WASTE MANAGEMENT INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

OR

[ ] 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 (I.R.S. employer
incorporation or organization) identification no.)

1001 FANNIN STREET, SUITE 4000 77002
HOUSTON, TEXAS (Zip code)
(Address of principal executive offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 512-6200

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
5.75% CONVERTIBLE SUBORDINATED NOTES DUE 2005

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 [X] No [ ]
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. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant at March 8, 2002, was approximately $17,126,272,242. 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, $.01 par value, of the registrant
outstanding at March 8, 2002, was 628,690,931 (excluding treasury shares of
1,640,661).

DOCUMENTS INCORPORATED BY REFERENCE

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TABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

GENERAL

Waste Management, Inc. is its industry's leading provider of integrated
waste services in North America. Through our subsidiaries, we provide
collection, transfer, recycling and resource recovery, and disposal services. We
are also a leading developer, operator and owner of waste-to-energy facilities
in the United States. Our customers include commercial, industrial, municipal
and residential customers, other waste management companies, governmental
entities and independent power markets. During 2001, none of our customers
accounted for more than 5% of our operating revenue. We employed approximately
57,000 people as of December 31, 2001.

The Company was incorporated in Oklahoma in 1987 under the name "USA Waste
Services, Inc." and was reincorporated as a Delaware company in 1995. In 1998,
we merged with Waste Management, Inc., who became our 100% owned subsidiary and
whose name we changed to Waste Management Holdings, Inc., or "WM Holdings" (the
"WM Holdings Merger"). At the same time, we changed our name to Waste
Management, Inc. When the terms "Waste Management," "WMI," the "Company," or
"we" are used in this document, those terms are being used to refer to Waste
Management, Inc., its subsidiaries, affiliates and predecessors, unless the
context requires otherwise. The Company's 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 stock is traded on the NYSE under the symbol "WMI."

In the past, our primary growth strategy was to purchase revenue through
acquisitions. In 1999, the Company announced a strategic plan focused on
emphasizing internal growth and focusing on our core business -- North American
solid waste ("NASW") services. As part of the plan, beginning in 1999 and
throughout 2000 and 2001, we divested all of our waste management operations
outside of North America. Our operations outside of North America consisted of
the collection and transportation of solid, hazardous and medical wastes and
recyclable materials and the treatment and disposal of recyclable materials.
Also included were the operation of solid and hazardous waste landfills,
municipal and hazardous waste incinerators, water and waste-water treatment
facilities, hazardous waste treatment facilities, waste-fuel powered independent
power facilities, and the construction of treatment or disposal facilities for
third parties.

The Company divested most of its non-solid waste operations in 2000, which
included all hazardous, low-level and other radioactive waste management and
other non-NASW services (except for hazardous waste landfills, which are
included in NASW operations). Our hazardous waste management services included
the collection, transfer and treatment of hazardous waste. Our low-level and
other radioactive waste services generally consisted of disposal, processing and
various other special services related to these types of waste. Additionally, we
provided hazardous, radioactive and mixed waste program and facilities
management services. Included in our remaining non-solid waste operations are
our independent power production plants ("IPPs"), which include the operation
and, in some cases, the ownership of IPPs that either cogenerate electricity and
thermal energy or generate electricity alone for sale to customers, including
public utilities and industrial customers. In 2000, we classified our IPPs as
held-for-sale operations. However, in the third quarter of 2001, we re-evaluated
our business alternatives and decided to hold and operate all but one of the
IPPs. As such, we reclassified all but one of our IPPs in the third quarter of
2001 from held-for-sale to held-for-use.

Also included in our remaining non-solid waste operations at year-end were
our geosynthetic manufacturing and installation services. These operations
generally consisted of fabricating and installing landfill liners. These
operations, which were marketed for sale in 2001 and which were classified as
held-for-sale operations in the Company's consolidated financial statements
included in this report, were sold in the first quarter of 2002, as described in
Note 25, "Subsequent Events," to the consolidated financial statements.

1

STRATEGY

As we have completed our divestitures, we have refocused on operational
excellence, which we seek to achieve by concentrating on (i) providing excellent
customer service, (ii) improving operational efficiencies, (iii) increasing cash
flow and (iv) generating higher profit margins. To that end, we established the
following company-wide initiatives for 2001:

- converting our existing financial systems to PeopleSoft enterprise
financial systems;

- implementing a procurement strategy to leverage our substantial buying
power;

- conducting in-depth studies of each metropolitan statistical area in
which we own and operate assets to determine the dynamics of different
markets, the way we serve those markets and the most profitable way to
operate in those markets; and

- implementing a strategy to improve customer focus and the way we service
our customers.

