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 Exchange Act).  Yes o     No þ

 

The number of shares of Common Stock, $0.01 par value, of the registrant outstanding at October 22, 2010 was 475,800,754 (excluding treasury shares of 154,481,707).

 

 

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 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 services that are not managed through our five Groups, which are presented in this report as “Other.” These five Groups are presented as our reportable segments, and additional information related to our segments can be found in Note 10.

 

The Condensed Consolidated Financial Statements as of and for the three and nine months ended September 30, 2010 and 2009 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, 2009.

 

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 methods. 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 present the greatest amount of uncertainty relate to our accounting for landfills, environmental remediation liabilities, asset impairments, reserves associated with our uninsured claims and reserves and recoveries associated with our insured claims. Actual results could differ materially from the estimates and assumptions that we use in the preparation of our financial statements.

 

Adoption of New Accounting Pronouncements

 

Consolidation of Variable Interest Entities — In June 2009, the Financial Accounting Standards Board, or FASB, issued revised authoritative guidance associated with the consolidation of variable interest entities. The revised guidance replaced the previous quantitative-based assessment for determining whether an enterprise is the primary beneficiary of a variable interest entity, and is, therefore, required to consolidate the entity, with an approach that is now primarily qualitative. This qualitative approach focuses on identifying the enterprise that has (i) the power to direct the activities of the variable interest entity that can most significantly impact the entity’s performance; and (ii) the obligation to absorb losses and the right to receive benefits from the variable interest entity that could potentially be significant to such entity. The revised guidance also requires that the enterprise continually reassess whether it is the primary beneficiary of a variable interest entity rather than conducting a reassessment only upon the occurrence of specific events.

 

As a result of our implementation of this guidance, effective January 1, 2010, we deconsolidated certain capping, closure, post-closure and environmental remediation trusts for which power over significant activities is

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

shared. Our financial interests in these entities are discussed below. The deconsolidation of these trusts has not materially affected our financial position, results of operations or cash flows during the periods presented.

 

Following is a description of our financial interests in variable interest entities that we consider significant, including (i) those for which we have determined that we are the primary beneficiary of the entities and, therefore, have continued to consolidate the entities into our financial statements; and (ii) those that represent a significant interest in an unconsolidated entity.

 

Consolidated Variable Interest Entities

 

Waste-to-Energy LLCs — In June 2000, two limited liability companies were established to purchase interests in existing leveraged lease financings at three waste-to-energy facilities that we lease, operate and maintain. We own a 0.5% interest in one of the LLCs (“LLC I”) and a 0.25% interest in the second LLC (“LLC II”). John Hancock Life Insurance Company owns 99.5% of LLC I, and 99.75% of LLC II is owned by LLC I and the CIT Group. In 2000, Hancock and CIT made an initial aggregate investment of $167 million in the LLCs, which was used to purchase the three waste-to-energy facilities and assume the seller’s indebtedness.

 

Income, losses and cash flows of the LLCs are allocated to the members based on their initial capital account balances until Hancock and CIT achieve targeted returns; thereafter, we will receive 80% of the earnings of each of the LLCs and Hancock and CIT will be allocated the remaining 20% proportionate to their respective equity interests. All capital allocations made through September 30, 2010 have been based on initial capital account balances as the target returns have not yet been achieved.

 

Our obligations associated with our interests in the LLCs are primarily related to the lease of the facilities. In addition to our minimum lease payment obligations, we are required to make cash payments to the LLCs for differences between fair market rents and our minimum lease payments. We may also be required under certain circumstances to make capital contributions to the LLCs based on differences between the fair market value of the facilities and defined termination values as provided for in the underlying lease agreements, although we believe the likelihood of the occurrence of these circumstances is remote.

 

We have determined that we are the primary beneficiary of the LLCs because (i) all of the equity owners of the LLCs are considered related parties for purposes of applying this accounting guidance; (ii) the equity owners share power over the significant activities of the LLCs; and (iii) we are the entity within the related party group whose activities are most closely associated with the LLCs.

