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 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 27, 2008 was 490,571,189 (excluding treasury shares of 139,711,272).

 

 

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 STOCKHOLDERS’ 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 Condensed Consolidated Financial Statements presented in this report include the accounts of Waste Management, Inc., a Delaware corporation, our wholly-owned and majority-owned subsidiaries and certain variable interest entities for which we have determined that we are the primary beneficiary. Waste Management, Inc. is a holding company and all operations are conducted by 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 the parent holding company.

 

WMI was incorporated in Oklahoma in 1987 under the name “USA Waste Services, Inc.” and was reincorporated as a Delaware company in 1995. In a 1998 merger, the Illinois-based waste services company formerly known as Waste Management, Inc. became a wholly-owned subsidiary of WMI and changed its name to Waste Management Holdings, Inc. (“WM Holdings”). At the same time, our parent holding company changed its name from USA Waste Services to Waste Management, Inc. Like WMI, WM Holdings is a holding company and all operations are conducted by subsidiaries. For detail on the financial position, results of operations and cash flows of WMI, WM Holdings and their subsidiaries, see Note 12.

 

We manage and evaluate our principal operations through six operating Groups, of which four are organized by geographic area and two are organized by function. The geographic Groups include our Eastern, Midwest, Southern and Western Groups, and the two functional Groups are our Wheelabrator Group, which provides waste-to-energy services, and our WM Recycle America, or WMRA, Group. We also provide additional waste management services that are not managed through our six Groups, which are presented in this report as “Other.” Refer to Note 9 for additional information related to our segments.

 

The Condensed Consolidated Financial Statements as of and for the three and nine months ended September 30, 2008 and 2007 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, 2007.

 

In preparing our financial statements, we make numerous estimates and assumptions that affect the accounting for and recognition and disclosure of assets, liabilities, stockholders’ 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.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Accounting Change — In September 2006, the Financial Accounting Standards Board issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. Effective January 1, 2008, we adopted SFAS No. 157 for assets and liabilities recognized at fair value on a recurring basis. Our adoption of SFAS No. 157 during the first quarter of 2008 resulted in the recognition of a $6 million charge to operating expenses and a corresponding $3 million credit to minority interest expense for the re-measurement of the fair value of environmental remediation recovery assets accounted for in accordance with Statement of Position No. 96-1, Environmental Remediation Liabilities. The adoption of SFAS No. 157 did not materially affect our consolidated financial position, results of operations or cash flows. Refer to Note 11 for information about our fair value measurements.

 

Reclassification of Segment Information — In the second quarter of 2008, we realigned our Midwest and Western Group organizations to facilitate improved business execution. We moved certain Canadian business operations from the Western Group to the Midwest Group. We have reflected the impact of this realignment for all periods presented to provide financial information that consistently reflects our current approach to managing our operations. Refer to Note 9 for information about our reportable segments.

 

 

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, 2007 and the nine months ended September 30, 2008 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

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

value of these escrow accounts and trust funds was $218 million at September 30, 2008, and is primarily included as long-term “Other assets” in our Condensed Consolidated Balance Sheet.

 

 

The following table summarizes the major components of debt at each balance sheet date (in millions):

 

 

We have $1.3 billion of scheduled debt maturities during the next twelve months. We have classified $522 million of these borrowings as long-term as of September 30, 2008 based on our intent and ability to refinance these borrowings on a long-term basis.

 

The significant changes in our debt balances from December 31, 2007 to September 30, 2008 are related to the following:

 

 

As of December 31, 2007 and September 30, 2008, $281 million and $255 million, respectively, of these advances 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.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

In connection with our issuance of the senior notes, we executed interest rate swap contracts with a total notional value of $200 million. We designated these fixed-to-floating interest rate swap agreements as fair value hedges, resulting in all fair value adjustments being reflected as a component of the carrying value of the underlying debt. For information related to the fair value of our interest rate derivatives, refer to Note 11.

