UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

Commission file number 1-12154

Waste Management, Inc.

(Exact name of registrant as specified in its charter)

 

1001 Fannin

Suite 4000

Houston, Texas 77002

(Address of principal executive offices)

 

(713) 512-6200

(Registrant’s telephone number, including area code)

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The number of shares of Common Stock, $0.01 par value, of the registrant outstanding at October 26, 2009 was 489,651,990 (excluding treasury shares of 140,630,471).

 

 

PART I.

 

 

WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(In Millions, Except Share and Par Value Amounts)

 

 

 

See notes to the Condensed Consolidated Financial Statements.

WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Millions, Except Per Share Amounts)
(Unaudited)

 

 

See notes to the Condensed Consolidated Financial Statements.

WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Millions)
(Unaudited)

 

 

See notes to the Condensed Consolidated Financial Statements.

WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(In Millions, Except Shares in Thousands)
(Unaudited)

 

 

See notes to the Condensed Consolidated Financial Statements.

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The financial statements presented in this report represent the consolidation of Waste Management, Inc., a Delaware corporation; Waste Management’s wholly-owned and majority-owned subsidiaries; and certain variable interest entities for which Waste Management or its subsidiaries are the primary beneficiary. Waste Management is a holding company and all operations are conducted by its subsidiaries. When the terms “the Company,” “we,” “us” or “our” are used in this document, those terms refer to Waste Management, Inc., its consolidated subsidiaries and consolidated variable interest entities. When we use the term “WMI,” we are referring only to Waste Management, Inc., the parent holding company.

 

We manage and evaluate our principal operations through five operating Groups. Our four geographic operating Groups, which include our Eastern, Midwest, Southern and Western Groups, provide collection, transfer, recycling and disposal services. Our fifth operating group is the Wheelabrator Group, which provides waste-to-energy services. We also provide additional waste management services that are not managed through our five Groups, which are presented in this report as “Other.” Additional information related to our segments, including changes in the basis for our reported segments from December 31, 2008, can be found under “Reclassifications” below and in Note 9.

 

The Condensed Consolidated Financial Statements as of and for the three and nine months ended September 30, 2009 and 2008 are unaudited. In the opinion of management, these financial statements include all adjustments, which, unless otherwise disclosed, 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, 2008.

 

In preparing our financial statements, we make numerous estimates and assumptions that affect the accounting for and recognition and disclosure of assets, liabilities, equity, revenues and expenses. We must make these estimates and assumptions because certain 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. In preparing our financial statements, 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, asset impairments, and self-insurance reserves and recoveries. Actual results could differ materially from the estimates and assumptions that we use in the preparation of our financial statements.

 

Adoption of New Accounting Standards

 

Fair Value Measurements — In September 2006, the Financial Accounting Standards Board issued new authoritative guidance associated with fair value measurements. This guidance defined fair value, established a framework for measuring fair value, and expanded disclosures about fair value measurements. In February 2008, the FASB delayed the effective date of the new guidance for all non-financial assets and non-financial liabilities, except those that are measured at fair value on a recurring basis. Accordingly, we adopted this guidance for assets and liabilities recognized at fair value on a recurring basis effective January 1, 2008 and adopted the guidance for non-financial assets and liabilities measured on a non-recurring basis effective January 1, 2009. The application of the fair value framework did not have a material impact on our consolidated financial position, results of operations or cash flows.

 

Business Combinations — In December 2007, the FASB issued revisions to the authoritative guidance associated with business combinations. This guidance clarified and revised the principles for how an acquirer

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

recognizes and measures identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree. This guidance also addressed the recognition and measurement of goodwill acquired in business combinations and expanded disclosure requirements related to business combinations. Effective January 1, 2009, we adopted the FASB’s revised guidance associated with business combinations. The portions of this guidance that relate to business combinations completed before January 1, 2009 did not have a material impact on our consolidated financial statements. Further, business combinations completed in 2009 have not been material to our financial position, results of operations or cash flows. However, to the extent that future business combinations are material, our adoption of the FASB’s revised authoritative guidance associated with business combinations will significantly impact our accounting and reporting for future acquisitions, principally as a result of (i) expanded requirements to value acquired assets, liabilities and contingencies at their fair values when such amounts can be determined and (ii) the requirement that acquisition-related transaction and restructuring costs be expensed as incurred rather than capitalized as a part of the cost of the acquisition.

