SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-Q
FOR THE TRANSITION PERIOD FROM __________ TO __________
Commission File Number: 1-14267
REPUBLIC SERVICES, INC.
Registrant’s Telephone Number, Including Area Code: (954) 769-2400
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 o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yesx Noo
On November 10, 2003, the registrant had outstanding 158,413,497 shares of Common Stock, par value $.01 per share.
TABLE OF CONTENTS
INDEX
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these statements.
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UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
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REPUBLIC SERVICES, INC. AND COMPREHENSIVE INCOME" -->
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITYAND COMPREHENSIVE INCOME
The accompanying notes are an integral part of this statement.
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UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Republic Services, Inc. (together with its subsidiaries, the “Company”) is a leading provider of non-hazardous solid waste collection and disposal services in the United States.
The accompanying Unaudited Condensed Consolidated Financial Statements include the accounts of the Company and have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. All significant intercompany accounts and transactions have been eliminated. Certain information related to the Company’s organization, significant accounting policies and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. In the opinion of management, these Unaudited Condensed Consolidated Financial Statements reflect all material adjustments (which include only normal recurring adjustments) necessary to fairly state the financial position and the results of operations for the periods presented, and the disclosures herein are adequate to make the information presented not misleading. Operating results for interim periods are not necessarily indicative of the results that can be expected for a full year. These interim financial statements should be read in conjunction with the Company’s audited Consolidated Financial Statements and notes thereto appearing in the Company’s Form 10-K for the year ended December 31, 2002.
The Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States and necessarily include amounts based on estimates and assumptions made by management. Actual results could differ from these amounts. Significant items subject to such estimates and assumptions include the depletion and amortization of landfill development costs, liabilities for final capping, closure and post-closure costs, valuation allowances for accounts receivable, liabilities for potential litigation, claims and assessments, and liabilities for environmental remediation, deferred taxes and self-insurance.
During the three and nine months ended September 30, 2002, the Company recorded unrealized gains of $.5 million ($.3 million, net of tax), and $2.9 million ($1.8 million, net of tax), respectively, relating to the change in fair value of its fuel hedge option agreements in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended. (For further information, see Note 11, Fuel Hedge.) The effective portion of the unrealized gain in the amount of $1.6 million, net of tax, was recorded to comprehensive income during the three and nine months ended September 30, 2002. During the three and nine months ended September 30, 2003, the Company recorded unrealized gains on available-for-sale securities of $.3 million, net of tax, to comprehensive income. The Company had no other components of other comprehensive income for the periods presented.
During the first quarter of 2003, the Company adopted Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”). SFAS 143 required the Company to change the methodology it used to record final capping, closure and post-closure costs relating to its landfills. As of January 1, 2003, the Company recorded an after-tax expense of $20.8 million, or $33.6 million on a pre-tax basis, as a cumulative effect of a change in accounting principle resulting from the adoption of SFAS 143. In addition, the Company also recorded an after-tax expense of $17.0 million, or $27.4 million on a pre-tax basis, as a cumulative effect of a change in accounting principle for its methane gas collection systems. This change in accounting for methane gas collection systems was prompted by a thorough evaluation of the Company’s landfill accounting policies in connection with the adoption of SFAS 143 and is consistent with the methodology used by other participants in the waste industry.
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The following table summarizes the adjustments to net income and earnings per share for the three and nine months ended September 30, 2002 as if SFAS 143 and the Company’s change in accounting principle relating to its methane gas collection systems were effective in 2002:
The following table summarizes the balance sheet impact of adopting SFAS 143 and the Company’s change in accounting relating to methane gas collection systems:
Certain amounts in the 2002 Condensed Consolidated Financial Statements have been reclassified to conform to the 2003 presentation.
2. LANDFILL, ENVIRONMENTAL AND LEGAL COSTS
Landfill, Environmental And Legal Costs
A summary of liabilities recorded for landfill, environmental and legal costs is as follows:
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Life Cycle Accounting
The Company uses life cycle accounting and the units-of-consumption method to recognize certain landfill costs over the life of the site. In life cycle accounting, all costs to acquire and construct a site are capitalized, and charged to expense based upon the consumption of cubic yards of available airspace. Costs and airspace estimates are developed annually by independent engineers together with the Company’s engineers. These estimates are used by the Company’s operating and accounting personnel to annually adjust the Company’s rates used to expense capitalized costs. Changes in these estimates primarily relate to changes in available airspace, inflation and applicable regulations. Changes in available airspace include changes due to the addition of airspace lying in probable expansion areas.
Total Available Disposal Capacity
As of September 30, 2003, the Company owned or operated 57 solid waste landfills with total available disposal capacity of approximately 1.8 billion in-place cubic yards. Total available disposal capacity represents the sum of estimated permitted airspace plus an estimate of expansion airspace that the Company believes has a probable likelihood of ultimately being permitted.
Probable Expansion Airspace
Before airspace included in an expansion area is determined as probable expansion airspace and, therefore, included in the Company’s calculation of total available disposal capacity, the following criteria must be met:
Upon meeting the Company’s expansion criteria, the rates used at each applicable landfill to expense or accrue costs to acquire, construct, cap, close and maintain a site during the post-closure period are adjusted to include probable expansion airspace and all additional costs to be capitalized or accrued associated with the expansion airspace.
The Company has identified three sequential steps that landfills generally follow to obtain expansion permits. These steps are as follows:
Once a landfill meets the Company’s expansion criteria, management continuously monitors each site’s progress in obtaining the expansion permit. If at any point it is determined that an expansion area no longer meets the required criteria, the probable expansion airspace is removed from the landfill’s total available
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capacity and the rates used at the landfill to expense or accrue costs to acquire, construct, cap, close and maintain a site during the post-closure period are adjusted accordingly.
Capitalized Landfill Costs
Capitalized landfill costs include expenditures for land, permitting costs, cell construction costs and environmental structures. Capitalized permitting and cell construction costs are limited to direct costs relating to these activities, including legal, engineering and construction associated with excavation, liners and site berms. Interest is capitalized on landfill construction projects while the assets are undergoing activities to ready them for their intended use.
Costs related to acquiring land, excluding the estimated residual value of unpermitted, non-buffer land, and costs related to permitting and cell construction are depleted as airspace is consumed using the units-of-consumption method.
Capitalized landfill costs may also include an allocation of purchase price paid for landfills. For landfills purchased as part of a group of several assets, the purchase price assigned to the landfill is determined based upon the discounted future expected cash flows of the landfill relative to the other assets within the group. If the landfill meets the Company’s expansion criteria, the purchase price is further allocated between permitted airspace and expansion airspace based upon the ratio of permitted versus probable expansion airspace to total available airspace. Landfill purchase price is amortized using the units-of-consumption method over the total available airspace including probable expansion airspace where appropriate.
