SECURITIES AND EXCHANGE COMMISSION
Form 10-Q
Commission file number 1-12154
Waste Management, Inc.
1001 Fannin
(713) 512-6200
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 þ No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934.) Yes þ No o
The number of shares of Common Stock, $0.01 par value, of the registrant outstanding at April 26, 2004 was 580,529,906 (excluding treasury shares of 49,752,555).
TABLE OF CONTENTS
PART I.
WASTE MANAGEMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
See notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
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CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
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The condensed financial statements presented herein represent the consolidation of Waste Management, Inc., a Delaware corporation, its majority-owned subsidiaries and entities required to be consolidated pursuant to the Financial Accounting Standards Board (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities(“FIN 46”) (See Note 9). Waste Management, Inc. is a holding company that conducts all of its operations through its subsidiaries. When the terms “the Company,” “we,” “us” or “our” are used in this document, those terms refer to Waste Management, Inc. and all of its consolidated subsidiaries. When we use the term “WMI,” we are referring only to the parent holding company, and are not including any of the subsidiaries.
The condensed consolidated financial statements as of and for the three months ended March 31, 2004 are unaudited. In the opinion of management, these financial statements include all adjustments, which, except as described elsewhere herein, are of a normal recurring nature, necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. The results for interim periods are not necessarily indicative of results for the entire year. The financial statements presented herein should be read in connection with the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003.
In preparing our financial statements, we make several estimates and assumptions that affect the accounting for and recognition of assets, liabilities, stockholders’ equity, revenues and expenses. We must make these estimates and assumptions because certain of the information that we use is dependent on future events, cannot be calculated with a high degree of precision from data available or simply cannot be readily calculated based on generally accepted methodologies. In some cases, these estimates are particularly difficult to determine and we must exercise significant judgment. Actual results could differ materially from the estimates and assumptions that we use in the preparation of our financial statements.
Accounting change —The FASB’s December 2003 revision to FIN 46 deferred until March 31, 2004 our application of the Interpretation to non-special purpose type variable interest entities created on or before January 31, 2003. Our application of FIN 46 to this type of entity resulted in the consolidation of certain trusts established to support the performance of closure, post-closure and environmental remediation activities. On March 31, 2004, we recorded an increase in our net assets and a credit to cumulative effect of changes in accounting principles of approximately $8 million, net of taxes, to consolidate these variable interest entities. The consolidation of these trusts has not had, nor is it expected to have, a material effect on our financial position, results of operations or cash flows. The impact of our implementation of FIN 46 is discussed further in Note 9.
Reclassifications —As a result of internal review processes, we identified certain mandatory fees and taxes that have historically been treated as pass through costs that actually represent direct obligations of the Company. Effective January 1, 2004, we began recording all mandatory fees and taxes that create direct obligations for us as operating expenses and recording revenue when the fees and taxes are billed to our customers. We have conformed the prior year’s presentation of our revenues and expenses with the current year’s presentation by increasing both our revenue and our operating expenses for the quarter ended March 31, 2003 by approximately $16 million.
Certain reclassifications have also been made in the 2003 consolidated statement of cash flows in order to conform to the current period presentation.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
We have material financial commitments for final capping, closure and post-closure obligations with respect to our landfills. The activities for which these asset retirement obligations were established include the following:
We develop our estimates of these obligations using input from our operations personnel, engineers and accountants. Our estimates are based on our interpretation of legal and regulatory requirements and are intended to approximate fair value under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 143,Accounting for Asset Retirement Obligations. An estimate of fair value under SFAS No. 143 should include the premium that a third party would receive for bearing the uncertainty in cash outflows. However, when using discounted cash flow techniques, reliable estimates of market premiums are not available because there is no market for selling the responsibility for final capping, closure and post-closure obligations independent of selling the landfill in its entirety. Accordingly, we do not believe that it is possible to develop a methodology to estimate reliably a market risk premium and therefore no market risk premium is included in our determination of expected cash outflows for landfill asset retirement obligations. The specific methods used to calculate the fair value for final capping, closure and post-closure and the method of accruing for these balances are explained in detail in our Annual Report on Form 10-K for the year ended December 31, 2003.
We inflate estimated final capping, closure and post-closure costs to the expected time of payment using an inflation rate of 2.5% and discount those expected future costs back to present value using a credit-adjusted, risk-free discount rate, which was 6.25% for liabilities incurred in 2004. Our credit-adjusted, risk-free discount rate is based on the risk-free interest rate on obligations of similar maturity adjusted for our own credit rating. Changes in our credit-adjusted, risk-free discount rate do not change recorded liabilities, but subsequently recognized obligations are measured using the revised credit-adjusted, risk-free discount rate. We determine the inflation rate and our credit-adjusted, risk-free discount rate on an annual basis unless interim changes would significantly impact our results of operations.
