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 October 25, 2004 was 572,129,820 (excluding treasury shares of 58,152,641).
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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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
The condensed consolidated financial statements as of and for the three and nine months ended September 30, 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 condensed consolidated balance sheet at December 31, 2003 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. 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 changes —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.
In the first quarter of 2003, we recorded a $46 million charge, net of tax, to cumulative effect of changes in accounting principles for the adoption of the (i) Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations; (ii) a change in our accounting for major repairs and maintenance expenditures and deferred costs associated with annual plant outages at our waste-to-energy facilities and independent power production plants; and (iii) a change in accounting for future losses under customer contracts that over the contract life are projected to have direct costs greater than revenues. These accounting changes do not affect the comparability of our financial position or income before cumulative effect of changes in accounting principles as presented herein.
Reclassifications —In 2004, as a result of internal review processes, we have identified certain items that require modifications to our accounting and reporting. The following discussion provides information about
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
each of the changes identified and the reclassifications made in the accompanying condensed consolidated financial statements to conform our prior year’s presentation to the current year’s presentation.
We have various investments in unconsolidated entities that we account for using the equity method. Our equity in the earnings of these entities has historically been presented as a component of other income in our statements of operations and the related cash flow impact has been reflected as a component of the change in other assets within our statements of cash flows. As a result of investments we made during the first and second quarters of 2004, as described in Note 4, this activity has become a more significant component of our net income and operating cash flow activity. Accordingly, we have shown equity in earnings and losses of unconsolidated entities as a separate component within our statement of operations and equity in earnings and losses of unconsolidated entities, net of distributions, as a separate component of cash provided by operating activities. Prior periods have been reclassified to conform to the current periods’ presentation.
We have material financial commitments at our landfills for final capping, closure and post-closure activities, as described below:
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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 SFAS No. 143. 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 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 more detail in the notes to the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003.
In accordance with SFAS No. 143, we inflate estimated final capping, closure and post-closure costs to the expected time of payment and discount those expected future costs back to present value using a credit-adjusted, risk-free discount rate. For liabilities incurred during the nine months ended September 30, 2004, we used an inflation rate of 2.5% and a credit-adjusted, risk free discount rate of 6.25%. 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 discount rate. We determine the inflation rate and our credit-adjusted, risk-free discount rate on an annual basis unless there have been interim changes in either rate that 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 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 the range in accordance with SFAS No. 5, Accounting for Contingencies, 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 $323 million recorded in our condensed consolidated financial statements as of September 30, 2004.
As of September 30, 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. Sixteen of these sites were initially developed by others and later acquired by us. 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 agreed-upon 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 that we do not own but 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
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known as CERCLA or 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 and has been accounted for accordingly. At others where no remedy has been selected or the potentially responsible parties have been unable to agree on an appropriate allocation, our future costs are uncertain, and 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 and discount the cost to present value using a risk-free discount rate, which is based on the rate for United States Treasury bonds with a term approximating the weighted average period until settlement of the underlying obligation. As of September 30, 2004, we are using an inflation rate of 2.5% and a risk-free discount rate of 4.25% to record our estimated environmental remediation obligations. We determine the inflation rate and the risk-free discount rate on an annual basis unless there have been interim changes in either rate that would significantly impact our results of operations.
Liabilities for landfill and environmental remediation costs are presented in the table below (in millions):
The changes to landfill and environmental remediation liabilities for the nine months ended September 30, 2004 and 2003 are reflected in the tables below (in millions):
At several of our landfills, we provide financial assurance by depositing cash into restricted escrow accounts or trust funds for purposes of settling closure, post-closure and environmental remediation
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obligations. The fair value of these escrow accounts and trust funds was approximately $200 million at September 30, 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.
Debt consisted of the following (in millions):
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Our debt balances are generally unsecured, except for approximately $431 million of the tax-exempt project bonds outstanding at September 30, 2004 that were issued by certain subsidiaries within our Wheelabrator Group. These bonds are secured by the related subsidiaries’ assets that have a carrying value of approximately $648 million and the related subsidiaries’ future revenue. Additionally, our consolidated variable interest entities have approximately $162 million of outstanding borrowings that are collateralized by certain of their assets. These assets have a carrying value of approximately $421 million as of September 30, 2004.
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 amount of the draw paid by the letter of credit provider generally converts into a term loan for the remaining term under the respective agreement or facility. Through September 30, 2004, we had not experienced any unreimbursed draws on letters of credit.
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 September 30, 2004. Interest rate swap agreements outstanding as of September 30, 2004 and December 31, 2003 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 $160 million as of September 30, 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 $23 million and $73 million for the three and nine months ended September 30, 2004, respectively, and $25 million and $72 million for the three and nine months ended September 30, 2003, respectively. The significant terms of the interest rate contracts and the underlying debt instruments are identical and therefore no ineffectiveness has been realized.