 

We have $386 million of 6.5% senior notes that mature in November 2008 and $500 million of 6.875% senior notes that mature in May 2009. As of September 30, 2008, $267 million of this debt was classified as long-term based on our intent and ability to refinance the obligations on a long-term basis. We are currently evaluating our repayment options and expect to refinance the $886 million of senior notes maturing in the next twelve months on a long-term basis. However, our classification of the borrowings as long-term as of September 30, 2008 was limited to $267 million by the available and forecasted capacity of our $2.4 billion revolving credit facility, resulting in the remaining $619 million being reflected as a current debt obligation as of September 30, 2008.

 

 

 

Our effective tax rates for the three and nine months ended September 30, 2008 were 39.3% and 38.5%, respectively, compared with 36.1% and 31.5% for the three and nine months ended September 30, 2007, respectively. Our estimated recurring effective tax rate as of September 30, 2008 is 40.0%, which is relatively consistent with our estimated recurring effective tax rate throughout 2008. Our estimated recurring effective tax rate as of September 30, 2007 was 35.9%, which represents a 1.9 percentage point increase from the June 30, 2007 rate. This increase, which was largely due to revisions in our expectations for the phase-out of Section 45K tax credits, resulted in additional “Provision for income taxes” and a reduction in our “Net income” of $24 million, or $0.05 per diluted share, for the three and nine months ended September 30, 2007.

 

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, 2008 was primarily due to the unfavorable impact of state and local income taxes, which was offset, in part, by the favorable impacts of tax audit settlements and the true-up of our 2007 non-conventional fuel tax credits.

 

The difference between federal income taxes computed at the federal statutory rate and reported income taxes for the three months ended September 30, 2007 was primarily due to the impacts of state and local income taxes, which were offset in part by the favorable impacts of the finalization of our 2006 tax returns and tax audit

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

settlements. These items also affected our reported income taxes for the nine months ended September 30, 2007. In addition, our reported income taxes for the nine months ended September 30, 2007 were favorably affected by non-conventional fuel tax credits and the revaluation of deferred tax balances for scheduled tax rate reductions in Canada and an increase in state tax credits.

 

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

 

Tax audit settlements — The settlement of tax audits resulted in a reduction to our provision for income taxes of $13 million, or $0.03 per diluted share, for the nine months ended September 30, 2008. The settlement of various federal and state tax audits resulted in a reduction in our provision for income taxes of $3 million, or $0.01 per diluted share, for the three months ended September 30, 2007 and $30 million, or $0.06 per diluted share, for the nine months ended September 30, 2007.

 

Non-conventional fuel tax credits — The favorable impact of non-conventional fuel tax credits on our 2007 effective tax rate was derived from our investments in two coal-based, synthetic fuel production facilities and our landfill gas-to-energy projects. The fuel generated from the facilities and our landfill gas-to-energy projects qualified for tax credits through 2007 pursuant to Section 45K of the Internal Revenue Code. Our recorded taxes for the nine months ended September 30, 2007 included a benefit of $58 million from Section 45K tax credits.

 

Our effective tax rate for the three and nine months ended September 30, 2007 reflected our expectations for the phase-out of 52% of Section 45K tax credits generated during 2007. As of December 31, 2007, our estimate of the 2007 phase-out rate had increased to 69%. In April 2008, the IRS published the phase-out percentage that must be applied to Section 45K tax credits generated in 2007, which was 67.2%. Our provision for income taxes for the first quarter of 2008 included an adjustment of our 2007 year-end estimate to the final 2007 phase-out, which resulted in the recognition of a $3 million benefit.

 

The tax credits generated by our investments in the synthetic fuel production facilities were offset, in part, by the recognition of our pro-rata share of the facilities’ losses, which were recognized as “Equity in net losses of unconsolidated entities” and “Interest expense.” During the nine months ended September 30, 2007, we recognized $50 million of equity losses and $2 million of interest expense associated with our interest in the facilities. The income tax benefit attributable to the facilities was $65 million for the nine months ended September 30, 2007, including $44 million of Section 45K tax credits. Our investment in the facilities increased net income for the nine months ended September 30, 2007 by $13 million. Our interest in the facilities did not contribute significantly to net income for the three and nine months ended September 30, 2008 due to the expiration of our investments and Section 45K tax credits at the end of 2007.