 

Noncontrolling Interests in Consolidated Financial Statements — In December 2007, the FASB issued new authoritative guidance that established accounting and reporting standards for noncontrolling interests in subsidiaries and for the deconsolidation of a subsidiary. The guidance also established that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. We adopted this new guidance on January 1, 2009. The presentation and disclosure requirements of this guidance, which must be applied retrospectively for all periods presented, have resulted in reclassifications to our prior period consolidated financial information and the remeasurement of our 2008 effective tax rates, which are discussed in Note 4.

 

Subsequent Events — In May 2009, the FASB established standards related to accounting for, and disclosure of, events that occur after the balance sheet date, but before financial statements are issued or are available to be issued. We have adopted the provisions of this new authoritative guidance, which became effective for interim and annual reporting periods ending after June 15, 2009. Subsequent events have been evaluated through the date and time the financial statements were issued on October 29, 2009. No material subsequent events have occurred since September 30, 2009 that required recognition or disclosure in our current period financial statements.

 

Reclassifications

 

Statement of Cash Flows — As a result of an increase in the significance of certain non-cash expenses, we have elected to separately identify the effects of “Interest accretion on landfill liabilities,” “Interest accretion on and discount rate adjustments to environmental remediation liabilities and recovery assets” and “Equity-based compensation expense” within the “Cash flows from operating activities” section of our Condensed Consolidated Statements of Cash Flows. We have made reclassifications in our 2008 Condensed Consolidated Statements of Cash Flows to conform prior-year information with our current period presentation.

 

Segments — During the first quarter of 2009, we transferred responsibility for the oversight of day-to-day recycling operations at our material recovery facilities and secondary processing facilities to the management teams of our four geographic Groups. We believe that, by integrating the management of these aspects of our recycling operations with the remainder of our solid waste business, we can more efficiently provide comprehensive environmental solutions to our customers and ensure that we are focusing on maximizing the profitability and return on invested capital of all aspects of our business. As a result of this operational change, we also changed the way we review the financial results of our geographic Groups. Beginning in 2009, the financial results of our material recovery facilities and secondary processing facilities are included as a component of their respective geographic Group and the financial results of our recycling brokerage business and electronics recycling services are included as part of our “Other” operations. We have reflected the impact of these changes for all periods presented to provide financial information that consistently reflects our current approach to managing our geographic Group operations. Refer to Note 9 for further discussion about our reportable segments.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Certain other minor reclassifications have been made to our prior period consolidated financial information in order to conform to the current year presentation.

 

 

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 year ended December 31, 2008 and the nine months ended September 30, 2009 are reflected in the table below (in millions):

 

 

 

 

At several of our landfills, we provide financial assurance by depositing cash into restricted trust funds or escrow accounts for purposes of settling closure, post-closure and environmental remediation obligations. The fair value of these escrow accounts and trust funds was $230 million at September 30, 2009, and is primarily included as long-term “Other assets” in our Condensed Consolidated Balance Sheet.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

The following table summarizes the major components of debt at each balance sheet date (in millions) and provides the maturities and interest rates of each major category as of September 30, 2009:

 

 

As of September 30, 2009, we had (i) $1,014 million of debt maturing within twelve months, consisting primarily of $269 million under our Canadian credit facility and $600 million of 7.375% senior notes that mature in August 2010; and (ii) $723 million of fixed-rate tax-exempt borrowings subject to re-pricing within the next twelve months. Under accounting principles generally accepted in the United States, this $1,737 million of debt must be classified as current unless we have the intent and ability to refinance it on a long-term basis. As discussed below, as of September 30, 2009, we had the intent and ability to refinance $995 million of this debt on a long-term basis. We have classified the remaining $742 million as current obligations as of September 30, 2009.

 

All of the borrowings outstanding under the Canadian credit facility mature less than one year from the date of issuance, but may be renewed under the terms of the facility, which matures in November 2012. As of September 30, 2009, we intend to repay $18 million of the outstanding borrowings under the facility with available cash during the next twelve months and refinance the remaining balance under the terms of the facility. As a result, as of September 30, 2009, $251 million of advances under the facility were classified as long-term based on our intent and ability to refinance the obligations on a long-term basis under the terms of the facility.