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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.
Our effective tax rate is evaluated at each interim period and adjusted accordingly as facts and circumstances warrant. The difference between federal income taxes computed at the federal statutory rate and reported income taxes for the three and nine months ended September 30, 2003 is primarily due to state and local income taxes, offset in part by non-conventional fuel tax credits. The difference between federal income taxes computed at the federal statutory rate and reported income taxes for the three and nine months ended September 30, 2004 is primarily due to favorable tax audit settlements and the favorable impact of non-conventional fuel tax credits, offset in part by state and local income taxes. The settlement of several tax audits resulted in a $62 million tax benefit for the three months ended September 30, 2004 and a $74 million tax benefit for the nine months ended September 30, 2004. These tax audit settlements resulted in an 18.4 percentage point reduction in our effective tax rate for the three months ended September 30, 2004 and an 8.8 percentage point reduction in our effective tax rate for the nine months ended September 30, 2004.
During 2004, the favorable impact of non-conventional fuel tax credits has been derived from our landfills and our investments in two coal-based synthetic fuel production facilities (the “Facilities”), which are discussed in more detail below. The fuel generated from our landfills and the Facilities qualifies for tax credits through 2007 pursuant to section 29 of the Internal Revenue Code, and may be phased-out when the price of oil exceeds a threshold annual average price determined by the U.S. Internal Revenue Service.
In the first and second quarters of 2004, we acquired minority ownership interests in two Facilities for approximately $119.7 million, which is comprised primarily of notes payable of $118.5 million, as well as commitments to fund our pro-rata share of the operations of the Facilities. We have also agreed to make additional payments to the seller based on our pro-rata allocation of the tax credits generated by each Facility. We have been granted private letter rulings from the IRS confirming that the synthetic fuel produced by the Facilities 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 Facilities.
We account for our investment in the Facilities using the equity method of accounting, which results in the recognition of our pro-rata share of the Facilities’ losses, the amortization of our initial investments 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 September 30, 2004 was approximately $28 million, making cumulative losses recognized during the nine months ended September 30, 2004 approximately $73 million. We also recognized interest expense related to these investments of approximately $2 million during the three months ended September 30, 2004 and approximately $6 million during the nine months ended September 30, 2004. The pre-tax impacts of these investments were losses of approximately $30 million for the three months ended September 30, 2004 and approximately $79 million for the nine months ended September 30, 2004. These impacts would not have been incurred if we had not acquired the minority ownership interest in the Facilities, and if, for some reason, the tax credits generated by the Facilities were no longer allowable under Section 29 of the Internal Revenue Code, we would no longer incur these financial impacts.
The tax benefits that we will realize as a result of our investments in the Facilities have been reflected as a reduction to our provision for income taxes. This resulted in a decrease in our tax provision of approximately $39 million (including $28 million of tax credits) for the three months ended September 30, 2004 and approximately $93 million (including $63 million of tax credits) for the nine months ended September 30, 2004, which more than offset the equity losses and interest expense recognized during each period. After excluding the impact of the favorable tax audit settlements noted above, the decreases in our tax provision
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resulting from these investments provide a reduction in our effective tax rate of approximately eight percentage points for the three and nine months ended September 30, 2004.
Comprehensive income represents all changes in our equity except for changes resulting from investments by, and distributions to, stockholders. As discussed in Note 1, during 2004 we identified certain amounts related to our consolidated Canadian operations that required adjustment to properly capture the impact of accounting for foreign currency translation adjustments. The following tables have been adjusted to properly reflect the effects of our foreign currency translation.
Comprehensive income for the three and nine months ended September 30, 2004 and September 30, 2003 was as follows (in millions):
The components of accumulated other comprehensive income (loss) were as follows:
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The following table reconciles net income as presented on the condensed consolidated statements of operations with diluted net income for purposes of calculating diluted earnings per common share (in millions):
The following table reconciles the number of common shares outstanding at September 30 of each year to the number of weighted average basic common shares outstanding and the number of weighted average diluted common shares outstanding for the purpose of calculating basic and diluted earnings per common share. The table also provides the number of shares of common stock potentially issuable at the end of each period and the number of potentially issuable shares excluded from the diluted earnings per share computation for each period (shares in millions):
Pursuant to our stock incentive plans, we have the ability to issue stock options, stock awards and stock appreciation rights, all on terms and conditions determined by the Compensation Committee of our Board of Directors. The following is a summary of the significant terms of the stock options and restricted stock granted to our officers and other employees under these plans during the nine months ended September 30, 2004.
