over all increased production. This increase in revenues was offset by
$6.7 million of additional amortization of intangible contract assets resulting
from the Redemption and the MSW Transactions.
Expenses. Operating and other expenses were $192.2 million for the year
ended December 31, 2003, an increase of $20.5 million, or 12% from the prior
year. The most significant increase, approximately $11.2 million, resulted from
increased disposal costs associated with the hauling and transfer station
operations and ash disposal. The remaining increases were primarily attributable
to increased maintenance expenses at the plants.
Depreciation and amortization of $59.2 million for the year ended December
31, 2003, decreased by $8.0 million, or 12 %, over the prior year. This decrease
resulted from the third quarter 2002 change in estimated of useful lives of
certain plant and equipment and the elimination of certain intangible assets as
a result of the purchase accounting adjustments recorded on account of the
Redemption.
18
General and administrative expenses were $44.3 million for the year ended
December 31, 2003, an increase of $0.7 million, or 2%, from the prior year
period. The difference from the prior year relates to several transactions which
occurred in 2002, including the relocation costs associated with Ref-Fuel
Holdings' corporate office move to Montvale, New Jersey, which was partially
offset by approximately $1.1 million reimbursement of legal expenses received.
During 2003, there was an increase in development spending related to the
exploration of the development of new plant facilities and $1.9 million of
increased insurance expenses, which further offset this difference.
Interest Income. Interest income was $3.2 million for the year ended
December 31, 2003, a decrease of $0.5 million, or 14%, as compared to the prior
year. This decrease was generally due to the change in interest rates on
invested funds.
Interest Expense. Interest expense was $62.1 million for the year ended
December 31, 2003, an increase of $1.2 million, or 2%, from the prior year. The
increase was due to the refinancing of variable rate debt with fixed rate debt
at 6.26% in May, 2003, partially offset by reduced balances on project-related
debt.
Loss on Early Extinguishment of Debt. Ref-Fuel Holdings expensed
approximately $3.2 million of deferred financing costs associated with the
refinancing of debt during 2003. There was no such expense in 2002.
Equity in Earnings of Equipment Leasing Entities. As a result of the
Redemption, Ref-Fuel Holdings no longer had an interest in the equipment leasing
entities in 2003, which caused the decrease in the equity earnings of equipment
leasing entities of $15.5 million from 2002.
Other expense, net. Other expenses were $0.3 million for the year ended
December 31, 2003, a decrease of $0.5 million, or 63% from the prior year
period. Other expenses consist primarily of income taxes levied on certain
wholly owned non-operating subsidiaries of Ref-Fuel Holdings that are taxable
corporations.
Income Attributable to Class B Minority Interests. Minority interest in net
income of subsidiaries of $4.9 million for the year ended December 31, 2002 was
due to Allied's interests in the HENS partnerships, which no longer existed as a
result of the Redemption.
Liquidity and Capital Resources
Ref-Fuel Holdings has historically generated funds from its operations
providing funding for its working capital requirements, capital spending, debt
repayments and dividend payout. The other source of liquidity was a $325 million
credit facility with a group of lending institutions. The facility provided for
term loans of $215 million to be borrowed by Ref-Fuel Holdings and its
subsidiaries and for a revolving credit facility of up to $110 million,
including $35.0 million of which could be used for letters of credit. Ref-Fuel
Holdings is contingently liable to furnish $25.0 million in letters of credit as
collateral under an indemnity agreement if Ref-Fuel Holdings' long-term debt
rating was reduced to below investment grade.
On May 9, 2003, American Ref-Fuel completed the sale of $275 million
aggregate principal amount of 6.26 percent Senior Notes due 2015. The proceeds
of the financing were used to repay $242.6 million under the outstanding credit
facility, fund debt service reserve accounts and for general corporate purposes.
As part of this refinancing, American Ref-Fuel entered into an amended and
restated revolving credit facility (the Amended Credit Facility) for up to $75
million, including $45 million of which could be used for letters of credit.
Under the terms of the credit facility, American Ref-Fuel is subject to certain
financial covenants, with respect to leverage and adjusted cash flow coverage
ratios. As of December 31, 2003, there were no borrowings and $7.0 million in
letters of credit outstanding.
Cash Flows
Operating Activities
Ref-Fuel Holding's net cash flows provided by operating activities totaled
$185.9 million for the year ended December 31, 2003, compared with $198.6
million for the year ended December 31, 2002. The decrease in cash flow from
operating activities of $12.7 million is attributable to a $23.8 million payout
under a terminated long-term compensation plan in 2003 that did not occur in
2002, offset by increased operating income in 2003.