 

Additionally, we have classified the $723 million of tax-exempt bonds subject to re-pricing within twelve months as long-term as of September 30, 2009 based on our intent and ability to refinance any failed re-pricings using our $2.4 billion revolving credit facility. Although we also intend to refinance the $600 million of senior notes maturing in August 2010 on a long-term basis, an aggregate of $1,632 million of capacity under our revolving credit facility is currently utilized to support outstanding letters of credit and we currently expect our utilization of the facility for this purpose to increase by $24 million during the next twelve months. After giving effect to these items, only $21 million of capacity is forecasted to be available under the revolving credit facility, giving us the ability to classify only $21 million of the August 2010 maturity as long-term as of September 30, 2009.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The significant changes in our debt balances from December 31, 2008 to September 30, 2009 are related to the following:

 

 

The remaining change in the carrying value of our senior notes from December 31, 2008 to September 30, 2009 is due to accounting for our fixed-to-floating interest rate swap agreements, which are accounted for as fair value hedges resulting in all fair value adjustments being reflected as a component of the carrying value of the underlying debt. For additional information regarding our interest rate derivatives, refer to Note 11.

 

 

 

Our effective tax rate for the three and nine months ended September 30, 2009 was 31.2% and 35.2%, respectively, compared with 38.4% and 37.6%, respectively, for the comparable prior-year periods. As a result of our adoption on January 1, 2009 of accounting guidance associated with noncontrolling interests in consolidated financial statements, the measurement of our effective tax rate has changed from previous years. This change is a result of an increase in our “Income before income taxes” because of the exclusion from this measure of “Net income attributable to noncontrolling interests,” or what was previously referred to as “Minority interest” expense. Our 2008 effective tax rates have been remeasured and reported in a manner consistent with the current measurement approach. Amounts reported as “Net income attributable to noncontrolling interests” are reported net of any applicable taxes.

 

The most significant items affecting the reconciliation of income taxes computed at the federal statutory rate and reported income taxes for the three- and nine-month periods ended September 30, 2009 were (i) the finalization of our 2008 tax returns, which reduced our provision for income taxes by $11 million; (ii) tax audit settlements, which reduced our provision for income taxes by $9 million; (iii) a $5 million benefit related to the utilization of

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

state net operating loss carryforwards; (iv) the impacts of state and local income taxes; and (v) a $6 million increase in our provision for income taxes related to an increase in our net accumulated state deferred tax liabilities.

 

The difference between income taxes computed at the federal statutory rate and reported income taxes for the three- and nine-month periods ended September 30, 2008 was primarily due to state and local income taxes. For the nine months ended September 30, 2008, the increase from state and local income taxes was offset, in part, by the favorable impact of tax audit settlements, which reduced our provision for income taxes by $13 million, and a $3 million tax benefit recognized for the final true-up of our non-conventional fuel tax credits.

 

We evaluate our effective tax rate at each interim period and adjust it accordingly as facts and circumstances warrant.

 

 

Comprehensive income was as follows (in millions):

 

 

The components of accumulated other comprehensive income, which is included as a component of Waste Management, Inc. stockholders’ equity, were as follows (in millions):

 

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

Basic and diluted earnings per share were computed using the following common share data (shares in millions):

 

 

 

Purchase commitments — We continue to focus on the expansion of our waste-to-energy business and are actively pursuing various projects in the United States and internationally. In August 2009, we entered into an agreement to purchase a 40 percent equity investment in Shanghai Environment Group (“SEG”), a subsidiary of Shanghai Chengtou Holding, for approximately $140 million. As a joint venture partner in SEG, we will participate in the operation and management of waste-to-energy and other waste services in the Chinese market. SEG will also focus on building new waste-to-energy facilities in China. Our purchase of an interest in SEG is subject to regulatory approval, but the transaction is currently expected to be approved in early 2010.

 

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. Letters of credit generally are supported by our revolving credit facility and other credit facilities established for that purpose. We obtain surety bonds and insurance policies from an entity in which we have a noncontrolling financial interest. We also obtain insurance from a wholly-owned insurance company, the sole business of which is to issue policies for us. In those instances where our use of financial assurance from entities we own or have financial interests in is not allowed, we generally have available alternative financial assurance mechanisms.

 

Management does not expect to have any claims against or draws on these instruments that would have a material adverse effect on our consolidated financial statements and we have not experienced any unmanageable difficulty in obtaining the required financial assurance instruments for our current operations.

 

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 significant 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 and internal estimates. The estimated accruals for these liabilities could be affected if future occurrences or loss development significantly

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

differ from the assumptions used. 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.

 

Guarantees — In the ordinary course of our business, WMI and WM Holdings enter into guarantee agreements associated with their subsidiaries’ operations. Additionally, WMI and WM Holdings have each guaranteed all of the senior debt of the other entity. No additional liabilities have been recorded for these intercompany guarantees because all of the underlying obligations are reflected in our Condensed Consolidated Balance Sheets.

