Waste Management 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number 1-12154
Registrants telephone number, including area code: (713) 512-6200
Securities registered pursuant to Section 12(b) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
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 if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
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):
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 aggregate market value of the voting stock held by non-affiliates of the registrant at June 30, 2007 was approximately $20.2 billion. The aggregate market value was computed by using the closing price of the common stock as of that date on the New York Stock Exchange (NYSE). (For purposes of calculating this amount only, all directors and executive officers of the registrant have been treated as affiliates.)
The number of shares of Common Stock, $0.01 par value, of the registrant outstanding at February 11, 2008 was 495,349,812 (excluding treasury shares of 134,932,649).
The financial statements presented in this report represent the consolidation 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 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 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. 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 22 to the Consolidated Financial Statements.
Our principal executive offices are located at 1001 Fannin Street, Suite 4000, Houston, Texas 77002. Our telephone number at that address is (713) 512-6200. Our website address is http://www.wm.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K are all available, free of charge, on our website as soon as practicable after we file the reports with the SEC. Our stock is traded on the New York Stock Exchange under the symbol WMI.
We are the leading provider of integrated waste services in North America. Using our vast network of assets and employees, we provide a comprehensive range of waste management services. Through our subsidiaries we provide collection, transfer, recycling, disposal and waste-to-energy services. In providing these services, we actively pursue projects and initiatives that we believe make a positive difference for our environment, including recovering and processing the methane gas produced naturally by landfills into a renewable energy source. Our customers include commercial, industrial, municipal and residential customers, other waste management companies, electric utilities and governmental entities. During 2007, none of our customers accounted for more than 1% of our operating revenue. We employed approximately 47,400 people as of December 31, 2007.
Our Companys goals are targeted at serving five key stakeholders: our customers, our employees, the environment, the communities in which we work, and our shareholders. Our goals are:
Our strategy, which we believe will enable us to meet these goals, remains the same as last year: improve our organization and maximize returns to shareholders by focusing on operational excellence, pricing excellence and profitably growing our business. We continue our efforts toward revenue growth through pricing and are continuously working to lower operating and selling, general and administrative costs through process standardization and productivity improvements. Additionally, we have been improving our portfolio of businesses through our fix or seek exit initiative. All of these measures help us to generate strong and consistent cash flows from operations that can be used to maximize shareholder value.
As we move forward, we are building on our strategy to meet the needs of a changing environment and to make the most of the successes we have had so far. As the largest waste services provider in North America, we believe we are well positioned to meet the needs of the customers and communities we serve as they, too, Think Green®. We
believe that doing things that will help our customers achieve their environmental goals will help us achieve profitable growth. We regularly help customers reduce, reuse and recycle the waste they produce. We also focus on what is left, and in many cases convert the waste to a usable energy source. By focusing on providing new environmentally responsible and sustainable solutions to our customers waste problems, we believe we can create a competitive advantage across all of our lines of business.
Our focus on operational excellence has provided us a foundation on which to build. We believe we are well positioned to enhance that foundation by seeking profitable growth through targeted sales efforts and acquisitions. We are seeking to grow our current business in a variety of areas, including waste-based energy and single-stream recycling. We also are looking at new ways to grow. We believe we can make investments that are synergistic and that are going to take advantage of what we do best to give us revenue and earnings growth.
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 (WMRA) Group, which provides recycling services not managed by our geographic Groups. We also provide additional waste management services that are not managed through our six Groups. These services include in-plant services, where we work at our clients facilities to provide environmental management systems and provide opportunities for process improvements and associated cost reductions in their waste management. Other services not managed within our Groups include methane gas recovery and third-party sub-contracted and administrative services. These services are presented in this report as Other.
The table below shows the total revenues (in millions) contributed annually by each of our reportable segments in the three-year period ended December 31, 2007. More information about our results of operations by reportable segment is included in Note 20 to the Consolidated Financial Statements and in the Managements Discussion and Analysis of Financial Condition and Results of Operations, included in this report.
The services we provide include collection, landfill (solid and hazardous waste landfills), transfer, Wheelabrator (waste-to-energy facilities and independent power production plants), recycling and other services, as described below. The following table shows revenues (in millions) contributed by these services for each of the three years indicated:
Collection. Our commitment to customers begins with a vast waste collection network. Collection involves picking up and transporting waste from where it was generated to a transfer station or disposal site. We generally provide collection services under one of two types of arrangements:
Landfill. Landfills are the main depositories for solid waste in North America and we have the largest network of landfills in North America. Solid waste landfills are built and operated on land with geological and hydrological properties that limit the possibility of water pollution, and are operated under prescribed procedures. A landfill must be maintained to meet federal, state or provincial, and local regulations. The operation and closure of a solid waste landfill includes excavation, construction of liners, continuous spreading and compacting of waste, covering of waste with earth or other inert material and constructing final capping of the landfill. These operations are carefully planned to maintain sanitary conditions, to maximize the use of the airspace and to prepare the site so it can ultimately be used for other purposes.
All solid waste management companies must have access to a disposal facility, such as a solid waste landfill. We believe it is usually preferable for our collection operations to use disposal facilities that we own or operate, a practice we refer to as internalization, rather than using third-party disposal facilities. Internalization generally allows us to realize higher consolidated margins and stronger operating cash flows. The fees charged at disposal facilities, which are referred to as tipping fees, are based on several factors, including competition and the type and weight or volume of solid waste deposited.
We also operate secure hazardous waste landfills in the United States. Under federal environmental laws, the federal government (or states with delegated authority) must issue permits for all hazardous waste landfills. All of our hazardous waste landfills have obtained the required permits, although some can accept only certain types of hazardous waste. These landfills must also comply with specialized operating standards. Only hazardous waste in a
stable, solid form, which meets regulatory requirements, can be deposited in our secure disposal cells. In some cases, hazardous waste can be treated before disposal. Generally, these treatments involve the separation or removal of solid materials from liquids and chemical treatments that transform waste into inert materials that are no longer hazardous. Our hazardous waste landfills are sited, constructed and operated in a manner designed to provide long-term containment of waste. We also operate a hazardous waste facility at which we isolate treated hazardous waste in liquid form by injection into deep wells that have been drilled in rock formations far below the base of fresh water to a point that is separated by other substantial geological confining layers.
We owned or operated 271 solid waste and six hazardous waste landfills at December 31, 2007 and we owned or operated 277 solid waste and six hazardous waste landfills at December 31, 2006. The landfills that we operate but do not own are generally operated under a lease agreement or an operating contract. The differences between the two arrangements usually relate to the owner of the landfill operating permit. Under lease agreements, the permit typically is in our name and we operate the landfill for its entire life, making payments to the lessor based either on a percentage of revenue or a rate per ton of waste received. We are usually responsible for the closure and post-closure obligations of the landfills we lease. For operating contracts, the property owner owns the permit and we operate the landfill for a contracted term, which may be the life of the landfill. The property owner is generally responsible for closure and post-closure obligations under our operating contracts.
Based on remaining permitted airspace as of December 31, 2007 and projected annual disposal volumes, the weighted average remaining landfill life for all of our owned or operated landfills is approximately 30 years. Many of our landfills have the potential for expanded disposal capacity beyond what is currently permitted. We monitor the availability of permitted disposal capacity at each of our landfills and evaluate whether to pursue an expansion at a given landfill based on estimated future waste volumes and prices, remaining capacity and likelihood of obtaining an expansion permit. We are currently seeking expansion permits at 54 of our landfills for which we consider expansions to be likely. Although no assurances can be made that all future expansions will be permitted or permitted as designed, the weighted average remaining landfill life for all owned or operated landfills is approximately 37 years when considering remaining permitted airspace, expansion airspace and projected annual disposal volume. Remaining permitted airspace and expansion airspace are defined in the Managements Discussion and Analysis of Financial Condition and Results of Operations section of this report under Critical Accounting Estimates and Assumptions. At December 31, 2007 and 2006, the expected remaining capacity in cubic yards and tonnage of waste that can be accepted at our owned or operated landfills is shown below (in millions):
The following table reflects landfill capacity and airspace changes, as measured in tons of waste, for landfills owned or operated by us during the years ended December 31, 2007 and 2006 (in millions):
The number of landfills we own or operate as of December 31, 2007, segregated by their estimated operating lives (in years), based on remaining permitted and expansion airspace and projected annual disposal volume was as follows:
The volume of waste that we received in 2007 was lower than in 2006, primarily as a result of pricing competition and a slow down in residential construction, which are discussed in the Managements Discussion and Analysis of Financial Condition and Results of Operations section of this report. The tons received at our landfills in 2007 and 2006 are shown below (in thousands):
When a landfill we own or operate (i) reaches its permitted waste capacity; (ii) is permanently capped; and (iii) receives certification of closure from the applicable regulatory agency, management of the site, including remediation activities, is generally transferred to our closed sites management group. In addition to the 277 active landfills we managed at December 31, 2007, we managed 187 closed landfills.
Transfer. At December 31, 2007, we owned or operated 341 transfer stations in North America. We deposit waste at these stations, as do other waste haulers. The solid waste is then consolidated and compacted to reduce the volume and increase the density of the waste and transported by transfer trucks or by rail to disposal sites.
Access to transfer stations is often critical to third-party haulers who do not operate their own disposal facilities in close proximity to their collection operations. Fees charged to third parties at transfer stations are usually based on the type and volume or weight of the waste transferred, the distance to the disposal site and general market factors.
The utilization of our transfer stations by our own collection operations improves internalization by allowing us to retain fees that we would otherwise pay to third parties for the disposal of the waste we collect. It allows us to manage costs associated with waste disposal because (i) transfer trucks, railcars or rail containers have larger capacities than collection trucks, allowing us to deliver more waste to the disposal facility in each trip; (ii) waste is accumulated and compacted at transfer stations that are strategically located to increase the efficiency of our collection operations; and (iii) we can retain the volume by managing the transfer of the waste to one of our own disposal sites.
The transfer stations that we operate but do not own are generally operated through lease agreements under which we lease property from third parties. There are some instances where transfer stations are operated under contract, generally for municipalities. In most cases we own the permits and will be responsible for the regulatory requirements relating to the operation, closure and post closure of the transfer station.
Wheelabrator. As of December 31, 2007, we owned or operated 16 waste-to-energy facilities and five independent power production plants, or IPPs, that are located in the Northeast and in Florida, California and Washington.
At our waste-to-energy facilities, solid waste is burned at high temperatures in specially designed boilers to produce heat that is converted into high-pressure steam. As of December 31, 2007, our waste-to-energy facilities were capable of processing up to 21,000 tons of solid waste each day, a decrease in capacity of approximately 3,000 tons per day from December 31, 2006. In 2007, our waste-to-energy facilities received and processed 7.1 million tons of solid waste, or approximately 19,500 tons per day. In 2006, our waste-to-energy facilities received and processed 7.8 million tons of solid waste, or approximately 21,300 tons per day. The decline in both the capacity and production of our waste-to-energy facilities during 2007 was due to the termination of an operating and maintenance agreement in May 2007.
Our IPPs convert various waste and conventional fuels into steam. The plants burn wood waste, anthracite coal waste (culm), tires, landfill gas and natural gas. These facilities are integral to the solid waste industry, disposing of urban wood, waste tires, railroad ties and utility poles. Our anthracite culm facility in Pennsylvania processes the waste materials left over from coal mining operations from over half a century ago. Ash remaining after burning the culm is used to reclaim the land damaged by decades of coal mining.
We sell the steam produced at our waste-to-energy facilities and IPPs to industrial and commercial users. Steam that is not sold is used to generate electricity for sale to electric utilities. Fees charged for steam and electricity at our waste-to-energy facilities and IPPs are generally subject to the terms and conditions of long-term contracts that include interim adjustments to the prices charged for changes in market conditions such as inflation, natural gas prices and other general market factors.
Recycling. Our WMRA Group focuses on improving the sustainability and future growth of recycling programs within communities and industries. In addition to our WMRA Group, our four geographic operating Groups provide certain recycling services that are embedded within the Groups other operations and, therefore, are not included within the WMRA Groups financial results.
Recycling involves the separation of reusable materials from the waste stream for processing and resale or other disposition. Our recycling operations include the following:
Collection and materials processing Through our collection operations, we collect recyclable materials from residential, commercial and industrial customers and direct these materials to one of our material recovery facilities (MRFs) for processing. We operate 99 MRFs where paper, glass, metals and plastics are recovered for resale. We also operate six secondary processing facilities where materials received from MRFs can be further processed into raw products used in the manufacturing of consumer goods. Specifically, material processing services include data destruction, automated color sorting, and construction and demolition processing.
Plastics and rubber materials recycling Using state-of-the-art sorting and processing technology, we process, inventory and sell plastic and rubber commodities making the recycling of such items more cost effective and convenient.
Electronics recycling services We provide an innovative, customized approach to recycling discarded computers, communications equipment, and other electronic equipment. Services include the collection, sorting and disassembling of electronics in an effort to reuse or recycle all collected materials.
Commodities recycling We market and resell recyclable commodities to customers world-wide. We manage the marketing of recyclable commodities for our own facilities and for third parties by maintaining comprehensive service centers that continuously analyze market prices, logistics, market demands and product quality.