19
Investing Activities
Cash flows utilized in investing activities are typically related to
capital additions and restricted cash changes. Ref-Fuel Holdings is required to
maintain cash and investment balances that are restricted by provisions of its
debt agreements and lease agreements. Ref-Fuel Holdings' capital additions
consist primarily of expenditures to maintain the operating facilities,
including expenditures for replacement and refurbishment of equipment and
environmental compliance that increase value, change capacities or extend useful
lives.
Cash flows utilized in investing activities totaled $34.2 million for the
year ended December 31, 2003, compared with $69.5 million for the year ended
December 31, 2002. The reduction of $35.3 million is primarily due to a change
in the requirement for restricted cash due to changes in the timing of debt
payments.
Financing Activities
Cash flows utilized in financing activities are related to borrowings of
long-term debt, principal payments of long-term debt and distributions to
members.
Cash flows utilized in financing activities totaled $125.3 million for the
year ended December 31, 2003, compared with $110.7 million for the year ended
December 31, 2002. In 2002, Ref-Fuel Holdings borrowed $40.0 million against its
revolving credit facility, and repaid debt of $56.0 million. Ref-Fuel Holdings
increased its outstanding borrowings by approximately $325.3 million partially
in conjunction with the refinancing of the Senior Notes in 2003. Repayments of
debt were approximately $372.9 million. Additionally, distributions to members
decreased by $22.0 million in 2003.
Capital Structure and Resources
As of December 31, 2003, the ARC operating companies had an aggregate of
$883.7 million in outstanding project debt, with maturities ranging from 2003 to
2026. Certain operating companies are obligated to restrict funds on a monthly
basis for payment of project debt and certain operating companies are required
to maintain debt service reserve funds. Ref-Fuel Holdings management believes
that all debt service reserve funds requirements have been satisfied.
In order to provide American Ref-Fuel with an additional source of funds to
meet calls on American Ref-Fuel's project support obligations, each Member has
entered into the Equity Contribution Agreement pursuant to which each Member has
agreed to provide up to $50 million in equity capital to the Company. Each
Member's obligation to make equity contributions under the Equity Contribution
Agreement is conditioned upon the other making an equal contribution and is
limited to each making no more than $50 million of aggregate equity
contributions. If a Member is not rated at least BBB by S&P, such party is
required to provide a letter of credit from a commercial bank that is rated at
least A- by S&P to secure its obligations under the Equity Contribution
Agreement.
Commitments and Contingencies
The following is a schedule of Ref-Fuel Holdings' contractual obligations
outstanding at December 31, 2003 (in thousands):
Contractual Less than 1 More than 5
Obligation Total Year 1-3 Years 3-5 Years Years
- -----------------------------------------------------------------------------------
Long Term
Debt
Obligations $1,142,687 $81,907 $166,559 $188,938 $705,283
Operating
Lease
Obligations 160,781 13,487 27,789 26,245 93,260
Other Long-
Term
Obligations 18,936 6,025 2,894 - 10,017
----------------------------------------------------------------------
Total $1,322,404 $101,419 $197,242 $215,183 $808,560
======================================================================
20
Additionally, a consolidated subsidiary of Ref-Fuel Holdings maintained
employment agreements with nine of its officers which expired on December 31,
2003. These agreements were replaced with new agreements on January 1, 2004, the
maximum liability of which is $2.2 million.
Effect of Inflation
Ref-Fuel Holdings' management believes that Ref-Fuel Holdings' results of
operations have not been materially impacted by inflation over the past three
years.
Critical Accounting Policies
The management of Ref-Fuel Holdings is responsible for its financial
statements and has evaluated the accounting policies used in their preparation.
The management of Ref-Fuel Holdings believes these policies to be reasonable and
appropriate. The following discussion identifies those accounting policies that
Ref-Fuel Holdings believes are critical in the preparation of Ref-Fuel Holdings'
financial statements, the judgments and uncertainties affecting the application
of those policies, and the possibility that materially different amounts would
be reported under different conditions or using different assumptions.
Use of Estimates in Preparing Financial Statements. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires that management make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of commitments and contingencies at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Among the significant estimates affecting the financial
statements are those related to the realizable value of accounts receivable,
long-lived assets, fair market value assumptions, power assets, waste contracts,
intangible assets, liabilities for self-insurance and certain landfill
liabilities. Such estimates are subsequently revised, as necessary, when
additional information becomes available. Actual results could differ from those
estimates.
Revenue Recognition. Ref-Fuel Holdings recognizes revenue from two major
sources: waste disposal services and energy production. Revenue from waste
disposal services is recognized as waste is received and revenue from energy
production is recognized as the energy is delivered. Each operating facility has
one or more long-term power sales contracts for the sale of energy with
contracts expiring in 2009 to 2021. Each ARC operating facility is contractually
obligated for waste services from its host community or communities with
contracts expiring in 2009 to 2020. In addition to the host community contracts,
certain facilities enter into long-term waste service contracts with surrounding
communities. Additionally, TransRiver, a wholly-owned subsidiary of Ref-Fuel
Holdings, markets waste capacity not committed to long-term waste contracts.