 

We also have guaranteed the obligations of, and provided indemnification to, third parties in the ordinary course of business. Guarantee agreements outstanding as of September 30, 2009 include (i) guarantees of unconsolidated entities’ financial obligations maturing through 2020 for maximum future payments of $10 million; and (ii) agreements guaranteeing the market value of homeowners’ properties adjacent to or near certain of our landfills. Our indemnification obligations generally arise in divestitures and provide that we will be responsible for liabilities associated with our operations for events that occurred prior to the sale of the operations. Additionally, under certain of our acquisition agreements, we have provided for additional consideration to be paid to the sellers if established financial targets are achieved post-closing. For acquisitions completed in 2009, we have recognized liabilities for these contingent obligations based on an estimate of the fair value of these contingencies at the time of acquisition. For acquisitions completed before 2009, the costs associated with any additional consideration requirements are accounted for as incurred. Contingent obligations related to indemnifications arising from our divestitures and contingent consideration provided for by our acquisitions are not expected to be material to our financial position, results of operations or cash flows.

 

Environmental matters — A significant portion of our operating costs and capital expenditures could be characterized as costs of environmental protection, as we are subject to an array of laws and regulations relating to the protection of the environment. Under current laws and regulations, we may have liabilities for environmental damage caused by our operations, or for damage caused by conditions that existed before we acquired a site. In addition to remediation activity required by state or local authorities, such liabilities include potentially responsible party, or PRP, investigations. The costs associated with these liabilities can include settlements, certain legal and consultant fees, as well as incremental internal and external costs directly associated with site investigation and clean-up.

 

Estimating our degree of responsibility for remediation of a particular site is inherently difficult and determining the method and ultimate cost of remediation requires that a number of assumptions be made. There can sometimes be a range of reasonable estimates of the costs associated with the likely remedy of a site. In these cases, we use the amount within the range that constitutes our best estimate. If no amount within a range appears to be a better estimate than any other, we use the amount that is the low end of such range. If we used the high ends of such ranges, our aggregate potential liability would be approximately $145 million higher than the $261 million recorded in the Condensed Consolidated Financial Statements as of September 30, 2009. Our ongoing review of our remediation liabilities could result in revisions to our accruals that could cause upward or downward adjustments to income from operations. These adjustments could be material in any given period.

 

As of September 30, 2009, we had been notified that we are a PRP in connection with 74 locations listed on the EPA’s National Priorities List, or NPL. Of the 74 sites at which claims have been made against us, 16 are sites we own. Each of the NPL sites we own was initially developed by others as a landfill disposal facility. At each of these facilities, we are working in conjunction with the government to characterize or remediate identified site problems, and we have either agreed with other legally liable parties on an arrangement for sharing the costs of remediation or are working toward a cost-sharing agreement. We generally expect to receive any amounts due from other participating parties at or near the time that we make the remedial expenditures. The other 58 NPL sites, which we do not own, are at various procedural stages under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, known as CERCLA or Superfund.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Litigation — In April 2002, two former participants in the ERISA plans of Waste Management Holdings, Inc., a wholly-owned subsidiary we acquired in 1998 (“WM Holdings”), filed a lawsuit in the U.S. District Court for the District of Columbia in a case entitled William S. Harris, et al. v. James E. Koenig, et al. The lawsuit named as defendants WM Holdings and various members of WM Holdings’ Board of Directors prior to July 1998, and the Administrative Committee of WM Holdings’ ERISA plans and its individual members; various members of the Administrative and Investment Committees of WMI’s ERISA plans; and State Street Bank & Trust, the trustee and investment manager of WMI’s ERISA plans. The lawsuit attempts 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 WMI that was settled in 2001. The defendants filed motions to dismiss the complaints on the pleadings, and in April 2009, the Court granted in part and denied in part the defendants’ motions. The Court dismissed the plaintiffs’ claims that were based on alleged accounting irregularities by WM Holdings for the period between January 1990 and February 1998. However, the Court denied defendants’ motion to dismiss plaintiffs’ claims alleging breaches of fiduciary duties against all of the defendants during the time period between July 1999 and December 1999 based primarily on defendants allowing the WM Holdings ERISA plan to participate in the settlement of the securities class action against WM Holdings. Each of Mr. Pope, Mr. Rothmeier and Ms. San Juan Cafferty, members of our Board of Directors, was a member of the WM Holdings’ Board of Directors and therefore is a named defendant in these actions, as is Mr. Simpson, our Chief Financial Officer, by virtue of his membership on the WMI ERISA plan Investment Committee at that time. The Court also denied the defendants’ motion for dismissal for the claims related to the period between February 2002 and July 2002 against State Street for failing to adequately represent the plaintiffs’ interests in the settlement of the securities class action against WMI. All of the defendants intend to defend themselves vigorously.