During 2006, we also provided glass recycling services. However, we divested of our glass recycling facilities in 2006 as part of our continued focus on improving the profitability of our business.
Fees for recycling services are influenced by frequency of collection, type and volume or weight of the recyclable material, degree of processing required, the market value of the recovered material and other market factors.
Our WMRA Group purchases recyclable materials processed in our MRFs from various sources, including third parties and other operating subsidiaries of WMI. The cost per ton of material purchased is based on market prices and the cost to transport the finished goods to our customers. The price our WMRA Group pays for recyclable materials is often referred to as a rebate and is based upon the price we receive for sales of finished goods and local market conditions. As a result, higher commodity prices increase our revenues and increase the rebates we pay to our suppliers.
Other. We provide in-plant services, in which employees of our Upstream organization work full-time inside our customers facilities to provide full-service waste management solutions. Our vertically integrated waste management operations allow us to provide customers with full management of their waste, including identifying recycling opportunities, minimizing waste, and determining the most efficient means available for waste collection and disposal.
We also develop, operate and promote projects for the beneficial use of landfill gas through our Waste Management Renewable Energy Program. Landfill gas is produced naturally as waste decomposes in a landfill. The methane component of the landfill gas is a readily available, renewable energy source that can be gathered and used beneficially as an alternative to fossil fuel. The United States Environmental Protection Agency endorses landfill gas as a renewable energy resource, in the same category as wind, solar and geothermal resources. At December 31, 2007, landfill gas beneficial use projects were producing commercial quantities of methane gas at 108 of our solid waste landfills. At 80 of these landfills, the processed gas is delivered to electricity generators. The electricity is then sold to public utilities, municipal utilities or power cooperatives. At 21 landfills, the gas is delivered by pipeline to industrial customers as a direct substitute for fossil fuels in industrial processes. At seven landfills, the landfill gas is processed to pipeline-quality natural gas and then sold to natural gas suppliers.
In addition, we rent and service portable restroom facilities to municipalities and commercial customers under the name Port-O-Let®, and provide street and parking lot sweeping services. We also have begun providing portable self-storage and fluorescent lamp recycling services. From time to time, we are also contracted to construct waste facilities on behalf of third parties.
The solid waste industry is very competitive. Competition comes from a number of publicly held solid waste companies, private solid waste companies, large commercial and industrial companies handling their own waste collection or disposal operations and public and private waste-to-energy companies. We also have competition from municipalities and regional government authorities with respect to residential and commercial solid waste collection and solid waste landfills. The municipalities and regional governmental authorities are often able to offer lower direct charges to customers for the same service by subsidizing their costs through the use of tax revenues and tax-exempt financing. Generally, however, municipalities do not provide significant commercial and industrial collection or waste disposal.
We compete for disposal business on the basis of tipping fees, geographic location and quality of operations. Our ability to obtain disposal business may be limited in areas where other companies own or operate their own landfills, to which they will send their waste. We compete for collection accounts primarily on the basis of price and quality of services. Operating costs, disposal costs and collection fees vary widely throughout the geographic areas in which we operate. The prices that we charge are determined locally, and typically vary by the volume and weight, type of waste collected, treatment requirements, risk of handling or disposal, frequency of collections, distance to final disposal sites, the availability of airspace within the geographic region, labor costs and amount and type of equipment furnished to the customer. We face intense competition based on pricing and quality of service. Under certain customer service contracts, our ability to increase our prices or pass on cost increases to our customers may be limited. From time to time, competitors may reduce the price of their services and accept lower margins in an effort to expand or maintain market share or to successfully obtain competitively bid contracts.
At December 31, 2007, we had approximately 47,400 full-time employees, of which approximately 7,900 were employed in administrative and sales positions and the balance in operations. Approximately 11,700 of our employees are covered by collective bargaining agreements.
Financial Assurance and Insurance Obligations
Municipal and governmental waste service contracts generally require contracting parties to demonstrate financial responsibility for their obligations under the contract. Financial assurance is also a requirement for obtaining or retaining disposal site or transfer station operating permits. Various forms of financial assurance are also required by regulatory agencies for estimated closure, post-closure and remedial obligations at many of our landfills. In addition, certain of our tax-exempt borrowings require us to hold funds in trust for the repayment of our interest and principal obligations.
We establish financial assurance using surety bonds, letters of credit, insurance policies, trust and escrow agreements and financial guarantees. The type of assurance used is based on several factors; most importantly the jurisdiction, contractual requirements, market factors and availability of credit capacity. The following table summarizes the various forms and dollar amounts (in millions) of financial assurance that we had outstanding as of December 31, 2007:
The assets held in our funded trust and escrow accounts may be drawn and used to meet the obligations for which the trusts and escrows were established. Other than these permitted draws on funds, virtually no claims have been made against our financial assurance instruments in the past, and considering our current financial position, management does not expect there to be claims against these instruments that will have a material adverse effect on our consolidated financial statements. In an ongoing effort to mitigate the risks of future cost increases and reductions in available capacity, we are continually evaluating various options to access cost-effective sources of financial assurance.
We carry a broad range of insurance coverages, including general liability, automobile liability, real and personal property, workers compensation, directors and officers liability, pollution legal liability and other coverages we believe are customary to the industry. Our exposure to loss for insurance claims is generally limited to the per incident deductible under the related insurance policy. Our general liability, workers compensation and auto insurance programs have per incident deductibles of $2.5 million, $1.5 million and $1 million, respectively. Effective January 1, 2008, we increased the per incident deductible for our workers compensation insurance program to $5 million. 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. Our estimated insurance liabilities as of December 31, 2007 are summarized in Note 10 to the Consolidated Financial Statements.
Our business is subject to extensive and evolving federal, state or provincial and local environmental, health, safety and transportation laws and regulations. These laws and regulations are administered by the EPA and various other federal, state and local environmental, zoning, transportation, land use, health and safety agencies in the United States and various agencies in Canada. Many of these agencies regularly examine our operations to monitor compliance with these laws and regulations and have the power to enforce compliance, obtain injunctions or impose civil or criminal penalties in case of violations.
Because the major component of our business is the collection and disposal of solid waste in an environmentally sound manner, a significant amount of our capital expenditures is related, either directly or indirectly, to environmental protection measures, including compliance with federal, state or provincial and local provisions that regulate the discharge of materials into the environment. There are costs associated with siting, design, operations, monitoring, site maintenance, corrective actions, financial assurance, and facility closure and post-closure obligations. In connection with our acquisition, development or expansion of a disposal facility or transfer station, we must often spend considerable time, effort and money to obtain or maintain necessary required permits and approvals. There cannot be any assurances that we will be able to obtain or maintain necessary governmental approvals. Once obtained, operating permits are subject to modification, suspension or revocation by the issuing agency. Compliance with these and any future regulatory requirements could require us to make significant capital and operating expenditures. However, most of these expenditures are made in the normal course of business and do not place us at any competitive disadvantage.
The primary United States federal statutes affecting our business are summarized below:
releases of hazardous substances into the environment that have created actual or potential environmental hazards. CERCLAs primary means for addressing such releases is to impose strict liability for cleanup of disposal sites upon current and former site owners and operators, generators of the hazardous substances at the site and transporters who selected the disposal site and transported substances thereto. Liability under CERCLA is not dependent on the intentional disposal of hazardous substances; it can be based upon the release or threatened release, even as a result of lawful, unintentional and non-negligent action, of hazardous substances as the term is defined by CERCLA and other applicable statutes and regulations. Liability may include contribution for cleanup costs incurred by a defendant in a CERCLA civil action or by an entity that has previously resolved its liability to federal or state regulators in an administrative or judicially approved settlement. Liability could also include liability to a PRP that voluntarily expends site clean-up costs. Further, liability may include damage to publicly owned natural resources. We are subject to potential liability under CERCLA as an owner or operator of facilities at which hazardous substances have been disposed or as a generator or transporter of hazardous substances disposed of at other locations.
The EPA has issued new source performance standards and emission guidelines for large and small municipal waste-to-energy facilities, which include stringent emission limits for various pollutants based on Maximum Achievable Control Technology standards. These sources are also subject to operating permit requirements under Title V of the Clean Air Act. The Clean Air Act requires the EPA to review and revise the MACT standards applicable to municipal waste-to-energy facilities every five years.
There are also various state or provincial and local regulations that affect our operations. Sometimes states regulations are stricter than federal laws and regulations when not otherwise preempted by federal law. Additionally, our collection and landfill operations could be affected by legislative and regulatory measures requiring or encouraging waste reduction at the source and waste recycling.
Various states have enacted, or are considering enacting, laws that restrict the disposal within the state of solid waste generated outside the state. While laws that overtly discriminate against out-of-state waste have been found to be unconstitutional, some laws that are less overtly discriminatory have been upheld in court. Additionally, certain state and local governments have enacted flow control regulations, which attempt to require that all waste generated within the state or local jurisdiction be deposited at specific sites. In 1994, the United States Supreme Court ruled that a flow control ordinance that gave preference to a local facility that was privately owned was unconstitutional, but in 2007 the Court ruled that an ordinance directing waste to a facility owned by the local government was constitutional. In addition, from time to time, the United States Congress has considered legislation authorizing states to adopt regulations, restrictions, or taxes on the importation of out-of-state or out-of-jurisdiction waste. The United States Congress adoption of legislation allowing restrictions on interstate transportation of out-of-state or out-of-jurisdiction waste or certain types of flow control or the adoption of legislation affecting interstate transportation of waste at the state level could adversely affect our operations. Courts interpretation of flow control legislation or the Supreme Court decisions also could adversely affect our solid waste management services.
Many states, provinces and local jurisdictions have enacted fitness laws that allow the agencies that have jurisdiction over waste services contracts or permits to deny or revoke these contracts or permits based on the applicant or permit holders compliance history. Some states, provinces and local jurisdictions go further and consider the compliance history of the parent, subsidiaries or affiliated companies, in addition to the applicant or permit holder. These laws authorize the agencies to make determinations of an applicant or permit holders fitness to be awarded a contract to operate, and to deny or revoke a contract or permit because of unfitness, unless there is a showing that the applicant or permit holder has been rehabilitated through the adoption of various operating policies and procedures put in place to assure future compliance with applicable laws and regulations.
See Notes 3 and 10 to the Consolidated Financial Statements for disclosures relating to our current assessments of the impact of regulations on our current and future operations.
In an effort to keep our shareholders and the public informed about our business, we may make forward-looking statements. Forward-looking statements usually relate to future events and anticipated revenues, earnings, cash flows or other aspects of our operations or operating results. Forward-looking statements generally include statements containing:
You should view these statements with caution. These statements are not guarantees of future performance, circumstances or events. They are based on facts and circumstances known to us as of the date the statements are made. All phases of our business are subject to uncertainties, risks and other influences, many of which we do not control. Any of these factors, either alone or taken together, could have a material adverse effect on us and could change whether any forward-looking statement ultimately turns out to be true. Additionally, we assume no obligation to update any forward-looking statement as a result of future events, circumstances or developments. The following discussion should be read together with the Consolidated Financial Statements and the notes thereto. Outlined below are some of the risks that we believe could affect our business and financial statements for 2008 and beyond. These are not the only risks that we face. There may be other risks that we do not presently know or that we currently believe are immaterial that could also impair our business and financial position.
The waste industry is highly competitive, and if we cannot successfully compete in the marketplace, our business, financial condition and operating results may be materially adversely affected.
We encounter intense competition from governmental, quasi-governmental and private sources in all aspects of our operations. In North America, the industry consists of large national waste management companies, and local and regional companies of varying sizes and financial resources. We compete with these companies as well as with counties and municipalities that maintain their own waste collection and disposal operations. These counties and municipalities may have financial competitive advantages because tax revenues are available to them and tax-exempt financing is more readily available to them. Also, such governmental units may attempt to impose flow control or other restrictions that would give them a competitive advantage.
In addition, competitors may reduce their prices to expand sales volume or to win competitively bid contracts. When this happens, we may rollback prices or offer lower pricing to attract or retain our customers, resulting in a negative impact to our revenue growth from yield on base business.
If we do not successfully manage our costs, our income from operations could be lower than expected.
In recent years, we have implemented several profit improvement initiatives aimed at lowering our costs and enhancing our revenues, and we continue to seek ways to reduce our selling, general and administrative and operating expenses. While generally we have been successful in managing our costs, including subcontractor costs and the effect of fuel price increases, our initiatives may not be sufficient. Even as our revenues increase, if we are unable to control variable costs or increases to our fixed costs in the future, we will be unable to maintain or expand our margins.
We cannot guarantee that we will be able to successfully implement our plans and strategies to improve margins and increase our income from operations.
We have announced several programs and strategies that we have implemented or planned to improve our margins and operating results. For example, except when prohibited by contract, we have implemented price increases and environmental fees, and we continue our fuel surcharge programs, all of which have increased our internal revenue growth. The loss of volumes as a result of price increases may negatively affect our cash flows or results of operations. Additionally, we continue to seek to divest under-performing and non-strategic assets if we cannot improve their profitability. We may not be able to successfully negotiate the divestiture of under-performing and non-strategic operations, which could result in asset impairments or the continued operation of low-margin businesses. If we are not able to fully implement our plans for any reason, many of which are out of our control, we may not see the expected improvements in our income from operations or our operating margins.