Final Capping, Closure and Post-Closure Costs
During the first quarter of 2003, the Company changed the methodology it used to record final capping, closure and post-closure expense in accordance with SFAS 143. SFAS 143 does not change the basic landfill accounting policies followed by the Company and others in the waste industry. Through December 31, 2002, the industry has generally amortized capitalized costs and accrued future final capping, closure and post-closure obligations using the units-of-consumption method as cubic yards of available airspace are consumed over the life of the related landfill. This practice is referred to as life cycle accounting and will continue to be followed except as modified by SFAS 143 as discussed below.
The table below reflects significant changes between the Company’s historical methodology and the methodology the Company currently uses to account for final capping, closure and post-closure activities and for methane gas collection systems:
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The Company has future obligations for final capping, closure and post-closure costs with respect to the landfills it owns or operates as set forth in applicable landfill permits. Final capping, closure and post-closure costs include estimated costs to be incurred for final capping and closure of landfills and estimated costs for providing required post-closure monitoring and maintenance of landfills. The permit requirements are based on the Subtitle C and Subtitle D regulations of the Resource Conservation and Recovery Act (RCRA), as implemented and applied on a state-by-state basis. Obligations associated with monitoring and controlling methane gas migration and emissions are set forth in applicable landfill permits and these requirements are based upon the provisions of the Clean Air Act of 1970, as amended. Final capping typically includes installing flexible membrane and geosynthetic clay liners, drainage and compact soil layers, and topsoil, and is constructed over an area of the landfill where total airspace capacity has been consumed and waste disposal operations have ceased. These final capping activities occur throughout the operating life of a landfill. Other closure activities and post-closure activities occur after the entire landfill ceases to accept waste and closes. These activities involve methane gas control, leachate management and groundwater monitoring, surface water monitoring and control, and other operational and maintenance activities that occur after the site ceases to accept waste. The post-closure period generally runs for up to 30 years after final site closure for municipal solid waste landfills and a shorter period for construction and demolition landfills and inert landfills.
Estimates of future expenditures for final capping, closure and post-closure are developed annually by independent engineers together with the Company’s engineers. These estimates are reviewed by management at least annually and are used by the Company’s operating and accounting personnel to adjust the rates used to capitalize and amortize these costs. These estimates involve projections of costs that will be
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incurred after the landfill ceases operations and during the legally required post-closure monitoring period. Additionally, the Company currently retains post-closure responsibility for several closed landfills.
Under SFAS 143, a liability for an asset retirement obligation must be recognized in the period in which it is incurred and should be initially measured at fair value. Absent quoted market prices, the estimate of fair value should be based on the best available information, including the results of present value techniques in accordance with Statement of Financial Accounting Concepts No. 7, “Using Cash Flow and Present Value in Accounting Measurements” (“SFAC 7”). The offset to the liability must be capitalized as part of the carrying amount of the related long-lived asset. Changes in the liability due to the passage of time are recognized as operating items in the income statement and are referred to as accretion expense. Changes in the liability due to revisions to estimated future cash flows are recognized by increasing or decreasing the liability with the offset adjusting the carrying amount of the related long-lived asset.
In applying the provisions of SFAS 143, the Company has concluded that a landfill’s asset retirement obligation includes estimates of all costs related to final capping, closure and post-closure. Costs associated with a landfill’s daily maintenance activities during the operating life of the landfill, such as leachate disposal, groundwater and gas monitoring, and other pollution control activities, will continue to be charged to expense as incurred. In addition, costs historically accounted for as capital expenditures during the operating life of a landfill, such as cell development costs, will continue to be capitalized when incurred, and charged to expense using life cycle accounting and the units-of-consumption method based on the consumption of cubic yards of available airspace.
The Company defines final capping as activities required to permanently cover a portion of a landfill that has been completely filled with waste. Final capping occurs in phases throughout the life of a landfill as specific areas are filled to capacity and the final elevation for that specific area is reached in accordance with the provisions of the operating permit. The Company considers final capping events to be discrete activities that are recognized as asset retirement obligations separately from other closure and post-closure obligations. These capping events occur generally during the operating life of a landfill and can be associated with waste actually placed under an area to be capped. As a result, the Company uses a separate rate per ton for recognizing the principal amount of the liability associated with each capping event. The Company amortizes the asset recorded pursuant to this approach as waste volume equivalent to the capacity covered by the capping event is placed into the landfill based upon the consumption of cubic yards of available airspace covered by the capping event.
The Company recognizes asset retirement obligations and the related amortization expense for closure and post-closure (excluding obligations for final capping) using the units-of-consumption method over the total remaining capacity of the landfill. The total remaining capacity includes probable expansion airspace.
In general, the Company relies on third parties to fulfill most of its obligations for final capping, closure and post-closure. Accordingly, the fair market value of these obligations is based upon quoted and actual prices paid for similar work. The Company does intend to perform some of its final capping, closure and post-closure obligations using internal resources. Where internal resources are expected to be used to fulfill an asset retirement obligation, the Company has added a profit margin onto the estimated cost of such services to better reflect their fair market value as required by SFAS 143. These services primarily relate to managing construction activities during final capping, and maintenance activities during closure and post-closure. If the Company does perform these services internally, the added profit margin would be recognized as a component of operating income in the period earned.
SFAC 7 states that an estimate of fair value should include the price that marketplace participants are able to receive for bearing the uncertainties in cash flows. However, when utilizing discounted cash flow techniques, reliable estimates of market premiums may not be obtainable. In this situation, SFAC 7 indicates that it is not necessary to consider a market risk premium in the determination of expected cash flows. While the cost of asset retirement obligations associated with final capping, closure and post-closure can be quantified and estimated, there is not an active market that can be utilized to determine the fair value of these activities. In the case of the waste industry, no market exists for selling the responsibility for final capping, closure and post-closure independent of selling the landfill in its entirety. Accordingly, the Company
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believes that it is not possible to develop a methodology to reliably estimate a market risk premium and has excluded a market risk premium from its determination of expected cash flow for landfill asset retirement obligations in accordance with SFAC 7.
Under SFAS 143, the primary modification to the Company’s historical methodology is to require that final capping, closure and post-closure costs be inflated and discounted to present value. The Company’s estimates of future final capping, closure and post-closure costs historically have not taken into account discounts for the present value of costs to be paid in the future. Consequently, the amount of expense (accretion expense plus amortization expense) will be higher in the later years of a landfill’s life than in earlier years.
The Company’s estimates of costs to discharge asset retirement obligations for landfills are developed in today’s dollars. These costs are inflated each year to reflect a normal escalation of prices up to the year they are expected to be paid. The Company uses a 2.5% inflation rate, which is the rate used by most waste industry participants.
These estimated costs are then discounted to their present value using a credit-adjusted, risk-free rate. The Company’s credit-adjusted, risk-free rate was determined to be 6.75% based upon the estimated all-in yield the Company believes it would need to offer to sell thirty-year debt in the public market. Changes in asset retirement obligations due to the passage of time are measured by recognizing accretion expense in a manner that results in a constant effective interest rate applied to the average carrying amount of the liability. The effective interest rate used to calculate accretion expense is the Company’s credit-adjusted, risk-free rate.