 

As of September 30, 2010, our Condensed Consolidated Balance Sheet included $322 million of net property and equipment associated with the LLCs’ waste-to-energy facilities and $242 million in noncontrolling interests associated with Hancock’s and CIT’s interests in the LLCs. As of September 30, 2010, all debt obligations of the LLCs had been paid in full and, therefore, the LLCs have no liabilities. We recognized expense of $13 million and $38 million during the three and nine months ended September 30, 2010, and September 30, 2009, respectively, for Hancock’s and CIT’s noncontrolling interests in the LLCs’ earnings. The LLCs’ earnings relate to the rental income generated from leasing the facilities to our subsidiaries, reduced by depreciation expense. The LLCs’ rental income is eliminated in WMI’s consolidation.

 

Significant Unconsolidated Variable Interest Entities

 

Trusts for Capping, Closure, Post-Closure or Environmental Remediation Obligations — We have significant financial interests in trust funds that were created to settle certain of our capping, closure, post-closure or environmental remediation obligations. We have determined that, under the current guidance, we are not the primary beneficiary of certain of these trust funds because power over the trusts’ significant activities is shared.

 

The deconsolidation of these variable interest entities as of January 1, 2010 decreased our restricted trust and escrow accounts by $109 million; increased investments in unconsolidated entities by $27 million; increased

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

receivables, principally long-term, by $51 million; and decreased noncontrolling interests by $31 million. Beginning in 2010, our interests in these variable interest entities have been accounted for as investments in unconsolidated entities. Our investments and receivables related to the trusts had a fair value of $105 million as of January 1, 2010 and $113 million as of September 30, 2010. We continue to reflect our interests in the unrealized gains and losses on marketable securities held by these trusts as a component of accumulated other comprehensive income. The deconsolidation of these variable interest entities has not materially affected our financial position or results of operations for the periods presented.

 

As the party with primary responsibility to fund the related capping, closure, post-closure or environmental remediation activities, we are exposed to risk of loss as a result of potential changes in the fair value of the trusts assets. The fair value of trust assets can fluctuate due to (i) changes in the market value of the investments held by the trusts; and (ii) credit risk associated with trust receivables. Although we are exposed to changes in the fair value of the trust assets, we currently expect the trust funds to continue to meet the statutory requirements for which they were established.

 

Federal low-income housing tax credits — In April 2010, we acquired a noncontrolling interest in a limited liability company established to invest in and manage low-income housing properties. Our consideration for this investment totaled $221 million, which was comprised of a $215 million note payable and an initial cash payment of $6 million. We determined that we are not the primary beneficiary of this entity as we do not have the power to direct the entity’s activities. At September 30, 2010, our investment balance was $208 million. Additional information related to this investment is discussed in Note 5.

 

 

Liabilities for landfill and environmental remediation costs are presented in the table below (in millions):

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The changes to landfill and environmental remediation liabilities for the year ended December 31, 2009 and the nine months ended September 30, 2010 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 capping, closure, post-closure and environmental remediation obligations. Generally, these trust funds are established to comply with statutory requirements and operating agreements and we are the sole beneficiary of the restricted balances. However, certain of the funds have been established for the benefit of both the Company and the host community in which we operate.

 

The fair value of trust funds and escrow accounts for which we are the sole beneficiary was $124 million at September 30, 2010. As discussed in Note 1, effective January 1, 2010, we deconsolidated the trusts for which power over significant activities of the trust is shared, which reduced our restricted trust and escrow accounts by $109 million as of January 1, 2010. Beginning in 2010, our interests in these variable interest entities have been accounted for as investments in unconsolidated entities and receivables. The fair value of our investment in these entities was $113 million as of September 30, 2010. These amounts are included in “Other receivables” and 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 rate ranges of each major category as of September 30, 2010:

 

 

Debt Classification

 

As of September 30, 2010, we had $477 million of debt maturing within twelve months. We have classified $316 million of these borrowings as long-term as of September 30, 2010 based on our intent and ability to refinance these borrowings on a long-term basis.

 

Debt Borrowings and Repayments

 

The significant changes in our debt balances from December 31, 2009 to September 30, 2010 are related to the following:

 

Canadian credit facility — The decrease in the carrying value is primarily due to $53 million of net debt repayments during the nine months ended September 30, 2010. This decrease was partially offset by currency translation adjustments and the impact of interest accretion.

 

Senior notes — In June 2010, we issued $600 million of 4.75% senior notes due June 2020. The net proceeds from the debt issuance were $592 million. We used the proceeds together with cash on hand to repay $600 million of 7.375% senior notes that matured in August 2010.

