10-K 1 h43426e10vk.htm FORM 10-K - ANNUAL REPORT e10vk
Table of Contents

 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
     
(Mark One)
   
 
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2006
    or
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
    For the transition period from          to
 
Commission file number 1-12154
Waste Management, Inc.
(Exact name of registrant as specified in its charter)
 
     
Delaware   73-1309529
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. employer
identification no.)
     
1001 Fannin Street, Suite 4000
Houston, Texas
(Address of principal executive offices)
  77002
(Zip code)
 
Registrant’s telephone number, including area code: (713) 512-6200
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Exchange on Which Registered
 
Common Stock, $.01 par value   New York Stock Exchange
 
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 is not contained herein, and will not be contained, to the best of Registrant’s 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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o
 
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, 2006 was approximately $19.4 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 9, 2007 was 533,077,368 (excluding treasury shares of 97,205,093).
 
DOCUMENTS INCORPORATED BY REFERENCE
 
     
Document
 
Incorporated as to
 
Proxy Statement for the
2007 Annual Meeting of Stockholders
  Part III
 


 

 
TABLE OF CONTENTS
 
             
        Page
 
  Business   1
  Risk Factors   12
  Unresolved Staff Comments   18
  Properties   18
  Legal Proceedings   19
  Submission of Matters to a Vote of Security Holders   19
 
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   19
  Selected Financial Data   22
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   23
  Quantitative and Qualitative Disclosure About Market Risk   52
  Financial Statements and Supplementary Data   54
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   118
  Controls and Procedures   118
  Other Information   118
 
  Directors and Executive Officers of the Registrant   119
  Executive Compensation   119
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   119
  Certain Relationships and Related Transactions   120
  Principal Accounting Fees and Services   120
 
  Exhibits and Financial Statement Schedules   121
 409A Deferral Savings Plan
 2007 Form of Restricted Stock Unit Award Agreement
 2007 Form of Performance Share Unit Award Agreement
 Computation of Ratio of Earnings to Fixed Charges
 Subsidiaries
 Consent of Independent Registered Public Accountant Firm
 Certification of CEO Pursuant to Rule 15d-14(a)
 Certification of SVP & CFO Pursuant to Rule 15d-14(a)
 Certification of CEO Pursuant to Section 1350
 Certification of SVP & CFO Pursuant to Section 1350


Table of Contents

 
PART I
 
Item 1.   Business.
 
General
 
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 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.
 
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 2006, none of our customers accounted for more than 1% of our operating revenue. We employed approximately 48,000 people as of December 31, 2006.
 
Our Company’s 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:
 
  •  To be the waste solutions provider of choice for customers;
 
  •  To be a best place to work for employees;
 
  •  To be a leader in promoting environmental stewardship;
 
  •  To be a trusted and valued community partner; and
 
  •  To maximize shareholder value.
 
WMI was incorporated in Oklahoma in 1987 under the name “USA Waste Services, Inc.” and was reincorporated as a Delaware company in 1995. In a 1998 merger, the Illinois-based waste services company formerly known as Waste Management, Inc., became a wholly-owned subsidiary of WMI and changed its name to Waste Management Holdings, Inc. (“WM Holdings”). At the same time, our parent holding company changed its name from USA Waste Services to Waste Management, Inc. Like WMI, WM Holdings is a holding company and all operations are conducted by subsidiaries.
 
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.”
 
Strategy
 
In 2006, we continued working on our long-term goals of improving our organization and maximizing returns to our shareholders by concentrating on operational excellence, profitability and growing our business. Our current strategies are based on four objectives: revenue growth through pricing; lowering operating and selling, general and administrative costs through process standardization and productivity improvements; improving our portfolio of business units through our “fix or seek exit” strategy; and generating strong and consistent cash flow from operations that can be returned to shareholders.


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Revenue Growth
 
Our revenue growth through pricing excellence objective centers around attaining a return on invested capital that appropriately considers our cost of capital, the risks we take in our business and the value of our disposal assets. We have been using an increasingly more disciplined approach to pricing, where we carefully analyze our operations and make decisions based on market specific information. In addition, we are rolling out comprehensive fee programs that are designed to recover the costs we incur for items such as collection of past due balances, container deliveries and infrequent pick-ups. We believe our success in increasing internal revenue growth from yield is a direct result of our pricing objectives.
 
Cost Control
 
We remain committed to finding the best practices throughout our organization and standardizing those practices and processes throughout the Company. In 2006, we were able to reduce our operating expenses for the first time in several years, demonstrating the progress we are making on our operational excellence initiatives such as improving productivity, reducing fleet maintenance costs, standardizing operating practices, and improving safety, as well as our divestiture of under-performing operations, which is discussed below.
 
We also believe that we must make investments in our business that will provide for longer-term cost savings and efficiencies. During 2006, we have made significant investments in our information technology, our people and our pricing strategies. Certain costs associated with these investments have increased our selling, general and administrative costs, but are being incurred to provide long-term returns. The most noteworthy investment we made in 2006 relates to our new revenue management software. During the last year, we focused on tailoring this revenue management software to our business and processes so that, when implemented, it will provide our employees with the information resources they need to serve our customers more effectively and efficiently. This implementation process will continue to be a focus of our people in 2007.
 
Improve Operations through Divestitures, Acquisitions and Investments
 
In the third quarter of 2005, we announced that our Board of Directors had approved a plan to divest under-performing and non-strategic operations. As of December 31, 2006, we had divested operations representing annual gross revenues of over $235 million. The ultimate sale of any of the operations identified for divestiture is dependent on several factors, including identifying interested purchasers, negotiating the terms and conditions of the sales, and obtaining regulatory approvals. We believe that we have made significant progress in 2006 in executing our “fix or seek exit” strategy.
 
In addition to our focus on divesting under-performing operations, we continue to look for acquisitions and other investments to improve our current operations’ performance and enhance and expand our services. In particular, we intend to make investments in our landfill gas-to-energy programs as well as other purchases that we believe will benefit future expansion efforts, all of which are complementary to our existing operations.
 
Return Value to Shareholders
 
We continue to use the cash that we generate not only to reinvest in our business, but also to return value to our shareholders through common stock repurchases and dividend payments. Our current, three-year capital allocation program authorizes up to $1.2 billion of combined stock repurchases and dividend payments for each of 2005, 2006 and 2007. Our Board of Directors approved an additional $350 million for stock repurchases in 2006. Accordingly, we repurchased over $1 billion of our common stock and paid dividends of $476 million in 2006. We recently announced that our Board of Directors expects that future quarterly dividend payments will be increased to $0.24 per share, although our Board of Directors must first declare each dividend payment. This will result in an increase in the amount of free cash flow that we expect to pay out as dividends for the fourth straight year.


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Operations
 
General
 
We are the leading provider of integrated waste services to commercial, industrial, municipal and residential customers throughout the United States, Puerto Rico and Canada. Our core business includes collection, transfer, recycling, disposal and waste-to-energy services. We manage and evaluate our 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 Recycling Group. We also provide additional waste management services that are not managed through our six Groups. These services include on-site services, methane gas recovery and third-party sub-contracted and administrative services managed by our National Accounts and Upstream organizations, and 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, 2006. More information about our results of operations by reportable segment is included in Note 20 to the Consolidated Financial Statements and in the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this report.
 
                         
    Years Ended December 31,  
    2006     2005     2004  
 
Eastern
  $ 3,830     $ 3,809     $ 3,744  
Midwest
    3,112       3,054       2,971  
Southern
    3,759       3,590       3,480  
Western
    3,160       3,079       2,884  
Wheelabrator
    902       879       835  
Recycling
    766       833       745  
Other
    283       296       261  
Intercompany
    (2,449 )     (2,466 )     (2,404 )
                         
Total
  $ 13,363     $ 13,074     $ 12,516  
                         
 
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:
 
                         
    Years Ended December 31,  
    2006     2005     2004  
 
Collection
  $ 8,837     $ 8,633     $ 8,318  
Landfill
    3,197       3,089       3,004  
Transfer
    1,802       1,756       1,680  
Wheelabrator
    902       879       835  
Recycling and other
    1,074       1,183       1,083  
Intercompany
    (2,449 )     (2,466 )     (2,404 )
                         
Total
  $ 13,363     $ 13,074     $ 12,516  
                         
 
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 two types of arrangements:
 
  •  For commercial and industrial collection services, typically we have a three-year service agreement. The fees under the agreements are influenced by factors such as collection frequency, type of collection equipment furnished by us, type and volume or weight of the waste collected, distance to the disposal


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  facility, labor costs, cost of disposal and general market factors. As part of the service, we provide steel containers to most of our customers to store their solid waste between pick-up dates. Containers vary in size and type according to the needs of our customers or restrictions of their communities and many are designed so that they can be lifted mechanically and either emptied into a truck’s compaction hopper or directly into a disposal site. By using these containers, we can service most of our commercial and industrial customers with trucks operated by only one employee.
 
  •  For most residential collection services, we have a contract with, or a franchise granted by, a municipality or regional authority that gives us the exclusive right to service all or a portion of the homes in an area. These contracts or franchises are typically for periods of one to five years. We also provide services under individual monthly subscriptions directly to households. The fees for residential collection are either paid by the municipality or authority from their tax revenues or service charges, or are paid directly by the residents receiving the service.
 
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 wastes 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 wastes 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 277 solid waste and six hazardous waste landfills at December 31, 2006 and December 31, 2005. 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. Generally, with a lease agreement, the permit is in our name and we operate the landfill for its entire life, making payments to the lessor, who is generally a private landowner, based either on a percentage of revenue or a rate per ton of waste received. We are generally responsible for closure and post-closure requirements under our lease agreements. For operating contracts, the owner of the property, generally a municipality, usually 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 defined within Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates and Assumptions) as of December 31, 2006 and projected annual disposal volumes, the weighted average remaining landfill life for all of our owned or operated landfills is approximately 28 years. Many of our landfills have the potential for expanded disposal capacity beyond


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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 62 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 35 years when considering remaining permitted airspace, expansion airspace (as defined within Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates and Assumptions) and projected annual disposal volume. At December 31, 2006 and 2005, 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):
 
                                                 
    December 31, 2006     December 31, 2005  
    Remaining
                Remaining
             
    Permitted
    Expansion
    Total
    Permitted
    Expansion
    Total
 
    Capacity     Capacity     Capacity     Capacity     Capacity     Capacity  
 
Remaining cubic yards
    4,255       1,037       5,292       3,954       1,287       5,241  
Remaining tonnage
    3,760       959       4,719       3,460       1,196       4,656  
 
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, 2006 and 2005 (in millions):
 
                                                 
    December 31, 2006     December 31, 2005  
    Remaining
                Remaining
             
    Permitted
    Expansion
    Total
    Permitted
    Expansion
    Total
 
    Capacity     Capacity     Capacity     Capacity     Capacity     Capacity  
 
Balance, beginning of year
    3,460       1,196       4,656       3,515       1,192       4,707  
Acquisitions, divestitures, newly permitted landfills and closures
    4             4       (16 )     3       (13 )
Changes in expansions pursued
          103       103             44       44  
Expansion permits granted
    387       (387 )           74       (74 )      
Airspace consumed
    (126 )           (126 )     (125 )           (125 )
Changes in engineering estimates and other(a),(b)
    35       47       82       12       31       43  
                                                 
Balance, end of year
    3,760       959       4,719       3,460       1,196       4,656  
                                                 
 
 
(a) Changes in engineering estimates result in either changes to the available remaining landfill capacity in terms of volume or changes in the utilization of such landfill capacity, affecting the number of tons that can be placed in the future. Estimates of the amount of waste that can be placed in the future are reviewed annually by our engineers and are based on a number of factors, including standard engineering techniques and site-specific factors such as 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. We continually focus on improving the utilization of airspace through efforts that include recirculating landfill leachate where allowed by permit, optimizing the placement of daily cover materials and increasing initial compaction through improved landfill equipment, operations and training.
 
(b) In 2005, the amount of landfill capacity was reduced by approximately 46 million tons, or approximately 1%, to reflect cumulative corrections to align the lives of nine of our landfills for accounting purposes with the terms of the underlying contractual lease or operating agreements supporting their operations.


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The number of landfills we own or operate segregated by their estimated operating lives (in years), based on remaining permitted and expansion airspace and projected annual disposal volume as of December 31, 2006, was as follows:
 
                                                 
    0 to 5     6 to 10     11 to 20     21 to 40     41+     Total  
 
Owned/operated through lease
    23       24       46       79       75       247  
Operating contracts
    14       4       9       5       4       36  
                                                 
Total landfills
    37       28       55       84       79       283  
                                                 
 
The volume of waste, as measured in tons, that we received in 2006 and 2005 at all of our landfills is shown below (in thousands):
 
                                                 
    2006     2005  
    # of
    Total
    Tons
    # of
    Total
    Tons
 
    Sites     Tons     per Day     Sites     Tons     per Day  
 
Solid waste landfills
    277 (a)     125,528       461       277       125,885       461  
Hazardous waste landfills
    6       1,287       5       6       1,368       5  
                                                 
      283       126,815       466       283       127,253       466  
                                                 
Solid waste landfills closed or divested during related year
    4       1,287               4       482          
                                                 
              128,102 (b)                     127,735 (b)        
                                                 
 
 
(a) We closed four landfills in 2006 and added four permitted landfills due to acquisitions. Our landfill count as of December 31, 2006 includes three landfills that were classified as held for sale for financial reporting purposes. One of these landfills was sold in January 2007.
 
(b) These amounts include 2.0 million tons at December 31, 2006 and 2.6 million tons at December 31, 2005 that were received at our landfills but were used for beneficial purposes and were generally redirected from the permitted airspace to other areas of the landfill. Waste types that are frequently identified for beneficial use include green waste for composting and clean dirt for on-site construction projects.
 
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 for any remediation activities, is generally transferred to our closed sites management group. In addition to the 283 active landfills we managed at December 31, 2006, we also managed 187 closed landfills.
 
Transfer.  At December 31, 2006, we owned or operated 342 transfer stations in North America. We deposit waste at these stations, as do other third-party 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 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


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contract, generally for municipalities. In most cases we own the permits and will be responsible for all of the regulatory requirements in accordance with the lease and operating agreements terms.
 
Wheelabrator.  As of December 31, 2006, we owned or operated 17 waste-to-energy facilities and five independent power production plants (“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, which is either sold or used to generate electricity. Our waste-to-energy facilities are capable of processing up to 24,000 tons of solid waste each day. In both 2006 and 2005, our waste-to-energy facilities received 7.8 million tons of solid waste, or approximately 21,300 tons per day.
 
Our IPPs convert various waste and conventional fuels into steam, which is either sold or used to generate electricity. 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.
 
Our waste-to-energy facilities and IPPs sell steam to industrial and commercial users. Steam that is not sold is used to generate electricity for sale to electric utilities. Fees at our waste-to-energy facilities and IPPs are generally subject to the terms and conditions of long-term contracts. Interim adjustments to the prices for steam and electricity under these long-term contracts are made for changes in market conditions such as inflation, natural gas prices and other general market factors.
 
Recycling.  Our Recycling Group focuses on improving the sustainability and future growth of recycling programs within communities and industries. In addition to our Recycling Group, our four geographic operating Groups provide certain recycling services that are embedded within the Groups’ other operations and, therefore, not included within the Recycling Group’s 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 108 MRFs where paper, glass, metals, plastics and compost are recovered for resale. We also operate five 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 2005 and 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.
 
Recycling fees 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.


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Our Recycling 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 Recycling 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 on-site services, in which we outsource our employees to provide full service waste management to customers at their plants and other facilities through our Upstream division. Our vertically integrated waste management operations allow us to provide customers with full management of their waste, including identifying recycling opportunities, minimizing their waste, determining the most efficient means available for waste collection and transporting and disposing of their waste.
 
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 (“EPA”) endorses landfill gas as a renewable energy resource, in the same category as wind, solar and geothermal resources. We actively pursue landfill gas beneficial use projects and at December 31, 2006 we were producing commercial quantities of methane gas at 104 of our solid waste landfills. At 76 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 23 landfills, the gas is delivered by pipeline to industrial customers as a direct substitute for fossil fuels in industrial processes such as steam boilers, cement kilns and utility plants. At five 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. From time to time, we are also contracted to construct waste facilities on behalf of third parties.
 
Competition
 
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 the customer for the same service by subsidizing the cost of the service 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 quality of service and pricing. 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.