 

There are two separate wage and hour lawsuits pending against certain of our subsidiaries in California, each seeking class certification. The actions have recently been coordinated to proceed in San Diego County. Both lawsuits make the same general allegations that the defendants failed to comply with certain California wage and hour laws, including allegedly failing to provide meal and rest periods, and failing to properly pay hourly and overtime wages. Similarly, a purported class action lawsuit was filed against WMI in August 2008 in federal court in Minnesota alleging that we violated the Fair Labor Standards Act. The court in the Minnesota lawsuit denied the plaintiffs’ motion for conditional class certification, and the plaintiffs have asked for reconsideration. The plaintiffs also have indicated that without class certification, they intend to pursue their claims through individual lawsuits. We deny the claims in all of the actions and intend to continue to vigorously defend all of these matters. Given the inherent uncertainties of litigation, the ultimate outcomes cannot be predicted at this time, nor can possible damages, if any, be reasonably estimated.

 

From time to time, we also are named as defendants in personal injury and property damage lawsuits, including purported class actions, on the basis of having owned, operated or transported waste to a disposal facility that is alleged to have contaminated the environment or, in certain cases, on the basis of having conducted environmental remediation activities at sites. Some of the lawsuits may seek to have us pay the costs of monitoring of allegedly affected sites and health care examinations of allegedly affected persons for a substantial period of time even where no actual damage is proven. While we believe we have meritorious defenses to these lawsuits, the ultimate resolution is often substantially uncertain due to the difficulty of determining the cause, extent and impact of alleged contamination (which may have occurred over a long period of time), the potential for successive groups of complainants to emerge, the diversity of the individual plaintiffs’ circumstances, and the potential contribution or indemnification obligations of co-defendants or other third parties, among other factors.

 

As a large company with operations across the United States and Canada, we are subject to various proceedings, lawsuits, disputes and claims arising in the ordinary course of our business. Many of these actions raise complex factual and legal issues and are subject to uncertainties. Actions filed against us include commercial, customer, and employment-related claims, including purported class action lawsuits related to our customer service agreements and purported class actions involving federal and state wage and hour and other laws. The plaintiffs in

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

some actions seek unspecified damages or injunctive relief, or both. These actions are in various procedural stages, and some are covered in part by insurance. We currently do not believe that any such actions will ultimately have a material adverse impact on our consolidated financial statements.

 

WMI’s charter and bylaws currently require indemnification of its officers and directors if statutory standards of conduct have been met and allow the advancement of expenses to these individuals upon receipt of an undertaking by the individuals to repay all expenses if it is ultimately determined that they did not meet the required standards of conduct. Additionally, WMI has entered into separate indemnification agreements with each of the members of its Board of Directors as well as its Chief Executive Officer, its President and its Chief Financial Officer. The Company may incur substantial expenses in connection with the fulfillment of its advancement of costs and indemnification obligations in connection with current actions involving former officers of the Company or its subsidiaries, including the Harris lawsuit mentioned above, or other actions or proceedings that may be brought against its former or current officers, directors and employees.

 

On March 20, 2008, we filed a lawsuit in state district court in Harris County, Texas against SAP AG and SAP America, Inc., alleging fraud and breach of contract. The lawsuit relates to our 2005 software license from SAP for a waste and recycling revenue management system and agreement for SAP to implement the software on a fixed-fee basis. We have alleged (i) that SAP demonstrated and sold software that SAP represented was a mature, “out-of-the-box” software solution that met the specific business requirements of the Company, (ii) that SAP represented no production, modification or customization would be necessary and (iii) that SAP represented the software would be fully implemented throughout the Company in 18 months. We are vigorously pursuing all claims available, including recovery of all payments we have made, costs we have incurred and the benefits we have not realized. SAP filed a general denial to the suit. Discovery is ongoing and trial is currently scheduled for May 2010.