In accordance with SFAS 143, changes due to revision of the estimates of the amount or timing of the original undiscounted cash flows used to record a liability are recognized by increasing or decreasing the carrying amount of the asset retirement obligation liability and the carrying amount of the related asset. Upward revisions in the amount of undiscounted estimated cash flows used to record a liability must be discounted using the credit-adjusted, risk-free rate in effect at the time of the change. Downward revisions in the amount of undiscounted estimated cash flows used to record a liability must be discounted using the credit-adjusted, risk-free rate that existed when the original liability was recognized.
The Company intends to annually review its calculations with respect to landfill asset retirement obligations unless there is a significant change in the facts and circumstances related to a landfill during the year, in which case the Company will review its calculations as soon as practical after the significant change has occurred.
The following table summarizes the activity in the Company’s asset retirement obligation liabilities for the nine months ended September 30, 2003:
The following table summarizes the activity in the Company’s accrued closure and post-closure account for the nine months ended September 30, 2002:
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Remediation
The Company accrues for remediation costs when they become probable and reasonably estimatable. Substantially all of the Company’s recorded remediation costs are for incremental landfill post-closure care required under approved remediation action plans for acquired landfills. Remediation costs are estimated by independent engineers together with the Company’s engineers based upon site remediation plans. These estimates do not take into account discounts for the present value of total estimated costs. Management believes that the amounts accrued for remediation costs are adequate. However, a significant increase in the estimated costs for remediation could have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Environmental Costs
In the normal course of business, the Company is subject to ongoing environmental investigations by certain regulatory agencies, as well as other claims and disputes that could result in litigation. Environmental costs are accrued by the Company through a charge to income in the period such liabilities become probable and can be reasonably estimated. No significant amounts were charged to expense during the nine months ended September 30, 2003 and 2002.
3. PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Expenditures for major additions and improvements are capitalized, while maintenance and repairs are charged to expense as incurred. When property is retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in the Unaudited Condensed Consolidated Statements of Income.
The Company revises the estimated useful lives of property and equipment acquired through business acquisitions to conform with its policies regarding property and equipment. Depreciation is provided over the estimated useful lives of the assets involved using the straight-line method. The estimated useful lives are seven to forty years for buildings and improvements, five to twelve years for vehicles, seven to ten years for most landfill equipment, three to fifteen years for all other equipment, and five to twelve years for furniture and fixtures.
Landfills and landfill improvements are stated at cost and include direct costs incurred to obtain landfill permits and direct costs incurred to acquire, construct and develop sites. These costs are depleted based on consumed airspace. All indirect landfill development costs are expensed as incurred. (For further information, see Note 2, Landfill, Environmental and Legal Costs.)
The Company capitalizes interest on landfill cell construction and other construction projects in accordance with Statement of Financial Accounting Standards No. 34, “Capitalization of Interest Cost.” Construction projects must meet the following criteria before interest is capitalized:
Interest is capitalized on qualified assets while they undergo activities to ready them for their intended use. Capitalization of interest ceases once an asset is placed into service or if construction activity is suspended for more than a brief period of time. The interest capitalization rate is based upon the Company’s weighted average cost of indebtedness. Interest capitalized was $2.1 million and $1.8 million for the nine months ended September 30, 2003 and 2002, respectively.
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A summary of property and equipment is as follows:
The Company periodically evaluates whether events and circumstances have occurred that may warrant revision of the estimated useful life of property and equipment or whether the remaining balance of property and equipment should be evaluated for possible impairment. The following are examples of such events or changes in circumstances:
There are certain indicators listed above that require significant judgment and understanding of the waste industry when applied to landfill development or expansion. For example, a regulator may initially deny a landfill expansion permit application though the expansion permit is ultimately granted. In addition, management may periodically divert waste from one landfill to another to conserve remaining permitted landfill airspace. Therefore, certain events could occur in the ordinary course of business and not necessarily be considered indicators of impairment due to the unique nature of the waste industry.
The Company uses an estimate of the related undiscounted cash flows over the remaining life of the property and equipment in assessing their recoverability. The Company measures impairment loss as the amount by which the carrying amount of the asset exceeds the fair value of the asset.
4. BUSINESS COMBINATIONS
The Company acquires businesses as part of its growth strategy. Businesses acquired are accounted for under the purchase method of accounting and are included in the Consolidated Financial Statements from the date of acquisition. The Company allocates the cost of the acquired business to the assets acquired and the liabilities assumed based on estimates of fair values thereof. These estimates are revised during the allocation period as necessary if, and when, information regarding contingencies becomes available to further define and quantify assets acquired and liabilities assumed. The allocation period generally does not exceed one year. To the extent contingencies such as preacquisition environmental matters, litigation and related
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legal fees are resolved or settled during the allocation period, such items are included in the revised allocation of the purchase price. After the allocation period, the effect of changes in such contingencies is included in results of operations in the periods in which the adjustments are determined. The Company does not believe potential differences between its fair value estimates and actual fair values are material.
The Company acquired various solid waste businesses during the nine months ended September 30, 2003 and 2002. The aggregate purchase price paid by the Company in these transactions was $30.2 million and $43.1 million in cash, respectively.
The following summarizes the preliminary purchase price allocations for business combinations consummated during the periods presented:
Substantially all of the intangible assets recorded for these acquisitions are deductible for tax purposes.
The Company’s unaudited pro forma consolidated results of operations assuming all significant acquisitions during the nine months ended September 30, 2003 had occurred at the beginning of the periods presented are as follows:
The unaudited pro forma results of operations are presented for informational purposes only and may not necessarily reflect the future results of operations of the Company or what the results of operations would have been had the Company owned and operated these businesses as of the beginning of the periods presented.
5. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill consists of the cost of acquired businesses in excess of the fair value of net assets acquired. Other intangible assets include values assigned to customer relationships, long-term contracts and covenants not to compete and are amortized generally over periods ranging from 3 to 25 years.
The following table summarizes the activity in goodwill and other intangible assets and related accumulated amortization accounts for the nine months ended September 30, 2002 and 2003:
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In general, goodwill is tested for impairment on an annual basis in the fourth quarter of each year. In testing for impairment, the Company estimates the fair value of each operating segment and compares the fair values with the carrying values. The fair value of goodwill is determined by deducting the fair value of an operating segment’s identifiable assets and liabilities from the fair value of the operating segment as a whole, as if that operating segment had just been acquired and the purchase price were being initially allocated. If the fair value were less than the carrying value for a segment, an impairment charge would be recorded to earnings in the Company’s Consolidated Statement of Income.
In addition, the Company would evaluate an operating segment for impairment if events or circumstances change between annual tests indicating a possible impairment. Examples of such events or circumstances include:
The Company incurred no impairment of goodwill as a result of its annual goodwill impairment test in 2002. However, there can be no assurance that goodwill will not be impaired at any time in the future.