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Employees
 
At December 31, 2006 we had approximately 48,000 full-time employees, of which approximately 7,600 were employed in administrative and sales positions and the balance in operations. Approximately 12,500 of our employees are covered by collective bargaining agreements.
 
Financial Assurance and Insurance Obligations
 
Financial Assurance
 
Municipal and governmental waste service contracts generally require the contracting party 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 in different ways including surety bonds, letters of credit, insurance policies, trust and escrow agreements and financial guarantees. The instrument decision 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, 2006:
 
                 
Surety bonds:
               
Issued by consolidated subsidiary
  $ 326 (a)        
Issued by affiliated entities
    1,589 (b)        
Issued by third-party surety companies
    772          
                 
Total surety bonds
            2,687  
Letters of credit:
               
Revolving credit facility
    1,301 (c)        
LC and term loan agreements
    295 (d)        
Letter of credit facility
    346 (e)        
Other lines of credit
    75          
                 
Total letters of credit
            2,017  
Insurance policies:
               
Issued by consolidated subsidiary
    923 (a)        
Issued by affiliated entity
    13 (b)        
                 
Total insurance policies
            936  
Funded trust and escrow accounts
            283 (f)
Financial guarantees
            226 (g)
                 
Total financial assurance
          $ 6,149  
                 
 
 
(a) We use surety bonds and insurance policies issued by a wholly-owned insurance subsidiary, National Guaranty Insurance Company of Vermont, the sole business of which is to issue financial assurance to WMI and our subsidiaries. National Guaranty Insurance Company is authorized to write up to approximately $1.3 billion in surety bonds or insurance policies for our closure and post-closure requirements, waste collection contracts and other business related obligations.
 
(b) We hold non-controlling financial interests in two entities that we use to obtain financial assurance. Our contractual agreements with these entities do not specifically limit the amounts of surety bonds or insurance that we may obtain, making our financial assurance under these agreements limited only by the guidelines and restrictions of surety and insurance regulations.


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(c) On August 17, 2006, WMI entered into a five-year, $2.4 billion revolving credit facility that matures in August 2011, replacing a $2.4 billion revolving credit facility that would have expired in 2009. At December 31, 2006, we had unused and available credit capacity of $1,099 million under our revolving credit facility.
 
(d) In June 2003, we entered into a five-year, $15 million letter of credit and term loan agreement, a seven-year, $175 million letter of credit and term loan agreement and a ten-year, $105 million letter of credit and term loan agreement, which expire in June 2008, 2010, and 2013, respectively (collectively, the “LC and term loan agreements”). At December 31, 2006, the entire capacity under the LC and term loan agreements was used to support outstanding letters of credit.
 
(e) In December 2003, we entered into a five-year, $350 million letter of credit facility (the “letter of credit facility”). At December 31, 2006, $4 million was unused and available under the facility to support letters of credit.
 
(f) Our funded trust and escrow accounts have been established to support landfill closure, post-closure and remedial obligations, the repayment of debt obligations and our performance under various operating contracts. Balances maintained in these trust funds and escrow accounts will fluctuate based on (i) changes in statutory requirements; (ii) future deposits made to comply with contractual arrangements; (iii) the ongoing use of funds for qualifying activities; (iv) acquisitions or divestitures of landfills; and (v) changes in the fair value of the financial instruments held in the trust fund or escrow accounts.
 
(g) Financial guarantees are provided on behalf of our subsidiaries to municipalities, customers and regulatory authorities. They are provided primarily to support our performance of landfill closure and post-closure activities.
 
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.
 
Insurance
 
We also 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 insurance program has a per incident deductible of $2.5 million and our workers’ compensation and auto insurance programs each have per incident deductibles of $1 million. Effective January 1, 2007, we increased the per incident deductible for our workers’ compensation insurance program to $1.5 million. We do not expect the impact of any known casualty, property, environmental or other contingency to be material to our financial condition, results of operations or cash flows. Our estimated insurance liabilities as of December 31, 2006 are summarized in Note 10 to the Consolidated Financial Statements.
 
Regulation
 
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


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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:
 
  •  The Resource Conservation and Recovery Act of 1976, as amended (“RCRA”), regulates handling, transporting and disposing of hazardous and non-hazardous wastes and delegates authority to states to develop programs to ensure the safe disposal of solid wastes. In 1991, the EPA issued its final regulations under Subtitle D of RCRA, which set forth minimum federal performance and design criteria for solid waste landfills. These regulations must be implemented by the states, although states can impose requirements that are more stringent than the Subtitle D standards. We incur costs in complying with these standards in the ordinary course of our operations.
 
  •  The Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (“CERCLA”), which is also known as Superfund, provides for federal authority to respond directly to releases or threatened releases of hazardous substances into the environment that have created actual or potential environmental hazards. CERCLA’s 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 may also 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 Federal Water Pollution Control Act of 1972 (the “Clean Water Act”) regulates the discharge of pollutants into streams, rivers, groundwater, or other surface waters from a variety of sources, including solid waste disposal sites. If run-off from our operations may be discharged into surface waters, the Clean Water Act requires us to apply for and obtain discharge permits, conduct sampling and monitoring, and, under certain circumstances, reduce the quantity of pollutants in those discharges. In 1990, the EPA issued additional standards for management of storm water runoff from landfills that require landfills to obtain storm water discharge permits. In addition, if a landfill or a transfer station discharges wastewater through a sewage system to a publicly owned treatment works, the facility must comply with discharge limits imposed by the treatment works. Also, before the development or expansion of a landfill can alter or affect “wetlands,” a permit may have to be obtained providing for mitigation or replacement wetlands. The Clean Water Act provides for civil, criminal and administrative penalties for violations of its provisions.
 
  •  The Clean Air Act of 1970, as amended, provides for increased federal, state and local regulation of the emission of air pollutants. Certain of our operations are subject to the requirements of the Clean Air Act, including large municipal solid waste landfills and large municipal waste-to-energy facilities. Standards have also been imposed on manufacturers of transportation vehicles (including waste collection vehicles). In 1996 the EPA issued new source performance standards and emission guidelines controlling landfill gases from new and existing large landfills. The regulations impose limits on air emissions from large municipal solid waste landfills, subject most of our large municipal solid waste landfills to certain operating permitting requirements under Title V of the Clean Air Act, and, in many instances, require installation of landfill gas collection and control systems to control emissions or to treat and utilize landfill gas on or off-site. In general, controlling emissions involves drilling collection wells into a landfill and routing the gas to a


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  suitable energy recovery system or combustion device. We are currently capturing and utilizing the renewable energy value of landfill gas at 104 of our solid waste landfills. In January 2003, the EPA issued additional regulations that required affected landfills to prepare, by January 2004, startup, shutdown and malfunction plans to ensure proper operation of gas collection, control and treatment systems.
 
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 (“MACT”) 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.
 
  •  The Occupational Safety and Health Act of 1970, as amended, establishes certain employer responsibilities, including maintenance of a workplace free of recognized hazards likely to cause death or serious injury, compliance with standards promulgated by the Occupational Safety and Health Administration (“OSHA”), and various record keeping, disclosure and procedural requirements. Various standards for notices of hazards, safety in excavation and demolition work and the handling of asbestos, may apply to our operations. The Department of Transportation and OSHA, along with other federal agencies, have jurisdiction over certain aspects pertaining to safety, movement of hazardous materials, movement and disposal of hazardous waste and equipment standards. Various state and local agencies have jurisdiction over disposal of hazardous waste and may seek to regulate movement of hazardous materials in areas not otherwise preempted by federal law.
 
There are also various state or provincial and local regulations that affect our operations. Sometimes states’ regulations are stricter than comparable 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 was unconstitutional. However, other courts have refused to apply the Supreme Court precedent in various circumstances. 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. These congressional efforts have to date been unsuccessful. 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, the adoption of legislation affecting interstate transportation of waste at the state level, or the courts’ interpretation or validation of flow control legislation 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 holder’s 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 holder’s 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 Note 3 to the consolidated financial statements for disclosures relating to our current assessments of the impact of regulations on our current and future operations.
 
Item 1A.   Risk Factors.
 
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,


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cash flows or other aspects of our operations or operating results. Forward-looking statements generally include statements containing:
 
  •  projections about accounting and finances;
 
  •  plans and objectives for the future;
 
  •  projections or estimates about assumptions relating to our performance; and
 
  •  our opinions, views or beliefs about current or future events, circumstances or performance.
 
You should view these statements with caution. These statements are not guarantees of future performance, circumstances or events. They are based on the 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 face and that could affect our business and financial statement for 2007 and beyond. However, they 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 or 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 selling, general and administrative costs, 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 have announced plans 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-


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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 the warmer months of the year, primarily due to the higher volume of construction and demolition waste in those months. 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, the storm conditions during hurricane season, which is generally June through November, can increase our revenues in the areas affected. However, for several reasons, including significant start-up costs, storm-related 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 perform scheduled maintenance at our waste-to-energy facilities in the slower winter months, when electrical demand is generally lower.
 
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 $3.0 billion of debt as of December 31, 2006 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:
 
  •  agencies of federal, state, local or foreign governments seek to impose liability on us under applicable statutes, sometimes involving civil or criminal penalties for violations, or to revoke or deny renewal of a permit we need; and
 
  •  local communities and citizen groups, adjacent landowners or governmental agencies oppose the issuance of a permit or approval we need, allege violations of the permits under which we operate or laws or regulations to which we are subject, or seek to impose liability on us for environmental damage.
 
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.


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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:
 
  •  limitations on siting and constructing new waste disposal, transfer or processing facilities or expanding existing facilities;
 
  •  limitations, regulations or levies on collection and disposal prices, rates and volumes;
 
  •  limitations or bans on disposal or transportation of out-of-state waste or certain categories of waste; or
 
  •  mandates regarding the disposal of solid waste
 
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.
 
Significant shortages in fuel supply or increases in fuel prices will increase our operating expenses and price increases may also increase our tax expense.
 
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 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 40% 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.
 
Additionally, our effective tax rate through 2007 is expected to be significantly lower than statutory tax rates due in part to Section 45K (formerly Section 29) tax credits we realize from our landfill gas sales and investments in coal-based synthetic fuel partnerships. The ability to earn Section 45K tax credits is tied to an average benchmark oil price determined by the Internal Revenue Service, and the credits are phased out as the benchmark average price increases. Higher crude oil prices will phase out our credits and increase our effective tax rate, which will result in higher tax expense.
 
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


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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 revenues will fluctuate based on changes in commodity prices.
 
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 (“OCC”), and old newsprint (“ONP”). We enter into commodity price derivatives in an effort to mitigate some of the variability in cash flows from the sales of recyclable materials at floating market prices. In the past three years, the year-over-year changes in the quarterly average market prices for OCC ranged from a decrease of as much as 33% to an increase of as much as 36%. The same comparisons for ONP have ranged from a decrease of as much as 15% to an increase of as much as 29%. 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 as much as 12%.


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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 wastes, such as yard wastes, 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 have purchased and developed a new revenue management system and are piloting the system in the first half of 2007, with additional implementation to occur in late 2007 and early 2008. We may encounter problems in the development or deployment of this system that could result in significant errors in, or disruption of, our billing processes. 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 $1.2 billion in aggregate dividend payments and share repurchases during 2007 and recently announced that it expects future quarterly dividend payments, when declared by the Board of Directors, to be $0.24 per share. If our cash flows from operations were negatively affected, we could be forced to


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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.
 
Item 1B.   Unresolved Staff Comments.
 
None.
 
Item 2.   Properties.
 
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 Management’s 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:
 
                 
    2006     2005  
 
Landfills:
               
Owned or operated through lease agreements
    247       245  
Operated through contractual agreements
    36       38  
                 
      283       283  
Transfer stations
    342       338  
Material recovery facilities
    108       116  
Secondary processing facilities
    5       15  
Waste-to-energy facilities
    17       17  
Independent power production plants
    5       6  
 
The following table provides certain information by Group regarding the 247 landfills owned or operated through lease agreements and a count, by Group, of contracted disposal sites as of December 31, 2006:
 
                                         
                            Contracted
 
          Total
    Permitted
    Expansion
    Disposal
 
    Landfills     Acreage(a)     Acreage(b)     Acreage(c)     Sites  
 
Eastern
    50       33,388       6,650       1,532       9  
Midwest
    72       30,895       9,148       1,028       9  
Southern
    83       39,551       12,296       598       12  
Western
    38       34,534       6,715       1,317       6  
Wheelabrator
    4       781       289              
                                         
      247       139,149       35,098       4,475       36  
                                         


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a) “Total acreage” includes permitted acreage, expansion acreage, other acreage available for future disposal that has not been permitted, buffer land and other land owned by our landfill operations.
 
b) “Permitted acreage” consists of all acreage at the landfill encompassed by an active permit to dispose of waste.
 
c) “Expansion acreage” consists of unpermitted acreage where the related expansion efforts meet our criteria to be included as expansion airspace. A discussion of the related criteria is included within the Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates and Assumptions section included herein.
 
Item 3.   Legal Proceedings.
 
Information regarding our legal proceedings can be found under the Litigation section of Note 10 in the Consolidated Financial Statements included in this report.
 
Item 4.   Submission of Matters to a Vote of Security Holders.
 
We did not submit any matters to a vote of our stockholders during the fourth quarter of 2006.
 
PART II
 
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
 
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:
 
                 
    High     Low  
 
2005
               
First Quarter
  $ 30.38     $ 28.37  
Second Quarter
    30.00       27.18  
Third Quarter
    29.76       26.80  
Fourth Quarter
    31.03       26.95  
2006
               
First Quarter
  $ 35.35     $ 30.08  
Second Quarter
    38.34       33.83  
Third Quarter
    37.41       32.88  
Fourth Quarter
    38.64       35.68  
2007
               
First Quarter (through February 9, 2007)
  $ 38.70     $ 34.69  
 
On February 9, 2007, the closing sale price as reported on the NYSE was $35.25 per share. The number of holders of record of our common stock at February 9, 2007 was 16,377.
 
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 following graph is presented pursuant to SEC rules and is not meant to be an indication of our future performance.


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Comparison of Cumulative Five Year Total Return
 
(CHART)
 
                                                             
      12/31/01     12/31/02     12/31/03     12/31/04     12/31/05     12/31/06
Waste Management, Inc.
    $ 100       $ 72       $ 93       $ 96       $ 100       $ 125  
S&P 500 Index
    $ 100       $ 78       $ 100       $ 111       $ 117       $ 135  
Dow Jones Waste & Disposal Services Index
    $ 100       $ 79       $ 104       $ 108       $ 115       $ 141  
                                                             


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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 each quarter in 2005 for a total of $449 million. We paid quarterly dividends in 2006 of $0.22 per common share for a total of $476 million.
 
In June 2006, our Board of Directors approved up to $350 million of additional share repurchases for 2006, increasing the amount of capital authorized for our share repurchases and dividends for 2006 to $1.55 billion. In 2006, we repurchased approximately 31 million shares of our common stock for $1,072 million. All of the repurchases were made pursuant to our capital allocation program. The following table summarizes our fourth quarter 2006 share repurchase activity:
 
Issuer Purchases of Equity Securities
 
                                 
                Total Number
    Approximate Maximum
 
                of Shares
    Dollar Value of
 
                Purchased as
    Shares that
 
                Part of
    May Yet be
 
    Total Number
    Average Price
    Publicly Announced
    Purchased Under
 
    of Shares
    Paid per
    Plans or
    the Plans
 
Period
  Purchased     Share(a)     Programs     or Programs(b)  
 
October 1-31
    960,700     $ 37.36       960,700     $ 99 million  
November 1-30
    1,828,900     $ 37.78       1,828,900     $ 30 million  
December 1-31
    750,400     $ 37.32       750,400     $ 2 million  
                                 
Total
    3,540,000     $ 37.57       3,540,000     $  
                                 
 
 
(a) This amount represents the weighted average price paid per share and includes a per share commission paid for all repurchases.
 
(b) For each period presented, the maximum dollar value of shares that may yet be purchased under the program has been provided as of the end of such period. As discussed above, the amount of capital available for share repurchases during 2006 was $1.55 billion, net of dividends paid. During the year ended December 31, 2006, we paid $476 million in dividends. The maximum dollar value of shares that may be purchased under the program included in the table above includes the effect of these dividend payments as if all payments had been made at the beginning of the earliest period presented. The “Total” amount available for repurchases under the plan is shown as zero because our capital allocation program, by its terms, provided for $1.55 billion in dividends and share repurchases in 2006, which makes any unexpended portion of the $1.55 billion unavailable after the end of the year.
 