We routinely review and evaluate sites that require remediation and determine our estimated cost for the likely remedy based on several estimates and assumptions. These estimates are sometimes a range of “reasonably possible” outcomes. “Reasonably possible” outcomes are those outcomes that are considered
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more than remote and less than likely. In cases where our estimates are a range, we use the amount within the range that constitutes our best estimate. If no amount within the range appears to be a better estimate than any other, we use the low end of each range in accordance with SFAS No. 5 and its interpretations. If we used the high ends of such ranges, our aggregate potential liability would be approximately $175 million higher on a discounted basis than the estimate recorded in our condensed consolidated financial statements as of March 31, 2004.
As of March 31, 2004, we had been notified that we are a potentially responsible party in connection with 71 locations listed on the NPL, which is the EPA’s National Priorities List. Through various acquisitions, we own 16 of these sites that were initially developed by others. We are working with the government to characterize or remediate identified site problems and have either agreed with other parties on an arrangement for sharing the costs of remediation or are pursuing resolution of an allocation formula. We generally expect to receive any amounts due from these parties at, or near, the time that we make environmental remediation expenditures. Claims have been made against us at another 55 sites we do not own where we have been an operator, transporter or generator of waste. These claims are at different procedural stages under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, which is also known as Superfund. At some of these sites, our liability is well defined as a consequence of a governmental decision and an agreement among the parties involved as to the allocation of costs. At others where no remedy has been selected or the liable parties have been unable to agree on an appropriate allocation, our future costs are uncertain. Any of these matters could have a material adverse effect on our condensed consolidated financial statements.
Where we believe that both the amount of a particular environmental remediation liability and the timing of the payments are reliably determinable, we inflate the cost in current dollars until the expected time of payment using an inflation rate of 2.5% and discount the cost to present value using a risk-free discount rate with a term approximating the weighted average period until settlement of the underlying obligation, or 4.25%. We determine the inflation rate and the risk-free discount rate, which is based on the rates for United States Treasury bonds with similar maturities, on an annual basis unless interim changes would significantly impact our results of operations.
Liabilities for landfill and environmental remediation costs are presented in the table below (in millions):
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The changes to landfill and environmental remediation liabilities for the three months ended March 31, 2004 and 2003 are reflected in the tables below (in millions):
At several of our landfills, we provide financial assurance by depositing cash into escrow accounts or trust funds that are legally restricted for purposes of settling closure, post-closure and environmental remediation obligations. The fair value of these escrow accounts and trust funds was approximately $210 million at March 31, 2004, and is primarily included as other long-term assets in our condensed consolidated balance sheet. Balances maintained in these trust funds and escrow accounts will fluctuate based on (i) changes in statutory requirements; (ii) the ongoing use of funds for qualifying closure, post-closure and environmental remediation activities; (iii) acquisitions or divestitures of landfills; and (iv) changes in the fair value of the underlying financial instruments.
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Debt consisted of the following (in millions):
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As of March 31, 2004, we had a three-year, $650 million syndicated revolving credit facility and a five-year, $1.75 billion syndicated revolving credit facility. The three-year revolver matures in June 2005 and the five-year revolver matures in June 2006. At March 31, 2004, no borrowings were outstanding under our revolving credit facilities, and we had unused and available credit capacity under the facilities of $725 million.
As part of our operations, and in connection with issuances of tax-exempt bonds, we use letters of credit to support our bonding and financial assurance needs. The following table summarizes our outstanding letters of credit (in millions):
Our letters of credit generally have terms allowing for automatic renewal after one year. In the event of an unreimbursed draw on a letter of credit, the unreimbursed amount generally converts into a term loan for the remaining term under the respective agreement or facility. Through March 31, 2004, we had not experienced any unreimbursed draws on letters of credit.
Our debt balances are generally unsecured, except for approximately $474 million of the tax-exempt project bonds outstanding at March 31, 2004 that are issued by certain of our subsidiaries within our Wheelabrator Group and secured by the related subsidiaries’ assets, with a carrying value of approximately $670 million, and by the related subsidiaries’ future revenue. Additionally, our consolidated variable interest entities have approximately $171 million of outstanding borrowings that are collateralized by assets of those entities. These assets have a carrying value of approximately $398 million as of March 31, 2004.
We manage the interest rate risk of our debt portfolio principally by using interest rate derivatives to achieve a desired position of fixed and floating rate debt, which was approximately 64% fixed and 36% floating
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at March 31, 2004. Interest rate swap agreements outstanding as of December 31, 2003 and March 31, 2004 are set forth in the table below (dollars in millions):
Fair value hedge accounting for interest rate swap contracts increased the carrying value of debt instruments by approximately $219 million as of March 31, 2004 and $168 million as of December 31, 2003. The following table summarizes the accumulated fair value adjustments from interest rate swap agreements by underlying debt instrument category (in millions):
Interest rate swap agreements reduced net interest expense by $24 million for both the three months ended March 31, 2004 and 2003. The significant terms of the interest rate contracts and the underlying debt instruments are identical and therefore no ineffectiveness has been realized.