These initiatives have developed into our new business strategy. This
strategy, which includes aspects of the already-in-progress initiatives and
additional initiatives to complement our previous plans, is designed to
emphasize internal growth and enable us to meet our continuing objective of
operational excellence. The key points to our strategy include:

- Local Market Business Integration -- We are creating integrated local
business strategies for all of our lines of operations, including
collection, disposal (including waste-to-energy plants), transfer and
recycling, with the goal of improving the utilization of our asset base;

- Service Excellence -- We are designing and implementing new procedures to
better meet our customers' requirements;

- Procurement -- We are implementing a procurement and sourcing process
that will leverage the Company's size and total purchasing ability to
realize savings and discounts through consolidation and reduction of the
number of suppliers we use;

- Information Technology -- We are continuing to improve system processes
and capabilities needed to transition the entire Company to our business
model of operational excellence;

- People Performance Management -- We are aligning our incentive
compensation with our strategies and guiding changes in our corporate
culture;

- Safety, Ethics and Compliance -- We are committed to providing a safe
workplace for all employees and are creating a compliance culture in
which abidance with laws and regulations and focus on integrity are the
key factors;

- Price/Revenue Management -- We are improving our pricing analysis
capabilities, and developing and implementing new revenue management
systems;

- Sales Force Effectiveness -- We are providing tools, leadership and
incentives throughout the Company that are designed to enable our sales
force to improve its effectiveness and increase revenue; and

- Financing -- We are utilizing a significant portion of the Company's free
cash flow to repurchase common stock as a means of enhancing shareholder
value.

To support our business strategy, we recently announced our plan to adopt a
new organizational structure. The new structure, which is discussed in Note 25,
"Subsequent Events," to the consolidated financial statements, is designed to
make us more market-based and customer driven, thereby aligning our
organizational structure with our strategy.

2

OPERATIONS

GENERAL

The table below shows for each of the three years in the three-year period
ended December 31, 2001 the total revenues (in millions) contributed by our
principal lines of business. More information about our results of operations is
included in Note 16 to the consolidated financial statements.

NORTH AMERICAN SOLID WASTE

We manage our NASW operations through six operating areas, all of which
have similar operating economies. These six areas are comprised of four areas
organized by geographic territories in the United States, plus our wholly-owned
subsidiaries, Wheelabrator Technologies Inc. (referred to, together with its
subsidiaries, as "WTI"), which overlaps certain of the U.S. areas, and Canadian
Waste Services Inc., which provides services throughout most provinces in
Canada. Each of the areas generally encompasses several states or provinces and
has a member of senior management responsible for all operational aspects of
such area. We have further divided the geographic areas into regions that
include several economic market places. The regions' vice presidents oversee the
districts, or the basic operating locations within each area, whose manager is
directly responsible for day-to-day operations. The NASW services provided by
these areas include collection, disposal (solid waste landfills, hazardous waste
landfills and waste-to-energy facilities), transfer, recycling and other
services in the United States and Canada.

Collection. Collection involves picking up and transporting waste from
where it was generated to a transfer station or disposal site. Depending on the
type of customer being served, we generally provide collection services under
one of two types of arrangements:

- For commercial and industrial collection services, there is generally a
one to three-year service agreement. The fees under the agreements are
determined by factors such as collection frequency, type of collection
equipment furnished by the Company, type and volume or weight of the
waste collected, the distance to the disposal facility, labor cost and
cost of disposal. As part of the service, we provide steel containers to
most of the commercial and industrial customers to store their solid
waste. The containers range in size from one to 50 cubic yards and 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, there is a contract with, or
franchise granted by, a municipality or regional authority that has
granted the Company the exclusive right to service all or a portion of
the homes in that area. These contracts or franchises are typically for
one to five years, but can sometimes be longer. The fees for residential
collection are either paid by the authorities from their tax revenues or
service charges, or are paid directly by the residents receiving the
service.

3

Disposal. Landfills are the main depository for solid waste in North
America. Solid waste landfills are located on land with geological and
hydrological properties that limit the possibility of water pollution, and are
operated under prescribed procedures. Currently, solid waste landfills in the
United States must be designed, permitted, operated, closed and maintained after
closure in compliance with federal, state and local regulations pursuant to
Subtitle D of the Resource Conservation and Recovery Act of 1976, as amended
("RCRA"). The operation of a solid waste landfill includes excavation,
construction of liners and final caps, continuous spreading and compacting of
waste, and covering of waste with earth or other inert material at least once a
day. These operations are carefully planned to maintain sanitary conditions and
to ensure the best possible use of the airspace and prepare the site so it can
ultimately be used for other purposes.

Access to a disposal facility, such as a solid waste landfill, is a
necessity for all solid waste management companies. While access can be obtained
to disposal facilities owned or operated by unaffiliated third parties, we
believe it is usually preferable for our collection operations to use disposal
facilities that we own or operate. That way, the Company achieves greater
internalization by paying itself instead of a third party, thus achieving higher
consolidated margins. The fees charged at disposal facilities, which are known
as "tipping fees," are based on market factors and the type and weight or volume
of solid waste deposited and the type and size of the vehicles used in the
transportation of the waste.