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6. DEBT
Debt consists of the following:
As of September 30, 2003, the Company had $389.8 million of availability under its revolving credit facility.
As of September 30, 2003, the Company had $219.5 million of restricted cash, of which $135.8 million were proceeds from the issuance of tax-exempt bonds and other tax-exempt financing that will be used to fund capital expenditures. Restricted cash also includes amounts held in trust as a guarantee of the Company’s performance.
Interest expense paid was $54.9 million (net of $2.1 million of capitalized interest) and $54.7 million (net of $1.8 million of capitalized interest) for the nine months ended September 30, 2003 and 2002, respectively.
The Company’s ability to obtain financing through the capital markets is a key component of its financial strategy. Historically, the Company has managed risk associated with executing this strategy, particularly as it relates to fluctuations in interest rates, by using a combination of fixed and floating rate debt. The Company has also entered into interest rate swap agreements to manage risk associated with fluctuations in interest rates and to take advantage of favorable floating interest rates. The swap agreements have total notional values of $225.0 million and $105.0 million, and mature in 2004 and 2011, respectively. These maturities are identical to the Company’s public notes that were sold in 1999 and 2001, respectively. Under the swap agreements, the Company pays interest at floating rates based on changes in LIBOR and receives interest at fixed rates of 6 5/8% and 6 3/4%, respectively. The Company has designated these agreements as hedges in changes in the fair value of the Company’s fixed-rate debt and accounts for them in accordance with SFAS 133. The Company has determined that these agreements qualify for the short-cut method under SFAS 133 and, therefore, changes in the fair value of the agreements are assumed to be perfectly effective in hedging changes in the fair value of the Company’s fixed rate debt due to changes in interest rates.
As of September 30, 2003, interest rate swap agreements are reflected at fair market value of $9.0 million and are included in other current and other assets and as an adjustment to short- and long-term debt in the accompanying Unaudited Condensed Consolidated Balance Sheets. During the nine months ended September 30, 2003 and 2002, the Company recorded net interest income of $7.5 million and $3.9 million, respectively, related to its interest rate swap agreements which is included in interest expense in the accompanying Unaudited Condensed Consolidated Statements of Income.
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7. INCOME TAXES
Income taxes have been provided for the nine months ended September 30, 2003 and 2002 based upon the Company’s anticipated annual effective income tax rate of 38.0%. Income taxes paid were $15.0 million and $40.5 million for the nine months ended September 30, 2003 and 2002, respectively.
8. STOCK OPTIONS
In July 1998, the Company adopted the 1998 Stock Incentive Plan (“Stock Incentive Plan”) to provide for grants of options to purchase shares of common stock to employees and non-employee directors of the Company who are eligible to participate in the Stock Incentive Plan. Options granted under the Stock Incentive Plan are non-qualified and are granted at a price equal to the fair market value of the Company’s Common Stock at the date of grant. Generally, options granted have a term of ten years from the date of grant, and vest in increments of 25% per year over a four year period beginning on the first anniversary date of the grant. Options granted to non-employee directors have a term of ten years and are fully vested at the grant date. In May 2002, the Company’s stockholders approved and adopted an amendment and restatement of the Stock Incentive Plan, which modified a number of its provisions, including an increase in the number of shares of Common Stock reserved for issuance under the Stock Incentive Plan from 20.0 million to 27.0 million. As of September 30, 2003, 7.5 million options remain available for future grants.
A summary of stock option transactions for the nine months ended September 30, 2003 is as follows:
The Company accounts for its stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the Stock Incentive Plan for the periods presented had an exercise price equal to the market value of the underlying common stock at the date of grant. Had compensation cost for stock option grants under the Company’s Stock Incentive Plan been determined pursuant to Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), the Company’s net income would have decreased accordingly. Using the Black-Scholes option pricing model, the Company’s pro forma net income and earnings per share, with related assumptions, are as follows:
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9. STOCKHOLDERS’ EQUITY AND EARNINGS PER SHARE
During 2000, 2001, 2002 and 2003, the Board of Directors authorized the repurchase of up to $150.0 million, $125.0 million, $175.0 million and $225.0 million, respectively, of its Common Stock. As of September 30, 2003, the Company had repurchased a total of 23.6 million shares of its stock for $435.6 million, of which 6.4 million shares were acquired during the nine months ended September 30, 2003 for $135.5 million.
Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is based on the combined weighted average number of common shares and common share equivalents outstanding which include, where appropriate, the assumed exercise of employee stock options. In computing diluted earnings per share, the Company utilizes the treasury stock method.
Earnings per share for the three and nine months ended September 30, 2003 and 2002 is calculated as follows (in thousands, except per share data):
In July 2003, the Company’s Board of Directors initiated a quarterly dividend program. On July 29, 2003, a $.06 per share cash dividend was declared to shareholders of record on September 30, 2003. The dividend was paid to record holders on October 15, 2003. In October 2003, the Company’s Board of Directors declared a quarterly dividend of $.06 per share for shareholders of record on January 2, 2004.
10. SEGMENT INFORMATION
The Company’s operations are managed and evaluated through five regions: Eastern, Central, Southern, Southwestern and Western. These five regions are presented below as the Company’s reportable segments. These reportable segments provide integrated waste management services consisting of collection, transfer and disposal of domestic non-hazardous solid waste.
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Summarized financial information concerning the Company’s reportable segments for the respective nine months ended September 30 is shown in the following table:
Total revenue of the Company by revenue source for the three and nine months ended September 30, 2003 and 2002 is as follows:
11. FUEL HEDGE
During June 2001, the Company entered into option agreements for approximately 14.3 million gallons of heating oil. Under SFAS 133, the options qualified for and were designated as effective hedges of changes in the prices of forecasted diesel fuel purchases. These option agreements settled each month in equal notional amounts through December 2002. The option agreements were structured as zero-cost collars indexed to the price of heating oil. These option agreements expired in December 2002. In accordance with SFAS 133,
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$1.6 million, representing the effective portion of the change in fair value for the nine months ended September 30, 2002, net of tax, has been recorded in stockholders’ equity as a component of accumulated other comprehensive income. The ineffective portion of the change in fair value was a gain of approximately $0 million and $.1 million for the three and nine months ended September 30, 2002, and has been included in other income (expense), net in the accompanying Unaudited Condensed Consolidated Statements of Income. Realized losses of $0 million and $.8 million related to these option agreements are included in cost of operations in the Company’s Unaudited Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2002.
12. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
The Company is a party to various general legal proceedings which have arisen in the ordinary course of business. While the results of these matters cannot be predicted with certainty, the Company believes that losses, if any, resulting from the ultimate resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows. However, unfavorable resolution could affect the consolidated financial position, results of operations or cash flows for the quarterly periods in which they are resolved.
Lease Commitments
The Company and its subsidiaries lease real property, equipment and software under various operating leases with terms from one month to twenty-five years.
Liability Insurance
The Company carries general liability, vehicle liability, employment practices liability, pollution liability, directors and officers liability, workers compensation and employer’s liability coverage, as well as umbrella liability policies to provide excess coverage over the underlying limits contained in these primary policies. The Company also carries property insurance.