In 2005, we repurchased 24.7 million shares of our common stock for $706 million, all of which was made pursuant to the capital allocation program discussed above.


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Item 6.   Selected Financial Data.
 
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.
 
                                         
    Years Ended December 31,  
    2006(a)     2005(a)     2004(a)     2003(b)     2002  
    (In millions, except per share amounts)  
 
Statement of Operations Data:
                                       
Operating revenues(c)
  $ 13,363     $ 13,074     $ 12,516     $ 11,648     $ 11,211  
                                         
Costs and expenses:
                                       
Operating(c)
    8,587       8,631       8,228       7,591       6,949  
Selling, general and administrative
    1,388       1,276       1,267       1,216       1,392  
Depreciation and amortization
    1,334       1,361       1,336       1,265       1,222  
Restructuring
          28       (1 )     44       38  
(Income) expense from divestitures, asset impairments and unusual items
    25       68       (13 )     (8 )     (34 )
                                         
      11,334       11,364       10,817       10,108       9,567  
                                         
Income from operations
    2,029       1,710       1,699       1,540       1,644  
Other expense, net
    (555 )     (618 )     (521 )     (417 )     (402 )
                                         
Income before income taxes and accounting changes
    1,474       1,092       1,178       1,123       1,242  
Provision for (benefit from) income taxes
    325       (90 )     247       404       422  
                                         
Income before accounting changes
    1,149       1,182       931       719       820  
Accounting changes, net of taxes
                8       (89 )     2  
                                         
Net income
  $ 1,149     $ 1,182     $ 939     $ 630     $ 822  
                                         
Basic earnings per common share:
                                       
Income before accounting changes
  $ 2.13     $ 2.11     $ 1.62     $ 1.22     $ 1.34  
Accounting changes, net of taxes
                0.01       (0.15 )      
                                         
Net income
  $ 2.13     $ 2.11     $ 1.63     $ 1.07     $ 1.34  
                                         
Diluted earnings per common share:
                                       
Income before accounting changes
  $ 2.10     $ 2.09     $ 1.60     $ 1.21     $ 1.33  
Accounting changes, net of taxes
                0.01       (0.15 )      
                                         
Net income
  $ 2.10     $ 2.09     $ 1.61     $ 1.06     $ 1.33  
                                         
Cash dividends declared per common share (2005 includes $0.22 paid in 2006)
  $ 0.66     $ 1.02     $ 0.75     $ 0.01     $ 0.01  
                                         
Balance Sheet Data (at end of period):
                                       
Working capital (deficit)
  $ (86 )   $ 194     $ (386 )   $ (1,015 )   $ (471 )
Goodwill and other intangible assets, net
    5,413       5,514       5,453       5,376       5,184  
Total assets
    20,600       21,135       20,905       20,382       19,951  
Debt, including current portion
    8,317       8,687       8,566       8,511       8,293  
Stockholders’ equity
    6,222       6,121       5,971       5,602       5,310  


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(a) For more information regarding this financial data, see the Management’s Discussion and Analysis of Financial Condition and Results of Operations section included in this report. For disclosures associated with the impact of the adoption of new accounting pronouncements and changes in our accounting policies on the comparability of this information, see Note 2 of the Consolidated Financial Statements.
 
(b) In the first quarter of 2003, we recorded $101 million, including tax benefit, or $0.17 per diluted share, as a charge to cumulative effect of changes in accounting principles for the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations (“SFAS No. 143”). Substantially all of this charge was related to changes in accounting for landfill final capping, closure and post-closure costs. Effective January 1, 2003, we also changed our accounting for repairs and maintenance and loss contracts, which resulted in a credit to cumulative effect of changes in accounting principles of $55 million, net of taxes, or $0.09 per diluted share. On December 31, 2003, we began consolidating two limited liability companies from which we lease three waste-to-energy facilities as a result of our implementation of Financial Accounting Standards Board Interpretation No. 46(R), Consolidation of Variable Interest Entities (revised December 2003) — an Interpretation of ARB No. 51 (“FIN 46(R)”). Upon consolidating these entities, we recorded a charge to cumulative effect of changes in accounting principles of $43 million, including tax benefit, or $0.07 per diluted share.
 
(c) Effective January 1, 2004, we began recording all mandatory fees and taxes that create direct obligations for us as operating expenses and recording revenue when the fees and taxes are billed to our customers. In prior years, certain of these costs had been treated as pass-through costs for financial reporting purposes. In 2004, we conformed the 2003 and 2002 presentation of our revenues and expenses with this presentation by increasing both our revenue and our operating expense by $74 million for the year ended December 31, 2003 and by $69 million for the year ended December 31, 2002.
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
This section includes a discussion of our operations for the three years ended December 31, 2006. This discussion may contain forward-looking statements that anticipate results based on management’s 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.
 
Overview
 
Significant financial achievements during the year ended December 31, 2006 include:
 
  •  Net cash provided by operating activities increased to $2.54 billion and free cash flow increased to $1.45 billion, increases of 6.2% and 3.3%, respectively, when compared with 2005;
 
  •  Internal revenue growth of 2.7% in 2006, driven by the 3.6% increase in yield on base business, which is the highest base business yield increase we have had in at least six years;
 
  •  Improvement in our operating expenses as a percentage of revenue, which decreased by 1.7 percentage points from 66.0% of revenue in 2005 to 64.3% of revenue in 2006; and
 
  •  Nearly $1.1 billion in share repurchases and $476 million in dividends paid pursuant to our capital allocation plan.
 
Free Cash Flow — Free cash flow is a non-GAAP measure of financial performance that we include in our disclosures because we believe the production of free cash flow is an important measure of our liquidity and performance and because we believe our investors are interested in the cash we produce from non-financing activities that is available for acquisitions, share repurchases, scheduled debt repayments and the payment of


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dividends. The most comparable GAAP financial measure to free cash flow is “Net cash provided by operating activities.” We calculate free cash flow as shown in the table below (in millions):
 
                 
    Years Ended
 
    December 31,  
    2006     2005  
 
Net cash provided by operating activities
  $ 2,540     $ 2,391  
Capital expenditures
    (1,329 )     (1,180 )
Proceeds from divestitures of businesses (net of cash divested) and other sales of assets
    240       194  
                 
Free cash flow
  $ 1,451     $ 1,405  
                 
 
The growth in our 2006 operating and free cash flow reflects the current year improvements in our operating results, particularly those contributed by our increase in revenue from yield, which is discussed below.
 
Revenue Growth — Our revenues for the year increased over 2%, from $13,074 million in 2005 to $13,363 million in 2006. The overall increase was largely a result of internal revenue growth, or IRG. IRG is an important indicator of our performance as it is a measure of our ability to increase revenues from our existing operations. Our IRG for the year was 2.7% and consisted primarily of improvement in yield on base business and an increase in revenues related to our fuel surcharge program. Our revenue growth from improved yield on base business for 2006 was 3.6%, which is an increase of 0.9 percentage points from the prior year. In addition, our fuel surcharge program contributed $117 million to revenue growth in 2006 compared with $157 million in 2005. The revenues generated by the program in 2006 recovered the increase in our operating costs attributable to fuel. The increases in revenue from improved yield on base business and our fuel surcharge program were partially offset by decreased revenues due to lower volumes. Additionally, the positive effect IRG had on overall revenue growth was offset by divestitures during the year. We have divested of under-performing operations, which resulted in lower revenues in the year. Although we continue to seek appropriate acquisitions, in 2006 we lost more revenue as a result of divestitures than we gained from acquisitions. As discussed below, we believe that the negative impact divestitures had on revenues resulted in improvements in our operating margins.
 
Margin Improvement — In 2006, our income from operations improved by $319 million, or 18.7%, as compared with 2005. Income from operations as a percentage of revenues was 15.2% for the year ended December 31, 2006 compared with 13.1% for the year ended December 31, 2005. Several items that negatively affected our 2005 results and are not part of our ongoing operations significantly impact the comparability of our 2006 and 2005 operating results. When focusing on our core operating costs (which are Operating; Selling, general and administrative; and Depreciation and amortization expenses) as a percentage of revenues, our margin improvement was considerable, increasing 1.6 percentage points from 13.8% in 2005 to 15.4% in 2006. The year-over-year decrease in our operating expenses as a percentage of revenue is largely a result of our increased revenue provided by base business yield, but is also due to the success of our cost control initiatives, which have focused on improving productivity and standardizing our practices, and the divestitures of under-performing operations. Our selling, general and administrative expenses in 2006 increased by $112 million, and as a percentage of revenue increased by 0.6 percentage points to 10.4%. The increase in selling, general and administrative expenses is due largely to higher bonus expense as a result of the significant improvement in the Company’s performance, non-capitalizable costs incurred to support the development of our revenue management system and a $20 million charge to record estimated unrecorded obligations associated with unclaimed property audits.
 
2007 Objectives — In 2007, we will continue to pursue our goal of improving our profitability by focusing on revenue growth through pricing, eliminating our less profitable work, lowering our operating expenses, managing our selling, general and administrative expenses and generating strong and consistent cash flows that can be returned to our shareholders.
 
Late in 2006, we began to see a decline in our revenue growth due to decreases in volumes. We believe that this decline can be attributed to our pricing strategy and an economic softening in certain lines of our business in certain parts of the country. Even when considering these volume declines, which may continue in 2007, we have seen that our focus on increasing revenue through yield and shedding our less profitable volumes has been positive for our


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operating margins and our cash flows. As we consider the continuing effects of this approach on our business, we will continue to focus on our stated long-term strategy of seeking operational excellence and improving profitability, divesting under-performing and non-strategic operations and seeking acquisition and investment candidates, such as landfill gas-to-energy projects, that we believe will offer superior margins and returns on capital.
 
Basis of Presentation of Consolidated and Segment Financial Information
 
Accounting Change — On January 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”), 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 (“SFAS No. 123”) for all unvested awards outstanding at the date of adoption.
 
Through December 31, 2005, as permitted by SFAS No. 123, we accounted for equity-based compensation in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, as amended (“APB No. 25”). Under APB No. 25, we recognized compensation expense based on an award’s intrinsic value. For stock options, which were the primary form of awards we granted through December 31, 2004, this meant that we recognized no compensation expense in connection with the grants, as the exercise price of the options was equal to the fair market value of our common stock on the date of grant and all other provisions were fixed. As discussed below, beginning in 2005, restricted stock units and performance share units became the primary form of equity-based compensation awarded under our long-term incentive plans. For restricted stock units, intrinsic value is equal to the market value of our common stock on the date of grant. For performance share units, APB No. 25 required “variable accounting,” which resulted in the recognition of compensation expense based on the intrinsic value of each award at the end of each reporting period until such time that the number of shares to be issued and all other provisions are fixed.
 
In December 2005, the Management Development and Compensation Committee of our Board of Directors approved the acceleration of the vesting of all unvested stock options awarded under our stock incentive plans, effective December 28, 2005. The decision to accelerate the vesting of outstanding stock options was made primarily to reduce the non-cash compensation expense that we would have otherwise recorded in future periods as a result of adopting SFAS No. 123(R). We estimated that the acceleration eliminated approximately $55 million of cumulative pre-tax compensation charges that would have been recognized during 2006, 2007 and 2008 as the stock options would have continued to vest. We recognized a $2 million pre-tax charge to compensation expense during the fourth quarter of 2005 as a result of the acceleration, but do not expect to recognize future compensation expense for the accelerated options under SFAS No. 123(R).
 
Additionally, as a result of changes in accounting required by SFAS No. 123(R) and a desire to design our long-term incentive plans in a manner that creates a stronger link to operating and market performance, the Management Development and Compensation Committee approved a substantial change in the form of awards that we grant. Beginning in 2005, annual stock option grants were replaced with either (i) grants of restricted stock units and performance share units or (ii) an enhanced cash compensation award. Stock option grants in connection with new hires and promotions were replaced with grants of restricted stock units. The terms of restricted stock units and performance share units granted during 2006 are summarized in Note 15 to the Consolidated Financial Statements.
 
As a result of the acceleration of the vesting of stock options and the replacement of future awards of stock options with other forms of equity awards, the adoption of SFAS No. 123(R) on January 1, 2006 did not significantly affect our accounting for equity-based compensation or net income for the year ended December 31, 2006. We do not currently expect this change in accounting to significantly impact our future results of operations. However, we do expect equity-based compensation expense to increase over the next three years because of the incremental expense that will be recognized each year as additional awards are granted.
 
Reconsideration of a Variable Interest — During 2006, the debt of a previously consolidated variable interest entity was refinanced. As a result of the refinancing, our guarantee arrangement was also renegotiated, significantly reducing the value of our guarantee. We determined that the refinancing of the entity’s debt obligations and


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corresponding renegotiation of our guarantee represented significant changes in the entity that required reconsideration of the applicability of FIN 46(R). As a result of the reconsideration of our interest in this variable interest entity, we concluded that we are no longer the primary beneficiary of this entity. Accordingly, in April 2006, we deconsolidated the entity. The deconsolidation of this entity did not materially impact our Consolidated Financial Statements for the periods presented.
 
Certain reclassifications have also been made in the accompanying financial statements to conform prior year information with the current period presentation. The supplementary financial information included in this section has been updated to reflect these changes.
 
Critical Accounting Estimates and Assumptions
 
In preparing our financial statements, we make several estimates and assumptions that affect the accounting for and recognition and disclosure of our 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.


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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:
 
  •  Personnel are actively working to obtain land use and local, state or provincial approvals for an expansion of an existing landfill;
 
  •  It is likely that the approvals will be received within the normal application and processing time periods for approvals in the jurisdiction in which the landfill is located;
 
  •  We have a legal right to use or obtain land to be included in the expansion plan;
 
  •  There are no significant known technical, legal, community, business, or political restrictions or similar issues that could impair the success of such expansion;
 
  •  Financial analysis has been completed, and the results demonstrate that the expansion has a positive financial and operational impact; and
 
  •  Airspace and related costs, including additional closure and post-closure costs, have been estimated based on conceptual design.
 
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 62 landfill sites with expansions at December 31, 2006, 14 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 six landfills required approval mainly due to local zoning restrictions or because the permit application processes would not meet the one or five year requirements, generally due to state-specific permitting procedures.
 
Once the remaining permitted and expansion airspace is determined, an airspace utilization factor (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


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initial selection of the AUF is subject to a subsequent multi-level review by our engineering group. 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 (“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:
 
  •  Management’s judgment and experience in remediating our own and unrelated parties’ sites;
 
  •  Information available from regulatory agencies as to costs of remediation;
 
  •  The number, financial resources and relative degree of responsibility of other PRPs who may be liable for remediation of a specific site; and
 
  •  The typical allocation of costs among PRPs.
 
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. However, accounting standards require us to write down assets or groups of assets if they become impaired. If significant events or


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changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable, we perform a test of recoverability by comparing the carrying value of the asset or asset group to its undiscounted expected future cash flows. If cash flows cannot be separately and independently identified for a single asset, we will determine whether an impairment has occurred for the group of assets for which we can identify the projected cash flows. If the carrying values are in excess of undiscounted expected future cash flows, we measure any impairment by comparing the fair value of the asset or asset group to its carrying value. Fair value is determined by either an internally developed discounted projected cash flow analysis of the asset or asset group or an actual third-party valuation. If the fair value of an asset or asset group is determined to be less than the carrying amount of the asset or asset group, an impairment in the amount of the difference is recorded in the period that the impairment indicator occurs.
 
Typical indicators that an asset may be impaired include:
 
  •  A significant decrease in the market price of an asset or asset group;
 
  •  A significant adverse change in the extent or manner in which an asset or asset group is being used or in its physical condition;
 
  •  A significant adverse change in legal factors or in the business climate that could affect the value of an asset or asset group, including an adverse action or assessment by a regulator;
 
  •  An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset;
 
  •  Current period operating or cash flow losses combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset or asset group; or
 
  •  A current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.
 
If any of these or other indicators occur, the asset is reviewed to determine whether there has been an impairment. Estimating future cash flows requires significant judgment and projections may vary from cash flows eventually realized. There are other considerations for impairments of landfills and goodwill, as described below.
 