Stock options — During the nine months ended September 30, 2004, we issued an aggregate of approximately 9.0 million of stock options to certain of our officers and other employees as part of the 2004 annual grant or as grants issued for promotions or new hire incentives. The weighted average exercise price of options granted during this period was $29.20 per common share. These stock options all have exercise prices equal to the fair market value of our common stock as of the date of grant, expire ten years from the date of grant and vest ratably over a four-year period.
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Restricted stock — During the nine months ended September 30, 2004, we issued an aggregate of 162,500 shares of restricted stock to certain of our officers as part of the 2004 annual grant or as grants issued for promotions or new hire incentives. The restricted stock grants also vest ratably over a four-year period. The shares issued are subject to forfeiture in the event of termination of employment and entitle the holder to all benefits of a stockholder, including the right to receive dividends and vote on all matters put to a vote of security holders.
We account for our stock-based compensation using the intrinsic value method. Under this method, we do not recognize any 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. We recognize compensation expense for restricted stock awards on a straight-line basis over the vesting period based on the fair market value of our common stock on the date of grant.
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 our Board of Directors approved a quarterly dividend program. In August 2004, we declared our third quarterly dividend of $0.1875 per share of common stock, or approximately $108 million, which was paid on September 24, 2004 to stockholders of record as of September 1, 2004. On October 12, 2004, we declared a quarterly dividend of $0.1875 per share of common stock, which will be paid on December 23, 2004 to stockholders of record as of December 1, 2004. Based on shares outstanding as of September 30, 2004, the payment of this dividend will result in a cash payment of approximately $107 million. We have paid approximately $326 million in dividends during the nine months ended September 30, 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 through 2004, to be implemented at management’s discretion. In August 2003, we amended the program, starting in 2004, to include quarterly dividend payments. The
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following is a summary of activity under the stock repurchase program through September 30, 2004 (in millions, except shares in thousands and price per share in dollars).
Total dividend payments and share repurchases were approximately $655 million during the nine months ended September 30, 2004.
As of September 30, 2004, we had the ability, under our most restrictive financial covenants, to make dividend payments and share repurchases in the aggregate amount of approximately $370 million. As discussed in Note 3, in October 2004, we replaced the revolving credit facilities that provided for this restriction with a five-year $2.4 billion revolving credit facility. The new facility does not define a minimum net worth that would restrict our ability to make future dividend payments or share repurchases. In October 2004, we announced that our Board of Directors approved a new capital allocation program that provides for up to $1.2 billion in aggregate dividend payments and share repurchases each year during 2005, 2006 and 2007.
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 these financial assurance instruments from several sources, including an entity that we have an investment in and account for under the equity method; a wholly-owned insurance company, the sole business of which is to issue policies for the parent holding company and its other subsidiaries; and a consolidated variable interest entity that was formed to provide surety bonds to the waste industry (as described in Note 9).
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. However, 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.
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Insurance — We carry insurance coverage for protection of our assets and operations from certain risks including automobile liability, general liability, real and personal property, workers’ compensation, directors’ and officers’ liability, pollution legal liability and other coverages we believe are customary to the industry. Our exposure to loss for insurance claims is generally limited to the per incident deductible under the related insurance policy. Our exposure, however, could increase if our insurers were unable to meet their commitments on a timely basis. We have retained a portion of the risks related to our automobile, general liability and workers’ compensation insurance programs. For our self-insured retentions, the exposure for unpaid claims and associated expenses, including incurred but not reported losses, is based on an actuarial valuation. The estimated accruals for these liabilities could be affected if future occurrences or loss development significantly differ from utilized assumptions. We do not expect the impact of any known casualty, property, environmental or other contingency to have a material impact on our financial condition, results of operations or cash flows.
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, currently estimated to be approximately $26 million, 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 several factors, including but not limited to legislation or regulation. 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. This case has remained in the pleadings stage for the last several years due to numerous motions and rulings by the court related to the viability of these claims. Based on the most recent pleadings by the plaintiff, the defendants have removed the case to federal court in Illinois where a remand motion is pending. Only limited discovery has occurred and the defendants continue to defend themselves vigorously. 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, WM Holdings and others, attempting to increase the recovery of a class of ERISA plan participants based on allegations related to both the events alleged in, and the settlements relating to, the securities class action against WM Holdings that was settled in 1998 and the securities class action against us that was settled in November 2001. Subsequently, the issues related to the latter class action have been dropped as to the Company, its officers and directors. However, the case is ongoing with respect to WM Holdings and others. Additionally, a single group of stockholders opted not to participate in the
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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 ourselves against these claims. In March 2004, the court granted our motion to dismiss the third case, which was pending in federal court, and the plaintiffs have appealed that dismissal. Finally, another shareholder has sued the Company in Louisiana making allegations similar to those made in the securities class action referred to above and by the plaintiff claiming damages for having held stock. The case has been removed to federal court and we are seeking a transfer to Texas where we will seek dismissal.