The Company’s insurance programs for worker’s compensation, general liability, vehicle liability and employee-related health care benefits are effectively self-insured. Claims in excess of self-insurance levels are fully insured subject to policy limits. Accruals are based on claims filed and estimates of claims incurred but not reported.
Self-insurance expense was $70.7 million and $145.6 million for the three and nine months ended September 30, 2003 versus $41.9 million and $102.3 million for the comparable 2002 periods. This increase in self-insurance expense relates to existing claims and is attributable to the expansion of the Company’s operations and various changes in estimates as a result of continued negative trends through the current policy year, based on recent actual claims experience, expected claims development and medical cost inflation.
The Company’s liabilities for unpaid and incurred but not reported claims at September 30, 2003 were $114.5 million and are included in other current and other liabilities in the accompanying Unaudited Condensed Consolidated Balance Sheets. While the ultimate amount of claims incurred is dependent on future developments, in management’s opinion, recorded reserves are adequate to cover the future payment of claims. However, it is possible that recorded reserves may differ from amounts required to pay future claims. Adjustments, if any, to estimates recorded resulting from ultimate claim payments will be reflected in operations in the periods in which such adjustments are known.
Guarantees of Subsidiary Debt
The Company has guaranteed the tax-exempt bonds of its subsidiaries. If a subsidiary fails to meet its obligations associated with tax-exempt bonds as they come due, the Company will be required to perform under the related guarantee agreement. No additional liability has been recorded for these guarantees because the underlying obligations are reflected in the Company’s Consolidated Balance Sheets. (For further information, see Note 6, Debt).
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Restricted Cash and Marketable Securities, and Other Financial Guarantees
In the normal course of business, the Company is required by regulatory agencies, governmental entities and contract parties to post performance bonds, letters of credit and/or cash deposits as financial guarantees of the Company’s performance. At September 30, 2003, letters of credit totaling $360.2 million were outstanding, and surety bonds totaling $541.1 million were outstanding, which will expire on various dates through 2015.
At September 30, 2003, the Company had $219.5 million of restricted cash deposits and $141.7 million of restricted marketable securities held as financial guarantees, including $135.8 million of restricted cash held for capital expenditures under certain debt facilities, and $37.7 million and $141.7 million of restricted cash and restricted marketable securities, respectively, pledged to regulatory agencies and governmental entities as financial guarantees of the Company’s performance related to its final capping, closure and post-closure obligations at its landfills. The Company’s restricted marketable securities consist of mutual funds invested in short-term investment grade securities, including mortgage-backed securities and U.S. Government obligations. These securities are available for sale and, as a result, are stated at fair value based upon quoted market prices. Unrealized gains and losses, net of tax, are recorded as a component of accumulated other comprehensive income. The Company intends to liquidate a portion of these marketable securities and use the proceeds to repay the $225.0 million of public notes, which mature in May 2004. The Company also intends to use letters of credit to replace the financial guarantees secured by marketable securities to be liquidated.
Other Matters
The Company’s business activities are conducted in the context of a developing and changing statutory and regulatory framework. Governmental regulation of the waste management industry requires the Company to obtain and retain numerous governmental permits to conduct various aspects of its operations. These permits are subject to revocation, modification or denial. The costs and other capital expenditures which may be required to obtain or retain the applicable permits or comply with applicable regulations could be significant. Any revocation, modification or denial of permits could have a material adverse effect on the Company.
Through the date of the Company’s initial public offering in July 1998, the Company filed consolidated federal income tax returns with AutoNation, Inc. (“AutoNation”). The Internal Revenue Service is auditing AutoNation’s consolidated tax returns for fiscal years 1997 through 1999. In accordance with the Company’s tax sharing agreement with AutoNation, the Company may be liable for certain assessments imposed by the Internal Revenue Service for the periods through June 1998, resulting from this audit. In addition, the Internal Revenue Service is auditing the Company’s consolidated tax returns for fiscal years 1998 and 1999. Management believes that the tax liabilities recorded are adequate. However, a significant assessment in excess of liabilities recorded against the Company could have a material adverse effect on the Company’s financial position, results of operations or cash flows.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and notes thereto included under Item 1. In addition, reference should be made to our audited Consolidated Financial Statements and notes thereto and related Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing in our Form 10-K for the year ended December 31, 2002.
Our Business
We are a leading provider of non-hazardous solid waste collection and disposal services in the United States. We provide solid waste collection services for commercial, industrial, municipal and residential customers through 142 collection companies in 22 states. We also own or operate 92 transfer stations and 57 solid waste landfills.
We generate revenue primarily from our solid waste collection operations. Our remaining revenue is obtained from landfill disposal services and other services, including recycling, remediation and composting operations.
The following table reflects our total revenue by source for the three and nine months ended September 30, 2003 and 2002 (dollars in millions):
Our revenue from collection operations consists of fees we receive from commercial, industrial, municipal and residential customers. Our residential and commercial collection operations in some markets are based on long-term contracts with municipalities. We generally provide industrial and commercial collection services to individual customers under contracts with terms up to three years. Our revenue from landfill operations is from disposal or tipping fees charged to third parties. In general, we integrate our recycling operations with our collection operations and obtain revenue from the sale of recyclable materials. No one customer has individually accounted for more than 5% of our consolidated revenue in any of the periods presented.
The cost of our collection operations is primarily variable and includes disposal, labor, fuel and equipment maintenance costs. We seek operating efficiencies by controlling the movement of waste from the point of collection through disposal. During the nine months ended September 30, 2003 and 2002, approximately 54% and 53%, respectively, of the total volume of waste we collected was disposed of at our landfills.
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Our landfill cost of operations includes daily operating expenses, costs of capital for cell development, costs for final capping, closure and post-closure, and the legal and administrative costs of ongoing environmental compliance. We expense all indirect landfill development costs as they are incurred. We use life cycle accounting and the units-of-consumption method to recognize certain direct landfill costs related to cell development. In life cycle accounting, certain direct costs are capitalized, and charged to expense based upon the consumption of cubic yards of available airspace. These costs include all costs to acquire and construct a site. Obligations associated with final capping, closure and post-closure are capitalized, and amortized on a unit-of-consumption basis as airspace is consumed.
Cost and airspace estimates are developed annually by independent engineers together with our engineers. These estimates are used by our operating and accounting personnel to annually adjust our rates used to expense capitalized costs. Changes in these estimates primarily relate to changes in available airspace, inflation and applicable regulations. Changes in available airspace include changes due to the addition of airspace lying in expansion areas that we believe have a probable likelihood of being permitted.
Business Combinations
We make decisions to acquire or invest in businesses based on financial and strategic considerations. Businesses acquired are accounted for under the purchase method of accounting and are included in our Consolidated Financial Statements from the date of acquisition.
We acquired various solid waste businesses during the nine months ended September 30, 2003 and 2002. The aggregate purchase price we paid in these transactions was $30.2 million and $43.1 million in cash, respectively.