Landfills — Certain of the indicators listed above 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 book value of goodwill to its implied fair value. The implied fair value of goodwill is determined by deducting the fair value of each of our reporting unit’s (Group’s) identifiable assets and liabilities from the fair value of the reporting unit as a whole, as if that reporting unit had just been acquired and the purchase price were being initially allocated. Additional impairment assessments may be performed on an interim basis if we encounter events or changes in circumstances, such as those listed above, that would indicate that, more likely than not, the book value of goodwill has been impaired.
 
Self-insurance reserves and recoveries — We have retained a 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.


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Results of Operations
 
The following table presents, for the periods indicated, the period-to-period change in dollars (in millions) and percentages for the respective Consolidated Statement of Operations line items:
 
                                 
    Period-to-Period Change  
    Years Ended
    Years Ended
 
    December 31,
    December 31,
 
    2006 vs. 2005     2005 vs. 2004  
 
Operating revenues
  $ 289       2.2 %   $ 558       4.5 %
                                 
Costs and expenses:
                               
Operating
    (44 )     (0.5 )     403       4.9  
Selling, general and administrative
    112       8.8       9       0.7  
Depreciation and amortization
    (27 )     (2.0 )     25       1.9  
Restructuring
    (28 )     *       29       *  
(Income) expense from divestitures, asset impairments and unusual items
    (43 )     *       81       *  
                                 
      (30 )     (0.3 )     547       5.1  
                                 
Income from operations
    319       18.7       11       0.6  
                                 
Other income (expense):
                               
Interest expense, net
    (11 )     2.4       (80 )     20.8  
Equity in net losses of unconsolidated entities
    71       *       (9 )     9.2  
Minority interest
    4       (8.3 )     (12 )     33.3  
Other, net
    (1 )     *       4       *  
                                 
      63       (10.2 )     (97 )     18.6  
                                 
Income before income taxes and cumulative effect of change in accounting principle
    382       35.0       (86 )     (7.3 )
Provision for (benefit from) income taxes
    415       *       (337 )     *  
                                 
Income before cumulative effect of change in accounting principle
  $ (33 )     (2.8 )%   $ 251       27.0 %
                                 
 
 
Percentage change does not provide a meaningful comparison. Refer to the explanations of these items included herein for a discussion of the relationship between current year and prior year activity.


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The following table presents, for the periods indicated, the percentage relationship that the respective Consolidated Statement of Operations line items has to operating revenues:
 
                         
    Years Ended December 31,  
    2006     2005     2004  
 
Operating revenues
    100.0 %     100.0 %     100.0 %
                         
Costs and expenses:
                       
Operating
    64.3       66.0       65.7  
Selling, general and administrative
    10.4       9.8       10.1  
Depreciation and amortization
    10.0       10.4       10.7  
Restructuring
          0.2        
(Income) expense from divestitures, asset impairments and unusual items
    0.1       0.5       (0.1 )
                         
      84.8       86.9       86.4  
                         
Income from operations
    15.2       13.1       13.6  
                         
Other income (expense):
                       
Interest expense, net
    (3.6 )     (3.6 )     (3.1 )
Equity in net losses of unconsolidated entities
    (0.3 )     (0.8 )     (0.8 )
Minority interest
    (0.3 )     (0.4 )     (0.3 )
Other, net
                 
                         
      (4.2 )     (4.8 )     (4.2 )
                         
Income before income taxes and cumulative effect of change in accounting principle
    11.0       8.3       9.4  
Provision for (benefit from) income taxes
    2.4       (0.7 )     2.0  
                         
Income before cumulative effect of change in accounting principle
    8.6 %     9.0 %     7.4 %
                         
 
Operating Revenues
 
Our operating revenues in 2006 were $13.4 billion, compared with $13.1 billion in 2005 and $12.5 billion in 2004. We manage and evaluate our operations primarily through our Eastern, Midwest, Southern, Western, Wheelabrator (which includes our waste-to-energy facilities and independent power production plants, or IPPs) and Recycling 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:
 
                         
    Years Ended December 31,  
    2006     2005     2004  
 
Eastern
  $ 3,830     $ 3,809     $ 3,744  
Midwest
    3,112       3,054       2,971  
Southern
    3,759       3,590       3,480  
Western
    3,160       3,079       2,884  
Wheelabrator
    902       879       835  
Recycling
    766       833       745  
Other
    283       296       261  
Intercompany
    (2,449 )     (2,466 )     (2,404 )
                         
Total
  $ 13,363     $ 13,074     $ 12,516  
                         
 
Our operating revenues generally come from fees charged for our collection, disposal, transfer, Wheelabrator and recycling services. Some of the fees we charge to our customers for collection services are billed in advance; a


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liability for future service is recorded when we bill the customer and operating revenues are recognized as services are actually provided. 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 and are normally billed monthly or semi-monthly. 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, and are normally billed monthly. 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 Recycling Group as well as our four geographic operating Groups, generally consists of the sale of recyclable commodities to third parties and tipping fees. 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):
 
                         
    Years Ended December 31,  
    2006     2005     2004  
 
Collection
  $ 8,837     $ 8,633     $ 8,318  
Landfill
    3,197       3,089       3,004  
Transfer
    1,802       1,756       1,680  
Wheelabrator
    902       879       835  
Recycling and other
    1,074       1,183       1,083  
Intercompany
    (2,449 )     (2,466 )     (2,404 )
                         
Total
  $ 13,363     $ 13,074     $ 12,516  
                         
 
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:
 
                                 
    Period-to-Period
    Period-to-Period
 
    Change for
    Change for
 
    2006 vs. 2005     2005 vs. 2004  
 
Average yield:
                               
Base business
  $ 461       3.6 %   $ 336       2.7 %
Commodity
    (48 )     (0.4 )     (38 )     (0.3 )
Electricity (IPPs)
    2             4        
Fuel surcharges and fees
    120       0.9       161       1.3  
                                 
Total
    535       4.1       463       3.7  
Volume
    (187 )     (1.4 )     3        
                                 
Internal revenue growth
    348       2.7       466       3.7  
Acquisitions
    52       0.4       112       0.9  
Divestitures
    (154 )     (1.2 )     (62 )     (0.4 )
Foreign currency translation
    43       0.3       42       0.3  
                                 
    $ 289       2.2 %   $ 558       4.5 %
                                 
 
Base Business — Revenue growth from 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. Our 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) certain average price changes related to the overall mix of services, which are due to both the types of services provided and the geographic locations where our services are provided. Our pricing excellence initiative continues to be the primary contributor to internal revenue growth.
 
In both 2005 and 2006, revenue growth from base business yield was primarily attributable to our collection operations, where we experienced substantial revenue growth in every geographic operating Group. Our base


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business yield improvement resulted largely from our focus on pricing our business based on market-specific factors, including our costs. As discussed below, the significant collection revenue increases due to yield have been partially offset by revenue declines from lower collection volumes. In assessing the impact of higher collection yield on our volumes, we continue to find that, in spite of collection volume declines, revenue growth from base business yield and a focus on controlling variable costs are providing notable earnings, margin and cash flow improvements.
 
Throughout 2006, increases in revenue due to yield on base business at our transfer stations and for our construction and demolition and municipal solid waste streams at our landfills were also noteworthy. These improvements were due to the practices implemented as a result of our findings from our pricing studies. The increases in transfer station revenues in 2006 were the most significant in the Eastern and Western portions of the United States. At our landfills, construction and demolition revenue growth from yield was the most significant in the West and South and municipal solid waste revenue growth from yield was provided by the East, South and Midwest. In 2005, our transfer business in the East and municipal solid waste landfill disposal operations in the South provided the most significant revenue growth from base business yield in those lines of our business.
 
We also experienced substantial yield contributions to revenues from our waste-to-energy facilities in the second half of 2005 and through the third quarter of 2006. The revenue improvements at our waste-to-energy facilities were largely due to significant increases in the rates charged for electricity under our long-term contracts with electric utilities, which generally are indexed to natural gas prices.
 
Our environmental cost recovery fee, which is included in base business yield, increased revenues on a year-over-year basis by $43 million in 2006 and $33 million in 2005. Other fee programs, which were targeted at recovering the costs we incur for services that are included in base business yield, such as fees for the collection of past due balances, also contributed to yield improvement in 2006.
 
The 2005 revenue improvements attributable to yield discussed above were partially offset by a general decline in yield in special waste landfill disposal operations, noted principally in our Midwest and Southern Groups.
 
Commodity — Our revenues in both 2005 and 2006 declined as compared with the prior year due to price decreases in recycling commodities. Average prices for old corrugated cardboard dropped by 8% in both 2005 and 2006, from $85 per ton in 2004 to $78 per ton in 2005 and to $72 per ton in 2006. Average prices for old newsprint were also down by about 3% in 2005 and 7% in 2006, from $86 per ton in 2004 to $83 per ton in 2005 and to $77 per ton in 2006.
 
A significant portion of revenues attributable to commodities is rebated to our suppliers of recyclable materials. Accordingly, changes in our revenues due to fluctuations in commodity prices have a corresponding impact on our cost of goods sold.
 
Fuel surcharges and fees — Fuel surcharges increased revenues year-over-year by $117 million for 2006 and $157 million for 2005. These increases are due to our continued effort to pass on higher fuel costs to our customers through fuel surcharges. The substantial 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. As discussed in the Operating Expenses section below, during 2006 our fuel surcharge program recovered both components of our higher costs. Our fuel surcharge program substantially recovered these costs for the year ended December 31, 2005.
 
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 — Declines in revenue due to lower volumes between 2006 and 2005 were driven by decreases in our collection volumes, due primarily to our focus on improving the margins in this line of business through pricing.


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These revenue declines were the most significant in our residential and industrial collection operations, with our Eastern, Southern and Midwestern Groups experiencing the most notable decreases. Our commercial collection operations also had declines in revenue due to lower volumes in 2006, principally in the Midwestern and Eastern Groups. The decline in revenue due to lower volumes for our collection operations was also due to a decrease in hurricane related revenues in the South.
 
The revenue declines in our collection businesses in 2006 were partially offset by increased disposal volumes in all of our geographic regions 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 is due to the lack of hurricane volumes in 2006, competition, impacts of our pricing initiatives and an economic softening in certain lines of our business in certain parts of the country.
 
Also contributing to the decline in our revenues due to lower volumes for 2006 were (i) the completion of the construction of an integrated waste facility on behalf of a municipality in Canada in early 2006; (ii) the deconsolidation of a variable interest entity during the second quarter of 2006; and (iii) decreased volumes from our transfer station and recycling operations.
 
Revenues due to changes in volumes were relatively flat when comparing 2005 with 2004. This was generally because of the combined impacts of (i) a decline in revenues associated with hurricanes; (ii) increases in recycling and landfill disposal volumes; and (iii) lower revenue from residential, commercial and industrial collection volumes, particularly in the East and Midwest, which can generally be attributed to our focus on improving our margins by increasing yield.
 
Our revenue due to volumes generated from hurricane related services were $56 million for the year ended December 31, 2005 as compared with $115 million for the year ended December 31, 2004. The $59 million decline was partially due to the temporary suspension of certain of our operations in the Gulf Coast region during 2005 as a result of the severe destruction caused by Hurricane Katrina. In addition, much of our 2004 hurricane related revenues was associated with subcontracted services, which generated comparatively lower margins. In 2005, we generally elected not to undertake hurricane related projects for which we could not support the required services with internal resources.
 
When excluding the impacts of the hurricanes, revenue due to higher volumes increased $62 million, or 0.5% during 2005. This increase was largely due to (i) increased recycling volumes provided by several brokerage contracts; (ii) increased landfill disposal volumes in the Midwest, West and South; (iii) increased transfer station volumes in the West and the South; and (iv) increased residential collection volumes in the West. Also included as a component of revenue growth from volumes in 2005 was revenue generated from our construction of an integrated waste facility on behalf of a municipality in Canada. The revenue generated by this project was low margin and largely offset by a corresponding increase in cost of goods sold.
 
These revenue increases were largely offset by volume declines experienced in each line of business in the Eastern portion of the United States and significant volume declines in our collection business in the Midwest.
 
Acquisitions and divestitures — The net impact of acquisitions and divestitures on our revenues was a decrease of $102 million in 2006 and an increase of $50 million in 2005. The significant change in these impacts is a result of our divestiture plan, which was initiated in the third quarter of 2005.
 
Operating Expenses
 
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 our waste to disposal facilities and are driven by transportation costs such as fuel prices;


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(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):
 
                                                         
          Period-to-
          Period-to-
       
    2006     Period Change     2005     Period Change     2004  
 
Labor and related benefits
  $ 2,479     $ 8       0.3 %   $ 2,471     $ 84       3.5 %   $ 2,387  
Transfer and disposal costs
    1,248       (22 )     (1.7 )     1,270       (19 )     (1.5 )     1,289  
Maintenance and repairs
    1,137       2       0.2       1,135       35       3.2       1,100  
Subcontractor costs
    971       34       3.6       937       26       2.9       911  
Cost of goods sold
    589       (56 )     (8.7 )     645       49       8.2       596  
Fuel
    579       47       8.8       532       131       32.7       401  
Disposal and franchise fees and taxes
    641       (1 )     (0.2 )     642       22       3.5       620  
Landfill operating costs
    238       5       2.1       233       14       6.4       219  
Risk management
    291       (21 )     (6.7 )     312       (7 )     (2.2 )     319  
Other
    414       (40 )     (8.8 )     454       68       17.6       386  
                                                         
    $ 8,587     $ (44 )     (0.5 )%   $ 8,631     $ 403       4.9 %   $ 8,228  
                                                         
 
Our operating expense margin improved 1.7 percentage points, from 66.0% in 2005 to 64.3% in 2006. This improvement can be attributed to the fact that we experienced increased revenues while controlling our total operating costs. Our ability to manage operating costs demonstrates progress on our operational excellence initiatives such as improving productivity, reducing fleet maintenance costs, standardizing operating practices and improving safety. In addition, our operating expenses have declined when comparing 2006 with 2005 due in part to divestitures and reduced volumes. Divestitures and reduced volumes have contributed to reduced costs or have offset other cost increases in every category throughout 2006.
 
The impact of our cost control initiatives, divestitures, volumes and other significant factors on the comparability of costs incurred for each operating expense category in 2006, 2005 and 2004 are summarized below.
 
Labor and related benefits — When comparing 2006 with 2005, these costs have increased due to annual merit increases and higher bonus expense due to the overall improvement in our performance on a year-over-year basis. These cost increases were partially offset by (i) declines in health and welfare insurance expenses, due to our focus on controlling costs and reductions in operations personnel as a result of divestitures; (ii) reduced overtime generally associated with our reduced volumes; and (iii) reduced headcount due to divestitures and our focus on operating efficiencies. In 2005, the year-over-year increase in costs was generally due to higher salary and wage costs, general increases in health care and benefits costs, increased costs attributable to contract labor and increased payroll taxes.
 
Transfer and disposal costs — In 2006 and 2005 the costs incurred by our collection operations to dispose of waste at third-party transfer stations or landfills declined due to our focus on improving internalization. During 2006, declines in these costs are also attributable to the impact of divestitures and general volume declines.
 
Maintenance and repairs — In 2006, these costs were relatively flat due to the offsetting impacts of increases in labor costs and decreases driven by (i) changes in the scope of maintenance projects at our waste-to-energy facilities; (ii) the impact of divestitures and (iii) various fleet initiatives, all of which have favorably affected our maintenance, parts and supplies costs. The increases in these costs in 2005 were attributable to (i) higher parts and supplies costs, which were driven by changes in the scope of maintenance projects at our waste-to-energy facilities


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and increased volumes in our Southern and Western Groups; (ii) increases in the cost of lubes and oils and (iii) increases in the labor costs associated with our maintenance and repairs.
 
Subcontractor costs — Throughout 2006 and 2005 we experienced increases in subcontractor costs due to higher diesel fuel prices, which drive the fuel surcharges we pay to third-party subcontractors. Subcontractor cost increases attributable to higher fuel costs were offset by the revenue generated from our fuel surcharge program, which is reflected as fuel yield increases within Operating Revenues.  Additionally, in 2006, the increase in our subcontractor costs due to higher fuel costs was partially offset by a decrease attributable to our divestiture of under-performing and non-strategic operations and decreases in volumes.
 
In 2005, we also incurred additional transportation costs due to increased volumes in subcontracted work, particularly in our National Accounts organization and our Western Group. This cost increase was partially offset by a year-over-year decline in the utilization of subcontractors to assist in providing hurricane related services, which were particularly significant during 2004.
 