The Company is currently defending allegations related generally to the termination of two separate joint ventures to which one of our wholly-owned subsidiaries was a party. The claims in both proceedings involve the value of the joint ventures. The joint venture relationships have ended and the contributed assets have been divested by the Company. The Company is defending itself vigorously in each of these proceedings, in which the parties are seeking a variety of remedies ranging from monetary damages to unwinding the transaction. However, the nature and extent of possible remedies or damages cannot be determined at this time.
From time to time, we pay fines or penalties in environmental proceedings relating primarily to waste treatment, storage or disposal facilities. As of September 30, 2004, there were six proceedings involving our subsidiaries where we reasonably believe that the sanctions could 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 late performance of work required under a Unilateral Administrative Order; (iii) improperly operated a solid waste landfill and caused excess odors; (iv) improperly operated a solid waste landfill by failing to maintain required records, properly place and cover waste and adhere to proper leachate levels; (v) discharged wastewater from a cogeneration facility in noncompliance with waste discharge requirements issued pursuant to a state water code; and (vi) failed to comply with air permit, landfill gas flow and emission limit requirements. 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, results of operations or cash flows in one or more future periods.
We also are currently involved in other routine civil litigation and governmental proceedings relating to the conduct of our business, including litigation involving former employees and competitors. We do not believe that any of the matters will ultimately 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 2000. The audits for these years should be completed within the next six months. We are in the examination phase of an IRS audit for 2001, which should be completed within the next three months. In addition, the planning phase of an IRS audit for the years 2002 and 2003 was recently initiated. This audit should be completed within the next 24 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 six months as these audits are completed, although we do not believe they will have a material adverse impact on our results of operations. For discussion regarding the current period impact of such matters, see Note 4.
Capitalized software costs — We are currently assessing our options with respect to the implementation of a revenue management system. Although no impairment has been required through September 30, 2004, there are certain reasonably possible implementation alternatives that could result in an impairment.
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 provide additional exemptions for application, an extended initial application period and clarification of key terms.
As it applies to us, the effective dates for FIN 46 were 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.”
Early in the third quarter of 2004, we implemented a market realignment that consisted of moving our Ohio operations to the Midwest Group and our Kentucky operations to the Southern Group, both of which were previously in the Eastern Group. We believe that the realignment will provide benefits to each of the operating groups affected. Specifically, the Ohio Market Area faces many of the same issues as other industrial regions in the Midwest Group and the Kentucky Market Area’s rural characteristics make it similar to other markets in the Southern Group. By balancing the revenues between each of the Groups, we will enable the Eastern Group leadership team to focus on the challenges associated with the Northeast corridor. As a result of the realignment, we have reclassified the operating results of the Ohio and Kentucky Market Areas for all periods presented to provide segment financial information that appropriately reflects our approach to managing operations. Approximately $622 million and $167 million of assets as of December 31, 2003 were transferred to the Midwest and Southern Groups, respectively, from the Eastern Group due to the realignment. Prior period information has also been reclassified to reflect our change in accounting for certain mandatory fees and taxes (as described in Note 1).
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Summarized financial information concerning our reportable segments for the three and nine months ended September 30 is shown in the following tables (in millions).
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The table below shows the total revenues by 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
September 30, 2004
December 31, 2003
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CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
Three Months Ended September 30, 2004
Three Months Ended September 30, 2003
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Nine Months Ended September 30, 2004
Nine Months Ended September 30, 2003
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CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
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In February 2003 we reduced the number of market areas that make up our geographic operating Groups and reduced certain overhead positions to further streamline our organization. In connection with the restructuring, we reduced our workforce by about 700 employees and 270 contract workers. We recorded $20 million of pre-tax charges for costs associated with our February 2003 restructuring and workforce reduction, all of which was associated with employee severance and benefit costs. The operational efficiencies provided by these organizational changes and a focus on fully utilizing the capabilities of our information technology resources enabled us to further reduce our workforce in June 2003. This workforce reduction resulted in the elimination of an additional 600 employee positions and 200 contract worker positions. We recorded $23 million of pre-tax charges for costs associated with the June 2003 workforce reduction during the nine months ended September 30, 2003. We do not expect to incur any additional costs for these restructuring and workforce reduction efforts. During the third quarter of 2004, we recorded a credit of approximately $1 million to reduce our accrual for employee severance costs associated with these activities. Approximately $1 million remains accrued as of September 30, 2004 for employee severance and benefit costs incurred as a result of these activities, which will be paid to certain employees through the third quarter of 2005.