The seasonal nature of our business and changes in general and local economic conditions cause our quarterly results to fluctuate, and prior performance is not necessarily indicative of our future results.
Our operating revenues tend to be somewhat higher in 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, such as the hurricanes experienced during 2004 and 2005, 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 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.
Our business is affected by changes in national and general economic factors that are also outside of our control, including interest rates and consumer confidence. We have $2.9 billion of debt as of December 31, 2007 that is exposed to changes in market interest rates because of the combined impact of our variable rate tax-exempt bonds and our interest rate swap agreements. Therefore, any increase in interest rates can significantly increase our expenses. Additionally, although our services are of an essential nature, a weak economy generally results in decreases in volumes of waste generated, which decreases our revenues. We also face risks related to other adverse
external factors, such as the ability of our insurers to meet their commitments in a timely manner and the effect that significant claims or litigation against insurance companies may have on such ability.
Any of the factors described above could materially adversely affect our results of operations and cash flows. Additionally, due to these and other factors, operating results in any interim period are not necessarily indicative of operating results for an entire year, and operating results for any historical period are not necessarily indicative of operating results for a future period.
We cannot predict with certainty the extent of future costs under environmental, health and safety laws, and cannot guarantee that they will not be material.
We could be liable if our operations cause environmental damage to our properties or to the property of other landowners, particularly as a result of the contamination of air, drinking water or soil. Under current law, we could even be held liable for damage caused by conditions that existed before we acquired the assets or operations involved. Also, we could be liable if we arrange for the transportation, disposal or treatment of hazardous substances that cause environmental contamination, or if a predecessor owner made such arrangements and under applicable law we are treated as a successor to the prior owner. Any substantial liability for environmental damage could have a material adverse effect on our financial condition, results of operations and cash flows.
In the ordinary course of our business, we have in the past, and may in the future, become involved in a variety of legal and administrative proceedings relating to land use and environmental laws and regulations. These include proceedings in which:
We generally seek to work with the authorities or other persons involved in these proceedings to resolve any issues raised. If we are not successful, the adverse outcome of one or more of these proceedings could result in, among other things, material increases in our costs or liabilities as well as material charges for asset impairments.
The waste industry is subject to extensive government regulation, and existing or future regulations may restrict our operations, increase our costs of operations or require us to make additional capital expenditures.
Stringent government regulations at the federal, state, provincial, and local level in the United States and Canada have a substantial impact on our business. A large number of complex laws, rules, orders and interpretations govern environmental protection, health, safety, land use, zoning, transportation and related matters. Among other things, they may restrict our operations and adversely affect our financial condition, results of operations and cash flows by imposing conditions such as:
Regulations affecting the siting, design and closure of landfills could require us to undertake investigatory or remedial activities, curtail operations or close landfills temporarily or permanently. Future changes in these regulations may require us to modify, supplement or replace equipment or facilities. The costs of complying with these regulations could be substantial.
In order to develop, expand or operate a landfill or other waste management facility, we must have various facility permits and other governmental approvals, including those relating to zoning, environmental protection and
land use. The permits and approvals are often difficult, time consuming and costly to obtain and could contain conditions that limit our operations.
Governmental authorities may enact climate change regulations that could increase our costs to operate.
Environmental advocacy groups and regulatory agencies in the United States have been focusing considerable attention on the emissions of greenhouse gases and their potential role in climate change. The adoption of laws and regulations to implement controls of greenhouse gases, including the imposition of fees or taxes, could adversely affect our collection and disposal operations. Additionally, certain of the states in which we operate are contemplating air pollution control regulations that are more stringent than existing and proposed federal regulations. Changing environmental regulations could require us to take any number of actions, including the purchase of emission allowances or installation of additional pollution control technology, and could make some operations less profitable, which could adversely affect our results of operations.
Significant shortages in fuel supply or increases in fuel prices will increase our operating expenses.
The price and supply of fuel are unpredictable, and can fluctuate significantly based on international, political and economic circumstances, as well as other factors outside our control, such as actions by the Organization of the Petroleum Exporting Countries, or OPEC, and other oil and gas producers, regional production patterns, weather conditions and environmental concerns. In the past two years, the year-over-year changes in the average quarterly fuel prices have ranged from an increase of 28% to a decrease of 5%. We need fuel to run our collection and transfer trucks and equipment used in our landfill operations. Supply shortages could substantially increase our operating expenses. Additionally, as fuel prices increase, our direct operating expenses increase and many of our vendors raise their prices as a means to offset their own rising costs. We have in place a fuel surcharge program, designed to offset increased fuel expenses; however, we may not be able to pass through all of our increased costs and some customers contracts prohibit any pass through of the increased costs. We may initiate other programs or means to guard against the rising costs of fuel, although there can be no assurances that we will be able to do so or that such programs will be successful. Regardless of any offsetting surcharge programs, the increased operating costs will decrease our operating margins.
We have substantial financial assurance and insurance requirements, and increases in the costs of obtaining adequate financial assurance, or the inadequacy of our insurance coverages, could negatively impact our liquidity and increase our liabilities.
The amount of insurance we are required to maintain for environmental liability is governed by statutory requirements. We believe that the cost for such insurance is high relative to the coverage it would provide, and therefore, our coverages are generally maintained at the minimum statutorily required levels. We face the risk of incurring liabilities for environmental damage if our insurance coverage is ultimately inadequate to cover those damages. We also carry a broad range of insurance coverages that are customary for a company our size. We use these programs to mitigate risk of loss, thereby allowing us to manage our self-insurance exposure associated with claims. To the extent our insurers were unable to meet their obligations, or our own obligations for claims were more than we estimated, there could be a material adverse effect to our financial results.
In addition, to fulfill our financial assurance obligations with respect to environmental closure and post-closure liabilities, we generally obtain letters of credit or surety bonds, rely on insurance, including captive insurance, or fund trust and escrow accounts. We currently have in place all financial assurance instruments necessary for our operations. We do not anticipate any unmanageable difficulty in obtaining financial assurance instruments in the future. However, in the event we are unable to obtain sufficient surety bonding, letters of credit or third-party insurance coverage at reasonable cost, or one or more states cease to view captive insurance as adequate coverage, we would need to rely on other forms of financial assurance. These types of financial assurance could be more expensive to obtain, which could negatively impact our liquidity and capital resources and our ability to meet our obligations as they become due.
The possibility of development and expansion projects or pending acquisitions not being completed or certain other events could result in a material charge against our earnings.
In accordance with generally accepted accounting principles, we capitalize certain expenditures and advances relating to disposal site development, expansion projects, acquisitions, software development costs and other
projects. If a facility or operation is permanently shut down or determined to be impaired, a pending acquisition is not completed, a development or expansion project is not completed or is determined to be impaired, we will charge against earnings any unamortized capitalized expenditures and advances relating to such facility, acquisition or project. We reduce the charge against earnings by any portion of the capitalized costs that we estimate will be recoverable, through sale or otherwise.
In future periods, we may be required to incur charges against earnings in accordance with this policy, or due to other events that cause impairments. Any such charges could have a material adverse effect on our results of operations.
Our recycling operations process for sale certain recyclable materials, including fibers, aluminum and glass, all of which are subject to significant market price fluctuations. The majority of the recyclables that we process for sale are paper fibers, including old corrugated cardboard, known as OCC, and old newsprint, or ONP. In the past two years, the year-over-year changes in the quarterly average market prices for OCC ranged from a decrease of as much as 34% to an increase of as much as 83%. The same comparisons for ONP have ranged from a decrease of as much as 16% to an increase of as much as 47%. These fluctuations can affect future operating income and cash flows. Additionally, our recycling operations offer rebates to suppliers, based on the market prices of commodities we buy to process for resale. Therefore, even if we experience higher revenues based on increased market prices for commodities, the rebates we pay will also increase.
Additionally, there may be significant price fluctuations in the price of methane gas, electricity and other energy related products that are marketed and sold by our landfill gas recovery, waste-to-energy and independent power production plant operations. The marketing and sales of energy related products by our landfill gas and waste-to-energy operations are generally pursuant to long-term sales agreements. Therefore, market fluctuations do not have a significant effect on these operations in the short-term. However, as those agreements expire and are up for renewal, changes in market prices may affect our revenues. Additionally, revenues from our independent power production plants can be affected by price fluctuations. In the past two years, the year-over-year changes in the average quarterly electricity prices have increased or decreased by as much as 5%.
The development and acceptance of alternatives to landfill disposal and waste-to-energy facilities could reduce our ability to operate at full capacity.
Our customers are increasingly using alternatives to landfill and waste-to-energy disposal, such as recycling and composting. In addition, some state and local governments mandate recycling and waste reduction at the source and prohibit the disposal of certain types of waste, such as yard waste, at landfills or waste-to-energy facilities. Although such mandates are a useful tool to protect our environment, these developments reduce the volume of waste going to landfills and waste-to-energy facilities in certain areas, which may affect our ability to operate our landfills and waste-to-energy facilities at full capacity, as well as the prices that we can charge for landfill disposal and waste-to-energy services.
Efforts by labor unions to organize our employees could increase our operating expenses.
Labor unions constantly make attempts to organize our employees, and these efforts will likely continue in the future. Certain groups of our employees have already chosen to be represented by unions, and we have negotiated collective bargaining agreements with some of the groups. Additional groups of employees may seek union representation in the future, and, if successful, the negotiation of collective bargaining agreements could divert management attention and result in increased operating expenses and lower net income. If we are unable to negotiate acceptable collective bargaining agreements, work stoppages, including strikes, could ensue. Depending on the type and duration of any labor disruptions, our operating expenses could increase significantly, which could adversely affect our financial condition, results of operations and cash flows.
Currently pending or future litigation or governmental proceedings could result in material adverse consequences, including judgments or settlements.
We are involved in civil litigation in the ordinary course of our business and from time-to-time are involved in governmental proceedings relating to the conduct of our business. The timing of the final resolutions to these types
of matters is often uncertain. Additionally, the possible outcomes or resolutions to these matters could include adverse judgments or settlements, either of which could require substantial payments, adversely affecting our liquidity.
We are increasingly dependent on technology in our operations and if our technology fails, our business could be adversely affected.
We may experience problems with either the operation of our current information technology systems or the development and deployment of new information technology systems that could adversely affect, or even temporarily disrupt, all or a portion of our operations until resolved. We encountered problems with the new revenue management application that we had been piloting throughout 2007, resulting in the termination of the pilot while we determine how to proceed on an enterprise-wide basis. The termination of the pilot may lead to additional costs and expenses, which could be material. Additionally, the delay in implementing a new, enterprise-wide revenue management system may negatively affect our ability to improve our operating margins. Finally, there can be no assurances that our issues related to the licensed application will not ultimately result in an impairment charge, which could be material.
Additionally, any systems failures could impede our ability to timely collect and report financial results in accordance with applicable law and regulations.
We may experience adverse impacts on our reported results of operations as a result of adopting new accounting standards or interpretations.
Our implementation of and compliance with changes in accounting rules, including new accounting rules and interpretations, could adversely affect our reported operating results or cause unanticipated fluctuations in our reported operating results in future periods.
Unforeseen circumstances could result in a need for additional capital.
We currently expect to meet our anticipated cash needs for capital expenditures, acquisitions and other cash expenditures with our cash flows from operations and, to the extent necessary, additional financings. However, materially adverse events could reduce our cash flows from operations. Our Board of Directors has approved a capital allocation program that provides for up to $1.4 billion in aggregate dividend payments and share repurchases during 2008 and recently announced that it expects future quarterly dividend payments, when declared by the Board of Directors, to be $0.27 per share. If our cash flows from operations were negatively affected, we could be forced to reduce capital expenditures, acquisition activity, share repurchase activity or dividend declarations. In these circumstances we instead may elect to incur more indebtedness. If we made such an election, there can be no assurances that we would be able to obtain additional financings on acceptable terms. In these circumstances, we would likely use our revolving credit facility to meet our cash needs.
In the event of a default under our credit facility, we could be required to immediately repay all outstanding borrowings and make cash deposits as collateral for all obligations the facility supports, which we may not be able to do. Additionally, any such default could cause a default under many of our other credit agreements and debt instruments. Any such default would have a material adverse effect on our ability to operate.
Our principal executive offices are in Houston, Texas, where we lease approximately 390,000 square feet under leases expiring at various times through 2010. Our operating Group offices are in Pennsylvania, Illinois, Georgia, Arizona, New Hampshire and Texas. We also have field-based administrative offices in Arizona, Illinois and Canada. We own or lease real property in most locations where we have operations. We have operations in each of the fifty states other than Montana and Wyoming. We also have operations in the District of Columbia, Puerto Rico and throughout Canada.