We also operate five secure hazardous waste landfills in the United States.
Under RCRA, all hazardous waste landfills must be permitted by the federal
government, and all of ours have obtained such permits. These landfills must
also comply with certain operating standards, and our hazardous waste landfills
have received the permits and approvals needed to accept hazardous waste,
although some of them can only accept certain kinds of hazardous waste. Only
hazardous waste in a stable, solid form, which meets applicable regulatory
requirements can be deposited in our secure disposal cells. Our hazardous waste
landfills are sited, constructed and operated in a manner designed to provide
long-term containment of the waste.

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 involve the transformation of wastes into
inert materials that are no longer hazardous. The Company operates a hazardous
waste facility at which it isolates 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 297 solid waste and five hazardous landfills at
December 31, 2001. Based on remaining permitted capacity as of December 31, 2001
and projected annual disposal volumes, the average remaining landfill life for
these landfills is approximately 21 years. Many of our existing landfills have
the potential for expanded disposal capacity beyond what is currently permitted.
We monitor the availability of permitted disposal capacity at each of our
landfills and evaluate whether to pursue an expansion at a given landfill based
on estimated future waste volumes and prices, remaining capacity and likelihood
of obtaining an expansion. We are currently seeking to expand permitted capacity
at 105 of our landfills for which we consider these expansions to be probable.
Although no assurances can be made that all future expansions will be permitted
as designed, the average remaining landfill life for all landfills is
approximately 31 years when considering remaining permitted capacity, probable
expansion capacity and projected annual disposal volume. For the Company's
operating landfills as of December 31, 2001, the expected remaining airspace
capacity in cubic yards and tonnage of waste that can be accepted at the
landfill is shown below (in millions):

4

The following table reflects landfill capacity and airspace changes, as
measured in tons, for landfills operated during the year ended December 31, 2001
(in millions):

The estimated operating lives, based on remaining permitted and probable
expansion capacity and projected annual disposal volume, in years, as of
December 31, 2001, is as follows:

Through WTI, we also own, or operate through agreements, 16 waste-to-energy
facilities, which, in addition to landfills, are facilities that accept solid
waste for disposal. Our waste-to-energy facilities are capable of processing up
to 23,600 tons of solid waste each day. The solid waste is burned at these
facilities, producing heat that is converted into high-pressure steam. We use
that steam to generate electricity for sales to public utility and industrial
companies under long-term contracts. Our waste-to-energy facilities can generate
up to 635 megawatts ("mW") of electricity per hour, enough to power
approximately 555,000 homes.

The tonnage volume that we received in 2001 at all of our disposal
facilities is shown below (in thousands):

Transfer Stations. A transfer station is a facility located near
residential and commercial collection routes where collection trucks take the
solid waste that has been collected. The solid waste is then transferred via
transfer trucks or rail to disposal sites. Fees at transfer stations are usually
based on the type and volume or weight of the waste transferred and the distance
to the disposal site. At December 31, 2001, we operated approximately 300
transfer stations in North America. There are two main reasons for using
transfer stations:

- Their use reduces the costs associated with transporting waste to final
disposal sites. This cost reduction is due to the fact that the trucks,
railcars or rail containers that we use for transfer have a larger
capacity than the collection trucks, again allowing more waste to be
transported to the disposal facility in each trip. The consolidation of
the waste also increases the efficient use of our collection personnel
and equipment since they are not making trips to the disposal sites and
instead are focusing on collection.

- The use of transfer stations also improves internalization by allowing us
to pay ourselves, rather than a third party, the fees charged to dispose
of waste we picked up. A greater percentage of the waste we collect can
be disposed of at one of our own disposal sites, rather than having to
use a closer disposal

5

site owned by a third party when our transfer station is used, because the
waste coming into one of our transfer stations will usually be taken to
one of our own disposal facilities. As the transfer vehicles can transport
waste longer distances more efficiently than the collection vehicles, we
are able to internalize more waste.

Recycling. The Company provides recycling services in the United States
and Canada through its Recycle America(R), Recycle Canada(R) and other
complementary programs. Recycling involves the removal of reusable materials
from the waste stream for processing and resale or other disposition for use in
various applications. Our commercial and industrial operations include
collection, including customized collection programs, data destruction,
shredding, automated sorting and construction and demolition processing. We use
state-of-the-art technology for sorting and processing glass to remove
contaminants and color separate the glass, which increases material recovery and
delivers higher quality recovered materials to manufacturers. We also provide
complete management marketing programs for processing, inventory and sale of
recovered plastic and rubber. In recent years, our recycling operations have
also focused on the recovery of electronic scrap, instituting programs for the
collection and recycling of electronic materials.

As part of our residential solid waste collection services, we also engage
in curbside collection of recyclable materials from residences in the United
States and Canada. Curbside recycling services generally involve the collection
of recyclable paper, glass, plastic and metal waste materials, which may be
separated by residents into different waste containers or disposed of together,
all as recyclable materials. Recyclable materials are deposited by one of our
collection trucks, or by residents themselves, at a local materials recovery
facility ("MRF") for weighing, processing and marketing. We operate over 190
MRFs, where paper, glass, metals, plastics and compost are recovered for resale,
and 18 secondary processing facilities where materials received from MRFs are
processed into raw products used in the manufacturing of consumer goods. Our
recycling operations include the marketing and reselling of recyclable materials
on behalf of our own facilities as well as for third parties.