 

Tax-exempt bonds — During the nine months ended September 30, 2010, we repaid $52 million of our tax-exempt bonds with available cash.

 

Capital leases and Other — The significant increase in our capital leases and other debt obligations for the nine-month period ended September 30, 2010 is primarily related to our federal low-income housing

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

investment discussed in Note 5, which increased our debt obligations by $215 million. This increase was offset by $44 million of repayments of various borrowings at their scheduled maturities.

 

Revolving Credit and Letter of Credit Facilities

 

As of September 30, 2010, we had an aggregate committed capacity of $2.5 billion for letters of credit under various credit facilities. Our primary source of letter of credit capacity is a three-year, $2.0 billion revolving credit facility that was executed in June 2010. Our remaining letter of credit capacity is provided under facilities with maturities that extend from June 2013 to June 2015. As of September 30, 2010, we had an aggregate of $1.7 billion of letters of credit outstanding under our revolving credit facility and letter of credit facilities. There have not been any borrowings outstanding under these credit facilities during 2010.

 

 

The following table summarizes the fair values of derivative instruments recorded in our Condensed Consolidated Balance Sheet (in millions):

 

 

Interest Rate Derivatives

 

Interest Rate Swaps

 

We use interest rate swaps to maintain a portion of our debt obligations at variable market interest rates. As of September 30, 2010, the outstanding principal of our fixed-rate senior notes was approximately $5.4 billion. The interest payments on $500 million, or 9.3%, of these senior notes have been swapped to variable interest rates to protect the debt against changes in fair value due to changes in benchmark interest rates, compared with $1.1 billion, or 20%, as of December 31, 2009. This significant decrease is primarily attributable to the repayment of $600 million of 7.375% senior notes at their scheduled maturities in August 2010, all of which were swapped to variable.

 

We have designated our interest rate swaps as fair value hedges of our fixed-rate senior notes. Fair value hedge accounting for interest rate swap contracts increased the carrying value of debt instruments by $100 million as of September 30, 2010 and $91 million as of December 31, 2009.

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 our interest rate swaps, are recognized in current earnings. We include gains and losses on our interest rate swaps as adjustments to interest expense, which is the same financial statement line item where offsetting gains and losses on the related hedged items are recorded. 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 (in millions):

 

 

 

We also recognize the impacts of (i) net periodic settlements of current interest on our active interest rate swaps and (ii) the amortization of previously terminated interest rate swap agreements as adjustments to interest expense. The following table summarizes the impact of periodic settlements of active swap agreements and the impact of terminated swap agreements on our results of operations (in millions):

 

 

 

 

Treasury Rate Locks

 

During the third quarter of 2009, we entered into Treasury rate locks with a total notional amount of $200 million to hedge the risk of changes in semi-annual interest payments for a portion of the senior notes that the Company planned to issue in June 2010. The Treasury rate locks were terminated in the second quarter of 2010 contemporaneously with the actual issuance of senior notes, and we paid cash of $7 million upon settlement. As of September 30, 2010, our “Accumulated other comprehensive income” includes $4 million of deferred losses, net of taxes, associated with these Treasury rate locks that will be reclassified to “Interest expense” over the life of the related senior notes maturing in June 2020. There was no significant ineffectiveness associated with these hedges during 2010.

 

Our “Accumulated other comprehensive income” also includes deferred losses, net of taxes, of $13 million as of September 30, 2010 and $16 million as of December 31, 2009 related to Treasury rate locks that had been executed in previous years in anticipation of senior note issuances. Our Treasury rate locks were designated as cash flow hedges and, accordingly, the deferred losses are being reclassified to earnings over the term of the hedged cash flows, which extend through 2032.

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Forward-Starting Interest Rate Swaps

 

The Company currently expects to issue fixed-rate debt in March 2011, November 2012 and March 2014 and has executed forward-starting interest rate swaps for these anticipated debt issuances with notional amounts of $150 million, $200 million and $175 million, respectively. We entered into the forward-starting interest rate swaps during the fourth quarter of 2009 to hedge the risk of changes in the anticipated semi-annual interest payments due to fluctuations in the forward ten-year LIBOR swap rate. Each of the forward-starting swaps has an effective date of the anticipated date of debt issuance and a term of ten years.