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Comprehensive income was as follows (in millions):

 

 

The components of accumulated other comprehensive income were as follows (in millions):

 

 

 

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

 

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Financial instruments — We use letters of credit, performance bonds and insurance policies as well as trust funds and financial guarantees for our financial assurance needs, which include supporting 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 non-controlling financial interest and 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 captive insurance is not allowed, we generally have available alternative bonding 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 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. 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 and internal estimates. The estimated accruals for these liabilities could be affected if future occurrences or loss development significantly 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, 2008 include guarantees of unconsolidated entities’ financial obligations maturing through 2020 for maximum future payments of $10 million; agreements guaranteeing the market value of homeowners’ properties adjacent to landfills; and the guarantee of interest rate swap obligations of the funding entity in connection with our letter of credit facility. Our indemnification obligations generally provide that we will be responsible for liabilities associated with our operations for events that occurred prior to the sale of the operations. We do not believe that it is possible to determine the contingent obligations associated with these indemnities. 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. The costs associated with any additional consideration requirements are accounted for as incurred.

 

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 operations, or for damage caused by conditions that existed before we acquired a site. Such liabilities include potentially responsible party, or PRP, investigations, settlements, certain legal and consultant fees, as well as costs directly associated with site investigation and clean up, such as materials and incremental internal costs directly related to the remedy.

 

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 the range appears

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

to be a better estimate than any other, we use the amounts that are the low ends of such ranges 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 $150 million higher than the $273 million recorded in the Condensed Consolidated Financial Statements as of September 30, 2008. Our ongoing review of our remediation liabilities could result in revisions that could cause upward or downward adjustments to income from operations. These adjustments could also be material in any given period.

 

As of September 30, 2008, we had been notified by the government 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. All of the NPL sites we own were initially developed by others as landfill disposal facilities. The NPL sites are at various procedural stages under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, known as CERCLA or Superfund. CERCLA generally provides for liability for those parties owning, operating, transporting to or disposing at the sites. Proceedings arising under Superfund typically involve numerous waste generators and other waste transportation and disposal companies and seek to allocate or recover costs associated with site investigation and remediation, which costs could be substantial and could have a material adverse effect on our consolidated financial statements. At some of the sites at which we have been identified as a PRP, our liability is well defined as a consequence of a governmental decision and an agreement among liable parties as to the share each will pay for implementing that remedy. At other sites, where no remedy has been selected or the liable parties have been unable to agree on an appropriate allocation, our future costs are uncertain. Any of these matters potentially could have a material adverse effect on our consolidated financial statements.

 

Litigation — In April 2002, two former participants in WM Holdings’ ERISA plans 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; various members of WM Holdings’ Board of Directors prior to the acquisition of WM Holdings by WMI, including Pastora San Juan Cafferty, Steven Rothmeier and John C. Pope, each of whom is currently a director of WMI; the Administrative Committee of WM Holdings’ ERISA plans and its individual members, which included former officers and directors of WM Holdings; various members of the Administrative Committee of WMI’s ERISA plans, including former officers of WMI; various members of the Investment Committee of WMI’s ERISA plans, including former officers of WMI and Robert G. Simpson; 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. Subsequently, the issues related to the latter class action have been dropped as to WMI and all of its current and former officers and directors, including Mr. Simpson. The case is ongoing with respect to the other defendants, including Ms. Cafferty, Mr. Rothmeier and Mr. Pope, in their capacities as former directors of WM Holdings. All of the defendants intend to defend themselves vigorously.