Cost of goods sold — These costs are primarily for rebates paid to our recycling suppliers, which are driven by the market prices of recyclable commodities. In 2006, we experienced lower market prices for recyclable commodities and reduced recycling volumes.
 
Additionally, in 2006, the decrease in costs of goods sold was partially due to completion of the construction of an integrated waste facility in Canada in early 2006. The increase in cost of goods sold in 2005 was partially due to costs incurred to construct this integrated waste facility. Also in 2005, we experienced lower market prices for recyclable commodities than in prior years. This decrease in pricing was more than offset by increased recycling volumes in 2005 due to several new brokerage contracts and acquisitions.
 
Fuel — We experienced an estimated average increase of $0.31 per gallon for 2006 as compared with 2005 and of $0.59 per gallon for 2005 as compared with 2004. While our fuel surcharge is designed to recover the cost increases incurred as a result of higher fuel prices, increased fuel costs continue to negatively affect 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 2006, these costs have remained relatively flat primarily as a result of decreases associated with divestitures and general volume declines, partially offset by increases in rates for mandated fees and taxes in certain markets. In 2005, these cost increases were the result of increased volumes and increased rates for mandated fees and taxes. 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 — For 2006 and 2005, these cost increases have generally been 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 largely due to reduced workers’ compensation costs, which can be attributed to our continued focus on safety and reduced accident and injury rates.
 
Other operating expenses — 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 hundreds of our employees who worked in the New Orleans area to help with the cleanup efforts; (ii) higher rental expense in 2005; and (iii) a decrease related to the deconsolidation of a variable interest entity in early 2006.
 
In addition to the 2005 items noted above, the increase in our other operating costs when comparing 2005 with 2004 can be attributed to (i) a year-over-year decrease in the realization of gains on sales of assets; (ii) costs incurred during 2005 attributable to labor strikes in New Jersey and Canada; and (iii) an increase in costs generated by the variable interest entity discussed above.


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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 telecommunications, advertising, travel and entertainment, rentals, postage and printing.
 
The following table summarizes the major components of our selling, general and administrative costs for the years ended December 31 (in millions):
 
                                                         
          Period-to-
          Period-to-
       
    2006     Period Change     2005     Period Change     2004  
 
Labor and related benefits
  $ 794     $ 37       4.9 %   $ 757     $ 16       2.2 %   $ 741  
Professional fees
    161       9       5.9       152       (17 )     (10.1 )     169  
Provision for bad debts
    49       (3 )     (5.8 )     52       4       8.3       48  
Other
    384       69       21.9       315       6       1.9       309  
                                                         
    $ 1,388     $ 112       8.8 %   $ 1,276     $ 9       0.7 %   $ 1,267  
                                                         
 
Our professional fees and, to a lesser extent, our labor costs and other general and administrative costs, for the year ended December 31, 2006 were increased by $20 million for non-capitalizable costs incurred to support the planned implementation of our new revenue management system. This increase and other significant changes in our selling, general and administrative expenses are summarized below.
 
Labor and related benefits — In both 2006 and 2005, these costs increased year-over-year due to higher bonus expense attributable to the overall improvement in our performance and higher non-cash compensation costs associated with the equity-based compensation provided for by our long-term incentive plan. Also contributing to the increase in labor costs in 2006 and 2005 are higher salaries and hourly wages driven by annual merit raises and an increase in the size of our sales force. These increases were partially offset by savings associated with our 2005 restructuring. Fluctuations in our use of contract labor for corporate support functions caused an increase in 2006 and a decline in 2005 as compared with the prior year periods.
 
Professional Fees — In 2006, our professional fees were higher than in 2005 due to higher consulting fees associated with our pricing initiatives and the development of our revenue management system. However, the overall increase in consulting fees in 2006 was partially offset by costs incurred during 2005 for computer support costs related to a revenue management project for our Recycling Group. In 2005, we experienced a decline in professional fees as compared with the prior year as a result of lower litigation and defense costs and lower consulting costs associated with Section 404 of the Sarbanes-Oxley Act as we moved from the implementation phase in 2004 to continued monitoring and testing in 2005.
 
Other — We are currently undergoing unclaimed property audits, which are being conducted by various state authorities. The property subject to review in this audit process generally includes unclaimed wages, vendor payments and customer refunds. During 2006, we submitted unclaimed property filings with all states. As a result of our findings, we determined that we had unrecorded obligations associated with unclaimed property for escheatable items for various periods between 1980 and 2004. The increase in our expenses includes a $20 million charge to record these estimated unrecorded obligations. Refer to Note 10 of our Consolidated Financial Statements for additional information related to the nature of this charge. Additionally, in both 2006 and 2005, our other costs increased due to higher sales and marketing costs associated with our national advertising campaign 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
 
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


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those incurred and all estimated future costs for landfill development, construction, closure and post-closure, on a units-of-consumption method as landfill airspace is consumed over the 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 decreased by $27 million during 2006 when compared with 2005. The decrease was due in part to the suspension of depreciation on assets held-for-sale, divestitures and the discontinuation of depreciation on enterprise-wide software that is now fully depreciated.
 
The comparability of our depreciation and amortization expense for the years ended December 31, 2006, 2005 and 2004 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, 2006, 2005 and 2004, landfill amortization expense was reduced by $1 million, $13 million and $18 million, respectively, for the effects of these changes in estimate. In each year, the majority of the reduced expense resulting from the revised estimates was associated with final capping changes.
 
Restructuring
 
Management continuously reviews our organization to determine if we are operating under the most advantageous structure. These reviews have highlighted efficiencies and cost savings we could capture by restructuring. 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.
 
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 has reduced costs at the Group and Corporate offices and increased the accountability of our Market Areas. We recorded $28 million of pre-tax charges for costs associated with the implementation of the new structure, principally for employee severance and benefit costs.
 
(Income) Expense from Divestitures, Asset Impairments and Unusual Items
 
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):
 
                         
    Years Ended December 31,  
    2006     2005     2004  
 
Asset impairments
  $ 42     $ 116     $ 17  
(Income) expense from divestitures
    (44 )     (79 )     (12 )
Other
    27       31       (18 )
                         
    $ 25     $ 68     $ (13 )
                         
 
Year Ended December 31, 2006
 
Asset impairments — During the second and third quarters of 2006, we recorded impairment charges of $13 million and $5 million, respectively, for operations we intend to sell as part of our divestiture program. The charges were required to reduce the carrying values of the operations to their estimated fair values less the cost to sell in accordance with the guidance provided by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, for assets to be disposed of by sale.


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During the third and fourth quarters of 2006, we recorded impairment charges of $10 million and $14 million, respectively, for assets and businesses associated with our continuing operations. The charges recognized during the third quarter of 2006 were related to operations in our Recycling and Southern Groups. The charges recognized during the fourth quarter of 2006 were primarily attributable to the impairment of a landfill in our Eastern Group as a result of a change in our expectations for future expansions.
 
(Income) expense from divestitures — We recognized $44 million of net gains on divestitures during the year ended December 31, 2006, which were direct results of the execution of our plan to review under-performing or non-strategic operations and to either improve their performance or dispose of the operations. The majority of these net gains was recognized during the second quarter of 2006 and relates to operations located in our Western Group. Total proceeds from divestitures completed during the year ended December 31, 2006 were $184 million, all of which were received in cash.
 
Other — During the fourth quarter of 2006, we recognized a charge of approximately $26 million for the impact of an arbitration ruling against us related to the termination of a joint venture relationship in 2000. The party that purchased our interest in the joint venture had sued us, seeking a variety of remedies ranging from monetary damages to unwinding the sale of assets. In the fourth quarter of 2006, the arbitration tribunal ruled in the other party’s favor, awarding them approximately $29 million, which includes monetary damages, interest, and certain fees and expenses. Prior to the ruling, the Company had recorded a reserve of $3 million. For additional information regarding this matter refer to Note 10 of our Consolidated Financial Statements.
 
Year Ended December 31, 2005
 
Asset impairments — During the second quarter of 2005, our Eastern Group recorded a $35 million charge for the impairment of the Pottstown Landfill located in West Pottsgrove Township, Pennsylvania. We determined that an impairment was necessary after the Pennsylvania Environmental Hearing Board upheld a denial by the Pennsylvania Department of Environmental Protection of a permit application for a vertical expansion at the landfill. After the denial was upheld, the Company reviewed the options available at the Pottstown Landfill and the likelihood of the possible outcomes of those options. After such evaluation and considering the length of time required for the appeal process and the permit application review, we decided not to pursue an appeal of the permit denial. This decision was primarily due to the expected impact of the permitting delays, which would hinder our ability to fully utilize the expansion airspace before the landfill’s required closure in 2010. We continued to operate the Pottstown Landfill using existing permitted airspace through the landfill’s permit expiration date of October 2005.
 
Through June 30, 2005, our “Property and equipment” had included approximately $80 million of accumulated costs associated with a revenue management system. Approximately $59 million of these costs were specifically associated with the purchase of the software along with efforts required to develop and configure that software for our use, while the remaining costs were associated with the general efforts of integrating a revenue management system with our existing applications and hardware. The development efforts associated with our revenue management system were suspended in 2003. Since that time, there have been changes in the viable software alternatives available to address our current needs. During the third quarter of 2005, we concluded our assessment of potential revenue management system options. As a result, we entered into agreements with a new software vendor for the license, implementation and maintenance of certain of its applications software, including waste and recycling functionality. We believe that these newly licensed applications, when fully implemented, will provide substantially better capabilities and functionality than the software we were developing. Our plan to implement this newly licensed software resulted in a $59 million charge in the third quarter of 2005 for the software that had been under development and capitalized costs associated with the development efforts specific to that software.
 
During the fourth quarter of 2005, we recognized an $18 million charge for asset impairments. This charge was primarily attributable 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 capitalized software costs related to two applications we decided not to develop further.


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(Income) expense from divestitures — During the first quarter of 2005, we recognized a $39 million gain as a result of the divestiture of a landfill in Ontario, Canada, which was required as a result of a Divestiture Order from the Canadian Competition Bureau. During the remainder of 2005, we recognized a total of $40 million in gains as a result of the divestiture of operations. With the exception of our divestiture of the Ontario, Canada landfill, our divestitures during 2005 were direct results of the execution of our plan to review under-performing or non-strategic operations and to either improve their performance or dispose of the operations.
 
Total proceeds from divestitures completed during the year ended December 31, 2005 were $172 million, of which $140 million was received in cash, $23 million was in the form of a note receivable and $9 million was in the form of non-monetary assets.
 
Other — In the first quarter of 2005, we recognized a charge of approximately $16 million for the impact of a litigation settlement reached with a group of stockholders that opted not to participate in the settlement of the securities class action lawsuit against us related to 1998 and 1999 activity. During the third quarter of 2005, we settled our ongoing defense costs and possible indemnity obligations for four former officers of WM Holdings related to legacy litigation brought against them by the SEC. As a result, we recorded a $26.8 million charge for the funding of the court-ordered distribution of $27.5 million to our shareholders in settlement of the legacy litigation against the former officers. These charges were partially offset by the recognition of a $12 million net benefit recorded during the year ended December 31, 2005, which was primarily for adjustments to our receivables and estimated obligations for non-solid waste operations divested in 1999 and 2000.
 
Year Ended December 31, 2004
 
For 2004, the significant items included within “(Income) expense from divestitures, asset impairments and unusual items” were (i) $17 million in impairment losses primarily due to the impairment of certain landfill assets and software development costs; (ii) $12 million in gains on divestitures that primarily related to certain Port-O-Let® operations; and (iii) $18 million in miscellaneous net gains, which were primarily for adjustments to our estimated obligations associated with non-solid waste services, which were divested 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 (in millions):
 
                                                         
          Period-to-
          Period-to-
       
    2006     Period Change     2005     Period Change     2004  
 
Eastern
  $ 417     $ 56       15.5 %   $ 361     $ 3       0.8 %   $ 358  
Midwest
    484       58       13.6       426       40       10.4       386  
Southern
    804       105       15.0       699       34       5.1       665  
Western
    561       90       19.1       471       56       13.5       415  
Wheelabrator
    315       10       3.3       305       22       7.8       283  
Recycling
    16       1       6.7       15       (10 )     (40.0 )     25  
Other
    (23 )     (26 )     *       3       15       *       (12 )
Corporate and other
    (545 )     25       (4.4 )     (570 )     (149 )     35.4       (421 )
                                                         
Total
  $ 2,029     $ 319       18.7 %   $ 1,710     $ 11       0.6 %   $ 1,699  
                                                         
 
 
Percentage change does not provide a meaningful comparison.
 
Overview — Revenue growth from base business yield improvement, which is primarily the result of our continued focus on pricing, significantly contributed to the operating income of each of our geographic Groups during the years ended December 31, 2006 and 2005. Base business yield provided revenue growth for each line of business in 2006, but was driven primarily by our collection operations, where we experienced substantial revenue growth in every geographic operating Group for the second consecutive year. The operating results of the Groups have also benefited from our focus on cost control and from increases in higher margin disposal volumes during


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both 2005 and 2006. These improvements were partially offset by declines in revenues due to lower volumes in the collection line of business, particularly in our Eastern Group. See the additional discussion in the Operating Revenues section above.
 
The operating results for the year ended December 31, 2006 also compare favorably with the prior years due to the $27 million restructuring charge recognized during the third quarter of 2005. “Corporate and other” reflects $10 million of this impact with the remaining $17 million allocated across the operating Groups. See additional discussion of these charges in the Restructuring section above.
 
Other significant items affecting the comparability of the operating segments’ results of operations for the years ended December 31, 2006, 2005 and 2004 are summarized below:
 
Eastern — The Group’s 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 2005 results compared with the prior year was a decline in landfill amortization expense generally as a result of changes in certain estimates related to our final capping, closure and post-closure obligations.
 
Southern — 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 — Gains on divestitures of operations were $48 million for the year ended December 31, 2006 as compared with $24 million for 2005 and $10 million for 2004.
 
Wheelabrator — The electric rates we charge to our customers at our waste-to-energy facilities increased significantly during the latter portion of 2005 as a result of higher market prices for natural gas. The rates we charge customers are indexed to natural gas prices, which increased significantly as a result of hurricane-related production disruptions, increased demand and increases in crude oil prices. This increase in rates was the principal reason for the 2005 increase in Wheelabrator’s income from operations as compared with 2004. The favorable impact of market prices for natural gas was partially offset by higher costs of goods sold and higher repair and maintenance costs due to the scope and timing of maintenance performed in 2005 as compared with 2004.
 
Recycling — During 2006, the Group recognized $10 million of charges for a loss on divestiture and an impairment of certain under-performing operations, which were slightly more than offset by savings associated with the Group’s cost control efforts. The decrease in income from operations in our Recycling Group during 2005 when compared with 2004 can generally be attributed to (i) an increase in the rebates paid to our suppliers as a result of increased competition; (ii) costs related to the deployment of new software; and (iii) higher subcontractor costs primarily related to increased distances traveled by third-party haulers.
 
The comparability of operating results for the Recycling Group for all of the periods presented has been affected by variances in the market prices for recyclable commodities. During the three years ended December 31, 2006, year-over-year changes in the quarterly average market prices of OCC and ONP have


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ranged from a decrease of as much as 33% to an increase of as much as 36%. However, declines in the market prices for recyclable commodities resulted in only marginal year-over-year decreases to our income from operations during 2006 and 2005 because a substantial portion of changes in market prices are generally passed on as rebates to our suppliers.
 
Other — The changes in “Income from operations” attributed to our other operations is driven primarily by the 2005 recognition of 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. The impact of this 2005 divestiture gain is partially offset by the effect of certain other quarter-end adjustments related to the operating segments that are recorded in consolidation and, due to timing, not included in the measure of segment income from operations used to assess their performance for the periods disclosed.
 
Corporate — Expenses were higher in 2005 as compared with 2006 primarily due to impairment charges in 2005 of $68 million associated with capitalized software costs and $31 million of net charges associated with various legal and divestiture matters. In 2006, we recognized $37 million of net charges associated with various legal and divestiture matters. These items are discussed in the (Income) Expense from Divestitures, Asset Impairments and Unusual Items section above.
 