We have entered into cash flow hedges to secure the underlying interest rates in anticipation of various senior note issuances. Upon issuing the related senior notes, the hedge agreements were terminated resulting in a deferred loss, net of taxes, of approximately $38 million at March 31, 2004, which is included in accumulated other comprehensive loss. Of this amount, $6 million (on a pre-tax basis) is scheduled to be reclassified into interest expense over the next twelve months.
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The current tax obligations associated with the provision for income taxes recorded in the statements of operations are reflected in the accompanying condensed consolidated balance sheets as a component of accrued liabilities, and the deferred tax obligations are reflected in deferred income taxes. The difference in federal income taxes computed at the federal statutory rate and reported income taxes for the three months ended March 31, 2004 is primarily due to the favorable impact of non-conventional fuel tax credits and a favorable audit settlement, offset in part by state and local income taxes. The difference in federal income taxes computed at the federal statutory rate and reported income taxes for the three months ended March 31, 2003 is primarily due to state and local income taxes, offset in part by non-conventional fuel tax credits. We continue to evaluate our effective tax rate at each interim period and adjust it accordingly as facts and circumstances warrant.
In January 2004, we acquired a minority ownership interest in a coal-based synthetic fuel production facility (the “Facility”) in exchange for consideration of $83.3 million, which is primarily comprised of a note payable for $82.5 million, as well as a commitment to fund our pro-rata share of the operations of the Facility. We have also agreed to make additional payments to the seller based on our pro-rata allocation of the tax credits generated by the Facility. The synthetic fuel produced at the Facility through 2007 qualifies for tax credits pursuant to Section 29 of the Internal Revenue Code (currently credits are not available for fuel produced after 2007).
We have been granted a private letter ruling from the U.S. Internal Revenue Service (“IRS”) confirming that the synthetic fuel produced by the Facility is a “qualified fuel” under Section 29 of the Internal Revenue Code and that the resulting tax credits may be allocated among the owners of the interests in the Facility.
We account for our investment in this entity using the equity method of accounting, which results in the recognition of our pro-rata share of the entity’s losses, the amortization of our initial investment and other estimated obligations being recorded as equity in losses of unconsolidated entities within our statement of operations. The total loss recognized during the three months ended March 31, 2004 was approximately $19 million. We also recognized approximately $2 million of interest expense related to this investment during the current period. The tax benefits that we will realize as a result of our investment in this entity have been reflected as a reduction to our provision for income taxes. This resulted in a decrease in our tax provision of approximately $19 million and a 5.2% reduction in our effective tax rate for the three months ended March 31, 2004, substantially offsetting the equity losses and interest expense realized during the period.
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Comprehensive income represents all changes in our equity except for changes resulting from investments by, and distributions to, stockholders. Comprehensive income for the three months ended March 31, 2004 and March 31, 2003 was as follows (in millions):
The components of accumulated other comprehensive loss were as follows:
The following reconciles the number of common shares outstanding at March 31 of each year to the weighted average number of common shares outstanding and the weighted average number of common and dilutive potential common shares outstanding for the purpose of calculating basic and diluted earnings per common share (shares in millions):
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We account for our stock-based compensation using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, as amended. Pursuant to APB Opinion No. 25, we do not recognize compensation cost for our stock options because the number of shares potentially issuable and the exercise price, which is equal to the fair market value of the underlying stock on the date of grant, are fixed.
The following schedule reflects the pro forma impact on net income and earnings per common share of accounting for our stock options using SFAS No. 123,Accounting for Stock-Based Compensation, which would result in the recognition of compensation expense for the fair value of stock options as computed using the Black-Scholes option-pricing model (in millions, except per share amounts):
In August 2003, we announced that the Board of Directors approved a quarterly dividend program. In January 2004, we declared our first quarter dividend of $0.1875 per share of common stock, which was paid on March 25, 2004 to stockholders of record as of March 1, 2004.
In February 2002 we announced that our Board of Directors had approved a stock repurchase program for up to $1 billion in annual repurchases each year through 2004, to be implemented at management’s discretion. We have repurchased over 60 million shares of our common stock at a cost of approximately $1.6 billion under this program. We have not repurchased any of our common stock in 2004, although we did make a payment of approximately $24 million in January 2004 to settle repurchases made in December 2003.
As of March 31, 2004, we have the ability, under our most restrictive financial covenants, to make dividend payments and share repurchases in the aggregate amount of approximately $595 million, plus 25% of future net income.
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Financial instruments — We have obtained letters of credit, performance bonds and insurance policies, and have established trust funds and issued financial guarantees to support tax-exempt bonds, contracts, performance of landfill closure and post-closure requirements, environmental remediation and other obligations. We obtain surety bonds and insurance policies from an affiliated entity that we have an investment in and account for under the equity method. We also use insurance policies issued by our wholly-owned insurance company, the sole business of which is to issue policies for the parent holding company and its other subsidiaries, to secure such performance obligations. In those instances where our use of captive insurance is not allowed, we generally have available alternative bonding mechanisms. Because virtually no claims have been made against these financial instruments in the past, and considering our current financial position, we do not expect that these instruments will have a material adverse effect on our consolidated financial statements. We have not experienced any unmanageable difficulty in obtaining the required financial assurance instruments for our current operations.