See Note 4, Business Combinations, of the Notes to our Unaudited Condensed Consolidated Financial Statements, for further discussion of business combinations.
Consolidated Results of Operations
Net income was $44.7 million for the three months ended September 30, 2003, or $.28 per share, as compared to $62.2 million, or $.38 per share, for the three months ended September 30, 2002. Net income was $121.9 million for the nine months ended September 30, 2003, or $.75 per share, as compared to $178.1 million, or $1.07 per share, for the nine months ended September 30, 2002. Net income for the nine months ended September 30, 2003 includes an after-tax expense of $37.8 million (net of an income tax benefit of $23.1 million), or $.23 per share, as a cumulative effect of a change in accounting principle resulting from the adoption of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations,” and a change in accounting principle for our methane gas collection systems. See Note 1, Basis of Presentation, of the Notes to our Unaudited Condensed Consolidated Financial Statements for further discussion of these changes in accounting principles.
The following table summarizes our costs and expenses in millions of dollars and as a percentage of our revenue for the three and nine months ended September 30, 2003 and 2002:
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Revenue was $648.0 million and $609.7 million for the three months ended September 30, 2003 and 2002, respectively, an increase of 6.3%. Revenue was $1,879.9 million and $1,759.8 million for the nine months ended September 30, 2003 and 2002, respectively, an increase of 6.8%. The following table reflects the components of our revenue growth for the three and nine months ended September 30, 2003 and 2002:
Price growth for the three and nine months ended September 30, 2003 includes approximately .2% of growth attributable to fuel surcharges that were levied against certain customers to offset rising fuel prices. Core volume growth for the nine months ended September 30, 2003 is primarily attributable to our residential collection business resulting from the addition of several new municipal contracts and our landfill and transfer station businesses resulting from newly opened sites and new contracts.
Cost of operations was $433.7 million and $1,200.7 million for the three and nine months ended September 30, 2003 versus $377.6 million and $1,091.1 million for the comparable 2002 periods. Cost of operations as a percentage of revenue was 66.9% and 63.8% for the three and nine months ended September 30, 2003 versus 61.9% and 62.0% for the comparable 2002 periods. The increase in aggregate dollars and as a percentage of revenue is primarily attributable to additional self-insurance expense. Self-insurance expense was $70.7 million and $145.6 million for the three and nine months ended September 30, 2003 versus $41.9 million and $102.3 million for the comparable 2002 periods. This increase in self-insurance expense relates to existing claims and is attributable to the expansion of our operations and various changes in estimates as a result of continued negative trends through our current policy year, based on recent actual claims experience, expected claims development and medical cost inflation. The increase in cost of operations as a percentage of revenue is also due to increased fuel prices, an increase in waste taxes levied on landfill volumes in certain states, an increase in revenue generated by lines of business that produce lower operating margins and an increase in costs associated with the long-haul transport of waste by third-party vendors. These increases in costs were partially offset by the elimination of closure and post-closure expense as a component of cost of operations in accordance with SFAS 143 and the termination of our operating lease facility.
Expenses for depreciation, amortization and depletion of property and equipment were $60.2 million and $173.9 million for the three and nine months ended September 30, 2003 versus $52.1 million and $142.3 million for the comparable 2002 periods. Expenses for depreciation, amortization and depletion of property and equipment as a percentage of revenue were 9.3% for the three and nine months ended September 30,
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2003 versus 8.6% and 8.1% for the comparable 2002 periods. The increase in such expenses in aggregate dollars and as a percentage of revenue versus the comparable periods last year is primarily due to an increase in landfill amortization associated with the adoption of SFAS 143 and, to a lesser extent, due to increased depreciation expense resulting from capital expenditures, acquisitions and the purchase of equipment originally placed into service pursuant to an operating lease.
Expenses for amortization of intangible assets were $1.5 million and $4.0 million for the three and nine months ended September 30, 2003 versus $1.3 million and $4.9 million for the comparable 2002 periods. Amortization of intangible assets as a percentage of revenue was .2% for the three and nine months ended September 30, 2003 versus .2% and .3% for the comparable 2002 periods.
Accretion expense was $3.2 million and $9.4 million for the three and nine months ended September 30, 2003, or .5% as a percentage of revenue, versus $0 for the comparable periods last year. The increase in accretion expense is due to the adoption of SFAS 143.
Selling, general and administrative expenses were $62.1 million and $185.7 million for the three and nine months ended September 30, 2003 versus $60.5 million and $180.1 million for the comparable 2002 periods. Selling, general and administrative expenses as a percentage of revenue were 9.6% and 9.9% for the three and nine months ended September 30, 2003 versus 9.9% and 10.2% for the comparable 2002 periods. The increase in such expenses in aggregate dollars versus the comparable periods last year is primarily the result of the expansion of our operations through internal growth and acquisitions. The decrease in such expenses as a percentage of revenue is primarily due to leveraging our existing overhead structure over an expanding revenue base.
Interest Expense
Interest expense relates primarily to borrowings under our unsecured notes and tax-exempt bonds. Interest expense was $18.6 million and $58.8 million for the three and nine months ended September 30, 2003 versus $19.3 million and $57.7 million for the comparable 2002 periods. The decrease in interest expense for the three months ended September 30, 2003 versus the comparable 2002 period is primarily due to increased interest income from interest rate swaps partially offset by increased interest expense resulting from higher average outstanding debt balances.
Capitalized interest was $1.1 million and $2.1 million for the three and nine months ended September 30, 2003 versus $.8 million and $1.8 million for the comparable 2002 periods.
Interest and Other Income (Expense), Net
Interest and other income, net of other expense, was $3.3 million and $10.1 million for the three and nine months ended September 30, 2003 versus $1.5 million and $3.6 million for the comparable 2002 periods. The increase in aggregate dollars versus the comparable periods last year is primarily due to increased interest income on higher average outstanding cash and restricted cash balances.
Income Taxes
The provision for income taxes was $27.3 million and $97.8 million for the three and nine months ended September 30, 2003 versus $38.2 million and $109.2 million for the comparable 2002 periods. In addition, on January 1, 2003, we recorded a $23.1 million income tax benefit associated with our changes in accounting principles. The effective income tax rate was 38.0% for the three and nine months ended September 30, 2003 and 2002. Income taxes have been provided based upon our anticipated annual effective tax rate.