In 2006, we experienced lower risk management and employee health and welfare plan costs largely due to our focus on safety and controlling costs. These cost savings have been largely offset by the following cost increases: (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 associated with the Company’s current strong performance; (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; and (v) the centralization of support functions that were provided by our Group offices prior to our 2005 reorganization.
 
The higher expenses in 2005 as compared with 2004 were driven by the previously noted $99 million charged to “(Income) expense from divestitures, asset impairments and unusual items” during 2005. Also contributing to the increase in expenses during 2005 were (i) non-cash employee compensation costs associated with current year changes in equity-based compensation; (ii) inflation in employee health care costs; (iii) salary and wage annual merit increases; (iv) costs for sales and marketing programs; and (v) costs at Corporate associated with our July 2005 restructuring charge and organizational changes, which were partially offset by associated savings at Corporate.
 
Other Components of Income Before Cumulative Effect of Change in Accounting Principle
 
The following summarizes the other major components of our income before cumulative effect of change in accounting principle for the year ended December 31 for each respective period (in millions):
 
                                                         
          Period-to-
          Period-to-
       
    2006     Period Change     2005     Period Change     2004  
 
Interest expense
  $ (545 )   $ (49 )     9.9 %   $ (496 )   $ (41 )     9.0 %   $ (455 )
Interest income
    69       38       *       31       (39 )     (55.7 )     70  
Equity in net losses of unconsolidated entities
    (36 )     71       *       (107 )     (9 )     9.2       (98 )
Minority interest
    (44 )     4       (8.3 )     (48 )     (12 )     33.3       (36 )
Other, net
    1       (1 )     *       2       4       *       (2 )
Provision for (benefit from) income taxes
    325       415       *       (90 )     (337 )     *       247  
 
 
* Percentage change does not provide a meaningful comparison. Refer to the explanations of these items below for a discussion of the relationship between current year and prior year activity.


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Interest Expense
 
The increase in interest expense in 2006 and 2005 is generally related to higher market interest rates, which have resulted in a decrease in the benefit of our interest rate swaps and an increase in the interest rates of our variable rate debt. The increase in our interest expense in 2006 due to higher market interest rates was partially offset by the impact of a decrease in our outstanding debt, which is due to our repayment of borrowings throughout the year.
 
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 $4 million for 2006 and net interest expense reductions of $39 million and $90 million for 2005 and 2004, respectively. 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 increased from 2.56% at December 31, 2004 to 4.54% at December 31, 2005 and to 5.36% at December 31, 2006. Included in the $4 million net increase in interest expense realized in 2006 for terminated and active interest rate swap agreements is a $41 million reduction in interest expense related to the amortization of terminated swaps. Our terminated interest rate swaps are expected to reduce interest expense by $37 million in 2007, $33 million in 2008 and $19 million in 2009.
 
In addition, we have $652 million of tax-exempt borrowings remarketed either daily or weekly to effectively maintain a variable yield. The interest rates of these borrowings increased over the last two years due to higher market rates.
 
Interest Income
 
The increase in interest income when comparing 2006 with 2005 is due to an increase in our investments in variable rate demand notes and auction rate securities throughout the year. Interest income for 2006 and 2004 includes interest income of $14 million and $46 million, respectively, realized on tax refunds received from the IRS for the settlement of several federal audits.
 
Equity in Net Losses of Unconsolidated Entities
 
In the first and second quarters of 2004, we acquired an equity interest in two coal-based synthetic fuel production facilities. The activities of these facilities drive our “Equity in net losses of unconsolidated entities”. The significant decrease in the equity losses attributable to these facilities when comparing 2006 with prior years is due to (i) the estimated effect of a 36% phase-out of Section 45K (formerly Section 29) credits generated during 2006 on our contractual obligations associated with funding the facilities’ losses as a result of a substantial increase in market prices of crude oil; (ii) the suspension of operations at the facilities from May to September of 2006; and (iii) 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. The increase in these losses from 2004 to 2005 is due to the timing of our initial investments in 2004.
 
These equity losses are more than offset by the tax benefit realized as a result of these investments. The impact of these facilities on our provision for taxes is discussed below within Provision for (Benefit from) Income Taxes. Additional information related to these investments is included in Note 8 to the Consolidated Financial Statements.
 
Minority Interest
 
On December 31, 2003, we consolidated two special purpose type variable interest entities as a result of our implementation of FIN 46(R). Our minority interest expense for 2006, 2005 and 2004 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.
 
Other, net
 
Our other income and expense is primarily attributable to the impact of foreign currency translation on our Canadian operations.


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Provision for (Benefit from) Income Taxes
 
We recorded a provision for income taxes of $325 million in 2006, a benefit from income taxes of $90 million in 2005, and a provision for income taxes of $247 million in 2004 resulting in an effective income tax rate of approximately 22.1%, (8.2)%, and 21.0% for each of the three years, respectively. When excluding the effect of interest income related to audit settlements, the settlement of various federal and state tax audit matters during 2006, 2005 and 2004 resulted in a reduction in our provision for income taxes of $149 million, (representing a 10.1 percentage point reduction in our effective tax rate), $398 million, (representing a 36.4 percentage point reduction in our effective tax rate) and $101 million, (representing an 8.5 percentage point reduction in our effective tax rate), respectively.
 
The benefit of non-conventional fuel tax credits is derived from methane gas projects at our landfills and our investments in two coal-based synthetic fuel production facilities, which are discussed in the Equity in Net Losses of Unconsolidated Entities section above. These tax credits are available through 2007 pursuant to Section 45K of the Internal Revenue Code, and are phased-out if the price of crude oil exceeds a threshold annual average price determined by the IRS. Our effective tax rate for 2006 reflects a phase-out of 36% of Section 45K tax credits generated during 2006 and a temporary shut down of the synthetic fuel production facilities. We have developed our estimate of the phase-out using market information for crude oil prices as of December 31, 2006. Our synthetic fuel production facility investments resulted in a decrease in our tax provision of $64 million for 2006, $145 million for 2005 and $131 million for 2004, which more than offset the related equity losses and interest expense for those entities. Refer to Note 8 of our Consolidated Financial Statements for additional information regarding the impact of these investments on our provision for taxes.
 
For all periods, a portion of the difference in income taxes computed at the federal statutory rate and reported income taxes is due to state and local income taxes.
 
Additionally, in 2006, we recorded reductions to income tax expense related to (i) a decrease in our effective state tax rate resulting in a $9 million benefit related to the revaluation of net accumulated deferred tax liabilities; (ii) a $20 million tax benefit due to scheduled tax rate reductions in Canada and the resulting revaluation of related net accumulated deferred tax liabilities; and (iii) an $11 million state tax benefit arising from the reduction in the valuation allowance related to the expected utilization of state net operating loss and credit carryforwards.
 
In 2005, we recorded additional income tax expense related to (i) the accrual of $4 million to increase net accumulated deferred tax liabilities resulting from a change in the provincial tax rate in Quebec and (ii) the accrual of $34 million of taxes associated with our plan to repatriate $496 million of accumulated earnings and capital from certain of our Canadian subsidiaries under the American Jobs Creation Act of 2004. These amounts were offset in part by a change in our estimated state effective tax rate causing us to realize a benefit of $16 million related to the revaluation of net accumulated deferred tax liabilities.
 
Cumulative Effect of Change in Accounting Principle
 
On March 31, 2004, we recorded a credit of $8 million, net of taxes, or $0.01 per diluted share, to “Cumulative effect of change in accounting principle” as a result of the consolidation of previously unrecorded trusts as required by FIN 46(R). See Notes 2 and 19 to the Consolidated Financial Statements for further discussion.
 
Liquidity and Capital Resources
 
General
 
We have consistently generated cash flows from operations in excess of our reinvestment needs. However, we operate in a capital-intensive business and continued access to various financing resources is vital to our continued financial strength. In the past, we have been successful in obtaining financing from a variety of sources on terms we consider attractive. Based on several key factors we believe are considered important by credit rating agencies and financial markets in determining our access to attractive financing alternatives, we expect to continue to maintain access to capital sources in the future. These factors include:
 
  •  the essential nature of the services we provide and our large and diverse customer base;


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  •  our ability to generate strong and consistent cash flows despite the economic environment;
 
  •  our liquidity profile;
 
  •  our asset base; and
 
  •  our commitment to maintaining a moderate financial profile and disciplined capital allocation.
 
We continually monitor our actual and forecasted cash flows, our liquidity and our capital resources, enabling us to plan for our present needs and fund unbudgeted business activities that may arise during the year as a result of changing business conditions or new opportunities. In addition to our working capital needs for the general and administrative costs of our ongoing operations, we have cash requirements for: (i) the construction and expansion of our landfills; (ii) additions to and maintenance of our trucking fleet; (iii) refurbishments and improvements at waste-to-energy and materials recovery facilities; (iv) the container and equipment needs of our operations; (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.
 
On October 22, 2004, the American Jobs Creation Act of 2004 (the “Act”) became law. A provision of the Act 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, 2006 and December 31, 2005 (in millions):
 
                 
    2006     2005  
 
Cash and cash equivalents
  $ 614     $ 666  
Short-term investments available for use
    184       300  
                 
Total cash, cash equivalents and short-term investments available for use
  $ 798     $ 966  
                 
Restricted trust and escrow accounts:
               
Tax-exempt bond funds
  $ 94     $ 185  
Closure, post-closure and environmental remediation funds
    219       205  
Debt service funds
    45       52  
Other
    19       18  
                 
Total restricted trust and escrow accounts
  $ 377     $ 460  
                 
Debt:
               
Current portion
  $ 822     $ 522  
Long-term portion
    7,495       8,165  
                 
Total debt
  $ 8,317     $ 8,687  
                 
Increase in carrying value of debt due to hedge accounting for interest rate swaps
  $ 19     $ 47  
                 
 
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.


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Short-term investments available for use — These investments include 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 marketing 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.
 
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 debt obligations, funds deposited in connection with landfill closure, post-closure and 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
 
Revolving credit and letter of credit facilities — The table below summarizes the credit capacity, maturity and outstanding letters of credit under our revolving credit facility, principal letter of credit facilities and other credit arrangements as of December 31, 2006 (in millions):
 
                     
              Outstanding
 
    Total Credit
        Letters
 
Facility
  Capacity    
Maturity
  of Credit  
 
Five-year revolving credit facility(a)
  $ 2,400     August 2011   $ 1,301  
Five-year letter of credit and term loan agreement(b)
    15     June 2008     15  
Five-year letter of credit facility(b)
    350     December 2008     346  
Seven-year letter of credit and term loan agreement(b)
    175     June 2010     175  
Ten-year letter of credit and term loan agreement(b)
    105     June 2013     105  
Other(c)
        Various     75  
                     
Total
  $ 3,045         $ 2,017  
                     
 
 
(a) On August 17, 2006, WMI entered into a five-year, $2.4 billion revolving credit facility, replacing the $2.4 billion syndicated revolving credit facility that would have expired in October 2009. This facility provides us with credit capacity that could be used for either cash borrowings or letters of credit. At December 31, 2006, no borrowings were outstanding under the facility, and we had unused and available credit capacity of $1,099 million.
 
(b) These facilities have been established to provide us with letter of credit capacity. In the event of an unreimbursed draw on a letter of credit, the amount of the draw paid by the letter of credit provider generally converts into a term loan for the remaining term under the respective agreement or facility. Through December 31, 2006 we had not experienced any unreimbursed draws on our letters of credit.
 
(c) We have letters of credit outstanding under various arrangements that do not provide for a committed capacity. Accordingly, the total credit capacity of these arrangements has been noted as zero.
 
We have used each of these facilities to support letters of credit that we issue to support our insurance programs, certain tax-exempt bond issuances, municipal and governmental waste management contracts, closure and post-closure obligations and disposal site or transfer station operating permits. These facilities require us to pay fees to the financial institutions and our obligation is generally to repay any draws that may occur on the letters of credit. We expect that similar facilities may continue to serve as a cost efficient source of letter of credit capacity in the future, and we continue to assess our financial assurance requirements to ensure that we have adequate letter of credit and surety bond capacity in advance of our business needs.
 
Canadian Credit Facility — In November 2005, Waste Management of Canada Corporation, one of our wholly-owned subsidiaries, entered into a three-year credit facility agreement under which we could borrow up to Canadian $410 million. The agreement was entered into to facilitate WMI’s repatriation of accumulated earnings and capital from its Canadian subsidiaries as discussed above.


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As of December 31, 2006, we had $313 million of principal ($308 million net of discount) outstanding under this credit facility. Advances under the facility do not accrue interest during their terms. Accordingly, the proceeds we initially received were for the principal amount of the advances net of the total interest obligation due for the term of the advance, and the debt was initially recorded based on the net proceeds received. The advances have a weighted average effective interest rate of 4.8% at December 31, 2006, which is being amortized to interest expense with a corresponding increase in our recorded debt obligation using the effective interest method. During the year ended December 31, 2006, we increased the carrying value of the debt for the recognition of $15 million of interest expense. A total of $47 million of advances under the facility matured during 2006 and were repaid with available cash. Accounting for changes in the Canadian currency translation rate did not significantly affect the carrying value of these borrowings during 2006.
 
Our outstanding advances mature less than one year from the date of issuance, but may be renewed under the terms of the facility. While we may elect to renew portions of our outstanding advances under the terms of the facility, we currently expect to repay our borrowings under the facility within one year with available cash. Accordingly, these borrowings are classified as current in our December 31, 2006 Consolidated Balance Sheet. As of December 31, 2005, we had expected to repay $86 million of outstanding advances with available cash and renew the remaining borrowings under the terms of the facility. Based on our expectations at that time, we classified $86 million as current and $254 million as long-term in our December 31, 2005 Consolidated Balance Sheet.
 
Senior notes — As of December 31, 2006, we had $4.8 billion of outstanding senior notes. The notes have various maturities ranging from October 2007 to May 2032, and interest rates ranging from 5.00% to 8.75%. On October 15, 2006, $300 million of 7.0% senior notes matured and were repaid with cash on hand. We have $300 million of 7.125% senior notes that mature in October 2007 that we currently expect to repay with available cash. Accordingly, this borrowing is classified as current as of December 31, 2006.
 
Tax-exempt bonds — We actively issue tax-exempt bonds as a means of accessing low-cost financing for capital expenditures. As of December 31, 2006, we had $2.4 billion of outstanding tax-exempt bonds. We issued $159 million of tax-exempt bonds during 2006. The proceeds from these debt issuances were deposited directly into a trust fund and may only be used for the specific purpose for which the money was raised, which is generally the construction of collection and disposal facilities and for the equipment necessary to provide waste management services. Accordingly, the restricted funds provided by these financing activities have not been included in “New borrowings” in our Consolidated Statement of Cash Flows for the year ended December 31, 2006. As we spend monies on the specific projects being financed, we are able to requisition cash from the trust funds. As discussed in the restricted trusts and escrow accounts section above, we have $94 million held in trust for future spending as of December 31, 2006. During 2006, we received $258 million from these funds for approved capital expenditures.
 
As of December 31, 2006, $606 million of our tax-exempt bonds are remarketed weekly by a remarketing agent to effectively maintain a variable yield. If the remarketing agent is unable to remarket the bonds, then the remarketing agent can put the bonds to us. These bonds are supported by letters of credit that were issued primarily under our $2.4 billion, five-year revolving credit facility that guarantee repayment of the bonds in the event the bonds are put to us. Accordingly, these obligations have been classified as long-term in our December 31, 2006 Consolidated Balance Sheet.
 
Additionally, as of December 31, 2006, we have $255 million of fixed rate tax-exempt bonds subject to repricing within the next twelve months, which is prior to their scheduled maturities. If the re-offerings of the bonds are unsuccessful, then the bonds can be put to us, requiring immediate repayment. These bonds are not backed by letters of credit supported by our long-term facilities that would serve to guarantee repayment in the event of a failed re-offering and are, therefore, considered a current obligation for financial reporting purposes. However, these bonds have been classified as long-term in our Consolidated Balance Sheet as of December 31, 2006. The classification of these obligations as long-term was based upon our intent to refinance the borrowings with other long-term financings in the event of a failed re-offering and our ability, in the event other sources of long-term financing are not available, to use our five-year revolving credit facility.
 