Fees for recycling services are determined by such considerations as market
factors, frequency of collection, type and volume or weight of the recyclable
material, degree of processing required, distance the recyclable material must
be transported and the market value of the recovered material.

Other NASW. As part of our other NASW operations, we operate methane gas
recovery projects at 69 of our owned or operated solid waste landfill
facilities. These operations involve the installation of a gas collection system
into a solid waste landfill. Through the gas collection system, methane gas
generated by decomposing solid waste is collected and transported to a
gas-processing facility at the landfill site. Through physical and chemical
processes, methane gas is separated from contaminants. At 37 of our facilities,
the processed methane gas is sold to an affiliate of the Company, which uses it
as a fuel to power electricity generators. The generated electricity is then
sold, usually to public utilities or industrial customers under long-term sales
contracts, often under terms or conditions which are subject to approval by
regulatory authorities. At the remaining 32 landfills, the methane gas is sold
directly to industrial customers who use it as an alternative to fossil fuel in
industrial processes such as steam boilers, cement kilns and utility plants.

In addition, as part of our other NASW operations, we rent and service
portable restroom facilities to municipalities and commercial customers under
the name Port-o-let(R), and provide street and parking lot sweeping services.

We also provide in-plant services, in which we outsource our employees to
provide full service waste management to customers at their plants. Our
vertically integrated waste management operations allow us to provide these
customers with full management of their waste, including choosing the right
sized containers, finding recycling opportunities, minimizing their waste, and
transporting and disposing of their waste.

6

OTHER

The Company's "Other" business segment consists of its non-solid waste
operations, including a geosynthetic manufacturing and installation service,
which generally involves the making and installing of landfill liners. This
business was marketed for sale in 2001 and has been classified as held-for-sale
operations in the consolidated financial statements included in this report. The
business was sold in the first quarter of 2002 as described in Note 25 to the
consolidated financial statements.

Also included in Other are the Company's IPPs, which convert various waste
fuels into electricity. The IPPs combust wood waste, anthracite culm, tires,
landfill gas and natural gas. The wood waste facilities combust the waste
products of the forest products industry, waste from agricultural operations,
and are integral to the solid waste industry, disposing of urban wood, waste
tires and railroad ties/utility poles. The anthracite culm project uses the ash
from old mine waste piles and reclaims the unusable land beneath. In addition to
electricity production, the IPPs also produce steam, which is sold to a state
hospital, a prison, sawmills, a particleboard plant and a pulp/paper complex.
The IPPs produce a total of 248 mW of electricity per hour, enough to power
approximately 225,000 homes.

In addition, the Company has a derivative trading operation that is just
getting started. The primary purpose of this operation is to hedge our exposure
to price fluctuations in the pulp and paper commodity markets.

COMPETITION

The solid waste industry is very competitive. The competition is from a
number of publicly-held companies, locally-owned private solid waste services
companies, and large commercial and industrial companies handling their own
waste collection or disposal operations. We also have competition from
municipalities and other regional government authorities with respect to
residential and commercial solid waste collection and solid waste landfills. The
municipalities and other regional governmental authorities can sometimes offer
lower direct charges to the customer for the same service by subsidizing the
cost of services through the use of tax revenues and tax-exempt financing.

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, type of waste collected,
treatment requirements, risks involved in the handling or disposing of waste,
frequency of collections, distance to final disposal sites, labor costs and
amount and type of equipment furnished to the customer. We face intense
competition for both quality of service and pricing considerations. From time to
time, competitors may reduce the price of their services and accept lower profit
margins in an effort to expand or maintain market share or to successfully
obtain competitively bid contracts.

EMPLOYEES

At December 31, 2001, the Company had approximately 57,000 full-time
employees, of which approximately 8,000 were employed in clerical,
administrative, and sales positions; approximately 6,000 in management; and the
balance in collection, disposal, transfer station and other operations.
Approximately 14,000 of our employees are covered by collective bargaining
agreements. The Company has not experienced a significant work stoppage, and
management considers its employee relations to be good.

INSURANCE AND FINANCIAL ASSURANCE OBLIGATIONS

We carry a broad range of insurance coverages, including general liability,
automobile liability, real and personal property, workers' compensation,
directors' and officers' liability, pollution legal liability, and other
coverages we believe are customary to the industry. Except as may be discussed
in Note 20 to the consolidated financial statements included in this report, we
do not expect the impact of any known casualty, property, environmental
insurance or other contingency to be material to our financial condition,
results of operations or cash flows.

7

Through December 31, 2001, we have not experienced any difficulty in
obtaining insurance. However, the tragic events of September 11th have had an
impact upon the financial status of a number of insurance, surety and
reinsurance providers, which could in turn cause an increase in the cost and a
decrease in the availability of surety and insurance coverages available to us
in the future. If we were unable to obtain adequate insurance in the future,
obtained insurance from a company that was ultimately unable to satisfy its
commitments, or decided to operate without insurance, any partially or
completely uninsured claim against us, if successful and of sufficient
magnitude, could have a material adverse effect upon our financial condition,
results of operations or cash flows. Additionally, our continued access to
casualty and pollution legal liability insurance with sufficient limits at
acceptable terms is an important aspect of obtaining revenue-producing waste
service contracts.