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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 third quarter of 2004 was a strong quarter for the Company, marked by trends similar to those seen in the first two quarters. During 2004, management has been focused primarily on the following:
Net income for the quarter was $302 million, or $0.52 per diluted share, as compared with $210 million or $0.35 per diluted share in the third quarter of 2003. Net income before cumulative effects of changes in accounting principles for the nine months ended September 30, 2004 was $662 million, or $1.14 per diluted share, as compared with $493 million, or $0.83 per diluted share for the nine months ended September 30, 2003. The increase in net income for both periods was primarily a result of favorable tax audit settlements and our ability to take advantage of our fixed cost structure on a growing revenue base, offsetting certain other rising components of cost.
Our favorable audit settlements increased our earnings by $71 million, or $0.12 per diluted share, during the current quarter, which includes a $62 million decline in our tax provision and $9 million of after-tax interest income. The earnings impact for the nine months ended September 30, 2004 was approximately $83 million, or $0.14 per diluted share, and includes an additional decline of approximately $12 million in our tax provision for audit settlements that occurred during the first and second quarters.
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Revenues for the current quarter were up $278 million, or 9.3%, to $3.27 billion in the third quarter of 2004. For the nine months ended September 30, 2004, our operating revenues were $9.31 billion as compared with $8.66 billion for the comparable nine-month period last year. Revenues for the third quarter of 2004 include approximately $59 million, or 2.0% of current quarter revenue growth, related to clean-up efforts from the hurricanes in Florida. The remaining revenue growth in the quarter is from (i) combined average yield improvement of 2.8% from our base business, recyclable commodities and fuel surcharges and fees; (ii) volume increases driven by economic growth; and (iii) acquisitions, net of divestitures.
Yield increase on base business improved to 0.8% in the third quarter, from 0.4% in the first half of 2004. While we continue to have reasonable success implementing annual price increases to our collection customer base, we have experienced increased price competition in the collection business in many markets. This increased competition has been characterized by offers from competitors to our customers to provide the same services at much lower prices than we are charging and lower average rates being offered by the competition on new business bids. The price competition is the greatest in our Midwestern Group, where negative yield on their base business of 2.0% was experienced in the third quarter. We have also experienced declines in yield for our landfill operations, due largely to competitive pricing on special waste that have been partially offset by yield increases on our municipal solid waste landfill operations.
At 4.5%, internal revenue growth from volumes in the quarter was the highest we have experienced in any quarter for several years. Excluding the increase in volumes related to the hurricanes, the remaining volume growth of 2.5% is similar to the volume growth reported for the second quarter. Volume growth in 2004 has been much better than recent years. This is primarily a result of improved general economic conditions, which among other things resulted in a substantial increase in construction and demolition activity in the U.S. Consistent with that view, our volumes were most improved in the landfill, industrial collection and commercial collection lines of business, with smaller volume increases experienced in the transfer and residential collection lines of business.
We have paid approximately $203 million, net of cash acquired, for acquisitions since the third quarter of 2003. The effect of these acquisitions was an increase of approximately 2.0% in third quarter 2004 net revenues as compared with the prior year’s quarter. Our acquisition program is directed towards maximizing the benefits of our fixed cost infrastructure by improving our collection route density and increasing our internalized waste volumes by investing in landfills and transfer stations.
We continue our efforts to improve our operating margins. We were not successful in doing that in the third quarter, primarily as a result of (i) a significant portion of the hurricane clean-up efforts being sub-contracted to third parties resulting in relatively low margins on these revenues; (ii) higher fuel costs driven by an increase in the per gallon cost of diesel fuel and third-party fuel surcharges that have more than offset the fuel surcharge revenues we have been able to generate; and (iii) increased costs of goods sold related to our recycling line of business due to higher commodity prices. Each of these items contributed to the margin declines we experienced on this quarter’s incremental revenues. We continue to seek opportunities to reduce our operating costs and improve our margins.
We believe that the production of free cash flow is a very important measure of our liquidity and operating results as it is indicative of our ability to pay our quarterly dividends, repurchase stock and execute our acquisition program. Free cash flow is not a measure of financial performance under generally accepted accounting principles and is not intended to replace the condensed consolidated statement of cash flows that was prepared in accordance with GAAP. Our free cash flow was $305 million for the quarter and $854 million for the nine-month period. Free cash flow is calculated by subtracting capital expenditures from net cash
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We are projecting full-year 2004 free cash flow to meet or exceed our previously stated range of $900 million to $1 billion, based on estimated net cash provided by operating activities meeting or exceeding a range of $2.1 billion to $2.2 billion, capital expenditures of between $1.25 billion and $1.3 billion, and proceeds from divestitures, net of cash divested and other sales of assets of $80 million to $100 million.