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Landfill and Environmental Matters
Available Airspace
The following table reflects landfill airspace activity for landfills owned or operated by us for the nine months ended September 30, 2003:
As of September 30, 2003, we owned or operated 57 solid waste landfills with total available disposal capacity estimated to be 1.8 billion in-place cubic yards. Total available disposal capacity represents the sum of estimated permitted airspace plus an estimate of probable expansion airspace. These estimates are developed annually by independent engineers together with our engineers utilizing information provided by annual aerial surveys. As of September 30, 2003, total available disposal capacity is estimated to be 1.5 billion in-place cubic yards of permitted airspace plus .3 billion in-place cubic yards of probable expansion airspace. Before airspace included in an expansion area is determined to be probable expansion airspace and, therefore, included in our calculation of total available disposal capacity, it must meet our expansion criteria. See Note 2, Landfill, Environmental and Legal Costs, of the Notes to our Unaudited Condensed Consolidated Financial Statements for further information. During the nine months ended September 30, 2003, we were granted permits at five of our landfills that had probable expansion airspace in their total available disposal capacity. These five permits increased our permitted airspace by 154.6 million cubic yards.
As of September 30, 2003, fifteen of our landfills meet the criteria for including expansion airspace in their total available disposal capacity. At projected annual volumes, these fifteen landfills have an estimated remaining average site life of 31 years, including the expansion airspace. The average estimated remaining life of all of our landfills is 30 years.
As of September 30, 2003, four of our landfills that meet the criteria for including expansion airspace had obtained approval from local authorities and are proceeding into the state permitting process. Also, as of September 30, 2003, six of our fifteen landfills that meet the criteria for including expansion airspace had submitted permit applications to state authorities. The remaining five landfills that meet the criteria for including expansion airspace are in the process of obtaining approval from local authorities and have not identified any fatal flaws or impediments associated with the expansions at either the local or state level.
During the three months ended March 31, 2003, we adopted Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations.” This statement required us to change the methodology we used to record final capping, closure and post-closure costs. See Note 2, Landfill, Environmental and Legal Costs, of the Notes to our Unaudited Condensed Consolidated Financial Statements for further information.
As of September 30, 2003, accrued final capping, closure and post-closure costs were $200.3 million. The current portion of these costs of $16.1 million is reflected in our Unaudited Condensed Consolidated Balance
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Sheets in other current liabilities. The long-term portion of these costs of $184.2 million is reflected in our Unaudited Condensed Consolidated Balance Sheets in accrued landfill, environmental and legal costs.
Investment in Landfills
The following table reflects changes in our investments in landfills for the nine months ended September 30, 2003 and the future expected investment as of September 30, 2003 (in millions):
The following table reflects our net investment in our landfills, excluding non-depletable land, our depletion, amortization and accretion expense, and our closure and post-closure expense for the nine months ended September 30, 2003 and 2002. It also shows on a pro forma basis what our depletion, amortization and accretion expense would have been if SFAS 143 and the change in accounting principle relating to our methane gas collection systems were effective in 2002:
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During the nine months ended September 30, 2003, our weighted average compaction rate was approximately 1,500 pounds per cubic yard.
As of September 30, 2003, we expect to spend an estimated additional $1.6 billion on existing landfills, primarily related to cell construction, over their expected remaining lives. Our total expected gross investment, excluding non-depletable land, estimated to be $2.3 billion, or $1.29 per cubic yard, is used in determining our depletion and amortization expense based upon airspace consumed using the units-of-consumption method.
We accrue costs related to environmental remediation activities through a charge to income in the period such liabilities become probable and can be reasonably estimated. We also accrue costs related to environmental remediation activities associated with properties acquired through business combinations as a charge to goodwill or landfill purchase price allocated to airspace, as appropriate. No material amounts were charged to expense during the nine months ended September 30, 2003 and 2002, respectively.
Financial Condition
At September 30, 2003, we had $219.5 million of restricted cash deposits and $141.7 million of restricted marketable securities held as financial guarantees, including $135.8 million of restricted cash held for capital expenditures under certain debt facilities, and $37.7 million and $141.7 million of restricted cash and restricted marketable securities, respectively, pledged to various regulatory agencies and governmental entities as financial guarantees of our performance related to final capping, closure and post-closure obligations at our landfills. Restricted marketable securities consist of mutual funds invested in short-term investment grade securities, including mortgage-backed securities and U.S. Government obligations. These securities are available for sale and, as a result, are stated at fair value based upon quoted market prices. Unrealized gains and losses, net of tax, are recorded as a component of accumulated other comprehensive income. We intend to liquidate a portion of these marketable securities and use the proceeds to repay the $225.0 million of public notes, which mature in May 2004. We also intend to use letters of credit to replace the financial guarantees secured by marketable securities to be liquidated.
In July 1998, we entered into a $1.0 billion unsecured revolving credit facility with a group of banks. $500.0 million of the credit facility was scheduled to expire in July 2002 and the remaining $500.0 million was scheduled to expire in July 2004. As a result of our strong financial position and liquidity, in February 2002, we reduced the short- and long-term portions of our credit facility to $300.0 million and $450.0 million, respectively. In July 2002, we renewed the long- and short-term portions of our credit facility, respectively, on substantially the same terms and conditions with the long-term portion expiring in 2007 and the short-term portion expiring in 2003. The short-term portion of the facility was renewed again in July 2003 and expires in July 2004. Borrowings under the credit facility bear interest at LIBOR-based rates. We
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use our operating cash flow and proceeds from our credit facilities to finance our working capital, capital expenditures, acquisitions, share repurchases, dividends and other requirements. As of September 30, 2003, we had $389.8 million available under the credit facility.
In May 1999, we sold $600.0 million of unsecured notes in the public market. $225.0 million of these notes bear interest at 6 5/8% per annum and mature in 2004. The remaining $375.0 million bear interest at 7 1/8% per annum and mature in 2009. Interest on these notes is payable semi-annually in May and November. The $225.0 million and $375.0 million in notes were offered at a discount of $1.0 million and $.5 million, respectively. Proceeds from the notes were used to repay our revolving credit facility.
In December 1999, we entered into an operating lease facility established to finance the acquisition of operating equipment. In July 2002, we exercised our right to purchase the equipment underlying this facility by paying $72.6 million, which was the balance outstanding under the facility at that time.
In August 2001, we sold $450.0 million of unsecured notes in the public market. The notes bear interest at 6 3/4% and mature in 2011. Interest on these notes is payable semi-annually in February and August. The notes were offered at a discount of $2.6 million. Proceeds from the notes were used to repay our revolving credit facility.
At September 30, 2003, we had $433.5 million of tax-exempt bonds and other tax-exempt financing outstanding at favorable interest rates.
In order to manage risk associated with fluctuations in interest rates and to take advantage of favorable floating interest rates, we have entered into interest rate swap agreements with investment grade rated financial institutions. The swap agreements have total notional values of $225.0 million and $105.0 million, respectively, and require our company to pay interest at floating rates based upon changes in LIBOR and receive interest at fixed rates of 6 5/8% and 6 3/4%, respectively. The swap agreements terminate in May 2004 and August 2011, respectively.
We intend to repay the $225.0 million of public notes that mature in May 2004 using proceeds from the liquidation of our restricted marketable securities, our excess cash, proceeds from our revolving credit facility, or a combination thereof. We believe that any of these actions, or combination thereof, would provide us with sufficient financial resources to meet our anticipated capital requirements and obligations as they come due. We believe that we would be able to raise additional debt or equity financing, if necessary, to fund special corporate needs or to complete acquisitions. However, we cannot assure you that we would be able to obtain additional financing under favorable terms.