Our principal property and equipment consist of land (primarily landfills and other disposal facilities, transfer stations and bases for collection operations), buildings, vehicles and equipment. We believe that our vehicles,
equipment, and operating properties are adequately maintained and sufficient for our current operations. However, we expect to continue to make investments in additional equipment and property for expansion, for replacement of assets, and in connection with future acquisitions. For more information, see Managements Discussion and Analysis of Financial Condition and Results of Operations included within this report.
The following table summarizes our various operations at December 31 for the periods noted:
The following table provides certain information by Group regarding the 242 landfills owned or operated through lease agreements and a count, by Group, of contracted disposal sites as of December 31, 2007:
Information regarding our legal proceedings can be found under the Litigation section of Note 10 in the Consolidated Financial Statements included in this report.
We did not submit any matters to a vote of our stockholders during the fourth quarter of 2007.
Our common stock is traded on the New York Stock Exchange (NYSE) under the symbol WMI. The following table sets forth the range of the high and low per share sales prices for our common stock as reported on the NYSE:
On February 11, 2008, the closing sale price as reported on the NYSE was $32.16 per share. The number of holders of record of our common stock at February 11, 2008 was 15,215.
The graph below shows the relative investment performance of Waste Management, Inc. common stock, the Dow Jones Waste & Disposal Services Index and the S&P 500 Index for the last five years, assuming reinvestment of dividends at date of payment into the common stock. The graph is presented pursuant to SEC rules and is not meant to be an indication of our future performance.
In October 2004, the Company announced that its Board of Directors approved a capital allocation program authorizing up to $1.2 billion of stock repurchases and dividend payments annually for each of 2005, 2006 and 2007. Under this program, we paid quarterly cash dividends of $0.20 per share for a total of $449 million in 2005; $0.22 per share for a total of $476 million in 2006; and $0.24 per share for a total of $495 million in 2007.
In March 2007, our Board of Directors approved up to $600 million of additional share repurchases for 2007, and in November 2007 approved up to $300 million of additional share repurchases, increasing the amount of capital authorized for our share repurchases and dividends for 2007 to $2.1 billion. In 2007, we repurchased approximately 40 million shares of our common stock for $1,421 million. All of the repurchases were made pursuant to our capital allocation program. The following table summarizes our fourth quarter 2007 share repurchase activity:
In 2006, we repurchased 31 million shares of our common stock for $1,072 million, all of which was made pursuant to the capital allocation program discussed above.
The information below was derived from the audited Consolidated Financial Statements included in this report and in previous annual reports we filed with the SEC. This information should be read together with those Consolidated Financial Statements and the notes thereto. The adoption of new accounting pronouncements, changes in certain accounting policies and certain reclassifications impact the comparability of the financial information presented below. These historical results are not necessarily indicative of the results to be expected in the future.
This section includes a discussion of our operations for the three years ended December 31, 2007. This discussion may contain forward-looking statements that anticipate results based on managements plans that are subject to uncertainty. We discuss in more detail various factors that could cause actual results to differ from expectations in Item 1A, Risk Factors. The following discussion should be read in light of that disclosure and together with the Consolidated Financial Statements and the notes to the Consolidated Financial Statements.
Our pricing program, cost control measures and fix-or-seek exit initiatives continued to provide earnings growth, margin expansion, and strong free cash flow in 2007. Despite volume losses resulting from pricing competition and an economic softening, particularly in the residential construction sector, our 2007 operating results were strong.
We improved our income from operations in 2007 by $225 million, or 11%, as compared with 2006. In addition, income from operations as a percentage of revenue increased by 1.7 percentage points in 2007 as compared with 2006. This earnings growth and margin expansion is a reflection of our continued focus on improving our cost structure and pricing each customer to provide profitable returns, as well as significant returns provided by our recycling operations in 2007, largely due to a very strong market for recycling commodities.
Our revenues in 2007 decreased by $53 million, or 0.4%, as compared with 2006, primarily as a result of volume declines and divestitures, offset largely by increased yield from base business and higher recycling commodity prices. The loss of revenue due to volume declines in 2007 has resulted primarily from pricing competition and a significant slowdown in residential construction across the United States.
In 2007, we decreased our operating expenses despite incurring $35 million in operating costs during the year for labor disputes in Oakland and Los Angeles, California. In 2007, operating expenses decreased by $185 million, or 2.2%, and as a percentage of revenue, declined by 1.2 percentage points as compared with 2006. Our selling, general and administrative expenses increased by $44 million, or 3.2%, as compared with 2006, primarily a result of higher costs associated with the implementation and execution of our strategic initiatives that we believe will improve operations and processes over the long-term.
Our free cash flow increased in 2007 due to lower capital spending and increased proceeds from divestitures, the effects of which were partially offset by lower net cash provided by operating activities. Our capital expenditures were less in 2007 than 2006 largely due to relatively high levels of fleet capital spending in 2006 to prepare for significant mandated changes in heavy-duty truck engines that began in January 2007. The increase in proceeds from divestitures was a result of our continued fix-or-seek exit initiative. We calculate free cash flow as shown in the table below (in millions):
We expect that in 2008 we may continue to face challenges related to volume losses as a result of general economic conditions and pricing competition. However, we are redirecting some of the focus in our sales department from the right-pricing of existing customers, which has largely been completed, to seeking out new customers that will provide profitable growth to our business. Throughout 2007, we continued to focus on building a trusted brand that stands for quality, reliable service, safety and environmental protection. We plan to cultivate this reputation; focus on quality customer service; actively manage our capital requirements and scheduled debt repayments; and grow our business with targeted acquisitions and other investments that will improve our current operations performance and enhance and expand our services. We believe all of these measures will ensure our ability to return value to our shareholders.
Technology Update For the last several years, we have been introducing systems and technologies to improve our business processes and profitability. We recently have successfully deployed our FastLane system, an enterprise-wide, automated point-of-sale system for management of scale house ticketing and our Compass system, a fleet maintenance system that automates many shop functions and tracks repairs. We also are proceeding with pilots of onboard computer systems for our fleet collection operations and modules for our pricing program. As part of our focus on technology, in October 2005, we entered into agreements with a major software vendor to license its waste and recycling revenue management application and have the vendor implement the licensed software throughout the Company on a fixed price basis. In January 2007, we began a pilot test of the licensed application in one of our smaller market areas, while the rest of our market areas continued to operate using our existing revenue management system. The results of the pilot demonstrated to us that the licensed application would not work. In the fourth quarter of 2007, we terminated the pilot and the pilot market areas operations are being returned to our existing revenue management system. Although we have continued to press the vendor to provide a revenue management application that fulfills its obligations to the Company, our negotiations have not yet resulted in a satisfactory commitment from the vendor. In March 2008, in an effort to avoid litigation, we will mediate and attempt to resolve our disputes with the vendor. Therefore, we will not be able to deploy a new revenue management system in the foreseeable future and we will continue to run our current system, although it does not provide the benefits we were expecting to get from the licensed application. However, we may be able to make enhancements to our current system. Our plans to install a new revenue management system, to make enhancements to our current system and to address the issues with the software vendor may result in cost increases, each of which could negatively affect our future cash flow and earnings.
Accounting Changes FIN 48, Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109) and FSP No. 48-1, Definition of Settlement in FASB Interpretation No. 48 Effective January 1, 2007, we adopted FIN 48 and FSP No. 48-1. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of tax positions taken or expected to be taken in tax returns. In addition, FIN 48 provides guidance on the de-recognition, classification and disclosure of tax positions, as well as the accounting for related interest and penalties. FSP No. 48-1 provides guidance associated with the criteria that must be evaluated in determining if a tax position has been effectively settled and should be recognized as a tax benefit.
SFAS No. 123(R) Share-Based Payment On January 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment, which requires compensation expense to be recognized for all share-based payments made to employees based on the fair value of the award at the date of grant. We adopted SFAS No. 123(R) using the modified prospective method, which results in (i) the recognition of compensation expense using the provisions of SFAS No. 123(R) for all share-based awards granted or modified after December 31, 2005 and (ii) the recognition of compensation expense using the provisions of SFAS No. 123, Accounting for Stock-Based Compensation for all unvested awards outstanding at the date of adoption.
Refer to Note 2 of our Consolidated Financial Statements for additional information related to the impact of the implementation of these new accounting pronouncements on our results of operations and financial position.
Reclassification of Segment Information In the first quarter of 2007, we realigned our Eastern, Midwest and Western Group organizations to facilitate improved business execution. We moved certain market areas in the Eastern and Midwest Groups to the Midwest and Western Groups, respectively. In addition, in early 2007 we moved certain of our WMRA operations to our Western Group to more closely align their recycling operations with the related collection, transfer and disposal operations. We have reflected the impact of these realignments for all periods presented to provide financial information that consistently reflects our current approach to managing our operations.
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, as described below. Actual results could differ materially from the estimates and assumptions that we use in the preparation of our financial statements.
Landfills The cost estimates for final capping, closure and post-closure activities at landfills for which we have responsibility are estimated based on our interpretations of current requirements and proposed or anticipated regulatory changes. We also estimate additional costs, pursuant to the requirements of SFAS No. 143, based on the amount a third party would charge us to perform such activities even when we expect to perform these activities internally. We estimate the airspace to be consumed related to each final capping event and the timing of each final capping event and of closure and post-closure activities. Because landfill final capping, closure and post-closure obligations are measured at estimated fair value using present value techniques, changes in the estimated timing of future landfill final capping and closure and post-closure activities would have an effect on these liabilities, related assets and results of operations.
Landfill Costs We estimate the total cost to develop each of our landfill sites to its remaining permitted and expansion capacity. This estimate includes such costs as landfill liner material and installation, excavation for airspace, landfill leachate collection systems, landfill gas collection systems, environmental monitoring equipment for groundwater and landfill gas, directly related engineering, capitalized interest, on-site road construction and other capital infrastructure costs. Additionally, landfill development includes all land purchases for landfill
footprint and required landfill buffer property. The projection of these landfill costs is dependent, in part, on future events. The remaining amortizable basis of each landfill includes costs to develop a site to its remaining permitted and expansion capacity and includes amounts previously expended and capitalized, net of accumulated airspace amortization, and projections of future purchase and development costs.
Final Capping Costs We estimate the cost for each final capping event based on the area to be finally capped and the capping materials and activities required. The estimates also consider when these costs would actually be paid and factor in inflation and discount rates. Our engineering personnel allocate final landfill capping costs to specific capping events. The landfill capacity associated with each final capping event is then quantified and the final capping costs for each event are amortized over the related capacity associated with the event as waste is disposed of at the landfill. We review these costs annually, or more often if significant facts change. Changes in estimates, such as timing or cost of construction, for final capping events immediately impact the required liability and the corresponding asset. When the change in estimate relates to a fully consumed asset, the adjustment to the asset must be amortized immediately through expense. When the change in estimate relates to a final capping event that has not been fully consumed, the adjustment to the asset is recognized in income prospectively as a component of landfill airspace amortization.
Closure and Post-Closure Costs We base our estimates for closure and post-closure costs on our interpretations of permit and regulatory requirements for closure and post-closure maintenance and monitoring. The estimates for landfill closure and post-closure costs also consider when the costs would actually be paid and factor in inflation and discount rates. The possibility of changing legal and regulatory requirements and the forward-looking nature of these types of costs make any estimation or assumption less certain. Changes in estimates for closure and post-closure events immediately impact the required liability and the corresponding asset. When the change in estimate relates to a fully consumed asset, the adjustment to the asset must be amortized immediately through expense. When the change in estimate relates to a landfill asset that has not been fully consumed, the adjustment to the asset is recognized in income prospectively as a component of landfill airspace amortization.
Remaining Permitted Airspace Our engineers, in consultation with third-party engineering consultants and surveyors, are responsible for determining remaining permitted airspace at our landfills. The remaining permitted airspace is determined by an annual survey, which is then used to compare the existing landfill topography to the expected final landfill topography.
Expansion Airspace We include currently unpermitted airspace in our estimate of remaining permitted and expansion airspace in certain circumstances. First, to include airspace associated with an expansion effort, we must generally expect the initial expansion permit application to be submitted within one year, and the final expansion permit to be received within five years. Second, we must believe the success of obtaining the expansion permit is likely, considering the following criteria:
For unpermitted airspace to be initially included in our estimate of remaining permitted and expansion airspace, the expansion effort must meet all of the criteria listed above. These criteria are evaluated by our field-based engineers, accountants, managers and others to identify potential obstacles to obtaining the permits. Once the unpermitted airspace is included, our policy provides that airspace may continue to be included in remaining permitted and expansion airspace even if these criteria are no longer met, based on the facts and circumstances of a
specific landfill. In these circumstances, continued inclusion must be approved through a landfill-specific review process that includes approval of the Chief Financial Officer and a review by the Audit Committee of the Board of Directors on a quarterly basis. Of the 54 landfill sites with expansions at December 31, 2007, 18 landfills required the Chief Financial Officer to approve the inclusion of the unpermitted airspace. Eight of these landfills required approval by the Chief Financial Officer because of a lack of community or political support that could impede the expansion process. The remaining ten landfills required approval primarily due to the permit application processes not meeting the one- or five-year requirements, generally as a result of state-specific permitting procedures.