 

We have designated our forward-starting interest rate swaps as cash flow hedges. As of September 30, 2010, the fair value of these interest rate derivatives is comprised of $20 million of current liabilities and $39 million of long-term liabilities. We recognized pre-tax and after-tax losses of $22 million and $13 million, respectively, to other comprehensive income for changes in the fair value of our forward-starting interest rate swaps during the three months ended September 30, 2010 and $68 million and $41 million, respectively, during the nine months ended September 30, 2010. There was no significant ineffectiveness associated with these hedges during the three and nine months ended September 30, 2010.

 

Credit-Risk-Related Contingent Features

 

Certain of our derivative instruments contain provisions related to the Company’s credit rating. If the Company’s credit rating were to fall to specified levels below investment grade, the counterparties have the ability to terminate the derivative agreements, resulting in immediate settlement of all affected transactions. As of September 30, 2010, we had not experienced any credit events that would trigger these provisions. The net liabilities of our derivative instruments with credit-risk-related features were immaterial as of September 30, 2010.

 

Foreign Exchange Derivatives

 

We use foreign currency exchange rate derivatives to hedge our exposure to changes in exchange rates for anticipated intercompany cash transactions between Waste Management Holdings, Inc., a wholly-owned subsidiary we acquired in 1998 (“WM Holdings”), and its Canadian subsidiaries. As of September 30, 2010, we have foreign currency forward contracts outstanding for all of the anticipated cash flows associated with a debt arrangement between these wholly-owned subsidiaries. The hedged cash flows include C$370 million of principal, which is scheduled for repayment on December 31, 2010, and C$22 million of interest payments scheduled for December 31, 2010. We have designated our foreign currency derivatives as cash flow hedges.

 

Gains or losses on the derivatives and 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 our foreign currency forward contracts as adjustments to “Other income and expense,” a component of “Other, net,” which is the same financial statement line item where offsetting gains and losses on the related hedged items are recorded. The following table summarizes the pre-tax impacts of our foreign currency cash flow derivatives on our results of operations and comprehensive income (in millions):

 

 

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Amounts reported in other comprehensive income and accumulated other comprehensive income are reported net of tax. Adjustments to other comprehensive income for changes in the fair value of our foreign currency cash flow hedges resulted in the recognition of after-tax losses of $7 million and $4 million during the three and nine months ended September 30, 2010, respectively. After-tax losses reclassified from accumulated other comprehensive income into income were $7 million and $4 million during the three and nine months ended September 30, 2010, respectively. There was no significant ineffectiveness associated with these hedges during the three and nine months ended September 30, 2010.

 

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.

 

Electricity Commodity Derivatives

 

During 2010, we entered into “receive fixed, pay variable” electricity swaps to mitigate the variability in our revenues and cash flows caused by fluctuations in the market prices for electricity. These swaps are expected to hedge 672,360 megawatt hours, or approximately 26% of our Wheelabrator Group’s 2010 merchant electricity sales. The electricity swaps in place as of September 30, 2010 have maturities extending through December 2010. All financial statement impacts associated with these derivatives were immaterial as of and for the three and nine months ended September 30, 2010.

 

 

Our effective tax rate for the three and nine months ended September 30, 2010 was 37.3% and 39.8%, respectively, compared with 31.2% and 35.2% for the comparable prior-year periods. We evaluate our effective tax rate at each interim period and adjust it accordingly as facts and circumstances warrant. The differences between federal income taxes computed at the federal statutory rate and reported income taxes for the three months ended September 30, 2010 were primarily due to the unfavorable impact of (i) state and local income taxes and (ii) adjustments to our accruals due to the filing of our 2009 income tax returns. These adjustments are offset in part by the favorable impact of federal low-income housing tax credits, other tax credits and audit settlements. In addition to the above, the effective tax rate for the nine months ended September 30, 2010 also includes an increase of $37 million to our provision for state deferred income taxes to reflect the impact of changes in the estimated tax rate at which existing temporary differences will be realized, which increased our effective tax rate for the nine-month period by 3.2 percentage points. Because the state deferred tax charges relate to existing temporary differences, they are not expected to impact our effective tax rate in future periods, absent prospective changes in income apportionment or state tax rates. The federal low-income housing tax credits decreased our effective tax rate for the three-month period by 1.0 percentage point and for the nine-month period by 1.1 percentage points.