For the 14 months ended January 1, 2000, the Company insured certain risks,
including auto, general and workers' compensation, with Reliance National
Insurance Company ("Reliance"). On June 11, 2001, the ultimate parent of
Reliance, Reliance Group Holdings, Inc., filed for bankruptcy under Chapter 11
of the United State Bankruptcy Code of 1978 as amended (the "Bankruptcy Code").
On October 3, 2001, Reliance was placed in liquidation by a Pennsylvania court.
We have determined that we will have coverage through various state insurance
guarantee funds in some, but not all, of the jurisdictions where we are subject
to claims that would have been covered by the Reliance insurance program. While
it is not possible to predict the outcome of proceedings involving Reliance, we
believe that because of the various insurance guarantee funds and potential
recoveries from the liquidation, it is unlikely that events relating to Reliance
will have a material adverse impact on our financial statements. However, we
believe that the ultimate resolution of claims that would have been covered by
Reliance may take several years.

Municipal and governmental waste management contracts typically require
performance bonds or bank letters of credit to secure performance. We are also
required to provide financial assurance for the final closure and post-closure
obligations with respect to our landfills. We establish financial assurance in
different ways, depending on the jurisdiction, including escrow-type accounts
funded by revenues during the operational life of a facility, letters of credit
from third parties, surety bonds, trust agreements and traditional insurance. We
also use captive insurance, or insurance policies issued by a wholly-owned
insurance company subsidiary, National Guaranty Insurance Company ("NGIC"), the
sole business of which is to issue such policies to the Company in order to
secure such obligations. NGIC is authorized to write up to $901 million in
insurance policies or surety bonds for our final closure and post-closure
requirements. In those instances where the use of captive insurance is not
acceptable, we have available alternative bonding mechanisms.

As of December 31, 2001, we had provided letters of credit of approximately
$1.6 billion (approximately $1.5 billion of which are issued under our $1.75
billion syndicated revolving credit facility), surety bonds of approximately
$2.7 billion, trust agreements of approximately $71 million, financial
guarantees of approximately $63 million and insurance policies of approximately
$830 million (including $798 million written by NGIC) to municipalities,
customers and regulatory authorities supporting tax-exempt bonds, performance of
landfill final closure and post-closure requirements, insurance contracts,
municipal contracts and financial guarantee obligations. To date, we have not
experienced unusual difficulty in obtaining financial assurance for our
operations. However, continued availability of letters of credit, surety bonds
and insurance policies in sufficient amounts at acceptable rates is a vital
aspect of our ongoing operations. Financial assurance is generally a requirement
for obtaining additional tax-exempt financing and municipal collection
contracts, and for obtaining or retaining disposal site or transfer station
operating permits.

REGULATION

Our business is subject to extensive and evolving federal, state, local and
foreign 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 other agencies
outside of the United States. Many of these agencies regularly examine our
operations to monitor compliance with these laws and regulations. Governmental
authorities have the power to enforce compliance with these laws and regulations
and to obtain injunctions or impose civil or criminal penalties in case of
violations.

8

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 are related, either directly or indirectly, to
environmental protection measures, including compliance with federal, state and
local provisions that have been enacted or adopted regulating the discharge of
materials into the environment. There are costs associated with siting, design,
operations, monitoring, site maintenance, corrective actions, financial
assurance, and facility closure and post-closure obligations. In connection with
our acquisition, development or expansion of a disposal facility or transfer
station, we must often spend considerable time, effort and money to obtain or
maintain necessary required permits and approvals. There cannot be any
assurances that we will be able to obtain or maintain necessary governmental
approvals. Once obtained, operating permits are subject to modification and
revocation by the issuing agency. Compliance with these and any future
regulatory requirements could require the Company 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:

- RCRA regulates the handling, transportation and disposal 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. From time to time, we may incur costs in complying with
these standards in the ordinary course of its operations. However, all of
our planned landfill developments and expansions will be engineered to
meet or exceed applicable Subtitle D requirements and we do not believe
that such costs would have a material adverse effect on our operations.

- The Comprehensive Environmental Response, Compensation and Liability Act
of 1980, as amended, which is also known as Superfund ("CERCLA"),
provides for federal authority to respond directly to releases or
threatened releases of hazardous substances into the environment.
CERCLA's primary means for avoiding such releases is to impose liability
for cleanup of disposal sites on current owners and operators, the owners
and operators at the time of disposal as well as the generators of the
waste and the transporters who select the disposal site. Liability under
CERCLA is not dependent on the intentional disposal of hazardous wastes.
It can be based upon the release or threatened release even as a result
of lawful, unintentional and non-negligent action, of any one of the more
than 700 "hazardous substances" listed by the EPA, even in very small
quantities.