 

During the first quarter of 2009, we determined to enhance and improve our existing revenue management system and not pursue alternatives associated with the development and implementation of a revenue management system that would include the licensed SAP software. Accordingly, after careful consideration of the failures and immaturity of the SAP software, we determined to abandon any alternative that includes the use of the SAP software. Our determination to abandon the SAP software resulted in a non-cash impairment charge of $49 million. Refer to Note 10 for additional information related to the impairment charge.

 

Item 103 of the SEC’s Regulation S-K requires disclosure of certain environmental matters when a governmental authority is a party to the proceedings and the proceedings involve potential monetary sanctions that we reasonably believe could exceed $100,000. The following matter, pending as of September 30, 2009, is disclosed in accordance with that requirement:

 

On April 4, 2006, the EPA issued a Finding and Notice of Violation (“FNOV”) to Waste Management of Hawaii, Inc., an indirect wholly-owned subsidiary of WMI, and to the City and County of Honolulu for alleged violations of the federal Clean Air Act, based on alleged failure to submit certain reports and design plans required by the EPA, and the failure to begin and timely complete the installation of a gas collection and control system for the Waimanalo Gulch Sanitary Landfill on Oahu. The FNOV did not propose a penalty amount and the parties have been in confidential settlement negotiations. Pursuant to an indemnity agreement, any penalty assessed will be paid by the Company, and not by the City and County of Honolulu.

 

Tax matters — In the third quarter of 2009 we effectively settled our 2008 federal tax audit and various state tax audits resulting in a tax benefit of $9 million. We participate in the IRS’s Compliance Assurance Program, whereby we work with the IRS throughout the year in order to resolve any material issues prior to the filing of our year-end tax return. We are currently in the examination phase of an IRS audit for the 2009 tax year. We expect this audit to be completed within the next 15 months. Audits associated with state and local jurisdictions date back to 1999 and examinations associated with Canada date back to 1998. To provide for certain potential tax exposures, we maintain a liability for unrecognized tax benefits, 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 as audits

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

are completed, although we do not believe that current tax audit matters will have a material adverse impact on our results of operations.

 

We have approximately $2.8 billion of tax-exempt bonds outstanding as of September 30, 2009. Tax-exempt financings are structured pursuant to certain terms and conditions of the Internal Revenue Code, which exempt from taxation the interest income earned by the bondholders. The requirements of the Code are complex, and failure to comply with these requirements could cause certain interest payments previously made on the bonds to be taxable and could cause either outstanding principal amounts on the bonds to be accelerated or future interest payments on the bonds to be taxable. Some of the Company’s tax-exempt financings have been, or currently are, the subject of examinations by the IRS to determine whether the financings meet the requirements of the Code and applicable regulations. We do not believe that current examinations will have a material adverse impact on our financial position, results of operations or cash flows.

 

 

In January 2009, we took steps to further streamline our organization by (i) consolidating many of our Market Areas; (ii) integrating the management of our recycling operations with the remainder of our solid waste business; and (iii) realigning our Corporate organization with this new structure in order to provide support functions more efficiently.

 

Our principal operations are managed through our Groups, which are discussed in Note 9. Each of our four geographic Groups had been further divided into several Market Areas. As a result of our restructuring, the 45 separate Market Areas that we previously operated have been consolidated into 25 Areas. We found that our larger Market Areas generally were able to achieve efficiencies through economies of scale that were not present in our smaller Market Areas, and this reorganization has allowed us to lower costs and to continue to standardize processes and improve productivity. In addition, during the first quarter of 2009, responsibility for the oversight of day-to-day recycling operations at our material recovery facilities and secondary processing facilities was transferred from our Waste Management Recycle America, or WMRA, organization to our four geographic Groups. By integrating the management of these recycling services with the remainder of our solid waste business, we are able to more efficiently provide comprehensive environmental solutions to our customers. In addition, as a result of this realignment, we have significantly reduced the overhead costs associated with managing this portion of our business and have increased the geographic Groups’ focus on maximizing the profitability and return on invested capital of all aspects of our business.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

This reorganization has eliminated over 1,500 employee positions throughout the Company. During the three and nine months ended September 30, 2009, we recognized $3 million and $46 million, respectively, of pre-tax restructuring charges associated with this reorganization, of which $2 million and $40 million, respectively, were related to employee severance and benefit costs. The remaining charges were primarily related to abandoned operating lease agreements. The following table summarizes the charges recognized for this restructuring by each of our current reportable segments and our Corporate and Other organizations (in millions):

 

 

Through September 30, 2009, we had paid approximately $32 million of the employee severance and benefit costs incurred as a result of this restructuring. The length of time we are obligated to make severance payments varies, with the longest obligation continuing through the fourth quarter of 2010.