 

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 months ended September 30, 2009 were (i) reductions to our provision for income taxes resulting from the finalization of our 2008 tax returns, tax audit settlements and a benefit

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

related to the utilization of state net operating loss carryforwards and (ii) increases to our tax provision for the impacts of state and local income taxes and an adjustment to our net accumulated state deferred tax liabilities.

 

Federal low-income housing tax credits — In April 2010, we acquired a noncontrolling interest in a limited liability company established to invest in and manage low-income housing properties. Our consideration for this investment totaled $221 million, which was comprised of a $215 million note payable and an initial cash payment of $6 million. The entity’s low-income housing investments qualify for federal tax credits that are expected to be realized through 2020 in accordance with Section 42 of the Internal Revenue Code.

 

We account for our investment in this entity using the equity method of accounting and recognize a charge to “Equity in net earnings (losses) of unconsolidated entities,” which is a component of “Other, net” within our Condensed Consolidated Statement of Operations, for reductions in the value of our investment. We recognized $4 million and $12 million of expense during the three and nine months ended September 30, 2010, respectively. We also recognized $3 million and $4 million of interest expense related to this investment during the current periods. As a result of this investment, our tax provision was reduced by $7 million (including $4 million of tax credits) for the three months ended September 30, 2010 and by $18 million (including $12 million of tax credits) for the nine months ended September 30, 2010.

 

Cash taxes — During the fourth quarter of 2009, we determined that a capital loss generated from the liquidation of a foreign subsidiary could be utilized to offset capital gains from 2006 and 2007 and recognized a reduction to our “Provision for income taxes.” During the third quarter of 2010, we received a federal tax refund of $65 million related to this capital loss.

 

Legislation updates — The Small Business Jobs Act, signed into law in September 2010, includes a provision extending bonus depreciation for assets placed in service in 2010. The acceleration of deductions on current year capital expenditures will have no impact on our effective tax rate but is expected to reduce our 2010 cash taxes by approximately $60 million. The current year cash tax benefit will result in increased cash taxes in future periods when the deduction for these capital expenditures would have otherwise been realized.

 

The Patient Protection and Affordable Care Act, which was signed into law in March 2010, includes a provision that eliminates the tax deductibility of retiree health care costs to the extent that retiree prescription drug benefits are reimbursed under Medicare Part D coverage. Although this provision of the Act does not take effect until 2013, we were required to recognize the full accounting impact of the change in law on our deferred tax assets during the first quarter of 2010, the period in which the law was enacted. The re-measurement of our deferred tax assets did not affect our financial position or results of operations as of and for the three and nine months ended September 30, 2010.

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

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):

 

 

 

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 capping, 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 have available alternative financial assurance mechanisms.

 

Management does not expect that any claims against or draws on these instruments would have a material adverse effect on our consolidated financial statements. We have not experienced any unmanageable difficulty in obtaining the required financial assurance instruments for our current operations. In an ongoing effort to mitigate risks of future cost increases and reductions in available capacity, we continue to evaluate various options to access cost-effective sources of financial assurance.

 

Insurance — 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 in 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 are 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 accruals for these liabilities could be revised if future occurrences or loss development significantly differ from our 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

WASTE MANAGEMENT, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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, 2010 include (i) guarantees of unconsolidated entities’ financial obligations maturing through 2020 for maximum future payments of $12 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 and we have recognized liabilities for these contingent obligations based on an estimate of the fair value of these contingencies at the time of acquisition. 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 is inherently difficult. We recognize and accrue for an estimated remediation liability when we determine that such liability is both probable and reasonably estimable. 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 investigation of the extent of environmental impact and identification of likely site-remediation alternatives. 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 $150 million higher than the $323 million recorded in the Condensed Consolidated Financial Statements as of September 30, 2010. 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, 2010, we had been notified by the government that we are a PRP in connection with 75 locations listed on the EPA’s National Priorities List, or NPL. Of the 75 sites at which claims have been made against us, 17 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 that 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.

 

The majority of these proceedings involve allegations that certain of our subsidiaries, or their predecessors, transported hazardous substances to the sites, often prior to our acquisition of these subsidiaries. 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 could be substantial and could have a material adverse effect on our consolidated financial statements. At

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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.