- The Federal Water Pollution Control Act of 1972 (the "Clean Water Act"),
establishes rules for regulating 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 rules
under the Clean Water Act, which establish standards for management of
storm water runoff from landfills and which 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, if development of a landfill may alter or
affect "wetlands," a permit may have to be obtained before such
development could commence, affecting the construction or expansion of
many landfill sites. The Clean Water Act provides for civil, criminal and
administrative penalties for violations of its provisions.

- The Clean Air Act of 1970, as amended (the "Clean Air Act"), provides for
increased federal, state and local regulation of the emission of air
pollutants. The EPA has applied the Clean Air Act to certain of our
operations, including solid waste landfills and waste collection
vehicles. Additionally, in 1996, the EPA issued new source performance
standards for new landfills and emission guidelines for existing
landfills to control emissions of landfill gases. The regulations impose
limits on air emissions from solid

9

waste landfills, subject most of our solid waste landfills to certain
permitting requirements and, in some instances, require installation of
methane gas recovery systems to reduce emissions to allowable limits. The
Company already operates methane gas recovery systems at 69 of its solid
waste landfills. The Company does not believe that continued costs of
compliance with Clean Air Act permitting and emission control
requirements will have a material adverse effect on the Company.

- The Occupational Safety and Health Act of 1970, as amended ("OSHA"),
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, and various record keeping, disclosures 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.

There are also various state and local regulations that affect our
operations. Generally, states have their own laws and regulations that are
sometimes more strict than comparable federal laws and regulations governing
solid waste disposal, water and air pollution, releases and cleanup of hazardous
substances and liability for such matters. Additionally, our collection and
landfill operations could be affected by the trend toward requiring the
development of waste reduction and recycling programs. Legislative and
regulatory measures to either require or encourage waste reduction at the source
and waste recycling have also been considered by the United States Congress and
the EPA.

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 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 the Company's
solid waste management services.

Many states 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 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.

FACTORS INFLUENCING FUTURE RESULTS AND ACCURACY OF FORWARD-LOOKING STATEMENTS

When we make statements containing projections about our accounting and
finances, about our plans and objectives for the future, about our future
economic performance or containing any other projections or estimates about our
assumptions relating to these types of statements, we are making forward-looking
statements. These statements usually relate to future events and anticipated
revenues, earnings or other aspects of our operations or operating results. We
make these statements in an effort to keep stockholders and the public informed
about our business, and have based them on our current expectations about future
events. You should view such statements with caution. These statements are not
guarantees of future performance or events. All phases of our business are
subject to uncertainties, risks and other influences, many of which the Company
has no control over. Any of these factors, either alone or taken together, could
have a material

10

adverse effect on the Company and could change whether any forward-looking
statement ultimately turns out to be true. Additionally, the Company assumes no
obligation to update any forward-looking statements as a result of future events
or developments.

Outlined below are some of the risks that the Company faces and that could
affect our business and financial statements for 2002 and beyond. However, they
are not the only risks that the Company faces. There may be additional risks
that we do not presently know of or that we currently believe are immaterial
which could also impair our business.

WE COULD BE LIABLE FOR ENVIRONMENTAL DAMAGES RESULTING FROM OUR OPERATIONS

We could be liable if our operations cause environmental damage to our
properties or to nearby landowners, particularly as a result of the
contamination of drinking water sources 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, 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 or violations, or to revoke or deny renewal of a
permit we need, and

- citizen groups, adjacent landowners or governmental agencies oppose the
issuance, renewal or expansion of a permit or approval we need, allege
violations of the permits or approval under which we operate or laws or
regulations to which we are subject, or seek to impose liability on us
for environmental damage.

The adverse outcome of one or more of these proceedings could have a
material adverse effect on our financial condition, results of operations and
cash flows.

From time-to-time we have received citations or notices from governmental
authorities alleging that our operations are not in compliance with our permits
or certain applicable environmental or land use laws and regulations. In the
future we may receive additional citations or notices. We generally seek to work
with the authorities to resolve the issues raised by such citations or notices.
However, we cannot guarantee that we will always be successful in this regard.
Where we are not successful, we may incur fines, penalties or other sanctions
that could have a material adverse effect on our financial condition, results of
operations and cash flows.

Our insurance for environmental liability meets or exceeds statutory
requirements. However, because we believe that the cost for such insurance is
high relative to the coverage it would provide, our coverages are generally
maintained only at statutorily required levels. Due to the limited nature of our
insurance coverage for environmental liability, if we were to incur liability
for environmental damage in excess of any coverage, such liability could have a
material adverse effect on our financial condition, results of operations and
cash flows.

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, or rely on insurance, including captive insurance. We
currently have in place all necessary financial assurance instruments, and we do
not anticipate any difficulties 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

11

financial assurance. These types of financial assurance, if available, could be
more expensive to obtain, which could negatively impact on our liquidity and
capital resources.