 

We currently expect to incur additional restructuring charges of between $5 million and $10 million associated with this reorganization during the remainder of 2009.

 

 

We currently manage and evaluate our operations primarily through our Eastern, Midwest, Southern, Western and Wheelabrator Groups. These five Groups are presented below as our reportable segments. Our segments provide 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 services and other services to commercial, industrial, municipal and residential customers throughout the United States and in Puerto Rico and Canada. The operations not managed through our five operating Groups are presented herein as “Other.”

 

As a result of the transfer of responsibility for the oversight of day-to-day recycling operations at our material recovery facilities and secondary processing facilities to the management teams of our geographic Groups, we also changed the way we review the financial results of our geographic Groups. Beginning in 2009, the financial results of our material recovery facilities and secondary processing facilities are included as a component of their respective geographic Group and the financial results of our recycling brokerage business and electronics recycling services are included as part of our “Other” operations. We have reflected the impact of these changes for all periods presented to provide financial information that consistently reflects our current approach to managing our geographic Group operations.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Summarized financial information concerning our reportable segments for the three and nine months ended September 30 is shown in the following tables (in millions):

 

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Fluctuations in our operating results may be caused by many factors, including period-to-period changes in the relative contribution of revenue by each line of business and operating segment and by general economic conditions. In addition, our revenues and income from operations typically reflect seasonal patterns. 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, although we saw a significantly weaker seasonal volume increase during 2009 than we generally experience.

 

Although there have not been significant impacts of weather-related services for the reported periods, certain destructive weather conditions that tend to occur during the second half of the year actually increase our revenues in the areas affected. For several reasons, including significant start-up costs, such revenue often generates comparatively lower margins. Certain weather conditions may result in the temporary suspension of our operations, which can significantly affect the operating results of the affected regions. The operating results of our first quarter also often reflect higher repair and maintenance expenses because we rely on the slower winter months, when waste flows are generally lower, to perform scheduled maintenance at our waste-to-energy facilities.

 

During the periods presented, the comparability of the revenue and operating results of our geographic Groups has been significantly affected by (i) the economic downturn, which resulted in a decrease in our revenues when comparing the three and nine months ended September 30, 2009 with the comparable prior-year periods due to reduced consumer and business spending; (ii) sharply lower recycling commodities prices and diesel fuel prices when comparing the three and nine months ended September 30, 2009 with the comparable prior-year periods, which resulted in a decline in both revenues and operating expenses; and (iii) our continued focus on pricing, which has increased revenues and the operating margins of our collection line of business.

 

The revenues and operating results of our Wheelabrator Group have been unfavorably affected by a significant decrease in the rates charged for electricity under our power purchase contracts, which are tied to natural gas prices. Exposure to market fluctuations in natural gas prices has increased for the Wheelabrator Group in 2009 due in large part to the expiration of several long-term energy contracts. Additionally, the Company’s current focus on the expansion of our waste-to-energy business both internationally and domestically has increased Wheelabrator’s costs and expenses, which has negatively affected the comparability of their operating results for the periods presented.

 

From time to time, the operating results of our reportable segments are significantly affected by unusual or infrequent transactions or events. As disclosed in Note 8, the income from operations of each of our geographic Groups for the three and nine months ended September 30, 2009 has been affected by our January 2009 reorganization. In addition, the Midwest Group’s operating results for the three and nine months ended September 30, 2008 were negatively affected by $26 million of increased “Operating” expenses due to a labor disruption associated with the renegotiation of a collective bargaining agreement in Milwaukee, Wisconsin and the related agreement of the bargaining unit to withdraw from the Central States Pension Fund.

 

 

Three and Nine Months Ended September 30, 2009

 

As of December 31, 2008, our “Property and equipment” included $70 million of accumulated costs associated with the development of our waste and recycling revenue management system. Approximately $49 million of these costs were specifically associated with the purchase of the license of SAP’s waste and recycling revenue management software and the efforts required to develop and configure that software for our use. The remaining costs were primarily associated with the general efforts of integrating a revenue management system with our existing applications and hardware.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

After a failed pilot implementation of the software in one of our smallest market areas, the development efforts associated with this revenue management system were suspended in 2007. As disclosed in Note 7, in March 2008, we filed suit against SAP and are currently scheduled for trial in May 2010.