 

Litigation — In April 2002, two former participants in the ERISA plans of 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; the members of WM Holdings’ Board of Directors prior to July 1998; the administrative and investment committees of WM Holdings’ ERISA plans and their individual members; WMI’s retirement savings plan; the investment committees of WMI’s plan and its individual members; and State Street Bank & Trust, the trustee and investment manager of the 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 the Court granted in part and denied in part the defendants’ motions in the first quarter of 2009. However, in December 2009, the Court granted the plaintiffs’ motion for leave to file a fourth amended complaint to overcome the dismissal of certain claims and the motion for leave to file a substitute fourth amended complaint to add two new claims. 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 was a named defendant in these actions. Additionally, Mr. Simpson, our Chief Financial Officer, is a named defendant in these actions by virtue of his membership on the WMI ERISA plan Investment Committee at that time. The defendants again moved to dismiss the fourth amended complaint, and during the second quarter of 2010, the Court dismissed certain claims against individual defendants, including the claims against Messrs. Pope and Rothmeier and Ms. San Juan Cafferty. All of the remaining defendants intend to continue to defend themselves vigorously.

 

Two separate wage and hour lawsuits were commenced in October 2006 and March 2007, respectively, that are pending against certain of our subsidiaries in California, each seeking class certification. The actions were coordinated to proceed in San Diego County Superior Court. 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. Additionally, in July 2008, we were named as a defendant in a purported class action in the Circuit Court of Bullock County, Alabama, which was subsequently removed to the United States District Court for the Northern District of Alabama. This suit pertains to our fuel and environmental charge and generally alleges that such charges were not properly disclosed, were unfair, and were contrary to contract. We filed a motion to dismiss that was partially granted during the third quarter of 2010, resulting in dismissal of the plaintiffs’ RICO and national class action claims. We deny the claims in all of these actions and intend to continue to oppose class certification and will vigorously defend these matters. Given the inherent uncertainties of litigation, the ultimate outcome of these cases 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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, as noted above, 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 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 President and Chief Executive Officer 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 that may be brought against its former or current officers, directors and employees.

 

In April 2010, we settled our previously disclosed lawsuit relating to a revenue management system. We received a one-time cash payment, and all parties dismissed their claims with prejudice. Additional information related to this settlement is discussed in Note 11.

 

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, or such proceedings are known to be contemplated, unless we reasonably believe that the matter will result in no monetary sanctions, or in monetary sanctions, exclusive of interest and costs, of less than $100,000. The following matters pending as of September 30, 2010 are disclosed in accordance with that requirement:

 

On April 4, 2006, the EPA issued a Notice of Violation (“NOV”) 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 (“GCCS”) for the Waimanalo Gulch Sanitary Landfill on Oahu. The EPA has also indicated that it will seek penalties and injunctive relief as part of the NOV enforcement for elevated landfill temperatures that were recorded after installation of the GCCS. 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 April 8, July 15, and September 8, 2010, the EPA issued Notices of Violation to Chemical Waste Management, Inc.’s Kettleman Hills facility for alleged violations of the federal Toxic Substances Control Act. The EPA has indicated it will seek civil penalties for the violations alleged, which relate to handling and disposal of polychlorinated biphenyls.

 

The Massachusetts Attorney General’s Office has commenced investigations into allegations of violations of the Clean Air Act, the Clean Water Act, solid waste regulations and permits at Wheelabrator Group facilities in Saugus and North Andover, Massachusetts. The Attorney General’s Office is also considering intervening in two private lawsuits alleging potential claims under the Massachusetts False Claims Act. No formal enforcement action has been brought against the Company, although we potentially could be subject to sanctions, including requirements to pay monetary penalties. We are cooperating with the Attorney General’s office in the investigations.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Multi-Employer, Defined Benefit Pension Plans — Over 20% of our workforce is covered by collective bargaining agreements, which are with various union locals across the United States. As a result of some 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. One of the multi-employer pension plans in which we participate is the Central States Southeast and Southwest Areas Pension Plan (“Central States Pension Plan”), which has reported that it adopted a rehabilitation plan as a result of its actuarial certification for the plan year beginning January 1, 2008. The Central States Pension Plan is 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 2010, we recognized $26 million of charges to “Operating” expenses for the agreed-upon withdrawals of five bargaining units from the Central States Pension Plan in connection with our negotiations of those units’ agreements. We do not believe that our withdrawals from multi-employer plans, individually or in the aggregate, will have a material adverse effect on our financial condition or liquidity. However, depending on the number of employees withdrawn in any future period and the financial condition of the multi-employer plans at the time of withdrawal, such withdrawals could result in material changes to our results of operations in the period of the withdrawal.