During 2003, we entered into three letter of credit and term loan agreements and a letter of credit facility to provide us with additional sources of letter of credit capacity. See Note 3 for information related to the letter of credit capacity provided by these agreements. Additionally in 2003, we guaranteed the debt of a newly-formed surety company in order to assist in the establishment of that entity. In an ongoing effort to mitigate risks of future cost increases and reductions in available capacity, we continue to evaluate various options to access cost-effective sources of financial assurance.
Insurance —For the 14 months ended January 1, 2000, we insured certain risks, including auto, general liability and workers’ compensation, with Reliance National Insurance Company, whose parent filed for bankruptcy in June 2001. In October 2001, the parent and certain of its subsidiaries, including Reliance National Insurance Company, were placed in liquidation. We believe that because of various state insurance guarantee funds and potential recoveries from the liquidation, it is unlikely that events relating to Reliance will have a material adverse impact on our financial statements.
Guarantees —We have entered into the following guarantee agreements associated with our operations.
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We currently believe that it is not reasonably likely that we will be required to perform under these guarantee agreements or that any performance requirement would have a material impact on our consolidated financial statements.
Environmental matters — Our business is intrinsically connected with the protection of the environment. As such, a significant portion of our operating costs and capital expenditures could be characterized as costs of environmental protection. Such costs may increase in the future as a result of legislation or regulation. However, we believe that we generally tend to benefit when environmental regulation increases, because such regulations increase the demand for our services, and we have the resources and experience to manage environmental risk. For more information regarding environmental matters, see Note 2.
Litigation —In December 1999, an individual brought an action against the Company, five former officers of WM Holdings, and WM Holdings’ former independent auditor, Arthur Andersen LLP, in Illinois state court on behalf of a proposed class of individuals who purchased WM Holdings common stock before November 3, 1994, and who held that stock through February 24, 1998. The action is for alleged acts of common law fraud, negligence and breach of fiduciary duty. In May 2001, the court granted in part and denied in part the defendants’ motion to dismiss and in August 2003 denied defendants’ motion for summary judgment. The extent of possible damages, if any, in this action cannot yet be determined.
In April 2002, a former participant in WM Holdings’ ERISA plans and another individual filed a lawsuit in Washington, D.C. against us and others, attempting to increase the recovery of a class of ERISA plan
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participants based on allegations related to both the events alleged in, and the settlements relating to, the class action against WM Holdings that was settled in 1998 and the class action against us that was settled in November 2001 and paid in September 2003. Subsequently, the issues related to the latter class action have been dropped as to the Company, its officers and directors. Additionally, a single group of stockholders opted not to participate in the settlement of the class action lawsuit against us related to 1998 and 1999 activity and filed an individual lawsuit against us. The Company intends to defend itself vigorously in all of these proceedings.
Three groups of stockholders have filed separate lawsuits in state courts in Texas and federal court in Illinois against us and certain of our former officers. The lawsuit filed in Illinois was subsequently transferred to federal court in Texas. The petitions allege that the plaintiffs are substantial holders of the Company’s common stock who intended to sell their stock in 1999, or to otherwise protect themselves against loss, but that the public statements we made regarding our prospects, and in some instances statements made by the individual defendants, were false and misleading and induced the plaintiffs to retain their stock or not to take other measures. The plaintiffs assert that the value of their retained stock declined dramatically and that they incurred significant losses. The plaintiffs assert claims for fraud, negligent misrepresentation, and conspiracy. The first of these cases was dismissed by summary judgment by a Texas state court in March 2002. That dismissal was reversed in the first quarter of 2004 by an intermediate appellate court, and we are appealing that decision. The second case also filed in state court is stayed pending resolution of the first case, and we intend to continue to vigorously defend these claims. In March 2004, the court granted our motion to dismiss in the third case, which was pending in federal court, and the plaintiffs have appealed that dismissal.
From time to time, we pay fines or penalties in environmental proceedings relating primarily to waste treatment, storage or disposal facilities. As of March 31, 2004, there were nine proceedings involving our subsidiaries where the sanctions involved in each could potentially exceed $100,000. The matters involve allegations that subsidiaries (i) operated a waste-to-energy facility that, as a result of intermittent and isolated equipment malfunctions, exceeded emission limits and failed to meet monitoring requirements, (ii) are responsible for remediation of landfill gas and chemical compounds required pursuant to a Unilateral Administrative Order associated with an NPL site, (iii) are responsible for late performance of work required under a Unilateral Administrative Order, (iv) improperly operated a solid waste landfill and caused excess odors, (v) improperly operated a solid waste landfill by failing to maintain required records, properly place and cover waste and adhere to proper leachate levels, (vi) did not comply with air regulations requiring control of emissions at a closed landfill, (vii) improperly operated a solid waste landfill by failing to maintain required leachate levels and erosion control and failing to properly operate and monitor gas wells and adequately control odors and stormwater, (viii) failed to comply with an operating permit for a solid waste incineration unit by exceeding permit limits for capacity, temperature and waste charging rates and record keeping and notifications associated with those permit violations, and (ix) discharged wastewater from a cogeneration facility in noncompliance with waste discharge requirements issued pursuant to a state water code. We do not believe that the fines or other penalties in any of these matters will, individually or in the aggregate, have a material adverse effect on our financial condition or results of operations.