As discussed in Notes 1 and 10 to the condensed consolidated financial statements, the following reclassifications have been made in our 2003 financial statements in order to conform to the current year presentation:
The supplementary financial information included in this section has been updated to reflect these changes.
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
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Results of Operations for the Three and Nine Months Ended September 30, 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.
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The following table presents, for the periods indicated, the percentage relationship that the respective consolidated statement of operations line items bear to operating revenues:
Our operating revenues for the three months ended September 30, 2004, were $3.3 billion, compared with $3.0 billion in 2003. For the nine months ended September 30, 2004, our operating revenues were $9.3 billion, as compared with $8.7 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.
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Our operating revenues generally come from fees charged for our collection, landfill, transfer, Wheelabrator (waste-to-energy facilities and independent power production plants) and recycling services. The mix of operating revenues from our different services is reflected in the table below (in millions):
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:
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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) transfer and 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.
The following table summarizes the major components of our operating expenses, including the impact of foreign currency translation, for the three and nine months ended September 30, 2004 and 2003 (in millions):
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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.
The following table summarizes the major components of our selling, general and administrative costs for the three and nine months ended September 30, 2004 and 2003 (in millions):
The following table summarizes the remaining components of income from operations for the three and nine months ended September 30, 2004 and 2003 (in millions):
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The following table summarizes income from operations by reportable segment for the three and nine months ended September 30, 2004 and 2003 and provides explanations of significant factors contributing to the identified variances (in millions):
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The following summarizes the other major components of our income before cumulative effect of changes in accounting principles for the three and nine months ended September 30, 2004 and 2003 (in millions):
On March 31, 2004, we recorded a credit of approximately $8 million, net of taxes, or $0.01 per diluted share, as a cumulative effect of change in accounting principle as a result of the consolidation of previously unrecorded trusts as required by Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities. See Note 9 to the condensed consolidated financial statements.
In the first quarter of 2003, we recorded a charge of $46 million, net of taxes, or $0.08 per diluted share, to cumulative effect of changes in accounting principles for the adoption of certain accounting changes described below.
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Liquidity and Capital Resources
As an organization that has consistently generated cash flows in excess of its reinvestment needs, our primary source of liquidity has been cash flows from operations. However, we operate in a capital-intensive business and continued access to various financing resources is vital to our continued financial strength. 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 important by credit rating agencies and financial markets in determining our access to attractive financing alternatives, we expect to continue to maintain access to capital sources in the future. These factors include:
We continually monitor our actual and forecasted cash flows, our liquidity and our capital resources enabling us to plan for our present needs and fund unbudgeted business activities that may arise during the year as a result of changing business conditions or new opportunities. In addition to our working capital needs for the general and administrative costs of our ongoing operations, we have cash requirements for: (i) the construction and expansion of our landfills; (ii) additions to and maintenance of our trucking fleet; (iii) refurbishments and improvements at waste-to-energy and materials recovery facilities; (iv) the container and equipment needs of our operations; and (v) capping, closure and post-closure activities at our landfills. Beginning in 2002, we committed ourselves to providing our shareholders with a return on their investment through our share repurchase program, and in 2004 began a quarterly dividend program. We also continue to invest in acquisitions that we believe will provide continued growth in our core business. Our Board of Directors has approved a new capital allocation program that provides for up to $1.2 billion in aggregate dividend payments and share repurchases each year during 2005, 2006 and 2007.
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The following is a summary of our cash, restricted fund and debt balances as of September 30, 2004 and December 31, 2003 (in millions):
Cash and cash equivalents — Cash and cash equivalents consist primarily of cash on deposit, certificates of deposit, money market accounts, and investment grade commercial paper purchased with original maturities of three months or less. The changes in our cash balance from December 31, 2003 are discussed in the “Summary of Cash Flow Activity” section below.
Restricted funds — Restricted funds consist primarily of funds held in trust for the construction of various facilities or repayment of debt obligations, funds deposited in connection with landfill closure, post-closure and remedial obligations and insurance escrow deposits. These balances are primarily included within long-term other assets in our condensed consolidated balance sheets.