In connection with the acquisition of the Semass Partnership, Ref-Fuel
Holdings is accounting for the long-term power contracts acquired in accordance
with Emerging Issues Task Force (EITF) Issues 91-6 "Revenue Recognition of
Long-Term Power Sales Contracts" and EITF 96-17 "Revenue Recognition under
Long-Term Power Sales Contracts That Contain both Fixed and Variable Pricing
Terms" which require the Semass Partnership and Ref-Fuel Holdings to recognize
power revenues under these contracts as the lesser of (a) amounts billable under
the respective contracts or (b) an amount determinable by the kilowatt hours
made available during the period multiplied by the estimated average revenue per
kilowatt hour over the term of the contract. The determination of the lesser
amount is to be made quarterly based on the cumulative amounts that would have
been recognized had each method been applied consistently from the beginning of
the contract.
Property, Plant and Equipment. Property, plant and equipment are carried at
cost. Ref-Fuel Holdings provides for depreciation using the straight-line method
over the estimated useful lives of the assets. Cost and accumulated depreciation
of retired or disposed plant and equipment are removed from the respective
accounts and the gain or loss, if any, is reflected in net income.
Routine repairs and maintenance are charged against current operations.
Expenditures that increase value, change capacities or extend useful lives are
capitalized.
Ref-Fuel Holdings maintains a supply of various spare parts integral to its
operations. Certain spare parts which management does not expect to use within
the upcoming year have been classified as long-term spare parts inventory within
property, plant and equipment.
21
Landfill Costs. In June 2001, the FASB issued SFAS No. 143, "Accounting for
Asset Retirement Obligations" (SFAS 143). SFAS 143 applies to all legally
enforceable obligations associated with the retirement of tangible long-lived
assets and provides the accounting and reporting requirements for such
obligations. SFAS 143 requires amounts initially recognized as an asset
retirement obligation to be measured at fair value. The recognized asset
retirement cost is capitalized as part of the cost of the asset and is
depreciated over the useful life of the asset.
SFAS 143, which primarily impacts Ref-Fuel Holdings' accounting for
landfill operation, does not change the landfill accounting followed
historically by Ref-Fuel Holdings. Ref-Fuel Holdings expenses costs for future
closure and post-closure obligations on a per-unit basis as the landfill space
is consumed. This practice will continue to be followed upon adoption of SFAS
143 except, under the new rules; costs associated with future final capping
activities that occur during the operating life of the landfill will be
accounted for as an asset retirement obligation. Effective January 1, 2003, upon
adoption of SFAS 143, Ref-Fuel Holdings recognized an asset and corresponding
liability of approximately $0.7 million relating to the landfill retirement
obligations related to post-closure activities equal to their estimated fair
value. Landfill retirement costs arising from post-closure obligations, which
were capitalized as part of the landfill asset, are amortized consistent with
Ref-Fuel Holdings' current estimated life and are non-cash in nature. Landfill
retirement costs arising from final capping obligations, will be amortized on a
units-of-consumption basis over the estimated number of tons of waste that each
final capping event covers.
Goodwill. Goodwill represents the total consideration paid in excess of the
fair value of the net tangible and intangible assets acquired. Effective January
1, 2002, upon adoption of SFAS No. 142, "Goodwill and Other Intangible Assets"
(SFAS 142), Ref-Fuel Holdings stopped recording goodwill amortization and
performed its assessment of its reporting units and its initial assessment of
impairment, which was estimated using discounted cash flows. Additionally,
Ref-Fuel Holdings performed its required annual fair value testing of its
recorded goodwill for its reporting units using the discounted cash flows
approach which was consistent with the approach used upon adoption of SFAS 142.
Based upon its most recent analysis, Ref-Fuel Holdings believes that no
impairment exists.
Energy Contract Intangibles. Energy contract intangibles represent the
amount by which the contractual rates in long-term energy sales contracts held
by certain subsidiaries of Ref-Fuel Holdings exceeded fair value on the dates
that such contracts were acquired. These contract related intangibles are being
amortized against income as a reduction of energy revenues on a straight-line
basis over periods ranging from 10 to 20 years, which represented the remaining
term of the applicable contracts as of the dates of acquisition.
Operating Lease. The fair value adjustment related to the operating lease
with respect to the Delaware Valley facility represents the liability by which
the present value of future rent payments on the Delaware Valley facility lease
exceeds the fair value of the Delaware Valley facility as of the acquisition
date. This amount is being amortized as a decrease in facility rent expense on a
straight-line basis over approximately 15 years, which represented the life of
the associated lease at the time of acquisition.