 

There are two separate wage and hour lawsuits pending against us 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 in August 2008 in federal court in Minnesota alleging that we violated the Fair Labor Standards Act. The Company has filed a motion to dismiss, alleging lack of jurisdiction. We deny all of these claims and intend to vigorously defend these matters. As the litigation is in the early stages of the legal process, and given the inherent uncertainties of litigation, the ultimate outcome 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

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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. Accordingly, it is possible such matters could have a material adverse impact on our consolidated financial statements.

 

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 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 or other actions or proceedings, including the Harris lawsuit mentioned above, that may be brought against its former or current officers, directors and employees.

 

On March 20, 2008, we filed a lawsuit in state court in the Southern District of 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 that SAP contracted to provide software that would not need to be customized or enhanced and that the software would be fully implemented throughout the Company in 18 months. We are pursuing all legal remedies, including recovery of all payments we have made, costs we have incurred and savings not realized. SAP filed a general denial to the suit. Discovery is ongoing and we have been assigned a trial date of October 2009. We are vigorously pursuing all claims available.

 

We are still examining all of our alternatives associated with the development and implementation of a revenue management system, some of which may be affected by the ultimate resolution of the lawsuit. As we continue to assess the alternatives available to us, we may determine that the best course of action will be to move forward with another software and abandon the SAP revenue management system. If we decide to abandon the SAP software, the abandonment would result in a charge of between $45 million and $55 million.

 

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 are the three matters pending as of September 30, 2008 that are 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

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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.

 

On March 17, 2008, Chemical Waste Management, LLC, an indirect wholly-owned subsidiary of WMI, received a proposed Order on Consent and Complaint from the New York State Department of Environmental Conservation (“DEC”) alleging violations under the Resource Conservation and Recovery Act that were either self-reported by Chemical Waste or observed during DEC inspections involving handling, disposal and transportation-related activities. The Order provided for a civil penalty in the amount of $240,250 and covers the period from November 2000 through January 2007. Subsequently, at the request of Chemical Waste, the DEC agreed to amend its proposed Order to include an alleged storm water violation with a total proposed penalty of $290,000. The parties are engaged in confidential settlement discussions involving the alleged violations and amount of the penalty.

 

By letter dated September 22, 2006, the Pennsylvania Department of Environmental Protection proposed a Consent Agreement and Order to Shade Landfill, Inc., an indirect wholly-owned subsidiary of WMI, to address boron effluent values in excess of the landfill’s discharge permits between 2002 and 2006. The proposed Consent Agreement and Order included a proposed penalty of $200,000. The parties are in confidential settlement negotiations.

 

Multi-employer, defined benefit pension plans — We have collective bargaining agreements with various union locals across the United States. As a result of many of these agreements, certain of our subsidiaries are participating employers in a number of trustee-managed multi-employer, defined benefit pension plans for the affected employees, including the Central States Southeast and Southwest Areas Pension Plan (“Central States Pension Plan”). In March 2008, the Central States Pension Plan reported that it has adopted a rehabilitation plan as a result of its actuarial certification for the plan year beginning January 1, 2008, which placed the Central States Pension Plan in “critical status,” as defined by the Pension Protection Act of 2006. In connection with our ongoing re-negotiation of various collective bargaining agreements, we may discuss and negotiate for the complete or partial withdrawal from one or more of these pension plans. In September 2008, we recognized an $18 million charge to “Operating” expenses for the agreed-upon withdrawal of a bargaining unit in Milwaukee, Wisconsin from the Central States Pension Fund in connection with our negotiations of that unit’s agreement. We do not believe that our withdrawals from the multi-employer plans, individually or in the aggregate, would have a material adverse effect on our financial condition or liquidity. However, withdrawals of other bargaining units in the future could have a material adverse effect on our results of operations for the period in which any such withdrawal were recorded.

 

Tax matters — In the second quarter of 2008, we concluded the IRS audit of the 2006 tax year and recognized a $4 million net benefit as a reduction to our provision for income taxes. We are currently in the examination phase of IRS audits for the years 2007 and 2008. We expect the 2007 audit to be completed within the next three months and the 2008 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 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 $3.0 billion of tax-exempt financings as of September 30, 2008. 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 in the transactions. The requirements of the Code can be complex, and failure to comply with these requirements could cause certain past interest payments 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

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

and applicable regulations. It is possible that an adverse determination by the IRS could have a material adverse effect on the Company’s cash flows and results of operations.