 

During the first quarter of 2009, we determined to enhance and improve our existing revenue management system and not pursue alternatives associated with the development and implementation of a revenue management system that would include the licensed SAP software. Accordingly, after careful consideration of the failures of the SAP software, we determined to abandon any alternative that would include the use of the SAP software. The determination to abandon the SAP software as our revenue management system resulted in a non-cash charge of $49 million.

 

Three and Nine Months Ended September 30, 2008

 

We recognized $28 million of net gains from divestitures during the nine months ended September 30, 2008 related to the divestiture of under-performing collection operations in our Southern Group, $2 million of which was recognized during the first quarter of 2008 and $26 million of which was recognized during the third quarter of 2008. The impact of the gains from divestitures was offset, in part, by the recognition of a $3 million impairment charge during the third quarter of 2008 as a result of a decision to close a landfill in our Southern Group.

 

 

Assets and Liabilities Accounted for at Fair Value

 

Authoritative guidance associated with fair value measurements provides a framework for measuring fair value and establishes a fair value hierarchy that prioritizes the inputs used to measure fair value, giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs).

 

We use valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. In measuring the fair value of our assets and liabilities, we use market data or assumptions that we believe market participants would use in pricing an asset or liability, including assumptions about risk when appropriate. As of September 30, 2009, our assets and liabilities that are measured at fair value on a recurring basis include the following (in millions):

 

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

 

Gains or losses on the derivatives as well as the offsetting losses or gains on the hedged items attributable to interest rate swaps are recognized in current earnings. We include gains and losses on derivative instruments in the same financial statement line item as offsetting gains and losses on the related hedged items. The following table summarizes the impact of changes in the fair value of our interest rate swaps and the underlying hedged items on our results of operations for the three and nine months ended September 30, 2009 (in millions):

 

 

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

Gains or losses on the derivatives as well as the offsetting losses or gains on the hedged items attributable to foreign currency exchange risk are recognized in current earnings. We include gains and losses on derivative instruments in the same financial statement line item as offsetting gains and losses on the related hedged items. The following table summarizes the pre-tax impacts of our foreign currency cash flow derivatives on our results of operations and comprehensive income for the three and nine months ended September 30, 2009 (in millions):

 

 

The above table represents the impacts of our foreign exchange contracts on a pre-tax basis. Amounts reported in other comprehensive income and accumulated other comprehensive income are reported net of tax. We recognized an after-tax loss to other comprehensive income for changes in the fair value of our foreign currency cash flow hedges of $18 million during the three months ended September 30, 2009 and $25 million during the nine months ended September 30, 2009. After-tax losses reclassified from accumulated other comprehensive income into income were $17 million and $25 million during the three and nine months ended September 30, 2009, respectively. There was no significant ineffectiveness associated with these hedges during the three and nine months ended September 30, 2009.

 

Fair Value of Debt

 

At September 30, 2009, the carrying value of our debt was approximately $8.2 billion compared with $8.3 billion at December 31, 2008. The carrying value of our debt includes adjustments for both the unamortized fair value adjustments related to terminated hedge arrangements and fair value adjustments of debt instruments that are currently hedged.

 

The estimated fair value of our debt was approximately $8.6 billion at September 30, 2009 and approximately $7.7 billion at December 31, 2008. The estimated fair value of our senior notes is based on quoted market prices. The carrying value of remarketable debt approximates fair value due to the short-term nature of the attached interest rates. The fair value of our other debt is estimated using discounted cash flow analysis, based on rates we would currently pay for similar types of instruments. The increase in the fair value of our debt when comparing September 30, 2009 with December 31, 2008 is primarily related to (i) an increase in market prices for corporate debt securities due to a significant improvement in the condition of the credit markets as compared with late 2008, which caused a substantial increase in the fair value of our publicly-traded senior notes; and (ii) a significant decrease in current market rates on fixed-rate tax-exempt bonds.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Although we have determined the estimated fair value amounts using available market information and commonly accepted valuation methodologies, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values. The fair value estimates are based on information available as of September 30, 2009 and December 31, 2008. These amounts have not been revalued since those dates, and current estimates of fair value could differ significantly from the amounts presented.

 

 

WM Holdings has fully and unconditionally guaranteed all of WMI’s senior indebtedness. WMI has fully and unconditionally guaranteed all of WM Holdings’ senior indebtedness. 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):

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

CONDENSED CONSOLIDATING BALANCE SHEETS

 

September 30, 2009
(Unaudited)