GOVERNMENTAL REGULATIONS MAY RESTRICT OUR OPERATIONS OR INCREASE OUR COSTS OF
OPERATIONS

Stringent government regulations at the federal, state 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 the siting and construction of new waste disposal,
transfer or processing facilities or the expansion of existing
facilities;

- limitations and regulations 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 also affect the siting, design and closure of landfills and
could require us to undertake investigatory or remedial activities, curtail
operations or close a landfill 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.

OUR ACCOUNTING POLICIES CONCERNING UNAMORTIZED CAPITALIZED EXPENDITURES COULD
RESULT IN A MATERIAL CHARGE AGAINST OUR EARNINGS

In accordance with generally accepted accounting principles, we capitalize
certain expenditures and advances relating to acquisitions, pending
acquisitions, and disposal site development and expansion projects. We expense
indirect acquisition costs, such as executive salaries, general corporate
overhead, public affairs and other corporate services, as incurred. Our policy
is to charge against earnings any unamortized capitalized expenditures and
advances relating to any facility or operation that is permanently shut down,
any pending acquisition that is not consummated, and any disposal site
development or expansion project that is not completed. The charge against
earnings is reduced by any portion of the capitalized expenditure and advances
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
our policy. Depending on the magnitude, any such charges could have a material
adverse effect on our results of operations.

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 utilize alternatives to landfill disposal, such as recycling
and composting. In addition, 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 can be a very useful tool to protect our environment,
these developments could 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.

OUR BUSINESS IS SEASONAL IN NATURE AND OUR REVENUES AND RESULTS VARY FROM
QUARTER TO QUARTER

Our operating revenues are usually lower in the winter months, primarily
because the volume of waste relating to construction and demolition activities
usually increases in the spring and summer months, and the

12

volume of industrial and residential waste in certain regions where we operate
usually decreases during the winter months. Our first and fourth quarter results
of operations typically reflect this seasonality. In addition, particularly
harsh weather conditions may result in the temporary suspension of certain of
our operations.

FLUCTUATIONS IN COMMODITY PRICES AFFECT OUR OPERATING REVENUES

Our recycling operations process for sale certain recyclable materials such
as paper, plastics, aluminum and other commodities, all of which are subject to
significant price fluctuations. 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 IPP operations. These fluctuations may affect our future
operating income and cash flows.

WE FACE UNCERTAINTIES RELATING TO PENDING LITIGATION AND INVESTIGATIONS

On three different occasions during July and August 1999, we lowered our
expected earnings per share for the three months ended June 30, 1999. More than
30 lawsuits that claim to be based on our 1999 announcements have been filed
against us and some of our current and former officers and directors. These
lawsuits, which have been consolidated into one action, assert various claims
under the federal securities laws, including claims that (i) the projections we
made about our June 30, 1999 earnings were false and misleading, (ii) we failed
to disclose information about our earnings projections that would have been
important to purchasers of our stock, (iii) we made further misrepresentations
after July 29, 1999 about our operations and finances, resulting in our company
taking a pre-tax charge of $1.76 billion in the third quarter of 1999, and (iv)
we made false or misleading representations in the registration statement and
prospectus filed with the SEC in connection with the WM Holdings Merger. The
plaintiffs also claim that certain of our current and former officers and
directors sold their common stock during times when they knew the price was
artificially inflated by the alleged misstatements and omissions.

On November 7, 2001, we announced that we had reached a settlement
agreement with plaintiffs in this case, resolving all claims against us and the
other defendants arising from or related to the allegations in the litigation.
Under the settlement agreement, which is subject to approval by the court, we
will pay $457 million to certain purchasers or acquirers of our securities
during the period from June 11, 1998 through November 9, 1999, and will present
and recommend to our stockholders a binding resolution to require that all of
our directors are elected annually. The court has scheduled a hearing to
determine the fairness of the settlement agreement for May 10, 2002. However, we
are unable to determine the outcome of the hearing that the court will hold
regarding whether the settlement is fair, reasonable and adequate. Additionally,
if the settlement is approved, there may be an appeal of that approval. Finally,
it is uncertain how many class members will request to be excluded from the
class and whether that number will be large enough to trigger a provision in the
settlement agreement that would allow termination of the agreement.

Other lawsuits relating to the facts described above, and the February 1998
restatements by WM Holdings of its prior-period financial statements, including
purported class actions, have been filed against WM Holdings and us. These
include lawsuits by individuals who purchased our stock or stock of WM Holdings,
sold businesses or assets to us or WM Holdings, or held their stock allegedly in
reliance on statements we made. For a more detailed discussion of our current
litigation, see Note 20, "Commitments and Contingencies," to the consolidated
financial statements included in this report.

We and our subsidiaries are also currently involved in other civil
litigation and governmental proceedings in the ordinary course of our business.
We cannot predict or determine the outcome or resolution of all of the
proceedings brought against us. In addition, the timing of the final resolutions
to these matters is uncertain. The possible outcomes or resolutions to these
matters or any new litigation or governmental proceedings could include
judgments against us or settlements, either of which could require substantial
payments by us and thus could have a material adverse effect on our financial
condition, results of operations and cash flows.