 

 

In the first quarter of 2007, we restructured certain operations and functions resulting in the recognition of a charge of $9 million. We incurred an additional $1 million of costs for this restructuring during the second quarter of 2007, increasing the pre-tax costs incurred to date to $10 million. Approximately $7 million of our restructuring costs was incurred by our Corporate organization, $2 million was incurred by our Midwest Group and $1 million was incurred by our Western Group. These charges included $8 million for employee severance and benefit costs and $2 million related to operating lease agreements.

 

Through September 30, 2008, we had paid $7 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 first quarter of 2009.

 

 

We manage and evaluate our operations primarily through our Eastern, Midwest, Southern, Western, Wheelabrator and WMRA Groups. These six 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 six operating Groups are presented herein as “Other.”

 

During the second quarter of 2008, we realigned our Midwest and Western Group organizations to facilitate improved business execution. We reassigned responsibility for the management of certain Canadian business operations in the Western Group to the Midwest Group. The prior period segment information provided in the following table has been reclassified to reflect the impact of our realignment to provide financial information that consistently reflects our current approach to managing our 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)

 

 

The income from operations provided by our four geographic segments is generally indicative of the margins provided by our collection, landfill and transfer businesses, although these Groups do provide recycling and other services that can affect these margins. The operating margins provided by our Wheelabrator segment (waste-to-energy facilities and independent power production plants) have historically been higher than the margins provided by our base business generally due to the combined impact of long-term disposal and energy contracts and the disposal demands of the region in which our facilities are concentrated. Income from operations provided by our WMRA segment generally reflects operating margins typical of the recycling industry, which tend to be lower than those provided by our base business, but may fluctuate significantly as market prices for commodities change. Fluctuations in our operating results between quarters 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 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. Additionally, certain destructive weather conditions that tend to occur during the second half of the year actually increase our revenues in the areas affected. However, 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

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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.

 

From time to time, the operating results of our reportable segments are significantly affected by unusual or infrequent transactions or events. In addition to the impacts of “(Income) Expense from Divestitures, Asset Impairments and Unusual Items,” which are discussed in Note 10, the following items have significantly affected the operating results of our segments during the periods presented:

 

 

 

(Income) expense from divestitures (including held-for-sale impairments) — 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. Total proceeds from divestitures completed during the nine months ended September 30, 2008 were $48 million, which we primarily received in cash.

 

We recognized $44 million of net gains from divestitures during the nine months ended September 30, 2007. We recognized $9 million of net gains from divestitures during the first quarter of 2007 that were primarily related to collection and disposal operations in our Southern Group; $33 million of net gains from divestitures during the second quarter of 2007 that were primarily related to collection and transfer operations in our Eastern Group, collection operations in our Western Group and WMRA operations; and $2 million of net gains from divestitures during the third quarter of 2007. Total proceeds from divestitures completed during the nine months ended September 30, 2007 were $186 million, which were primarily received in cash.

 

Impairments of assets held-for-use — During the third quarter of 2008, we recognized a $3 million impairment charge as a result of a decision to close a landfill in our Southern Group. During the nine months ended September 30, 2007, we recognized $11 million in impairment charges for our landfill line of business. These charges were principally due to impairments recognized during the first quarter of 2007 for two landfills in our Southern Group. The impairments were necessary as a result of the re-evaluation of our business alternatives for one

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

landfill and the expiration of a contract that we had expected would be renewed that had significantly contributed to the volumes for the second landfill.

 

 

SFAS No. 157 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, 2008, our assets and liabilities that are measured at fair value on a recurring basis include the following (in millions):

 

 

 

 

 

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, 2008

(Unaudited)

 

 

December 31, 2007

 

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

 

Three Months Ended September 30, 2008

(Unaudited)