Revolving credit and letter of credit facilities — The table below summarizes the credit capacity, maturity and outstanding letters of credit under our revolving credit facilities and principal letter of credit facilities outstanding at September 30, 2004 (in millions). We also had an additional $110 million in outstanding letters
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We have used each of these facilities to support letters of credit that we issue to support our insurance programs, certain tax-exempt bond issuances, municipal and governmental waste management contracts, closure and post-closure obligations and disposal site or transfer station operating permits. These facilities require us to pay fees to the lenders and our obligation is generally to repay any draws that may occur on the letters of credit. We expect that similar facilities may 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.
The letters of credit we have issued generally have a one-year term, and therefore, as of September 30, 2004, the three-year $650 million syndicated revolving credit facility, which had a maturity date in June 2005, was no longer a viable source to support new letters of credit. On October 15, 2004, we replaced our three-year $650 million and five-year $1.75 billion revolving credit facilities with a single, five-year $2.4 billion syndicated revolving credit facility.
Senior notes — 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 used these proceeds to repay $150 million of 8.0% senior notes due April 30, 2004 and $200 million of 6.5% senior notes due May 15, 2004. As of September 30, 2004, we had $295 million of 7.0% senior notes due October 1, 2004, which were paid with cash on hand at maturity. We also have $100 million of 7.0% senior notes due May 15, 2005 that we currently expect to redeem with available cash.
Tax-exempt bonds — We issued approximately $245 million of tax-exempt bonds during the nine months ended September 30, 2004, $35 million of which was issued to refinance higher rate tax-exempt bonds. We actively issue tax-exempt bonds as a means of accessing low-cost financing for capital expenditures. The proceeds from these financing arrangements are deposited directly into trust funds and may only be used for the specific purpose for which the money was raised, which is generally the construction of collection and disposal facilities. As we spend monies on the specific projects being financed, we are able to requisition cash from the trust funds. As discussed in the restricted funds section above, we have approximately $382 million held in trust for future spending as of September 30, 2004. During the nine months ended September 30, 2004, we received $293 million from these funds for approved capital expenditures.
As of September 30, 2004, approximately $590 million of our tax-exempt bonds are remarketed weekly by a remarketing agent to effectively maintain a variable yield. If the remarketing agent is unable to remarket the bonds, then the remarketing agent can put the bonds to us. These bonds are supported by letters of credit, that were issued under our $1.75 billion, five-year revolving credit facility, that guarantee repayment of the
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Tax-exempt project bonds — Tax-exempt project bonds are used by our Wheelabrator Group to finance the development of waste-to-energy facilities. The bonds generally require periodic principal installment payments. As of September 30, 2004, approximately $46 million of these bonds are remarketed either daily or weekly by a remarketing agent to effectively maintain a variable yield. If the remarketing agent is unable to remarket the bonds, then the remarketing agent can put the bonds to us. Repayment of these bonds has been guaranteed with letters of credit issued under our five-year revolving credit facility. Approximately $44 million of these bonds will be repaid with available cash within the next twelve months.
Convertible subordinated notes — We have approximately $34 million of convertible subordinated notes that mature January 24, 2005. Each $1,000 note is convertible into 18.9 shares of our common stock, subject to adjustment upon the occurrence of certain events. Upon any such conversion, we have the option to pay cash equal to the market value of the shares that would otherwise be issuable. We currently expect to redeem these notes with available cash.
Interest rate swaps — 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. As of September 30, 2004, the interest payments on approximately $2.6 billion of our fixed rate debt have been swapped to variable rates, allowing us to maintain approximately 64% of our debt at fixed interest rates and approximately 36% at variable interest rates. Fair value hedge accounting for interest rate swap contracts increased the carrying value of debt instruments by approximately $160 million as of September 30, 2004 and approximately $168 million at December 31, 2003.
The following is a summary of our cash flows for the nine months ended September 30, 2004 and 2003 (in millions):
Net Cash Provided by Operating Activities — Cash flows generated from operations for the nine months ended September 30, 2003 were favorably affected by $109 million for the termination of interest rate swap agreements before their scheduled maturities and negatively affected by a $259 million net cash outflow for the settlement of our securities class action lawsuit in the third quarter of 2003. Settlement related activity impacting our operating cash flows during the nine-month period ended September 20, 2003 includes: (i) the final cash payment of $377 million plus accrued interest; (ii) use of insurance proceeds of approximately $87 million to settle the remainder of the $457 million provided for under the settlement agreement; (iii) second and third quarter tax benefits of approximately $66 million and $36 million, respectively; and (iv) related net settlement recoveries of approximately $16 million. We have excluded the net $150 million decrease to the prior nine-month period from our discussion because of the non-recurring nature of those items.