Tax-exempt project bonds — As of December 31, 2006, we had $352 million of outstanding tax-exempt project bonds. These debt instruments are primarily used by our Wheelabrator Group to finance the development of waste-to-energy facilities. The bonds generally require periodic principal installment payments. As of


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December 31, 2006, $46 million of these bonds are remarketed either daily or weekly by a remarketing agent to effectively maintain a variable yield. If the remarketing agent is unable to remarket the bonds, then the remarketing agent can put the bonds to us. Repayment of these bonds has been guaranteed with letters of credit issued under our five-year revolving credit facility. Accordingly, these obligations have been classified as long-term in our December 31, 2006 Consolidated Balance Sheet. Approximately $61 million of our tax-exempt project bonds will be repaid with either available cash or debt service funds within the next twelve months.
 
Interest rate swaps — We manage the interest rate risk of our debt portfolio principally by using interest rate derivatives to achieve a desired position of fixed and floating rate debt. As of December 31, 2006, the interest payments on $2.4 billion of our fixed rate debt have been swapped to variable rates, allowing us to maintain approximately 64% of our debt at fixed interest rates and approximately 36% of our debt at variable interest rates. Fair value hedge accounting for interest rate swap contracts increased the carrying value of debt instruments by $19 million as of December 31, 2006 and $47 million at December 31, 2005.
 
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):
 
                         
    2006     2005     2004  
 
Net cash provided by operating activities
  $ 2,540     $ 2,391     $ 2,218  
                         
Net cash used in investing activities
  $ (788 )   $ (1,062 )   $ (882 )
                         
Net cash used in financing activities
  $ (1,803 )   $ (1,090 )   $ (1,130 )
                         
 
Net Cash Provided by Operating Activities — During 2006 and 2005, our cash flows from operating activities increased $149 million and $173 million, respectively, on a year-over-year basis. In both years, the increases were due to growth in our operating income and comparative changes in our receivables and accounts payable and accrued liabilities, and were partially offset by increases in cash paid for income taxes.
 
The change in our receivables balances, net of effects of acquisitions and divestitures, provided a source of cash of $12 million in 2006, compared to a use of cash in both 2005 and 2004 of $102 million and $223 million, respectively. In 2006, our receivables balances declined in part due to a decrease in fourth quarter revenues as compared with the prior year, but also due to improved efficiency of collections. We have created and implemented new processes to assist our Market Areas with collections. The increases in our receivables balances, and resulting uses of cash in the Consolidated Statements of Cash Flows, in 2005 and 2004 were primarily related to increased revenues. However, the significant year-over-year change can partially be attributed to 2004 receivable balances associated with significant revenues generated from hurricane related services provided in the second half of 2004.
 
We made income tax payments of $475 million in 2006, $233 million in 2005 and $136 million in 2004. The increase in 2006 is primarily the result of improved earnings, a 36% phase-out of Section 45K tax credits and the temporary shutdown of our two coal-based synthetic fuel production facilities. There was no phase-out of Section 45K tax credits or temporary shutdown of the coal-based synthetic fuel production facilities in either 2005 or 2004. The increase from 2004 to 2005 is the combined result of increased earnings and the expiration of first-year bonus depreciation on property acquired after September 1, 2001 and before January 1, 2005, which favorably impacted taxes paid in 2004.
 
Our provision for income taxes has been significantly affected by tax audit settlements in each period presented. Tax audit settlements and related interest positively affected our net income by $158 million in 2006, $398 million in 2005 and $129 million in 2004. Additionally, we received cash refunds of $62 million in 2006 and $71 million in 2005 related to these tax audit settlements. The remaining impact of these settlements has been reflected as changes in our “Accounts payable and accrued liabilities” for the related periods.
 
The comparability of our operating cash flows for the periods presented is also 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 compensation to be included in cash flows from financing


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activities, which are discussed below. Prior to adopting SFAS No. 123(R), our excess tax benefits associated with equity-based compensation were included within cash flows from operating activities as a change in “Accounts payable and accrued liabilities.” During 2005 and 2004, these excess tax benefits improved our operating cash flows by approximately $17 million and $37 million, respectively.
 
Net Cash Used in Investing Activities — We used $788 million of our cash resources for investing activities during 2006, a decrease of $274 million compared with 2005. This decrease is primarily due to (i) a $417 million increase in net cash flows provided by purchases and sales of short-term investments; (ii) a $110 million decline in spending for acquisitions of businesses; and (iii) a $46 million increase in proceeds from divestitures of businesses (net of cash divested) and other sales of assets. The effect of these items on our cash used in investing activities was partially offset by a $149 million increase in capital spending and a $142 million decline in net receipts from restricted trust and escrow accounts.
 
Net sales of short-term investments provided $122 million of cash in 2006, compared with net purchases of short-term investments of $295 million during 2005. In 2006, we experienced net sales of short-term investments as we utilized our short-term investments and available cash to fund our common stock repurchases, dividend payments and debt repayments, which are discussed below.
 
Our spending on acquisitions decreased from $142 million during 2005 to $32 million in 2006. As we make progress on our divestiture program, we plan to increase our focus on accretive acquisitions and other investments that will contribute to improved future results of operations and enhance and expand our existing service offerings.
 
Proceeds from divestitures (net of cash divested) and other sales of assets were $240 million in 2006 compared with $194 million in 2005, an increase of $46 million. Approximately $89 million of our 2005 proceeds were related to the sale of one of our landfills in Ontario, Canada as required by a Divestiture Order from the Canadian Competition Tribunal. When excluding the cash proceeds generated by this transaction, proceeds from divestitures have increased by $135 million during 2006 when compared with 2005. This increase is primarily a result of the execution of our plan to divest of certain under-performing and non-strategic operations.
 
Net funds received from our restricted trust and escrow accounts, which are largely generated from the issuance of tax-exempt bonds for our capital needs, contributed $253 million to our investing activities in 2006 compared with $395 million in 2005. The decrease is due to a decline in new tax-exempt borrowings.
 
We used $1,329 million during 2006 for capital expenditures, compared with $1,180 million in 2005. The increase occurred across all asset categories. However, our landfill and vehicles asset categories were the most significantly affected.
 
We used $1,062 million of our cash resources for investing activities during 2005, an increase of $180 million compared with 2004. This increase is primarily due to a $266 million change in net cash flows associated with purchases and sales of short-term investments. Net purchases of short-term investments during 2005 were $295 million compared with net purchases of $29 million during 2004. The increase in our short-term investments available for use as of December 31, 2005 can generally be attributed to an increase in our available cash, which we used to fund, among other things, a $275 million accelerated share repurchase agreement that became effective in January 2006 and our first quarter 2006 dividend that was paid in March 2006. Our share repurchases and dividends are discussed in our Net Cash Used in Financing Activities section below.
 
The increase in net cash outflows from investing activities as a result of our short-term investments was partially offset by (i) an increase in proceeds from divestitures of businesses (net of cash divested) and other sales of assets and (ii) a decrease in capital expenditures. Proceeds from divestitures of businesses (net of cash divested) and other sales of assets were $194 million in 2005 and $96 million in 2004. The $98 million increase from 2004 to 2005 is largely attributable to the sale of one of our landfills in Ontario, Canada. Capital expenditures were $1,180 million in 2005, which is $78 million less than we invested in capital in 2004.
 
Net Cash Used in Financing Activities — The most significant changes in our financing cash flows during the three years ended December 31, 2006 are related to (i) increases in cash paid for our repurchases of common stock and cash dividends; (ii) variances in our net debt repayments, which can generally be attributed to scheduled


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maturities; and (iii) variances in proceeds from the exercise of common stock options and warrants. These financing activities are discussed below.
 
Our 2006 and 2005 share repurchases and dividend payments have been made in accordance with a three-year capital allocation program that was approved by our Board of Directors. This capital allocation program authorizes up to $1.2 billion of combined share repurchases and dividend payments each year during 2005, 2006 and 2007. In June 2006, the Board of Directors authorized up to $350 million of additional share repurchases in 2006, increasing the total of capital authorized for share repurchases and dividends in 2006 to $1.55 billion.
 
We paid $1,072 million for share repurchases in 2006, as compared with $706 million in 2005 and $496 million in 2004. We repurchased approximately 31 million, 25 million and 17 million shares of our common stock in 2006, 2005 and 2004, respectively. We currently expect to continue repurchasing common stock under the capital allocation program discussed above.
 
We paid an aggregate of $476 million in cash dividends during 2006 compared with $449 million in 2005 and $432 million in 2004. The increase in dividend payments is due to annual increases in our per share dividend payment, which increased from a quarterly per share dividend of $0.1875 in 2004, to $0.20 in 2005 and to $0.22 in 2006. 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 2006, the Board of Directors announced that it expects future quarterly dividend payments will be $0.24 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.
 
Net debt repayments were $500 million in 2006, $11 million in 2005 and $386 million in 2004. The following summarizes our most significant cash borrowings and debt repayments made during each year (in millions):
 
                         
    Years Ended December 31,  
    2006     2005     2004  
 
Borrowings:
                       
Canadian credit facility
  $ 432     $ 365     $  
Senior notes
                346  
Other debt
                69  
                         
    $ 432     $ 365     $ 415  
                         
Repayments:
                       
Canadian credit facility
  $ (479 )   $     $  
Senior notes
    (300 )     (103 )     (645 )
Tax exempt bonds
    (9 )           (25 )
Tax exempt project bonds
    (50 )     (46 )     (42 )
Convertible subordinated notes
          (35 )      
Capital leases and other debt
    (94 )     (192 )     (89 )
                         
    $ (932 )   $ (376 )   $ (801 )
                         
Net repayments
  $ (500 )   $ (11 )   $ (386 )
                         
 
The exercise of common stock options and warrants and the related excess tax benefits generated a total of $340 million of financing cash inflows during 2006, compared with $129 million in 2005 and $193 million in 2004. We believe the significant increase in stock option and warrant exercises in 2006 is due to the substantial increase in the market value of our common stock during 2006. The accelerated vesting of all outstanding stock options in December 2005 also resulted in increased cash proceeds from stock option exercises because the acceleration made additional options available for exercise. As discussed above, the adoption of SFAS No. 123(R) on January 1, 2006 resulted in the classification of tax savings provided by equity-based compensation as a financing cash inflow rather than an operating cash inflow beginning in the first quarter of 2006. This change in accounting increased cash flows from financing activities by $45 million in 2006.


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Summary of Contractual Obligations
 
The following table summarizes our contractual obligations as of December 31, 2006 and the anticipated effect of these obligations on our liquidity in future years (in millions):
 
                                                         
    2007     2008     2009     2010     2011     Thereafter     Total  
 
Recorded Obligations:
                                                       
Expected environmental liabilities(a)
                                                       
Final capping, closure and post-closure
  $ 111     $ 112     $ 110     $ 110     $ 58     $ 1,566     $ 2,067  
Environmental remediation
    44       41       29       22       12       179       327  
                                                         
      155       153       139       132       70       1,745       2,394  
Debt payments(b),(c)
    815       539       681       713       247       5,305       8,300  
Unrecorded Obligations:(d)
                                                       
Share repurchases(e)
    70                                     70  
Non-cancelable operating lease obligations
    89       71       59       51       34       152       456  
Estimated unconditional purchase obligations(f)
    150       133       127       114       70       357       951  
                                                         
Anticipated liquidity impact as of
December 31, 2006
  $ 1,279     $ 896     $ 1,006     $ 1,010     $ 421     $ 7,559     $ 12,171  
                                                         
 
 
(a) Environmental liabilities include final capping, closure, post-closure and environmental remediation costs. The amounts included here reflect environmental liabilities recorded in our Consolidated Balance Sheet as of December 31, 2006 without the impact of discounting and inflation. Our recorded environmental liabilities will increase as we continue to place additional tons within the permitted airspace at our landfills.
 
(b) Our debt obligations as of December 31, 2006 include $255 million of fixed rate tax-exempt bonds subject to repricing within the next twelve months, which is prior to their scheduled maturities. If the re-offerings of the bonds are unsuccessful, then the bonds can be put to us, requiring immediate repayment. We have classified the anticipated cash flows for these contractual obligations based on the scheduled maturity of the borrowing for purposes of this disclosure. For additional information regarding the classification of these borrowings in our Consolidated Balance Sheet as of December 31, 2006, refer to Note 7 to the Consolidated Financial Statements.
 
(c) Our recorded debt obligations include non-cash adjustments associated with discounts, premiums and fair value adjustments for interest rate hedging activities. These amounts have been excluded here because they will not result in an impact to our liquidity in future periods. In addition, $45 million of our future debt payments and related interest obligations will be made with debt service funds held in trust and included as long-term “Other assets” within our December 31, 2006 Consolidated Balance Sheet.
 
(d) Our unrecorded obligations represent operating lease obligations and purchase commitments from which we expect to realize an economic benefit in future periods. We have also made certain guarantees, as discussed in Note 10 to the Consolidated Financial Statements, that we do not expect to materially affect our current or future financial position, results of operations or liquidity.
 
(e) In December 2006, we entered into a plan under SEC Rule 10b5-1 to effect market purchases of our common stock. The $70 million disclosed here represents the minimum amount of common stock that could be repurchased under the terms of the plan. These common stock repurchases were made in accordance with our Board of Directors approved capital allocation program which authorizes up to $1.2 billion in share repurchases and dividends in 2007. We repurchased $72 million of our common stock pursuant to the plan, which was completed on February 9, 2007.
 
(f) Our unconditional purchase obligations are for various contractual obligations that we generally incur in the ordinary course of our business. Certain of our obligations are quantity driven. For these contracts, we have estimated our future obligations based on the current market values of the underlying products or services. See Note 10 to the Consolidated Financial Statements for discussion of the nature and terms of our unconditional purchase obligations.


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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.
 
Off-Balance Sheet Arrangements
 
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, 2006 nor are they expected to have a material impact on our future financial position, results of operations or liquidity.
 
Seasonal Trends and Inflation
 
Our operating revenues tend to be somewhat higher in the summer months, primarily due to the higher volume of construction and demolition waste. The volumes of industrial and residential waste in certain regions where we operate also tend to increase during the summer months. Our second and third quarter revenues and results of operations typically reflect these seasonal trends. Additionally, certain destructive weather conditions that tend to occur during the 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 electrical demand is 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, management’s estimates associated with inflation have had, and will continue to have, an impact on our accounting for landfill and environmental remediation liabilities.
 
New Accounting Pronouncements
 
FIN 48 — Accounting for Uncertainty in Income Taxes
 
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109) (“FIN 48”), which clarifies the relevant criteria and approach for the recognition, de-recognition and measurement of uncertain tax positions. FIN 48 will be effective for the Company beginning January 1, 2007. We do not expect the adoption of FIN 48 to have a material impact on our Consolidated Financial Statements.
 
SFAS No. 157 — Fair Value Measurements
 
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), 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 are currently in the process of assessing the provisions of SFAS No. 157 and determining how this framework for measuring fair value will affect our current accounting policies and procedures and our financial statements. We have not determined whether the adoption of SFAS No. 157 will have a material impact on our consolidated financial statements.
 
Item 7A.   Quantitative and Qualitative Disclosure About Market Risk.
 
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, 2006, all of our derivative transactions were related to


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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 $460 million at December 31, 2006 and $480 million at December 31, 2005. 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 $377 million and $460 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, 2006 and 2005, 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, a change in foreign currency rates would not significantly affect our fair value positions.
 
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. All derivative transactions are subject to our risk management policy, which governs the type of instruments that may be used. The fair value position of our commodity derivatives would decrease by approximately $5 million at December 31, 2006 and by approximately $10 million at December 31, 2005 if there were an instantaneous 10% increase across all commodities and applicable yield curves.
 
See Notes 3 and 7 to the Consolidated Financial Statements for further discussion of the use of and accounting for derivative instruments.


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Item 8.   Financial Statements and Supplementary Data.
 
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
 
         
    Page
 
    55  
    56  
    57  
    58  
    59  
    60  
    61  
    62  


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MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
 
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, 2006 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, 2006.
 
Ernst & Young LLP, an independent registered public accounting firm, has issued an attestation report on management’s assessment of internal control over financial reporting, which is included herein.


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
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, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s 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, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
 
As discussed in Note 2 to the consolidated financial statements, effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” and, effective March 31, 2004, the Company adopted the remaining portion of Financial Accounting Standard Board Interpretation No. 46(R), “Consolidation of Variable Interest Entities (revised December 2003) — an Interpretation of ARB No. 51.”
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, 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 14, 2007 expressed an unqualified opinion thereon.
 
ERNST & YOUNG LLP
 
Houston, Texas
February 14, 2007


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
 
The Board of Directors and Stockholders of Waste Management, Inc.
 