Selected Balance Sheet Accounts
The following table reflects the activity in our allowance for doubtful accounts, final capping, closure, post-closure and remediation liabilities, accrued self-insurance and amounts due to former owners during the nine months ended September 30, 2003 (in millions):
Our expense related to doubtful accounts as a percentage of revenue for the nine months ended September 30, 2003 was .4%. As of September 30, 2003, accounts receivable were $266.3 million, net of
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allowance for doubtful accounts of $19.5 million, resulting in days sales outstanding of 37, or 25 days net of deferred revenue.
Property and Equipment
The following tables reflect the activity in our property and equipment accounts for the nine months ended September 30, 2003 (in millions):
Liquidity and Capital Resources
The major components of changes in cash flows for the nine months ended September 30, 2003 and 2002 are discussed below.
Cash Flows From Operating Activities. Cash provided by operating activities was $432.4 million and $413.2 million for the nine months ended September 30, 2003 and 2002, respectively. The changes in cash provided by operating activities during the periods are due to expansion of our business, the timing of payments received for accounts receivable, and the timing of payments for accounts payable and income taxes. We use cash flows from operations to fund capital expenditures, acquisitions, share repurchases, dividends and debt repayments.
Cash Flows Used In Investing Activities. Cash used in investing activities was $394.1 million and $180.4 million for the nine months ended September 30, 2003 and 2002, respectively, and consists primarily of cash used for capital additions and business acquisitions in 2003 and 2002 and amounts transferred from unrestricted cash to restricted cash and marketable securities during 2003 for financial guarantees. Capital additions were $180.8 million and $162.3 million for the nine months ended September 30, 2003 and 2002, respectively. Cash used to acquire businesses, net of cash acquired, was $30.2 million and $43.1 million during the nine months ended September 30, 2003 and 2002, respectively.
We intend to finance capital expenditures and acquisitions through cash, restricted cash held for capital expenditures, cash flow from operations, our revolving credit facility, additional tax-exempt bond offerings and other financings. We expect to use primarily cash for future business acquisitions.
Cash Flows Used In Financing Activities. Cash used in financing activities for the nine months ended September 30, 2003 and 2002 was $55.1 million and $186.0 million, respectively.
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During 2000, 2001, 2002 and 2003, our board of directors authorized the repurchase of up to $150.0 million, $125.0 million, $175.0 million and $225.0 million, respectively, of our common stock. As of September 30, 2003, we repurchased a total of 23.6 million shares of our stock for $435.6 million of which 6.4 million shares were acquired during the nine months ended September 30, 2003 for $135.5 million. We intend to finance future stock repurchases through cash on hand, cash flow from operations, our revolving credit facility and other financings.
In July 2003, our board of directors initiated a quarterly dividend program. On July 29, 2003, a $.06 per share cash dividend was declared to shareholders of record on September 30, 2003. The dividend was paid on October 15, 2003. In October 2003, our board of directors declared a quarterly dividend of $.06 per share for shareholders of record on January 2, 2004. We intend to finance future dividends through cash on hand, cash flow from operations, our revolving credit facility and other financings.
We used proceeds from bank facilities and tax-exempt bonds to fund capital additions and acquisitions and to repay debt.
We have investment grade ratings from the three major credit rating agencies. During the three months ended June 30, 2003, Moody’s and Standard & Poor’s upgraded our credit ratings. As of September 30, 2003, our senior debt was rated Baa2 by Moody’s, BBB+ by Standard & Poor’s and BBB+ by Fitch.
Free Cash Flow
We define free cash flow, which is not a measure determined in accordance with generally accepted accounting standards, as cash provided by operating activities less purchases of property and equipment plus proceeds from the sale of property and equipment as presented in our consolidated statement of cash flows. Our free cash flow for the three and nine months ended September 30, 2003 is calculated as follows (in millions):
We believe that the presentation of free cash flow, which is a non-GAAP financial measure, provides useful information regarding our recurring cash provided by operating activities after expenditures for property and equipment, net of proceeds from the sale of equipment. It also demonstrates our ability to execute our financial strategy which includes reinvesting in existing capital assets to ensure a high level of customer service, investing in capital assets to facilitate growth in our customer base and services provided, pursuing strategic acquisitions that augment our existing business platform, repurchasing shares of common stock at prices that provide value to our shareholders, paying cash dividends, maintaining our investment grade rating and minimizing debt. In addition, free cash flow is a key metric used to determine compensation. Free cash flow does not represent our cash flow available for discretionary expenditures because it excludes certain expenditures that are required or that we have committed to such as debt service requirements and dividend payments. Our definition of free cash flow may not be comparable to similarly titled measures presented by other companies.
Seasonality
Our operations can be adversely affected by periods of inclement weather which could delay the collection and disposal of waste, reduce the volume of waste generated, or delay the construction or expansion of our landfill sites and other facilities.
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Disclosure Regarding Forward Looking Statements
Certain statements and information included herein constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from any future results, performance, or achievements expressed or implied, in or by such forward-looking statements. Such factors include, among other things, whether the Company’s estimates and assumptions concerning its selected balance sheet accounts, final capping, closure, post-closure and remediation costs, available airspace, and projected costs and expenses related to the Company’s landfills and property and equipment, and labor, fuel rates and economic and inflationary trends, turn out to be correct or appropriate, and various factors that will impact the actual business and financial performance of the Company such as competition and demand for services in the solid waste industry; the Company’s ability to manage growth; compliance with, and future changes in, environmental regulations; the Company’s ability to obtain approval from regulatory agencies in connection with expansions at the Company’s landfills; the ability to obtain financing on acceptable terms to finance the Company’s operations and growth strategy and for the Company to operate within the limitations imposed by financing arrangements; the ability of the Company to repurchase common stock at prices that are accretive to earnings per share; the Company’s dependence on key personnel; general economic and market conditions including, but not limited to, inflation and changes in commodity pricing, fuel, labor, risk and health insurance, and other variable costs that are generally not within the control of the Company; dependence on large, long-term collection contracts; dependence on acquisitions for growth; risks associated with undisclosed liabilities of acquired businesses; risks associated with pending legal proceedings; and other factors contained in the Company’s filings with the Securities and Exchange Commission.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our market sensitive financial instruments consist primarily of variable rate debt and interest rate swaps. Therefore, our major market risk exposure is changing interest rates in the United States and fluctuations in LIBOR. We manage interest rate risk through a combination of fixed and floating rate debt as well as interest rate swap agreements.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report in accumulating and communicating to our management, including our Chief Executive Officer and Chief Financial Officer, material information required to be included in the reports we file or submit under the Securities Exchange Act of 1934 as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
Based on an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, there has been no change in our internal control over financial reporting during our last fiscal quarter, identified in connection with that evaluation, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
(b) Reports on Form 8-K:
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant, Republic Services, Inc., has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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