After excluding those items, our cash flows generated from operations have increased by approximately $182 million, from $1,436 million during the nine months ended September 30, 2003 to $1,618 million in the
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Net Cash Used in Investing Activities — The $179 million decrease in cash used in investing activities is primarily due to a decline in acquisition spending, from $244 million during the nine months ended September 30, 2003 to $110 million in the current year period. In recent years, our business acquisition strategy has been to focus on tuck-in acquisitions, which are relatively small, accretive businesses that will easily integrate with, and provide value to, our existing operations. However, our 2003 acquisition activity was uncharacteristically high because of a few relatively large acquisitions, particularly in our recycling line-of-business, that were made in addition to numerous smaller tuck-in acquisitions. Our current market development and capital allocation strategies reflect our desire to continue to invest in businesses that will enable us to effectively utilize our existing assets and the development or acquisition of disposal assets, which tend to provide higher returns on investment and operating margins. We intend to continue to make accretive tuck-in investments throughout the remainder of 2004. However, we currently expect cash paid for acquisitions to be less than our original $250 million target for the full year.
Also contributing to the current period decrease was an $80 million increase in net receipts from restricted funds and a $29 million increase in proceeds from divestitures and other sales of assets. Through September 30, 2004, proceeds from divestitures, net of cash divested, and other sales of assets were approximately $73 million. We are currently expecting total 2004 proceeds to be between $80 million and $100 million. Our projection of proceeds from divestitures for 2004 does not include the effect of compliance with a Divestiture Order from the Canadian Competition Bureau that requires the divestiture of one of our landfills because we received a stay of the Divestiture Order in August 2004. There continues to be uncertainty associated with the potential impact and timing of the Divestiture Order. We expect to obtain legal and regulatory resolutions late in the fourth quarter, which could result in our having to divest of the landfill. If this occurred, the divestiture could take place as early as the fourth quarter of 2004.
These declines have been partially offset by a $39 million increase in capital expenditures, from $798 million during the nine months ended September 30, 2003 to $837 million in the current year period. We expect that total 2004 capital expenditures will be in the range of $1.25 billion to $1.3 billion, which is a level of spending consistent with the $1.2 billion in cash resources used for capital expenditures in 2003.
Net Cash Used in Financing Activities — The primary reason for the $334 million increase in net cash used in financing activities is the payment of our quarterly dividends, which has resulted in $326 million in cash payments during the year. Our Board of Directors approved our quarterly dividend program during the first quarter of 2004, and we have declared and paid a dividend of $0.1875 per share of common stock in each of the first three quarters of 2004, compared with the prior year’s annual $0.01 per share dividend, which was paid in the fourth quarter of 2003. On October 12, 2004, we declared our fourth quarterly dividend, which will be paid on December 23, 2004 to stockholders of record as of December 1, 2004. Based on shares outstanding as of September 30, 2004, the payment of this dividend will result in a fourth quarter cash outlay of approximately $107 million and total payments of $433 million in 2004.
We paid approximately $353 million for share repurchases during the nine months ended September 30, 2004, an $89 million increase from the $264 million we paid during the comparable prior year period. During the second and third quarters of 2004, we purchased approximately 11.7 million shares of our common stock for a weighted average price of $28.22 per common share, or approximately $329 million, and in the first quarter made a cash payment of approximately $24 million to settle repurchases made in December 2003. Our current capital allocation program authorizes up to $1 billion for stock repurchases and cash dividends this year. We currently expect total 2004 share repurchases and cash dividends to be in the range of $850 million to
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Net debt repayments during the nine months ended September 30, 2004 were approximately $86 million, an increase of $70 million from the corresponding prior year period. The following summary shows our most significant borrowings and debt repayments made during the current year:
Offsetting these net cash outflows are cash receipts of approximately $150 million for common stock option and warrant exercises, which is a $129 million increase in the cash generated by this activity year-over-year.
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 three or nine-month periods ended September 30, 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 higher in the summer months, primarily due to the higher volume of construction and demolition waste. The volumes of industrial and residential waste in certain regions where we operate also tend to increase during the summer months. Our second and third quarter revenues and results of operations typically reflect these seasonal trends. Additionally, certain destructive weather conditions that tend to occur during the summer, such as the hurricanes experienced during the third quarter of 2004, actually increase our revenues in the areas affected, although, for several reasons, including significant start-up costs, such revenues tend to be low margin. Conversely, harsh winter weather conditions may result in the temporary suspension of our operations, which can significantly affect the operating results of those periods. The operating results of our first quarter also often reflect higher repair and maintenance expenses because we rely on the slower winter months for scheduled maintenance at our waste-to-energy facilities.
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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Disclosure Controls and Procedures
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.
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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.
Issuer Purchases of Equity Securities
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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: October 28, 2004
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INDEX TO EXHIBITS