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Waste Management, Inc. maintained effective internal control over financial reporting as of December 31, 2006, 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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s 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, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, 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 company’s 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 company’s 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 company’s 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, management’s assessment that Waste Management, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Waste Management, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, 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 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2006 and our report dated February 14, 2007 expressed an unqualified opinion thereon.
 
ERNST & YOUNG LLP
 
Houston, Texas
February 14, 2007


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WASTE MANAGEMENT, INC.
 
(In millions, except share and par value amounts)
 
                 
    December 31,  
    2006     2005  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 614     $ 666  
Accounts receivable, net of allowance for doubtful accounts of $51 and $61, respectively
    1,650       1,757  
Other receivables
    208       247  
Parts and supplies
    101       99  
Deferred income taxes
    82       94  
Other assets
    527       588  
                 
Total current assets
    3,182       3,451  
Property and equipment, net of accumulated depreciation and amortization of $11,993 and $11,287, respectively
    11,179       11,221  
Goodwill
    5,292       5,364  
Other intangible assets, net
    121       150  
Other assets
    826       949  
                 
Total assets
  $ 20,600     $ 21,135  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 693     $ 719  
Accrued liabilities
    1,298       1,533  
Deferred revenues
    455       483  
Current portion of long-term debt
    822       522  
                 
Total current liabilities
    3,268       3,257  
Long-term debt, less current portion
    7,495       8,165  
Deferred income taxes
    1,365       1,364  
Landfill and environmental remediation liabilities
    1,234       1,180  
Other liabilities
    741       767  
                 
Total liabilities
    14,103       14,733  
                 
Minority interest in subsidiaries and variable interest entities
    275       281  
                 
Commitments and contingencies
               
Stockholders’ equity:
               
Common stock, $0.01 par value; 1,500,000,000 shares authorized; 630,282,461 shares issued
    6       6  
Additional paid-in capital
    4,513       4,486  
Retained earnings
    4,410       3,615  
Accumulated other comprehensive income
    129       126  
Restricted stock unearned compensation
          (2 )
Treasury stock at cost, 96,598,567 and 78,029,452 shares, respectively
    (2,836 )     (2,110 )
                 
Total stockholders’ equity
    6,222       6,121  
                 
Total liabilities and stockholders’ equity
  $ 20,600     $ 21,135  
                 
 
See notes to Consolidated Financial Statements.


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WASTE MANAGEMENT, INC.
 
(In millions, except per share amounts)
 
                         
    Years Ended December 31,  
    2006     2005     2004  
 
Operating revenues
  $ 13,363     $ 13,074     $ 12,516  
                         
Costs and expenses:
                       
Operating
    8,587       8,631       8,228  
Selling, general and administrative
    1,388       1,276       1,267  
Depreciation and amortization
    1,334       1,361       1,336  
Restructuring
          28       (1 )
(Income) expense from divestitures, asset impairments and unusual items
    25       68       (13 )
                         
      11,334       11,364       10,817  
                         
Income from operations
    2,029       1,710       1,699  
                         
Other income (expense):
                       
Interest expense
    (545 )     (496 )     (455 )
Interest income
    69       31       70  
Equity in net losses of unconsolidated entities
    (36 )     (107 )     (98 )
Minority interest
    (44 )     (48 )     (36 )
Other, net
    1       2       (2 )
                         
      (555 )     (618 )     (521 )
                         
Income before income taxes and cumulative effect of change in accounting principle
    1,474       1,092       1,178  
Provision for (benefit from) income taxes
    325       (90 )     247  
                         
Income before cumulative effect of change in accounting principle
    1,149       1,182       931  
Cumulative effect of change in accounting principle, net of income tax expense of $5
                8  
                         
Net income
  $ 1,149     $ 1,182     $ 939  
                         
Basic income per common share:
                       
Income before cumulative effect of change in accounting principle
  $ 2.13     $ 2.11     $ 1.62  
Cumulative effect of change in accounting principle
                0.01  
                         
Net income
  $ 2.13     $ 2.11     $ 1.63  
                         
Diluted income per common share:
                       
Income before cumulative effect of change in accounting principle
  $ 2.10     $ 2.09     $ 1.60  
Cumulative effect of change in accounting principle
                0.01  
                         
Net income
  $ 2.10     $ 2.09     $ 1.61  
                         
Cash dividends declared per common share (2005 includes $0.22 paid in 2006)
  $ 0.66     $ 1.02     $ 0.75  
                         
 
See notes to Consolidated Financial Statements.


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WASTE MANAGEMENT, INC.
 
(In millions)
 
                         
    Years Ended December 31,  
    2006     2005     2004  
 
Cash flows from operating activities:
                       
Net income
  $ 1,149     $ 1,182     $ 939  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Cumulative effect of change in accounting principle
                (8 )
Provision for bad debts
    43       50       48  
Depreciation and amortization
    1,334       1,361       1,336  
Deferred income tax provision
    (23 )     (61 )     156  
Minority interest
    44       48       36  
Equity in net losses of unconsolidated entities, net of distributions
    47       76       67  
Net gain on disposal of assets
    (15 )     (14 )     (24 )
Effect of (income) expense from divestitures, asset impairments and unusual items
    25       68       (13 )
Excess tax benefits associated with equity-based compensation
    (45 )            
Change in operating assets and liabilities, net of effects of acquisitions and divestitures:
                       
Receivables
    12       (102 )     (223 )
Other current assets
    (1 )     (27 )     (33 )
Other assets
    (9 )     (20 )     (23 )
Accounts payable and accrued liabilities
    (45 )     (187 )     (43 )
Deferred revenues and other liabilities
    24       17       3  
                         
Net cash provided by operating activities
    2,540       2,391       2,218  
                         
Cash flows from investing activities:
                       
Acquisitions of businesses, net of cash acquired
    (32 )     (142 )     (130 )
Capital expenditures
    (1,329 )     (1,180 )     (1,258 )
Proceeds from divestitures of businesses (net of cash divested) and other sales of assets
    240       194       96  
Purchases of short-term investments
    (3,001 )     (1,079 )     (1,348 )
Proceeds from sales of short-term investments
    3,123       784       1,319  
Net receipts from restricted trust and escrow accounts
    253       395       444  
Other
    (42 )     (34 )     (5 )
                         
Net cash used in investing activities
    (788 )     (1,062 )     (882 )
                         
Cash flows from financing activities:
                       
New borrowings
    432       365       415  
Debt repayments
    (932 )     (376 )     (801 )
Common stock repurchases
    (1,072 )     (706 )     (496 )
Cash dividends
    (476 )     (449 )     (432 )
Exercise of common stock options and warrants
    295       129       193  
Excess tax benefits associated with equity-based compensation
    45              
Minority interest distributions paid
    (22 )     (26 )     (25 )
Other
    (73 )     (27 )     16  
                         
Net cash used in financing activities
    (1,803 )     (1,090 )     (1,130 )
                         
Effect of exchange rate changes on cash and cash equivalents
    (1 )     3       1  
                         
Increase (decrease) in cash and cash equivalents
    (52 )     242       207  
Cash and cash equivalents at beginning of year
    666       424       217  
                         
Cash and cash equivalents at end of year
  $ 614     $ 666     $ 424  
                         
Supplemental cash flow information:
                       
Cash paid during the year for:
                       
Interest, net of capitalized interest and periodic settlements from interest rate swap agreements
  $ 548     $ 505     $ 479  
Income taxes
    475       233       136  
 
See notes to Consolidated Financial Statements.


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WASTE MANAGEMENT, INC.
 
(In millions, except shares in thousands)
 
                                                                         
                            Accumulated
                         
                            Other
    Restricted
                   
                Additional
          Comprehensive
    Stock
                   
    Common Stock     Paid-In
    Retained
    Income
    Unearned
    Treasury Stock     Comprehensive
 
    Shares     Amounts     Capital     Earnings     (Loss)     Compensation     Shares     Amounts     Income  
 
Balance, December 31, 2003
    630,282     $ 6     $ 4,501     $ 2,497     $ (14 )   $       (54,164 )   $ (1,388 )        
Net income
                      939                             $ 939  
Cash dividends declared
                      (432 )                              
Equity-based compensation transactions, net of taxes
                (18 )                 (4 )     10,060       260        
Common stock repurchases
                                        (16,541 )     (472 )      
Unrealized loss resulting from changes in fair values of derivative instruments, net of taxes of $11
                            (17 )                       (17 )
Realized losses on derivative instruments reclassified into earnings, net of taxes of $6
                            10                         10  
Unrealized gain on marketable securities, net of taxes of $2
                            2                         2  
Translation adjustment of foreign currency statements
                            88                         88  
Other
                (2 )                       575       15        
                                                                         
Balance, December 31, 2004
    630,282     $ 6     $ 4,481     $ 3,004     $ 69     $ (4 )     (60,070 )   $ (1,585 )   $ 1,022  
                                                                         
Net income
                      1,182                             $ 1,182  
Cash dividends declared
                      (571 )                              
Equity-based compensation transactions, net of taxes
                6                   2       6,573       176        
Common stock repurchases
                                        (24,727 )     (706 )      
Unrealized gain resulting from changes in fair values of derivative instruments, net of taxes of $11
                            16                         16  
Realized losses on derivative instruments reclassified into earnings, net of taxes of $4
                            6                         6  
Unrealized gain on marketable securities, net of taxes of $1
                            2                         2  
Translation adjustment of foreign currency statements
                            33                         33  
Other
                (1 )                       195       5        
                                                                         
Balance, December 31, 2005
    630,282     $ 6     $ 4,486     $ 3,615     $ 126     $ (2 )     (78,029 )   $ (2,110 )   $ 1,239  
                                                                         
Net income
                      1,149                             $ 1,149  
Cash dividends declared
                      (355 )                              
Cash dividends adjustment
                      1                                
Equity-based compensation transactions, net of taxes
                24                   2       11,483       321        
Common stock repurchases
                                        (30,965 )     (1,073 )      
Unrealized loss resulting from changes in fair values of derivative instruments, net of taxes of $7
                            (11 )                       (11 )
Realized losses on derivative instruments reclassified into earnings, net of taxes of $3
                            5                         5  
Unrealized gain on marketable securities, net of taxes of $3
                            5                         5  
Translation adjustment of foreign currency statements
                            3                         3  
Underfunded post-retirement benefit obligations, net of taxes of $3
                            1                         1  
Other
                3                         912       26        
                                                                         
Balance, December 31, 2006
    630,282     $ 6     $ 4,513     $ 4,410     $ 129     $       (96,599 )   $ (2,836 )   $ 1,152  
                                                                         
 
See notes to Consolidated Financial Statements.


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WASTE MANAGEMENT, INC.
 
Years Ended December 31, 2006, 2005 and 2004
 
1.   Business
 
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 (See Note 19). Waste Management, Inc. is a holding company and all operations are conducted by subsidiaries. When the terms “the Company,” “we,” “us” or “our” are used in this document, those terms refer to Waste Management, Inc., its consolidated subsidiaries and consolidated variable interest entities. When we use the term “WMI,” we are referring only to the parent holding company.
 
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.
 
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 Recycling Group. We also provide additional waste management services that are not managed through our six Groups, which are presented in this report as “Other.” Refer to Note 20 for additional information related to our operating segments.
 
2.   Accounting Changes and Reclassifications
 
Accounting Changes
 
SFAS No. 123(R) — Share-Based Payment
 
On January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”), 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 (“SFAS No. 123”) for all unvested awards outstanding at the date of adoption. Under this transition method, the results of operations of prior periods have not been restated. Accordingly, we will continue to provide pro forma financial information for periods prior to January 1, 2006 to illustrate the effect on net income and earnings per share of applying the fair value recognition provisions of SFAS No. 123.
 
Through December 31, 2005, as permitted by SFAS No. 123, we accounted for equity-based compensation in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, as amended (“APB No. 25”). Under APB No. 25, we recognized compensation expense based on an award’s intrinsic value. For stock options, which were the primary form of equity-based awards we granted through December 31, 2004, this meant we recognized no compensation expense in connection with the grants, as the exercise price of the options was equal to the fair market value of our common stock on the date of grant and all other provisions were fixed. As discussed below, beginning in 2005, restricted stock units and performance share units became the primary form of equity-based compensation awarded under our long-term incentive plans. For restricted stock units, intrinsic value is equal to the market value of our common stock on the date of grant. For performance share units, APB No. 25 required “variable accounting,” which resulted in the recognition of compensation expense based on the intrinsic value of each award at the end of each reporting period until such time that the number of shares to be issued and all other provisions are fixed.


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WASTE MANAGEMENT, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The most significant difference between the fair value approaches prescribed by SFAS No. 123 and SFAS No. 123(R) and the intrinsic value method prescribed by APB No. 25 relates to the recognition of compensation expense for stock option awards based on their grant date fair value. Under SFAS No. 123, we estimated the fair value of stock option grants using the Black-Scholes-Merton option-pricing model. The following table reflects the pro forma impact on net income and earnings per common share for the years ended December 31, 2005 and 2004 of accounting for our equity-based compensation using SFAS No. 123 (in millions, except per share amounts):
 
                 
    Years Ended December 31,  
    2005     2004  
 
Reported net income
  $ 1,182     $ 939  
Add: Equity-based compensation expense included in reported net income, net of tax benefit
    12       2  
Less: Total equity-based compensation expense per SFAS No. 123, net of tax benefit
    (99 )     (59 )
                 
Pro forma net income
  $ 1,095     $ 882  
                 
Basic earnings per common share:
               
Reported net income
  $ 2.11     $ 1.63  
Add: Equity-based compensation expense included in reported net income, net of tax benefit
    0.02        
Less: Total equity-based compensation expense per SFAS No. 123, net of tax benefit
    (0.17 )     (0.10 )
                 
Pro forma net income
  $ 1.96     $ 1.53  
                 
Diluted earnings per common share:
               
Reported net income
  $ 2.09     $ 1.61  
Add: Equity-based compensation expense included in reported net income, net of tax benefit
    0.02        
Less: Total equity-based compensation expense per SFAS No. 123, net of tax benefit
    (0.17 )     (0.10 )
                 
Pro forma net income
  $ 1.94     $ 1.51  
                 
Weighted average fair value per share of stock options granted
  $ 6.26     $ 7.23  
                 
 
In December 2005, the Management Development and Compensation Committee of our Board of Directors approved the acceleration of the vesting of all unvested stock options awarded under our stock incentive plans, effective December 28, 2005. The decision to accelerate the vesting of outstanding stock options was made primarily to reduce the non-cash compensation expense that we would have otherwise recorded in future periods as a result of adopting SFAS No. 123(R). We estimated that the acceleration eliminated approximately $55 million of cumulative pre-tax compensation charges that would have been recognized during 2006, 2007 and 2008 as the stock options would have continued to vest. We recognized a $2 million pre-tax charge to compensation expense during the fourth quarter of 2005 as a result of the acceleration, but do not expect to recognize future compensation expense for the accelerated options under SFAS No. 123(R). Total equity-based compensation expense per SFAS No. 123, net of tax benefit as presented in the table above, includes a pro forma charge of $41 million, net of tax benefit, for the December 2005 accelerated vesting of outstanding stock options.
 
Additionally, as a result of changes in accounting required by SFAS No. 123(R) and a desire to design our long-term incentive plans in a manner that creates a stronger link to operating and market performance, the Management


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WASTE MANAGEMENT, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Development and Compensation Committee approved a substantial change in the form of awards that we grant. Beginning in 2005, annual stock option grants were replaced with either (i) grants of restricted stock units and performance share units or (ii) an enhanced cash compensation award. Stock option grants in connection with new hires and promotions were replaced with grants of restricted stock units. The terms of restricted stock units and performance share units granted during 2006 are summarized in Note 15.
 
As a result of the acceleration of the vesting of stock options and the replacement of future awards of stock options with other forms of equity awards, the adoption of SFAS No. 123(R) on January 1, 2006 did not significantly affect our accounting for equity-based compensation or our net income for the year ended December 31, 2006. We do not currently expect this change in accounting to significantly impact our future results of operations. However, we do expect equity-based compensation expense to increase over the next three years because of the incremental expense that will be recognized each year as additional awards are granted.
 
Prior to the adoption of SFAS No. 123(R), we included all tax benefits associated with equity-based compensation as operating cash flows in the Statement of Cash Flows. SFAS No.