Long-Term Waste Contracts. The fair value adjustment related to the
acquired long-term waste contracts represents the liability by which the present
value of costs of disposal and processing of waste delivered pursuant to certain
long-term waste contracts held by the Semass Partnership exceeded the estimated
fair value of the contract revenue at the date of acquisition. The liability is
being amortized as an increase to waste disposal revenues using the
straight-line method and an increase to interest expense using the effective
interest method over 19 years, the remaining term of the applicable contracts as
of the date of acquisition.
Review of Long-Lived Assets. Ref-Fuel Holdings reviews long-lived assets
for impairment, whenever events or changes in business circumstances indicate
the carrying amount of the assets may not be fully recoverable. Ref-Fuel
Holdings performs cash flow analyses to determine if impairment exists. If the
sum of the expected future cash flows is less than the carrying amount, an
impairment loss is recognized. Based upon its most recent analysis, Ref-Fuel
Holdings believes that no impairment exists. Additionally, Ref-Fuel Holdings
periodically reviews the estimated useful lives of long-lived assets.
Taxation. The operating subsidiaries consist of limited liability companies
and partnerships. Accordingly, income taxes are not levied at the Ref-Fuel
Holdings level, but rather on the individual members. Certain wholly-owned
non-operating subsidiaries of Ref-Fuel Holdings are taxable corporations.
22
Effect of New Accounting Standards
In January 2003, the FASB issued Interpretation (FIN) No. 46,
"Consolidation of Variable Interest Entities." FIN 46 requires that
unconsolidated variable interest entities be consolidated by their primary
beneficiaries. A primary beneficiary is the party that absorbs a majority of the
entity's expected losses or residual benefits. FIN 46 applies immediately to
variable interest entities created after January 31, 2003, and to existing
variable interest entities in the periods beginning after June 15, 2003.
Ref-Fuel Holdings does not believe that it will have a material effect on its
financial position, results of operations or cash flows.
RISK FACTORS
Any of the following risks could materially adversely affect our business,
financial condition or results of operations.
Our substantial indebtedness and the substantial indebtedness of American
Ref-Fuel could adversely affect our financial condition.
We have a substantial amount of indebtedness. As of December 31, 2003, our
total indebtedness was $200 million, which represented approximately 55.5% of
our total capitalization. As of December 31, 2003, American Ref-Fuel's total
indebtedness was approximately $1.1 billion, which represented approximately
60.7% of American Ref-Fuel's total capitalization.
This substantial indebtedness could have important consequences. For
example, it could
-- make it more difficult for us to satisfy our obligations with respect
to our outstanding debt, including our repurchase obligations;
-- increase our vulnerability to general economic and industry
conditions;
-- limit our flexibility in planning for, or reacting to, changes in the
business and industry in which American Ref-Fuel operates;
-- place us and American Ref-Fuel at a competitive disadvantage compared
to competitors of American Ref-Fuel that have less debt; and
-- limit our ability to borrow additional funds in order to make capital
contributions to fund the ARC operating facilities.
Our indenture imposes significant operating and financial restrictions on
us.
The indenture governing our outstanding debt contains restrictive covenants
that limit our ability to engage in activities that may be in our long-term best
interests. These restrictions limit our ability and the ability of any
restricted subsidiaries to do the following, among other things:
-- incur additional indebtedness;
-- create liens;
-- pay dividends or make other equity distributions;
-- purchase or redeem capital stock;
-- make investments;
-- sell assets or consolidate or merge with or into other companies; and
23
-- engage in transactions with affiliates.
Our failure to comply with those covenants could result in an event of
default which, if not cured or waived, could result in the acceleration of all
of our debt. Moreover, it is possible that in the future the owners of MSW
Energy Holdings and MSW Energy II could determine to merge those companies with
each other or into Ref-Fuel Holdings. While such a merger would be required to
comply with the terms of the indenture, a result would be an increase in the
amount of indebtedness of the successor.
Our sole source of cash flow relates to our investment in Ref-Fuel
Holdings, whose sole source of cash flow, in turn, relates to its 100% interest
in American Ref-Fuel, and accordingly our performance will depend solely on cash
distributions from American Ref-Fuel and Ref-Fuel Holdings.
We will need to receive sufficient ongoing cash distributions from Ref-Fuel
Holdings in order to pay principal and interest on our outstanding debt.
Accordingly, our ability to service our debt is subject to a number of risks,
including the following:
-- We depend on the ability of American Ref-Fuel and its subsidiaries to
generate sufficient cash flow to service American Ref-Fuel's
significant debt and to make distributions to Ref-Fuel Holdings. The
business of American Ref-Fuel is subject to a variety of risks, many
of which, as described below, are outside the control of American
Ref-Fuel. Any of these risks could affect American Ref-Fuel's ability
to generate cash flow. In the event that American Ref-Fuel fails to
generate cash