Once the remaining permitted and expansion airspace is determined, an airspace utilization factor, or AUF, is established to calculate the remaining permitted and expansion capacity in tons. The AUF is established using the measured density obtained from previous annual surveys and then adjusted to account for settlement. The amount of settlement that is forecasted will take into account several site-specific factors including current and projected mix of waste type, initial and projected waste density, estimated number of years of life remaining, depth of underlying waste, and anticipated access to moisture through precipitation or recirculation of landfill leachate. In addition, the initial selection of the AUF is subject to a subsequent multi-level review by our engineering group and the AUF used is reviewed on a periodic basis and revised as necessary. Our historical experience generally indicates that the impact of settlement at a landfill is greater later in the life of the landfill when the waste placed at the landfill approaches its highest point under the permit requirements.
When we include the expansion airspace in our calculations of available airspace, we also include the projected costs for development, as well as the projected asset retirement cost related to final capping, and closure and post-closure of the expansion in the amortization basis of the landfill.
After determining the costs and remaining permitted and expansion capacity at each of our landfills, we determine the per ton rates that will be expensed through landfill amortization. We look at factors such as the waste stream, geography and rate of compaction, among others, to determine the number of tons necessary to fill the remaining permitted and expansion airspace relating to these costs and activities. We then divide costs by the corresponding number of tons, giving us the rate per ton to expense for each activity as waste is received and deposited at the landfill. We calculate per ton amortization rates for each landfill for assets associated with each final capping event, for assets related to closure and post-closure activities and for all other costs capitalized or to be capitalized in the future. These rates per ton are updated annually, or more often, as significant facts change.
It is possible that actual results, including the amount of costs incurred, the timing of final capping, closure and post-closure activities, our airspace utilization or the success of our expansion efforts, could ultimately turn out to be significantly different from our estimates and assumptions. To the extent that such estimates, or related assumptions, prove to be significantly different than actual results, lower profitability may be experienced due to higher amortization rates, higher final capping, closure or post-closure rates, or higher expenses; or higher profitability may result if the opposite occurs. Most significantly, if our belief that we will receive an expansion permit changes adversely and it is determined that the expansion capacity should no longer be considered in calculating the recoverability of the landfill asset, we may be required to recognize an asset impairment. If it is determined that the likelihood of receiving an expansion permit has become remote, the capitalized costs related to the expansion effort are expensed immediately.
Environmental Remediation Liabilities 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. These 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. We provide for expenses associated with environmental remediation obligations when such amounts are probable and can be reasonably estimated. We routinely review and evaluate sites that require remediation and determine our estimated cost for the likely remedy based on several estimates and assumptions.
We estimate costs required to remediate sites where it is probable that a liability has been incurred based on site-specific facts and circumstances. We routinely review and evaluate sites that require remediation, considering whether we were an owner, operator, transporter, or generator at the site, the amount and type of waste hauled to the site and the number of years we were associated with the site. Next, we review the same type of information with
respect to other named and unnamed PRPs. Estimates of the cost for the likely remedy are then either developed using our internal resources or by third-party environmental engineers or other service providers. Internally developed estimates are based on:
Asset Impairments Our long-lived assets, including landfills and landfill expansions, are carried on our financial statements based on their cost less accumulated depreciation or amortization. We review the carrying value of our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In order to assess whether a potential impairment exists, the assets carrying values are compared with their undiscounted expected future cash flows. Estimating future cash flows requires significant judgment about factors such as general economic conditions and projected growth rates, and our estimates often vary from cash flows eventually realized. Impairments are measured by comparing the fair value of the asset to its carrying value. Fair value is determined by either an internally developed discounted projected cash flow analysis of the asset or an actual third-party valuation. If the fair value of an asset is determined to be less than the carrying amount of the asset, an impairment in the amount of the difference is recorded in the period that the impairment indicator occurs.
There are other considerations for impairments of landfills and goodwill, as described below.
Landfills Certain impairment indicators require significant judgment and understanding of the waste industry when applied to landfill development or expansion projects. For example, a regulator may initially deny a landfill expansion permit application though the expansion permit is ultimately granted. In addition, management may periodically divert waste from one landfill to another to conserve remaining permitted landfill airspace. Therefore, certain events could occur in the ordinary course of business and not necessarily be considered indicators of impairment of our landfill assets due to the unique nature of the waste industry.
Goodwill At least annually, we assess whether goodwill is impaired. We assess whether an impairment exists by comparing the carrying value of each Groups goodwill to its implied fair value. The implied fair value of goodwill is determined by deducting the fair value of each Groups identifiable assets and liabilities from the fair value of the Group as a whole. We rely on discounted cash flow analysis, which requires significant judgments and estimates about the future operations of each Group, to develop our estimates of fair value. Additional impairment assessments may be performed on an interim basis if we encounter events or changes in circumstances that would indicate that, more likely than not, the carrying value of goodwill has been impaired.
Self-insurance reserves and recoveries We have retained a significant portion of the risks related to our health and welfare, automobile, general liability and workers compensation insurance programs. Our liabilities associated with the exposure for unpaid claims and associated expenses, including incurred but not reported losses, generally is estimated with the assistance of external actuaries and by factoring in pending claims and historical trends and data. Our estimated accruals for these liabilities could be significantly different than our ultimate obligations if variables such as the frequency or severity of future incidents are significantly different than what we assume. Estimated insurance recoveries related to recorded liabilities are recorded as assets when we believe that the receipt of such amounts is probable.
Results of Operations
Our operating revenues in 2007 were $13.3 billion, compared with $13.4 billion in 2006 and $13.1 billion in 2005. We manage and evaluate our operations primarily through our Eastern, Midwest, Southern, Western, Wheelabrator and WMRA Groups. These six operating Groups are our reportable segments. Shown below (in millions) is the contribution to revenues during each year provided by our six operating Groups and our Other waste services:
Our operating revenues generally come from fees charged for our collection, disposal, transfer, Wheelabrator and recycling services. Revenues from our disposal operations consist of tipping fees, which are generally based on the weight, volume and type of waste being disposed of at our disposal facilities. Fees charged at transfer stations are generally based on the volume of waste deposited, taking into account our cost of loading, transporting and disposing of the solid waste at a disposal site. Our Wheelabrator revenues are based on the type and volume of waste received at our waste-to-energy facilities and IPPs and fees charged for the sale of energy and steam. Recycling revenue, which is generated by our WMRA Group as well as recycling operations embedded in the operations of our four geographic operating Groups, generally consists of the sale of recyclable commodities to third parties and tipping fees. Our other revenues include our in-plant services, methane gas operations, Port-O-Let® services and street and parking lot sweeping services. Intercompany revenues between our operations have been eliminated in the consolidated financial statements. The mix of operating revenues from our different services is reflected in the table below (in millions):
The following table provides details associated with the period-to-period change in revenues (dollars in millions) along with an explanation of the significant components of the current period changes:
Base Business Yield on base business reflects the effect on our revenue from the pricing activities of our collection, transfer, disposal and waste-to-energy operations, exclusive of volume changes. Revenue growth from base business yield includes not only price increases, but also (i) price decreases to retain customers; (ii) changes in average price from new and lost business; and (iii) changes related to the overall mix of services, which are due principally to the types of services provided and the geographic locations where our services are provided.
In both 2006 and 2007, our pricing excellence initiative was the primary contributor to our base business yield growth. The increases in base business yield were driven by our collection operations, which experienced substantial growth in every geographic operating Group primarily as a result of our continued focus on pricing our services based on market-specific factors, including our costs. In 2006, increased collection revenues due to pricing were partially offset by revenue declines from lower collection volumes and in 2007, the increased collection revenues were more than offset by revenue declines from lower collection volumes. However, we continue to find that, in spite of collection volume declines, increased yield on base business and a focus on controlling variable costs provide notable margin improvements and earnings expansion in our collection line of business.
Throughout 2007, we experienced increases in revenue due to yield on base business from our pricing excellence initiatives at our transfer stations and the municipal solid waste, special waste and construction and demolition waste streams at our landfills. The increases in transfer station revenues in 2007 were the most significant in the Eastern and Western portions of the United States. At our landfills, municipal solid waste revenue growth from yield was the most significant in the South and East; special waste revenue growth from yield was the most significant in the West; and our construction and demolition revenue growth from yield was the most significant in the South.
Revenues from our environmental fee, which is included in base business yield, were $121 million, $76 million and $33 million for the years ended December 31, 2007, 2006 and 2005, respectively.
Commodity Recycling prices approached all time highs in 2007 and drove the substantial revenue growth from yield. Increases in the prices of the recycling commodities we process contributed $306 million of revenue growth in 2007. Average prices for old corrugated cardboard increased by 62% and average prices for old newsprint increased by 39% in 2007. Approximately 50% of the increase in revenue from yield on our recycling operations is associated with our relatively lower margin brokerage activities.
Our revenues in 2006 declined $48 million as compared with the prior year due to price decreases in recycling commodities. In 2006, average prices for old corrugated cardboard dropped by 8% and average prices for old newsprint were down by about 7%.
Fuel surcharges and mandated fees Fuel surcharges increased revenues year-over-year by $29 million in 2007. This increase is due to our continued effort to pass on higher fuel costs to our customers through fuel surcharges. We experienced relatively flat market prices for fuel for the first nine months of the year. During the fourth quarter of 2007, we experienced a significantly higher increase in market prices for fuel, which contributed all of the revenue increase due to fuel surcharges in 2007.
Fuel surcharges increased revenues year-over-year by $117 million for 2006. The substantial 2006 increases in revenue provided by our fuel surcharge program can generally be attributed to (i) increases in market prices for fuel; (ii) an increase in the number of customers who participate in our fuel surcharge program; and (iii) the revision of our fuel surcharge program at the beginning of the third quarter of 2005 to incorporate the indirect fuel cost increases passed on to us by subcontracted haulers and vendors.
Increases in our operating expenses due to higher diesel fuel prices include our direct fuel costs for our operations, which are included in Operating Expenses Fuel, as well as estimated indirect fuel costs, which are included primarily in Operating Expenses Subcontractor Costs.
The mandated fees included in this line item are primarily related to the pass-through of fees and taxes assessed by various state, county and municipal governmental agencies at our landfills and transfer stations. These mandated fees have not had a significant impact on the comparability of revenues for the periods included in the table above.
Volume The declines in our revenues due to lower volumes when comparing 2007 and 2006 with the corresponding prior year periods have been driven by declines in our collection volumes and, to a lesser extent, lower transfer station and third-party disposal volumes.
Volume reductions in 2007 have significantly affected the revenues of each of our collection lines of business in each geographic operating Group. Our industrial collection operations have experienced the most significant revenue declines due to lower volumes. Reduced volumes continue to be significantly affected by our focus on improving margins through increased pricing. Volume declines in our industrial collection business have also been affected by the significant slowdown in residential construction across the United States. Our commercial and residential collection operations have experienced revenue declines due to lower volumes in each geographic group as well.
Declines in revenue due to lower third-party volumes in our transfer station operations have been the most notable in our Eastern Group and can generally be attributed to the effects of pricing. In 2007, we also experienced declines in third-party revenue at our landfills due to reduced disposal volumes. The most significant declines were in our construction and demolition waste, particularly in our Southern Group. The reduction in construction and demolition volumes was largely due to the significant slowdown in residential construction across the United States. The volume declines for our municipal solid waste disposal operations have been the most significant in our Midwest Group due primarily to our focus on pricing increases. Waste-to-energy revenue from disposal volumes also declined in 2007, largely due to the termination of an operating and maintenance agreement in May 2007. The revenue decline due to lower third-party volumes in our recycling business was primarily attributable to decreases in certain brokerage activities and the closure of a plastics processing facility.
The revenue declines in our collection businesses in 2006 were partially offset by increased disposal volumes in all of our geographic operating Groups through the first nine months of the year. Our special waste, municipal solid waste and construction and demolition waste streams were the primary drivers of this growth in revenues due to higher volumes. We believe that the strength of the economy throughout most of the year and favorable weather in many parts of the country were the primary drivers of the higher disposal volumes. In the fourth quarter of 2006, we experienced a decline in disposal volumes as compared with the fourth quarter of 2005, which we believe was due to the lack of hurricane volumes in 2006, competition, impacts of our pricing initiatives and an economic softening that caused a significant decline in residential construction.
Divestitures Divestitures of under-performing and non-strategic operations accounted for decreased revenues of $320 million in 2007 and $154 million in 2006. These divestitures were primarily comprised of collection operations and, to a lesser extent, transfer station and recycling operations.
Our operating expenses include (i) labor and related benefits (excluding labor costs associated with maintenance and repairs included below), which include salaries and wages, bonuses, related payroll taxes, insurance and benefits costs and the costs associated with contract labor; (ii) transfer and disposal costs, which include tipping fees paid to third-party disposal facilities and transfer stations; (iii) maintenance and repairs relating to equipment, vehicles and facilities and related labor costs; (iv) subcontractor costs, which include the costs of independent haulers who transport waste collected by us to disposal facilities and are driven by transportation costs such as fuel prices; (v) costs of goods sold, which are primarily the rebates paid to suppliers associated with recycling commodities; (vi) fuel costs, which represent the costs of fuel and oil to operate our truck fleet and landfill operating equipment; (vii) disposal and franchise fees and taxes, which include landfill taxes, municipal franchise fees, host community fees and royalties; (viii) landfill operating costs, which include landfill remediation costs, leachate and methane collection and treatment, other landfill site costs and interest accretion on asset retirement obligations; (ix) risk management costs, which include workers compensation and insurance and claim costs and (x) other operating costs, which include, among other costs, equipment and facility rent and property taxes.