It is not always possible to predict the impact that lawsuits, proceedings, investigations and inquiries may have on us, nor is it possible to predict whether additional suits or claims may arise out of the matters described above in the future. We intend to defend ourselves vigorously in all the above matters. However, it is possible that the outcome of any of the matters described, or others, may ultimately have a material adverse impact on our financial condition or results of operations in one or more future periods.
We are also currently involved in other routine civil litigation and governmental proceedings relating to the conduct of our business. We do not believe that any of these routine matters will have a material adverse impact on our consolidated financial statements.
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Tax matters —We are currently under audit by the IRS and from time to time are audited by other taxing authorities. We fully cooperate with all audits, but defend our positions vigorously. Our audits are in various stages of completion. Specifically, we are in the process of concluding the appeals phase of IRS audits for the years 1989 to 1996. The audits for these years should be completed within the next 15 months. In addition, we are in the examination phase of an IRS audit for the years 1997 to 2000. This audit should also be completed within the next 15 months. To provide for potential tax exposures, we maintain an allowance for tax contingencies, the balance of which management believes is adequate. Results of audit assessments by taxing authorities could have a material effect on our quarterly or annual cash flows over the next 15 months as these audits are completed. However, we do not believe that any of these matters will have a material adverse impact on our results of operations.
In January 2003, the FASB issued FIN 46, which requires variable interest entities to be consolidated by their primary beneficiaries. A primary beneficiary is the party that absorbs a majority of the entity’s expected losses or receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. In December 2003, the FASB revised FIN 46 to clarify key terms, additional exemptions for application and an extended initial application period.
As it applies to us, the effective dates for FIN 46 are as follows:
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We manage and evaluate our operations primarily through our Eastern, Midwest, Southern, Western, Canadian, Wheelabrator and Recycling Groups. These seven operating Groups are presented below as our reportable segments. These reportable segments, when combined with certain other operations not managed through the seven operating Groups, comprise our North American Solid Waste, or NASW, operations. NASW, our core business, provides integrated waste management services consisting of collection, disposal (solid waste and hazardous waste landfills), transfer, waste-to-energy facilities and independent power production plants that are managed by Wheelabrator, recycling and other miscellaneous services to commercial, industrial, municipal and residential customers throughout the United States, Puerto Rico and Canada. The operations not managed through our seven operating Groups are presented herein as “Other NASW.”
Summarized financial information concerning our reportable segments for the three months ended March 31 is shown in the following table (in millions). For comparability purposes, prior period information has been restated to conform to the current year presentation.
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The table below shows the total revenues contributed by our principal lines of business (in millions):
WM Holdings has fully and unconditionally guaranteed WMI’s senior indebtedness. WMI has fully and unconditionally guaranteed all of WM Holdings’ senior indebtedness and its 5.75% convertible subordinated notes due 2005. None of WMI’s other subsidiaries have guaranteed any of WMI’s or WM Holdings’ debt. As a result of these guarantee arrangements, we are required to present the following condensed consolidating financial information (in millions).
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CONDENSED CONSOLIDATING BALANCE SHEETS
March 31, 2004
December 31, 2003
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CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2004
Three Months Ended March 31, 2003
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CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
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When we make statements containing projections about our accounting and finances, plans and objectives for the future, future economic performance or when we make statements containing any other projections or estimates about our assumptions relating to these types of statements, we are making forward-looking statements. These statements usually relate to future events and anticipated revenues, earnings, cash flows or other aspects of our operations or operating results. We make these statements in an effort to keep stockholders and the public informed about our business, and have based them on our current expectations about future events. You should view such statements with caution. These statements are not guarantees of future performance or events. All phases of our business are subject to uncertainties, risks and other influences, many of which we have no control over. Any of these factors, either alone or taken together, could have a material adverse effect on us and could change whether any forward-looking statement ultimately turns out to be true. Additionally, we assume no obligation to update any forward-looking statement as a result of future events or developments. The following discussion should be read together with the condensed consolidated financial statements and the notes to the condensed consolidated financial statements.
Some of the risks that we face and that could affect our business and financial statements for the remainder of 2004 and beyond include:
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These are not the only risks that we face. There may be additional risks that we do not presently know of or that we currently believe are immaterial which could also impair our business and financial position.
General
Our principal executive offices are located at 1001 Fannin Street, Suite 4000, Houston, Texas 77002. Our telephone number at that address is (713) 512-6200. Our website address is http://www.wm.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K are all available, free of charge, on our website as soon as practicable after we file the reports with the SEC. Our stock is traded on the New York Stock Exchange under the symbol “WMI.”