 

Tax Matters  — We are currently in the examination phase of IRS audits for the tax years 2009 and 2010 and expect these audits to be completed within the next three and 15 months, respectively. We participate in the IRS’s Compliance Assurance Program, which means 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 also currently undergoing audits by various state and local jurisdictions that date back to 1999. In the third quarter of 2010, we settled audits in Canada through the 2004 tax year and are not currently under audit for any subsequent tax years. 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 are not currently expected to have a material adverse impact on our results of operations or cash flows.

 

 

In January 2009, we took steps to 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.

 

This reorganization 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. During the remainder of 2009, we incurred an additional $4 million of pre-tax restructuring charges associated with this reorganization, of which $1 million was related to employee severance and benefit costs. The remaining charges were primarily related to operating lease obligations for property that will no longer be utilized. The following table summarizes the charges recognized for this restructuring by each of our current reportable segments and our Corporate and Other organization for the three and nine months ended September 30, 2009 (in millions):

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

For the nine months ended September 30, 2010, we recognized $1 million of income related to the reversal of pre-tax restructuring charges. Through September 30, 2010, we have paid approximately $38 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 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 four geographic operating Groups provide collection, transfer, disposal (in both solid waste and hazardous waste landfills) and recycling services. Our Wheelabrator Group provides waste-to-energy services and manages waste-to-energy facilities and independent power production plants. We serve 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.”

 

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

 

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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 traditional seasonal increase in the 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Additionally, certain destructive weather conditions that tend to occur during the second half of the year, such as hurricanes typically experienced by our Southern Group, can actually increase our revenues in the areas affected. However, for several reasons, including significant mobilization costs, such revenue often generates earnings at comparatively lower margins. Certain weather conditions, including severe winter storms, 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.

 

From time to time, the operating results of our reportable segments are significantly affected by unusual or infrequent transactions or events. During 2010, our Midwest Group recognized expense charges of $26 million as a result of employees of five bargaining units in Michigan and Ohio agreeing to our proposal to withdraw them from an under-funded multi-employer pension plan. During the second quarter of 2009, employees of a bargaining unit in New Jersey agreed to a similar proposal and our Eastern Group recognized expense of $9 million. Refer to Note 8 for additional information related to our participation in multi-employer pension plans. Further, as disclosed in Note 9, the income from operations of each of our geographic Groups for the three and nine months ended September 30, 2009 was affected by our January 2009 reorganization.

 

Segment assets — The total assets of our Wheelabrator segment increased $309 million, or 14%, from December 31, 2009 to September 30, 2010, primarily as a result of our continued focus on the expansion of our waste-to-energy business. In the first quarter of 2010, we paid $142 million to acquire a 40% equity investment in Shanghai Environment Group (“SEG”), a subsidiary of Shanghai Chengtou Holding Co., Ltd. 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. In April 2010, we paid $150 million for the acquisition of a waste-to-energy facility in Portsmouth, Virginia. These investments did not have a significant impact on our operating revenues or income from operations for the three and nine months ended September 30, 2010.

 

 

Through December 31, 2008, we capitalized $70 million of accumulated costs associated with the development of a new waste and recycling revenue management system. A significant portion of these costs was specifically associated with the purchase of a license for waste and recycling revenue management software and the efforts required to develop and configure that software for our use. After a failed pilot implementation of the software in one of our smallest Market Areas, the development efforts associated with the revenue management system were suspended in 2007. During 2009, we determined to enhance and improve our existing revenue management system and not pursue alternatives associated with the development and implementation of the licensed software. Accordingly, in 2009, we recognized a non-cash charge of $51 million, $49 million of which was recognized during the first quarter of 2009 and $2 million of which was recognized during the fourth quarter of 2009, for the abandonment of the licensed software.

 

We filed a lawsuit in March 2008 related to the revenue management software implementation that was suspended in 2007 and abandoned in 2009. In April 2010, we settled the lawsuit and received a one-time cash payment. The settlement, included in “(Income) expense from divestitures, asset impairments and unusual items,” resulted in an increase in income from operations for the nine months ended September 30, 2010 of $77 million.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Assets and Liabilities Accounted for at Fair Value

 

As of September 30, 2010, our assets and liabilities that are measured at fair value on a recurring basis include the following (in millions):