The following table summarizes the major components of our operating expenses, including the impact of foreign currency translation, for the years ended December 31 (in millions):
The decreases in operating expenses for both 2007 and 2006 as compared with the prior year periods can be attributed primarily to (i) our efforts to maximize margin expansion by focusing on managing our fixed costs and reducing our variable costs; (ii) the divestiture of under-performing and low margin businesses; and (iii) volume declines due to our pricing program and the slowdown in residential construction. In 2007, our cost containment efforts had the most significant impact on our risk management and maintenance and repair costs, while the impact of divestitures and volume declines provided significant reductions in transfer, disposal and subcontractor costs. The operating expense declines during 2007 were partially offset by increased Cost of goods sold due to significantly higher commodity prices and Other operating expenses incurred for labor disputes in Oakland and Los Angeles, California. These expenses are discussed below.
In addition to lowering overall costs the last two years, our operating expenses as a percentage of revenues decreased by 1.2 percentage points for 2007, from 64.3% in 2006 to 63.1% in 2007, building on the improvement of 1.7 percentage points during 2006. The improvement in operating expenses as a percentage of revenues reflects our continued focus on identifying operational efficiencies that translate into cost savings, revenue growth on base business yield, shedding low margin volumes and divesting operations that are not improving.
As discussed above, the changes in our Operating expenses when comparing 2007, 2006 and 2005 can largely be attributed to our focus on cost control, volume declines and divestitures. Overall, these favorable items have been slightly offset by the unfavorable effect of changes in Canadian currency exchange rates. However, there
are several additional items that affect the comparability of our operating expenses by category for the periods presented. These additional items are summarized, by category, below:
Labor and related benefits In each year, wage increases due to annual merit adjustments have partially offset cost reductions due to headcount reductions related to operating efficiencies, divestitures and volume declines. During 2006, bonus expense was higher than either 2007 or 2005 due to the out-performance of 2006 incentive plan measures. The Companys performance in both 2007 and 2005 was more in line with established incentive plan targets.
Transfer and disposal costs In addition to the impacts of divestitures and volume declines, the costs incurred by our collection operations to dispose of waste at third-party transfer stations or landfills have declined due to our focus on improving internalization.
Maintenance and repairs Throughout 2006 and 2007, cost savings were generated from (i) various fleet initiatives targeted at improving our maintenance practices while reducing maintenance, parts and supplies costs; and (ii) changes in the scope of maintenance projects at our waste-to-energy facilities. In 2006, year-over-year reductions due to divestitures, volume declines and the items previously noted were outweighed by increased labor costs.
Subcontractor costs During the fourth quarter of 2007 and throughout 2006, we experienced increases in subcontractor costs due to higher diesel fuel prices, which drive the fuel surcharges we pay to third-party subcontractors. These cost increases were offset in part by the revenue generated from our fuel surcharge program, which is reflected as fuel yield increases within Operating Revenues. Additionally, in 2006, we incurred significant subcontractor costs during the first quarter of 2006 to assist in providing hurricane related services.
Cost of goods sold Fluctuations in these costs are generally based on changes in our recycling revenues because they are primarily related to rebates we pay to our recycling suppliers. When comparing 2007 with 2006, substantially higher market prices for recyclable commodities resulted in significant revenue growth and higher cost of goods sold. When comparing 2006 with 2005, these costs were lower due to a decrease in market prices for recyclable commodities and reduced recycling volumes. Additionally, in 2006, the decrease in costs of goods sold was partially due to the completion of the construction of an integrated waste facility in Canada in early 2006.
Fuel We experienced an estimated average increase of $0.18 per gallon for 2007 as compared with 2006 and of $0.31 per gallon for 2006 as compared with 2005. Fuel costs were relatively constant through the first nine months of 2007, but increased sharply during the fourth quarter. While our fuel surcharge is designed to respond to changes in the market price for fuel, the sharp increase late in 2007 negatively affected our ability to recover increased costs resulting from higher fuel prices within the year due to a lag in the timing of increased revenues following fuel cost increases. In each year, increased fuel costs have negatively affected our operating margin percentages. Revenues generated by our fuel surcharge program are reflected as fuel yield increases within Operating Revenues.
Disposal and franchise fees and taxes In 2007, these cost declines were partially due to the resolution of a disposal tax matter in our Eastern Group, which resulted in the recognition of $18 million in favorable adjustments to operating costs during 2007. In 2006, we experienced increases in rates for mandated fees and taxes in certain markets. Certain of these cost increases are passed through to our customers, and have been reflected as fee yield increases within Operating Revenues.
Landfill operating costs These costs increased during 2007 due to charges for revisions in our estimates associated with remediation obligations and changes in the risk-free discount rate that we use to estimate the present value of these obligations. During 2007 we recorded an $8 million charge to reduce the discount rate from 4.75% to 4.00% and during 2006 we recorded a $6 million decrease in expense to reflect an increase in the rate from 4.25% to 4.75%. For 2006, the cost increases as compared with 2005 generally related to higher site maintenance, leachate collection, monitoring and testing, and closure and post-closure expenses.
Risk management Over the last two years, we have been increasingly successful in reducing these costs, which can be attributed to our continued focus on safety and reduced accident and injury rates. For 2007, the decrease in expense was largely associated with reduced actuarial projections of auto and general liability claims and, to a lesser extent, reduced workers compensation costs. During 2006, the decline in expenses as compared with 2005 was primarily due to reduced workers compensation costs.
Other operating expenses In the third and fourth quarters of 2007, we incurred a significant increase in Other expenses due in large part to costs incurred for labor disputes with the Teamsters Local 70 in Oakland, California that was resolved in July 2007 and with Teamsters Local 396 in Los Angeles that was resolved in October 2007. These labor disputes negatively affected the Income from operations of our Western Group by $37 million, including $33 million of additional Other operating expenses, for the year ended December 31, 2007. The increased operating costs were primarily related to security and the deployment and lodging costs incurred for the Companys replacement workers who were brought to California from across the organization. For the year ended December 31, 2006, our Eastern Group incurred $14 million for similar costs, which were primarily for a labor strike in the New York City area.
Also affecting the comparability of our Other operating expenses for 2007 as compared with 2006 were (i) $21 million of lease termination costs incurred during the first quarter of 2007 associated with the purchase of one of our independent power production plants that had previously been operated through a lease agreement; (ii) lower lease and rental expenses in 2007; and (iii) an increase in gains recognized on the sales of assets for 2007.
The lower costs in 2006 as compared with 2005 can be attributed to (i) Hurricane Katrina related support costs in 2005, particularly in Louisiana, where we built Camp Waste Management to house and feed employees who worked in the New Orleans area to help with the cleanup efforts; (ii) comparatively higher rental expense in 2005; and (iii) a decrease related to the deconsolidation of a variable interest entity in early 2006.
Selling, General and Administrative
Our selling, general and administrative expenses consist of (i) labor costs, which include salaries, bonuses, related insurance and benefits, contract labor, payroll taxes and equity-based compensation; (ii) professional fees, which include fees for consulting, legal, audit and tax services; (iii) provision for bad debts, which includes allowances for uncollectible customer accounts and collection fees; and (iv) other general and administrative expenses, which include, among other costs, facility-related expenses, voice and data telecommunication, advertising, travel and entertainment, rentals, postage and printing. In addition, the financial impacts of litigation settlements generally are included in our other selling, general and administrative expenses.
The following table summarizes the major components of our selling, general and administrative costs for the years ended December 31 (in millions):
Our labor and related benefits, professional fees and other general and administrative costs for the year ended December 31, 2007 increased by $24 million as a result of non-capitalizable costs associated with investments in our information technology and our people strategies. Other significant changes in our selling, general and administrative expenses are summarized below.
Labor and related benefits In both 2007 and 2006, these costs increased year-over-year due to higher compensation costs driven by an increase in the size of our sales force; increased investments in our information technology and people strategies, as noted above; higher non-cash compensation expense associated with the equity-based compensation provided for by our long-term incentive plan; and annual merit raises. The higher labor costs for our pricing, people and other initiatives are necessary as we implement new ways to grow our business and strengthen our ongoing operations. Our bonus expenses were relatively higher in 2006 than either 2005 or 2007 due to the strength of our performance against incentive plan measures in that year. Fluctuations in our use of contract labor for corporate support functions also caused an increase in 2006 as compared with 2005. These cost increases in 2006 were partially offset by savings associated with our 2005 restructuring.
Professional Fees In both 2007 and 2006, our consulting fees increased as a result of our strategic initiatives. In 2007, this increase was offset by (i) lower consulting costs associated with our pricing initiatives; and
(ii) reductions in legal fees and expenses, largely as a result of higher costs in 2006 related to indemnification obligations for former officers in legacy litigation brought by the SEC.
Other Our Selling, general and administrative expenses for the years ended 2007 and 2006 included net charges of approximately $2 million and $20 million, respectively, to record our estimated obligations for unclaimed property. Refer to Note 10 of our Consolidated Financial Statements for additional information related to the nature of these charges.
Additionally, in both 2007 and 2006, our other costs increased due to higher sales and marketing costs and higher travel and entertainment costs due partially to the development of our revenue management system and our efforts to implement various initiatives.
Depreciation and amortization includes (i) depreciation of property and equipment, including assets recorded due to capital leases, on a straight-line basis from three to 50 years; (ii) amortization of landfill costs, including those incurred and all estimated future costs for landfill development, construction, asset retirement costs arising from closure and post-closure, on a units-of-consumption method as landfill airspace is consumed over the estimated remaining permitted and expansion capacity of a site; (iii) amortization of landfill asset retirement costs arising from final capping obligations on a units-of-consumption method as airspace is consumed over the estimated capacity associated with each final capping event; and (iv) amortization of intangible assets with a definite life, either using a 150% declining balance approach or a straight-line basis over the definitive terms of the related agreements, which are from two to ten years depending on the type of asset.
Depreciation and amortization expense was $1,259 million, or 9.5% of revenues, for the year ended December 31, 2007; $1,334 million, or 10.0% of revenues, for the year ended December 31, 2006; and $1,361 million, or 10.4% of revenues, for the year ended December 31, 2005. The $75 million decrease when comparing 2007 with 2006 can be attributed, in part, to landfill volume declines. The $27 million decrease when comparing 2006 with 2005 was primarily due to the suspension of depreciation on assets held-for-sale and divestitures. Additonally, in both 2007 and 2006 there were decreases in depreciation due to components of enterprise-wide software becoming fully depreciated.
The comparability of our depreciation and amortization expense for the years ended December 31, 2007, 2006, and 2005 has also been significantly affected by (i) a $21 million charge to landfill amortization recognized in 2005 to adjust the amortization periods of nine of our leased landfills and (ii) adjustments to landfill airspace and landfill asset retirement cost amortization recorded in each year for changes in estimates related to our final capping, closure and post-closure obligations. During the years ended December 31, 2007, 2006 and 2005, landfill amortization expense was reduced by $17 million, $1 million and $13 million, respectively, for the effects of these changes in estimates. In each year, the majority of the reduced expense resulting from the revised estimates was associated with final capping changes.
Management continuously reviews our organization to determine if we are operating under the most advantageous structure. Our 2007 and 2005 restructurings were the result of reviews that highlighted opportunities for efficiencies and cost savings. The most significant cost savings we have obtained through our restructurings have been attributable to the labor and related benefits component of our Selling, general and administrative expenses.
In the first quarter of 2007, we restructured certain operations and functions, resulting in the recognition of a charge of approximately $9 million. We incurred an additional $1 million of costs for this restructuring during the second quarter of 2007, increasing the 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 approximately $8 million for employee severance and benefit costs and approximately $2 million related to operating lease agreements.
During the third quarter of 2005, we reorganized and simplified our organizational structure by eliminating certain support functions performed at the Group or Corporate office. We also eliminated the Canadian Group office, which reduced the number of our operating Groups from seven to six. This reorganization reduced costs at
the Group and Corporate offices and increased the accountability of our Market Areas. We recorded $28 million of pre-tax charges in 2005 for costs associated with the implementation of the new structure, principally for employee severance and benefit costs.
The following table summarizes the major components of (Income) expense from divestitures, asset impairments and unusual items for the year ended December 31 for the respective periods (in millions):
(Income) expense from divestitures (including held-for-sale impairments) The net gains from divestitures in all three years were a result of our fix-or-seek exit initiative, and 2005 also included a $39 million gain from the divestiture of a landfill in Canada as a result of a Divestiture Order by the Competition Bureau. Gains recognized from divestitures in 2006 were partially offset by the recognition of aggregate impairment charges of $18 million for operations held for sale as required by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
Impairments of assets held-for-use During 2007, we recognized $12 million in impairment charges due to impairments recognized for two landfills in our Southern Group. The impairments were necessary as a result of the re-evaluation of our business alternatives for one 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.