We are the leading provider of integrated waste services in North America. Through our subsidiaries we provide collection, transfer, recycling and resource recovery, and disposal services. We are also a leading developer, operator and owner of waste-to-energy facilities in the United States. Our customers include commercial, industrial, municipal and residential customers, other waste management companies, electric utilities and governmental entities.
The first quarter of 2004 was positive for the Company. Before cumulative effects of changes in accounting principles, net income for the quarter was $144 million, or $0.25 per diluted share, as compared to $107 million, or $0.18 per diluted share in the first quarter of 2003. The increase in net income was primarily due to progress we have made in growing our customer base and revenues, reducing certain of our costs and leveraging our infrastructure.
Revenues for the quarter were up 6.0%, from $2.73 billion in the first quarter 2003 to $2.90 billion in the current quarter. Half of the increase was due to average yield and volume increases, whereas most of the remainder was due to our acquisition program.
Our increase in revenue due to average yield increases came mostly from collection customers that have been with us for a year or longer. We were not able to sustain the same yield improvement throughout all of our lines of business mostly because we strategically lowered some prices to avoid losing customers to competitors and because of customer churn. Increases in commodity prices for recyclable materials was a significant component in our increased revenue, although much of that increase is rebated back to our suppliers, reducing the impact on income.
Revenue growth from volumes in the quarter was the strongest we have seen in the past few years. The increase in volumes as compared to last year’s quarter can be attributed primarily to the additional day in February 2004 and the harsh winter in the first quarter of 2003 that was not experienced in 2004, although the increases were partially offset by the loss of the Chicago Blue Bag contract in 2003. Although volumes in the current quarter were actually down slightly after considering these factors, we believe that the trends late in the quarter and early in the second quarter are positive, and therefore remain optimistic that the recent positive trends will continue. Additionally, volumes in certain lines of business have been very encouraging, such as in our roll-off business, where we have begun initiating price increases in many of our markets.
We have paid approximately $325 million, net, for acquisitions since the first quarter of 2003. The effect of these acquisitions was an approximately 2.6% increase in revenues in the first quarter of 2004 as compared to the prior year’s quarter. We will continue to focus on acquisitions that improve our collection route density and internalize waste volumes into our disposal facilities as they become available.
We continue our efforts to control costs. Our total operating expenses increased from the first quarter of last year, but as a percentage of revenue they remained constant between the first quarter of 2003 and the current quarter. Increased operating expenses in the first quarter of 2004 as compared to the first quarter of 2003 were generally due to increased volumes, including from acquisitions. Adversely affecting our effort to lower operating costs as a percentage of revenue were increased third-party transportation costs due to higher volumes, the redirection of waste to more distant landfills, primarily in the Eastern United States, and higher third party transportation rates, again primarily in the East. Additionally, while increased market prices for
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Finally, our free cash flow for the quarter was approximately $311 million. Our net cash provided by operating activities in the first quarter of 2004 was approximately $470 million. Free cash flow was calculated by subtracting from net cash provided by operating activities our capital expenditures of approximately $181 million and adding to that the proceeds from our divestitures, net of cash divested, and other sales of assets of approximately $22 million. We expect that our free cash flows will be lower in certain future quarters in 2004 due principally to higher capital expenditures. We are still projecting free cash flow for the year to be in line with the outlook we provided previously of $900 million to $1 billion, based on estimated projections of net cash provided by operating activities of over $2.1 billion, capital expenditures of $1.15 billion to $1.25 billion and proceeds from divestitures, net of cash divested, and other sales of assets of over $50 million for the year.
In preparing our financial statements, we make several estimates and assumptions that affect the accounting for and recognition of our assets and liabilities and revenues and expenses. We must make these estimates and assumptions because certain of the information that we use is dependent on future events, cannot be calculated with a high degree of precision from available data or is simply not capable of being readily calculated based on generally accepted methodologies. In some cases, these estimates are particularly difficult to determine and we must exercise significant judgment. The most difficult, subjective and complex estimates and the assumptions that deal with the greatest amount of uncertainty relate to our accounting for landfills, environmental remediation liabilities and asset impairments, as described in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2003.
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Results of Operations for the Three Months Ended March 31, 2004
The following table presents, for the periods indicated, the period to period change in dollars (in millions) and percentages for the respective consolidated statement of operations line items.
The following table presents, for the periods indicated, the percentage relationship that the respective consolidated statement of operations line items bear to operating revenues:
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Our operating revenues for the three months ended March 31, 2004, were $2.9 billion, compared with $2.7 billion in 2003. Shown below (in millions)is the contribution to revenues during each period provided by our seven operating Groups and our Other North American Solid Waste, or NASW, services.