The $24 million of impairment charges recognized during 2006 was primarily related to the impairment of a landfill in our Eastern Group as a result of a change in our expectations for future expansions and the impairment of under-performing operations in our WMRA Group.
During the second quarter of 2005, our Eastern Group recorded a $35 million charge for the impairment of the Pottstown Landfill in Pennsylvania. We determined that the impairment was necessary after the denial of a permit application for a vertical expansion at the landfill was upheld and we decided not to pursue an appeal of that decision. In addition, during 2005 we recorded $68 million in impairment charges associated with capitalized software, driven by a $59 million charge for revenue management system software that had previously been under development. The remaining impairment charges recognized in 2005 were largely related to the impairment of a landfill in our Eastern Group as a result of a change in our expectations for future expansions.
Other In both 2006 and 2005 we recognized charges associated with the termination of legal matters related to issues that arose in 2000 and earlier. In 2006, we recognized a $26 million charge for the impact of an arbitration ruling against us related to the termination of a joint venture relationship in 2000. In 2005, we recognized a $16 million charge for the impact of a settlement reached with a group of stockholders that had opted not to participate in the settlement of the securities class action lawsuit against us related to 1998 and 1999 activity and a $27 million charge to settle our ongoing defense costs associated with possible indemnity obligations to former officers of WM Holdings related to the litigation brought against them by the SEC. The 2005 charges were partially offset by the recognition of a net benefit of $12 million, primarily for adjustments to receivables and estimated obligations for non-solid waste operations that had been sold in 1999 and 2000.
Income From Operations by Reportable Segment
The following table summarizes income from operations by reportable segment for the years ended December 31 and provides explanations of significant factors contributing to the identified variances (in millions):
Operating segments Increased yield on base business as a result of our pricing strategies, our continued focus on controlling costs through operating efficiencies and higher-margin disposal volumes have improved the operating income of our geographic Groups each year during the three-year period ended December 31, 2007. Base business yield provided revenue growth for each line of business in 2007 and in 2006, and was driven primarily by our collection operations, where we experienced substantial revenue growth in every geographic operating Group for the third consecutive year. The improvements in operating income have been partially offset by the effects of declines in revenues due to lower volumes, which generally are the result of pricing competition, as well as the significant downturn in residential construction and the slowdown of the general economic environment in 2007. See additional discussion in the Operating Revenues section above.
Other significant items affecting the comparability of the operating segments results of operations for the years ended December 31, 2007, 2006 and 2005 are summarized below:
Eastern The Groups operating income for the year ended December 31, 2007 includes (i) net divestiture gains of $33 million; (ii) an $18 million decrease in disposal fees and taxes due to the favorable resolution of a disposal tax matter; and (iii) a reduction in landfill amortization expense as a result of changes in certain estimates related to our final capping, closure and post-closure obligations. The Groups operating income for the year ended December 31, 2006 was negatively affected by $26 million in charges associated with (i) the impairment of businesses being sold as part of our divestiture program and (ii) the impairment of a landfill. The year ended December 31, 2005 was negatively affected by the recognition of $44 million in impairment charges related primarily to the Pottstown landfill. Finally, the operating results of our Eastern Group for 2006 and 2005 were negatively affected by costs incurred in connection with labor strikes. For the year ended December 31, 2006, we incurred $14 million of costs related primarily to a strike in the New York City area. The Group incurred similar costs during the first quarter of 2005 for a labor strike in New Jersey, which decreased operating income for the year ended December 31, 2005 by approximately $9 million.
Midwest Positively affecting operating results in 2007 and in 2005 were reductions in landfill amortization expense resulting from changes in certain estimates related to our final capping, closure and post-closure obligations.
Southern During 2007, the Group recorded $12 million of impairment charges attributable to two of its landfills. These charges were offset by gains on divestitures of $11 million. During 2005, several large non-recurring type items were recognized, impacting comparisons to the other periods presented. These items include $13 million of pre-tax gains recognized on the divestiture of operations during 2005 and declines in earnings related to (i) hurricanes, largely due to the temporary suspension of operations in the areas affected by Hurricane Katrina; (ii) the effects of higher landfill amortization costs, generally due to reductions in landfill
amortization periods to align the lives of the landfills for amortization purposes with the terms of the underlying contractual agreements supporting their operations; and (iii) higher landfill amortization expense as a result of changes in certain estimates related to our final capping, closure and post-closure obligations.
Western The Groups 2007 operating results were negatively affected by $37 million as a result of various labor disputes, which are discussed in the Operating Expenses section above. Gains on divestitures of operations were $16 million for the year ended December 31, 2007 as compared with $48 million for 2006 and $24 million for 2005.
Wheelabrator The decline in operating income for the year ended December 31, 2007 was driven by a $21 million charge recorded in the first quarter of 2007 for the early termination of a lease agreement. The early termination was due to the Groups purchase of an independent power production plant that it had previously operated through a lease agreement. Additionally, the termination of an operating and maintenance agreement in May 2007 resulted in a decline in revenue and operating income compared with the prior years.
WMRA The Groups 2007 operating income has benefited from substantial increases in market prices for commodities and $7 million of net gains on divestitures. In addition, the Group has experienced significant returns from operational improvements, including an increased focus on maintaining or reducing rebates made to suppliers. During 2006, the Group recognized $10 million of charges for a loss from a divestiture and an impairment of certain under-performing operations, which were slightly more than offset by savings associated with the Groups cost control efforts. Income from operations in our WMRA Group during 2005 includes costs related to the deployment of new software.
Significant items affecting the comparability of the remaining components of our results of operations for the years ended December 31, 2007, 2006 and 2005 are summarized below:
Other The changes in operating results for the periods presented are largely related to certain year-end adjustments recorded in consolidation related to our reportable segments that were not included in the measure of segment income from operations used to assess their performance for the periods disclosed. The unfavorable change in operating results in 2007 when compared with 2006 can also be attributed, in part, to the deconsolidation of a variable interest entity in April 2006. The favorable operating results in 2005 were also significantly affected by a $39 million pre-tax gain resulting from the divestiture of one of our landfills in Ontario, Canada. This impact is included in (Income) expense from divestitures, asset impairments and unusual items within our Consolidated Statement of Operations. As this landfill had been divested at the time of our 2005 reorganization, historical financial information associated with its operations has not been allocated to our remaining reportable segments. Accordingly, these impacts have been included in Other.
Corporate and Other In 2007 and 2006 we experienced significantly lower risk management costs largely due to our focus on safety and controlling costs. Other significant items occurring in 2007 include (i) a reduction in expenses from the discontinuation of depreciation for certain enterprise-wide software that is now fully depreciated; (ii) increased spending on the support and development of our information technology, people and pricing strategic initiatives; (iii) increased labor and related benefits costs; and (iv) restructuring charges.
When comparing 2006 operating results with 2005, in addition to lower risk management costs, we experienced lower employee health and welfare plan costs, also as a result of our focus on controlling costs. These cost savings were largely offset by: (i) a $20 million charge recorded to recognize unrecorded obligations associated with unclaimed property, which is discussed in the Selling, General and Administrative section above; (ii) increased incentive compensation expense; (iii) higher consulting fees and sales commissions primarily related to our pricing initiatives; (iv) an increase in our marketing costs due to our national advertising campaign; (v) the centralization of support functions that were provided by our Group offices prior to our 2005 reorganization; and (vi) a $26 million charge associated with an arbitration ruling against us related to a joint venture relationship that terminated in 2000.
Our 2005 operating results include impairment charges of $68 million associated with capitalized software costs and $31 million of net charges associated with various legal and divestiture matters. Also contributing to expenses during 2005 were costs at Corporate associated with our July 2005 restructuring charge and other organizational changes, which were partially offset by the associated savings at Corporate.
Other Components of Net Income
The following table summarizes the other major components of our income for the year ended December 31 for each respective period (in millions):
The variances in interest expense during the reported periods are generally related to (i) decreases in our outstanding debt balances due to our repayment of borrowings throughout 2006 and 2007; (ii) the maturity of higher rate debt that we have effectively refinanced at lower interest rates; and (ii) fluctuations in market interest rates, which influence the impacts of our interest rate swaps and the interest rates of our variable rate debt.
We use interest rate derivative contracts to manage our exposure to changes in market interest rates. The combined impact of active and terminated interest rate swap agreements resulted in a net interest expense increase of $11 million for 2007 and $4 million for 2006. For the year ended December 31, 2005, interest rate swaps reduced net interest expense by $39 million. The significant decline in the benefit recognized as a result of our active interest rate swap agreements is attributable to the increase in short-term market interest rates. Our periodic interest obligations under our active interest rate swap agreements are based on a spread from the three-month LIBOR, which has varied significantly during the three-year period ended December 31, 2007. Specifically, the three-month LIBOR was as low as 2.75% in early 2005 and as high as 5.62% in the second half of 2007. Included in the $11 million net increase in interest expense realized in 2007 for terminated and active interest rate swap agreements is a $37 million reduction in interest expense related to the amortization of terminated swaps. Our terminated interest rate swaps are expected to reduce interest expense by $33 million in 2008, $19 million in 2009 and $12 million in 2010.
In 2007, decreases in our average cash and investment balances on a year-over-year basis resulted in a decline in interest income. In addition, interest income for 2006 included interest income of $14 million realized on tax refunds received from the IRS for the settlement of several federal audits. When comparing 2006 with 2005, the increase in interest income was due to the 2006 tax refund and an increase in our investments in variable rate demand notes and auction rate securities throughout the year.
Equity in Net Losses of Unconsolidated Entities
Our Equity in net losses of unconsolidated entities is primarily related to our equity interests in two coal-based synthetic fuel production facilities. Our equity in the losses of these facilities was $42 million for the year ended December 31, 2007, $41 million for the year ended December 31, 2006 and $112 million for the year ended December 31, 2005. The equity losses generated by the facilities are offset by the tax benefit realized as a result of these investments as discussed below within Provision for (benefit from) income taxes.
Our equity in the losses of the facilities in both 2007 and 2006 have been significantly affected by our expectations for a partial phase-out of Section 45K credits on our contractual obligations associated with funding the facilities losses. The IRS has not yet published the phase-out percentage that must be applied to Section 45K tax credits generated in 2007. Accordingly, we have used market information for oil prices to estimate that we expect 69% of Section 45K tax credits generated in 2007 to be phased-out. The IRS establishment of the final phase-out of
Section 45K credits generated during 2007 could further impact the equity in losses of the facilities we recognized for 2007. Any subsequent adjustment to the amount of realizable Section 45K credits and related equity losses will be reflected in our 2008 Consolidated Financial Statements.
As of December 31, 2006, we had estimated that 36% of Section 45K tax credits generated during 2006 would be phased out. On April 4, 2007, the IRS established the final phase-out of Section 45K credits generated during 2006 at approximately 33%. We did not experience any phase-out of Section 45K tax credits in 2005.
In addition, the facilities temporarily suspended operations in May 2006, reducing our obligations associated with funding the facilities losses for the year ended December 31, 2006. During the second quarter of 2006, we also recognized a cumulative adjustment necessary to appropriately reflect our life-to-date obligations to fund the costs of operating the facilities and the value of our investment.
On December 31, 2003, we consolidated two limited liability companies that own three waste-to-energy facilities operated by our Wheelabrator Group as a result of our implementation of FIN 46(R). Our minority interest expense for 2007, 2006 and 2005 is primarily related to the other members equity interest in the earnings of these entities. Additional information related to these investments is included in Note 19 to the Consolidated Financial Statements.
Provision for (Benefit from) Income Taxes
We recorded a provision for income taxes of $540 million in 2007 and $325 million in 2006, and a benefit from income taxes of $90 million in 2005. These tax provisions resulted in an effective income tax rate of approximately 31.7%, 22.1% and (8.2)% for each of the three years, respectively. The comparability of our reported income taxes for the years ended December 31, 2007, 2006 and 2005 is primarily affected by (i) increases in our income before taxes and (ii) differences in the impacts of tax audit settlements and non-conventional fuel tax credits, which are discussed in more detail below. Other items that have affected our reported income taxes during the reported periods include the following:
The impacts of tax audit settlements and non-conventional fuel tax credits, which are the items that had the most significant impacts on the comparability of our effective tax rate during the years ended December 31, 2007, 2006 and 2005, are summarized below:
Non-conventional fuel tax credits expired at the end of 2007 pursuant to Section 45K of the Internal Revenue Code. Accordingly, at current income levels, we expect that our 2008 effective tax rate will be approximately 40% without the benefit of the tax credits.
Liquidity and Capital Resources
We continually monitor our actual and forecasted cash flows, our liquidity and our capital resources, enabling us to plan for our present needs and fund unbudgeted business activities that may arise during the year as a result of changing business conditions or new opportunities. In addition to our working capital needs for the general and administrative costs of our ongoing operations, we have cash requirements for: (i) the construction and expansion of our landfills; (ii) additions to and maintenance of our trucking fleet; (iii) construction, refurbishments and improvements at waste-to-energy and materials recovery facilities; (iv) the container and equipment needs of our operations; (v) capping, closure and post-closure activities at our landfills; and (vi) repaying debt and discharging other obligations. We also are committed to providing our shareholders with a return on their investment through our capital allocation program that provides for dividend payments, share repurchases and investments in acquisitions that we believe will be accretive and provide continued growth in our business.