Our operating revenues generally come from fees charged for our collection, landfill, transfer, Wheelabrator (waste-to-energy) and recycling services. The mix of operating revenues from our different services is reflected in the table below (in millions):
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The following table provides details associated with the period-to-period change in NASW revenues (dollars in millions) along with an explanation of the significant components of the current period changes:
Operating expenses are (i) labor and related benefits, which include salaries and wages, related payroll taxes, insurance and benefits costs and the costs associated with contract labor; (ii) disposal costs, which include tipping fees paid to third party disposal facilities and transfer stations; (iii) maintenance and repairs relating to both equipment and facilities; (iv) subcontractor costs, which include the costs of independent haulers who transport our waste to disposal facilities; (v) costs of goods sold, which are primarily the rebates paid to suppliers associated with recycling commodities; (vi) fuel costs, which represent the costs of fuel and oils to operate our truck fleet and landfill operating equipment; (vii) disposal and franchise fees and taxes, which include landfill taxes, host community fees and royalties; and (viii) other operating costs, which include equipment and facility rent, property taxes, insurance and claims costs, and landfill operating costs.
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The following table summarizes the major components of our operating expenses, including the impact of foreign currency translation, for the three months ended March 31, 2004 and 2003 (in millions):
Selling, general and administrative expenses are (i) labor costs, which include salaries, related insurance and benefits, contract labor, and payroll taxes; (ii) professional fees, which include fees for consulting, legal, audit, and tax services; (iii) provision for bad debts, which includes allowances for uncollectible customer accounts and collection fees; and (iv) other general and administrative expenses, which include voice and data telecommunications, advertising, travel and entertainment, rentals, postage, and printing.
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The following table summarizes the major components of our selling, general and administrative costs for the three months ended March 31, 2004 and 2003 (in millions):
The following table summarizes the remaining components of income from operations for the three months ended March 31, 2004 and 2003 (in millions):
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The following table summarizes income from operations by reportable segment for the three months ended March 31, 2004 and 2003 and provides explanations of significant factors contributing to the identified variances (in millions):
The following summarizes the other major components of our income before cumulative effect of changes in accounting principles for the three months ended March 31, 2004 and 2003 (in millions):
On March 31, 2004, we recorded a credit of approximately $8 million, net of tax, or $0.01 per diluted share, as a cumulative effect of change in accounting principle as a result of the consolidation of previously
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In the first quarter of 2003, we recorded a charge of $46 million, net of taxes, to cumulative effect of changes in accounting principles for the adoption of certain accounting changes described below.
Liquidity and Capital Resources
The following is a summary of our cash balances and cash flows for the three months ended March 31, 2004 and 2003 (in millions):
Net Cash Provided by Operating Activities — We generated approximately $470 million in cash flows from our operating activities during the three months ended March 31, 2004 compared with $429 million provided in the comparable prior year period, an increase of $41 million. Current period operating cash flows were favorably affected by improved profitability due in part to the harsh winter weather experienced during the first quarter of 2003. However, we experienced fluctuations in each of the components of working capital, resulting in a net unfavorable change. This decline was largely due to the favorable impact of the termination of interest rate swap agreements before their scheduled maturities in 2003.
Net Cash Used in Investing Activities — We used approximately $154 million of our cash resources for investing activities during the first quarter of 2004, a decrease of approximately $73 million as compared to the first quarter of 2003. This decrease is primarily due to a $43 million decline in acquisition spending and capital expenditures, from $297 million in 2003 to $254 million in 2004. Also contributing to the current period decrease was a $6 million increase in proceeds from divestitures and other sales of assets and a $24 million increase in net receipts from restricted funds.
Net Cash Provided by and Used in Financing Activities — During the first quarter of 2004 we issued $350 million of 5.0% senior notes, which was the primary driver of the $238 million increase in cash as a result of our financing activities during the three months ended March 31, 2004. We also received approximately
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We operate in a capital intensive business and continuing access to various financing sources is vital to our operations. In the past, we have been successful in obtaining financing from a variety of sources on terms we consider attractive. Based on several key factors we believe are considered by credit rating agencies and financial markets to be important in determining our future access to financing, we expect to continue to maintain access to capital sources in the future. These factors include:
In addition to our working capital needs for ongoing operations, we have capital requirements for (i) capital expenditures for construction and expansion of landfill sites, as well as new trucks and equipment for collection and other operations, (ii) refurbishments and improvements at waste-to-energy facilities and (iii) business acquisitions. We currently expect to spend approximately $1 billion for capital expenditures and approximately $175 million for acquisitions during the remainder of 2004.
Our Board of Directors has approved a quarterly dividend program that is expected to result in an annual payment of $0.75 per share. The program was initiated in the first quarter of 2004 when we declared our first quarter dividend of $0.1875 per share of common stock, or approximately $109 million, which was paid on March 25, 2004 to stockholders of record as of March 1, 2004. We currently expect to make dividend payments of approximately $325 million for remaining 2004 quarterly dividends.
Our share repurchase program, which was approved by our Board of Directors in 2002, is in its final year. Under this program, we have repurchased over 60 million shares of our common stock at a cost of approximately $1.6 billion. We have not purchased any of our common stock in 2004, although we did make a payment of approximately $24 million in January 2004 to settle repurchases made in December 2003. We believe that the program has been an important source of shareholder value and we intend to continue to use cash flows from operations for share repurchases in either open market or privately negotiated transactions during the remainder of 2004.
Our strategy is to primarily utilize cash flows from operations to meet our capital needs and contractual obligations. However, we also have bank borrowings available to meet these capital requirements and, when appropriate, will obtain financing by issuing debt or common stock.
As of March 31, 2004, we had a three-year, $650 million syndicated revolving credit facility and a five-year, $1.75 billion syndicated revolving credit facility. The three-year revolver matures in June 2005 and the five-year revolver matures in June 2006. We have generally used each of these facilities to issue letters of credit that support our tax-exempt bond issuances, municipal and governmental waste management contracts, closure and post-closure obligations and disposal site or transfer station operating permits. We expect that similar facilities will continue to serve as a cost efficient source of this form of financial assurance in the future, and we continue to assess our financial assurance requirements to ensure that we have adequate letter of credit and surety bond capacity in advance of our business needs. Because letters of credit generally have a one-year term, the three-year $650 million syndicated revolving credit facility will no longer be a viable source of new
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During March 2004 we issued $350 million of 5.0% senior notes due March 15, 2014. The net proceeds of the offering were approximately $346 million after deducting underwriters’ discounts and expenses. We have invested these proceeds in cash equivalent investments pending repayment of $150 million of 8.0% senior notes due April 30, 2004 and $200 million of 6.5% senior notes due May 15, 2004. Our debt obligations as of March 31, 2004 also include $294 million of 7.0% senior notes due October 1, 2004, which have been classified as long-term debt in the accompanying condensed consolidated balance sheet. The classification of these obligations as long-term was based upon our current and forecasted available capacity under our two long-term revolving credit facilities and our intent to refinance the borrowings with other long-term financings. In the event other sources of long-term financing are not available, we intend to use our revolving credit facilities.
We also issued approximately $75 million of tax-exempt bonds during the first quarter of 2004, $35 million of which was issued to refinance higher rate tax-exempt bonds. Proceeds from these financing arrangements are primarily used for the construction of collection and disposal facilities and are deposited directly into trust funds because we do not have the ability to use the funds in our regular operating activities. Accordingly, we report these amounts as an investing activity when the cash is released from the trust funds and a financing activity when the industrial revenue bonds are repaid out of our cash balances. At March 31, 2004, approximately $424 million of funds were held in trust to meet future capital expenditures at various facilities. These fund balances are included as other long-term assets in the accompanying condensed consolidated balance sheets. We continue to increase our use of tax-exempt financing due to the attractive rates offered for these instruments.
Off-Balance Sheet Arrangements
We are party to (i) lease agreements with unconsolidated variable interest entities and (ii) guarantee arrangements with unconsolidated entities as discussed in the Guarantees section of Note 8 to the condensed consolidated financial statements. These lease agreements are established in the ordinary course of our business and are designed to provide us with access to facilities at competitive, market-driven prices. Our third-party guarantee arrangements are generally established to support our financial assurance needs and landfill operations. These arrangements have not materially affected our financial position, results of operations or liquidity during the period ended March 31, 2004 nor are they expected to have a material impact on our future financial position, results of operations or liquidity.
Seasonal Trends and Inflation
Our operating revenues tend to be somewhat lower in the winter months, primarily due to the lower volume of construction and demolition waste. The volumes of industrial and residential waste in certain regions where we operate also tend to decrease during the winter months. Our first and fourth quarter results of operations typically reflect these seasonal trends. We also use the slower winter months for scheduled maintenance at our waste-to-energy facilities, so repair and maintenance expense is generally higher in our first quarter than in other quarters during the year. In addition, particularly harsh weather conditions may result in the temporary suspension of certain of our operations.
We believe that inflation has not had, and in the near future is not expected to have, any material adverse effect on our results of operations. However, management’s estimates associated with inflation have had, and will continue to have, an impact on our accounting for landfill and environmental remediation liabilities.
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We maintain a set of disclosure controls and procedures designed to ensure that information we are required to disclose in reports that we file or submit with the SEC is recorded, processed, summarized and reported within the time periods specified by the SEC. An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the CEO and CFO have concluded that the Company’s disclosure controls and procedures are effective to ensure that we are able to collect, process and disclose the information we are required to disclose in the reports we file with the SEC within required time periods.
PART II.
Information regarding our legal proceedings can be found under the “Litigation” section of Note 8, Commitments and Contingencies, to the condensed consolidated financial statements.
(a) Exhibits:
(b) Reports on Form 8-K:
In the first quarter of 2004, we filed Current Reports on Form 8-K dated March 3rd and March 5th to announce we had entered into an underwriting agreement for the public offering of $350 million of our 5.0% senior notes due March 15, 2014 and to file a legal opinion and an accountant’s consent related to that offering. On March 3rd, 9th and 19th, we also filed Current Reports on Form 8-K in order to file legal opinions in connection with certain offerings of common stock under our universal shelf registration statement.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: April 30, 2004
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INDEX TO EXHIBITS