The American Jobs Creation Act of 2004 allowed U.S. companies to repatriate earnings from their foreign subsidiaries at a reduced tax rate during 2005. Our Chief Executive Officer and Board of Directors approved a domestic reinvestment plan under which we repatriated $496 million of our accumulated foreign earnings and capital in 2005. The repatriation was funded with cash on hand and bank borrowings. For a discussion of the tax impact and bank borrowings see Notes 7 and 8 to the Consolidated Financial Statements.
Summary of Cash, Short-Term Investments, Restricted Trust and Escrow Accounts and Debt Obligations
The following is a summary of our cash, short-term investments available for use, restricted trust and escrow accounts and debt balances as of December 31, 2007 and December 31, 2006 (in millions):
Cash and cash equivalents Cash and cash equivalents consist primarily of cash on deposit, certificates of deposit, money market accounts, and investment grade commercial paper purchased with original maturities of three months or less.
Short-term investments available for use Periodically, we have invested in auction rate securities and variable rate demand notes, which are debt instruments with long-term scheduled maturities and periodic interest rate reset dates. The interest rate reset mechanism for these instruments results in a periodic remarketing of the underlying securities through an auction process. Due to the liquidity provided by the interest rate reset mechanism and the short-term nature of our investment in these securities, they have been classified as current assets in our Consolidated Balance Sheets. Due to the decline in our overall cash balances near the end of 2007, we did not hold any of these investments as of December 31, 2007.
Restricted trust and escrow accounts Restricted trust and escrow accounts consist primarily of funds held in trust for the construction of various facilities or repayment of our debt obligations, funds deposited for purposes of settling landfill closure, post-closure and environmental remediation obligations and insurance escrow deposits. These balances are primarily included within long-term Other assets in our Consolidated Balance Sheets. See Note 3 to the Consolidated Financial Statements for additional discussion.
Debt We use long-term borrowings in addition to the cash we generate from operations as part of our overall financial strategy to support and grow our business. We primarily use senior notes and tax-exempt bonds to borrow on a long-term basis, but also use other instruments and facilities when appropriate. The components of our long-term borrowings as of December 31, 2007 are described in Note 7 to the Consolidated Financial Statements.
Changes in our outstanding debt balances from December 31, 2006 to December 31, 2007 can primarily be attributed to (i) the cash repayment of $1,200 million of outstanding borrowings at their scheduled maturities; (ii) $944 million of cash borrowings, generally to refinance amounts repaid in cash during the year; (iii) non-cash proceeds from tax-exempt borrowings, net of principal payments made directly from trust funds of $144 million; (iv) a $53 million increase in the carrying value of our debt due to hedge accounting for interest rate swaps; and (v) the impacts of accounting for other non-cash changes in our balances due to foreign currency translation, interest and capital leases.
We have approximately $1.2 billion of scheduled debt maturities during the next twelve months. We have classified approximately $840 million of these borrowings as long-term as of December 31, 2007 based on our intent and ability to refinance these borrowings on a long-term basis.
Summary of Cash Flow Activity
The following is a summary of our cash flows for the year ended December 31 for each respective period (in millions):
Net Cash Provided by Operating Activities The comparability of our operating cash flows for the periods presented is affected by our adoption of SFAS No. 123(R) on January 1, 2006. SFAS No. 123(R) requires reductions in income taxes payable attributable to excess tax benefits associated with equity-based transactions to be included in cash flows from financing activities, which are discussed below. Prior to adopting SFAS No. 123(R), our excess tax benefits associated with equity-based transactions were included within cash flows from operating activities as a change in Accounts payable and accrued liabilities. During 2005, these excess tax benefits improved our operating cash flows by approximately $17 million.
The most significant items affecting the comparison of our operating cash flows for 2007 and 2006 are summarized below:
The most significant items affecting the comparison of our operating cash flows for 2006 and 2005 are summarized below:
Net Cash Used in Investing Activities The most significant items affecting the comparison of our investing cash flows for the periods presented are summarized below:
Net Cash Used in Financing Activities The most significant items affecting the comparison of our financing cash flows for the periods presented are summarized below:
In December 2007, our Board of Directors approved a new capital allocation program that includes the authorization for up to $1.4 billion in combined cash dividends and common stock repurchases in 2008. Approximately $184 million of the additional authorization of $300 million in November 2007 was not used in 2007. As a result, the maximum amount of capital to be allocated to our share repurchases and dividend payments in 2008 is $1,584 million. We currently intend to allocate up to $1.4 billion of capital to dividends and share repurchases in 2008.
We paid $1,421 million for share repurchases in 2007, as compared with $1,072 million in 2006 and $706 million in 2005. We repurchased approximately 40 million, 31 million and 25 million shares of our common stock in 2007, 2006 and 2005, respectively. We currently expect to continue repurchasing common stock under the capital allocation program discussed above.
We paid an aggregate of $495 million in cash dividends during 2007 compared with $476 million in 2006 and $449 million in 2005. The increase in dividend payments is due to our quarterly per share dividend increasing from $0.20 in 2005, to $0.22 in 2006 and to $0.24 in 2007. The impact of the year-over-year increases in the per share dividend has been partially offset by a reduction in the number of our outstanding shares as a result of our share repurchase program. In December 2007, the Board of Directors announced that it expects future quarterly dividend payments will be $0.27 per share. All future dividend declarations are at the discretion of the Board of Directors, and depend on various factors, including our net earnings, financial condition, cash required for future prospects and other factors the Board may deem relevant.
Summary of Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2007 and the anticipated effect of these obligations on our liquidity in future years (in millions):
We have contingencies that are not considered reasonably likely. As a result, the impact of these contingencies have not been included in the above table. See Note 10 to the Consolidated Financial Statements for further discussion of these contingencies.
We are party to guarantee arrangements with unconsolidated entities as discussed in the Guarantees section of Note 10 to the Consolidated Financial Statements. Our third-party guarantee arrangements are generally established to support our financial assurance needs and landfill operations. These arrangements have not materially affected our financial position, results of operations or liquidity during the year ended December 31, 2007 nor are they expected to have a material impact on our future financial position, results of operations or liquidity.
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, such as the hurricanes experienced in 2004 and 2005, can 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 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.
While inflationary increases in costs, including the cost of fuel, have affected our operating margins in recent periods, we believe that inflation generally has not had, and in the near future is not expected to have, any material adverse effect on our results of operations. However, managements estimates associated with inflation have had, and will continue to have, an impact on our accounting for landfill and environmental remediation liabilities.
SFAS No. 157 Fair Value Measurements
In September 2006, the FASB 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. SFAS No. 157 will be effective for the Company beginning January 1, 2008. We do not currently expect the adoption of SFAS No. 157 on January 1, 2008 to have a material impact on our consolidated financial statements. However, we are continuing to assess the potential effects of SFAS No. 157 as additional guidance becomes available.
SFAS No. 159 Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB Statement No. 115, which permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 will be effective for the Company beginning January 1, 2008. The Company has elected not to measure eligible items at fair value upon initial adoption and does not believe the adoption of this statement will have a material impact on its consolidated financial statements.
SFAS No. 141(R) Business Combinations
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, which establishes principles and requirements for how the acquirer recognizes and measures in the financial statements the
identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. This statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) will be effective for the Company beginning January 1, 2009. We are currently evaluating the effect the adoption of SFAS No. 141(R) will have on our accounting and reporting for future acquisitions.
SFAS No. 160 Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements an amendment of ARB No. 51, which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS No. 160 will be effective for the Company beginning January 1, 2009. We are currently evaluating the effect the adoption of SFAS 160 will have on our consolidated financial statements.
In the normal course of business, we are exposed to market risks, including changes in interest rates, Canadian currency rates and certain commodity prices. From time to time, we use derivatives to manage some portion of these risks. Our derivatives are agreements with independent counterparties that provide for payments based on a notional amount, with no multipliers or leverage. As of December 31, 2007, all of our derivative transactions were related to actual or anticipated economic exposures although certain transactions did not qualify for hedge accounting. We are exposed to credit risk in the event of non-performance by our derivative counterparties. However, we monitor our derivative positions by regularly evaluating our positions and the creditworthiness of the counterparties, all of whom we either consider credit-worthy, or who have issued letters of credit to support their performance.
We have performed sensitivity analyses to determine how market rate changes might affect the fair value of our market risk sensitive derivatives and related positions. These analyses are inherently limited because they reflect a singular, hypothetical set of assumptions. Actual market movements may vary significantly from our assumptions. The effects of market movements may also directly or indirectly affect our assumptions and our rights and obligations not covered by the sensitivity analyses. Fair value sensitivity is not necessarily indicative of the ultimate cash flow or the earnings effect from the assumed market rate movements.
Interest Rate Exposure. Our exposure to market risk for changes in interest rates relates primarily to our debt obligations, which are primarily denominated in U.S. dollars. In addition, we use interest rate swaps to manage the mix of fixed and floating rate debt obligations, which directly impacts variability in interest costs. An instantaneous, one percentage point increase in interest rates across all maturities and applicable yield curves would have decreased the fair value of our combined debt and interest rate swap positions by approximately $445 million at December 31, 2007 and $460 million at December 31, 2006. This analysis does not reflect the effect that increasing interest rates would have on other items, such as new borrowings, nor the unfavorable impact they would have on interest expense and cash payments for interest.
We are also exposed to interest rate market risk because we have $418 million and $377 million of assets held in restricted trust funds and escrow accounts primarily included within long-term Other assets in our Consolidated Balance Sheets at December 31, 2007 and 2006, respectively. These assets are generally restricted for future capital expenditures and closure, post-closure and environmental remediation activities at our disposal facilities and are, therefore, invested in high quality, liquid instruments including money market accounts and U.S. government agency debt securities. Because of the short terms to maturity of these investments, we believe that our exposure to changes in fair value due to interest rate fluctuations is insignificant.
Currency Rate Exposure. From time to time, we have used currency derivatives to mitigate the impact of currency translation on cash flows of intercompany Canadian-currency denominated debt transactions. Our foreign
currency derivatives have not materially affected our financial position or results of operations for the periods presented. In addition, while changes in foreign currency exchange rates could significantly affect the fair value of our foreign currency derivatives, we believe these changes in fair value would not have a material impact to the Company.
Commodities Price Exposure. We market recycled products such as wastepaper, aluminum and glass from our material recovery facilities. We have entered into commodity swaps and options to mitigate the variability in cash flows from a portion of these sales. Under the swap agreements, we pay a floating index price and receive a fixed price for a fixed period of time. With regard to our option agreements, we have purchased price protection on certain wastepaper sales via synthetic floors (put options) and price protection on certain wastepaper purchases via synthetic ceilings (call options). Additionally, we have entered into collars (combination of a put and call option) with financial institutions in which we receive the market price for our wastepaper and aluminum sales within a specified floor and ceiling. We record changes in the fair value of commodity derivatives not designated as hedges to earnings, as required. The fair value position of our commodity derivatives is not material to our financial position at December 31, 2007 and 2006.
CONSOLIDATED FINANCIAL STATEMENTS
Management of the Company, including the Chief Executive Officer and the Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. Our internal controls were designed to provide reasonable assurance as to (i) the reliability of our financial reporting; (ii) the reliability of the preparation and presentation of the consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States; and (iii) the safeguarding of assets from unauthorized use or disposition.
We conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2007 based on the framework in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Through this evaluation, we did not identify any material weaknesses in our internal controls. There are inherent limitations in the effectiveness of any system of internal control over financial reporting; however, based on our evaluation, we have concluded that our internal control over financial reporting was effective as of December 31, 2007.
The effectiveness of our internal control over financial reporting has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included herein.
The Board of Directors and Stockholders of Waste Management, Inc.
We have audited the accompanying consolidated balance sheets of Waste Management, Inc. (the Company) as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Waste Management, Inc. at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, effective January 1, 2007, the Company adopted Financial Accounting Standard Board (FASB) Interpretation No. 48 Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109) and FASB Staff Position No. FIN 48-1 Definition of Settlement in FASB Interpretation No. 48. Additionally, effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Waste Management, Inc.s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 18, 2008 expressed an unqualified opinion thereon.
ERNST & YOUNG LLP
February 18, 2008
The Board of Directors and Stockholders of Waste Management, Inc.
We have audited Waste Management, Inc.s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Waste Management, Inc.s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Waste Management, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Waste Management, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders equity and cash flows for each of the three years in the period ended December 31, 2007 and our report dated February 18, 2008 expressed an unqualified opinion thereon.
ERNST & YOUNG LLP
February 18, 2008
WASTE MANAGEMENT, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except share and par value amounts)
See notes to Consolidated Financial Statements.
WASTE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
See notes to Consolidated Financial Statements.
WASTE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to Consolidated Financial Statements.
WASTE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(In millions, except shares in thousands)