13

INTENSE COMPETITION COULD REDUCE OUR PROFITABILITY

We encounter intense competition from governmental, quasi-governmental and
private sources in all aspects of our operations. In North America, the industry
consists of several 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 and tax-exempt
financing are 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 municipal contracts.

WE FACE POTENTIAL DIFFICULTIES IMPLEMENTING OUR NEW ORGANIZATION PLAN AND
MANAGING OUR PAST GROWTH

In March 2002, we announced our plan to adopt a new organizational
structure. This structure changes the way in which our field operations are set
up and reduces the staffing levels in the field. The new structure aligns the
decision-making, staff support and operations of the field operations with
metropolitan statistical areas that closely parallel the generation, transport
and movement of solid waste in the United States. We believe that the new
structure will improve our business by optimizing our resources, assets and
people to lower our cost structure and add value for our stockholders. However,
there can be no assurance that implementation of our plan will be without
disruption to our operations or that the new structure will result in the
benefits anticipated.

Additionally, we made a number of acquisitions in past years, some of them
substantial, and continue to pursue attractive acquisition opportunities. Our
future financial results and prospects depend in part on our ability to
successfully manage and improve the operating efficiencies and productivity of
the operations acquired. In particular, whether the anticipated benefits of our
acquired operations are ultimately achieved will depend on a number of factors,
including our ability to achieve administrative cost savings, rationalization of
collection routes, insurance and bonding cost reductions, general economies of
scale, and our ability, generally, to capitalize on our asset base and strategic
position. Our acquisitions also involve the potential risk that we failed to
accurately assess all of the pre-existing liabilities of the companies acquired.

EFFORTS BY LABOR UNIONS TO ORGANIZE OUR EMPLOYEES COULD DIVERT MANAGEMENT
ATTENTION AND 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
chosen to be represented by unions, and we have negotiated collective bargaining
agreements with some of the groups. We cannot predict which, if any, groups of
employees may seek union representation in the future or the outcome of
collective bargaining. The negotiation of these 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, we might have to wait through "cooling off" periods, which are often
followed by union-initiated work stoppages, including strikes. Depending on the
type and duration of such work stoppage, our operating expenses could increase
significantly.

FLUCTUATIONS IN FUEL COSTS COULD AFFECT OUR OPERATING EXPENSES AND RESULTS

The price and supply of fuel is unpredictable and fluctuates based on
events outside our control, including geopolitical developments, supply and
demand for oil and gas, actions by OPEC and other oil and gas producers, war and
unrest in oil producing countries, regional production patterns and
environmental concerns. Fuel is needed to run our collection and transfer
trucks, and any price escalations or reductions in supply could increase our
operating expenses and have a negative impact on our consolidated financial
condition, results of operations and cash flows. We have implemented a fuel
surcharge to partially offset increased fuel costs. However, we are not always
able to pass through all of the increased fuel costs due to the terms of certain
customers' contracts.

14

WE FACE RISKS RELATING TO GENERAL ECONOMIC CONDITIONS

We face risks related to general economic and market conditions, including
the potential impact of the status of the economy, and interest rate
fluctuations. We also face risks related to other adverse external economic
conditions, such as the ability of our insurers to timely meet their commitments
and the effect that significant claims or litigation against insurance companies
may have on such ability. Any negative general economic conditions could
materially adversely affect our financial condition, results of operation and
cash flows.

WE MAY NEED ADDITIONAL CAPITAL IF OUR CASH FLOW IS LESS THAN EXPECTED

We currently expect to generate sufficient cash flow from operations to
cover our anticipated cash needs for capital expenditures, acquisitions and
other cash expenditures. However, we recently announced a stock buy back program
of up to $1 billion annually, and we expect to fund the settlement of our
stockholder class action lawsuit in July 2002. If our cash flow from operations
is less than currently expected, or our capital requirements increase, either
due to strategic decisions or otherwise, or if we buy back stock such that our
available cash is reduced, we may elect to incur further indebtedness or issue
equity securities to cover any additional capital needs. However, we cannot
guarantee that we will be successful in obtaining additional capital on
acceptable or favorable terms.

Our credit facilities require us to comply with certain financial ratios.
If our cash flows are less than expected or our capital or other cash
requirements are more than expected, we may not be in compliance with the
ratios. This would result in a default under our credit agreements. If there
were a default, we may not be able to get waivers or amendments to our credit
facilities, and the lenders could choose to declare all outstanding borrowings
due and payable. If that happened, there can be no assurances that we could
fully repay the amounts due or obtain a waiver of such default or timely obtain
alternative financing. Since we are partially dependent on our credit facilities
to fund borrowing and bonding needs, any default could have a material adverse
effect on our consolidated financial condition, results of operation and cash
flows.

WE MAY ENCOUNTER DIFFICULTIES DEPLOYING OUR ENTERPRISE SOFTWARE

We have recently deployed enterprise-wide software systems that replaced
our previous financial, human resources and payroll systems. These systems may
initially contain errors or cause other problems that could adversely affect, or
even temporarily disrupt, all or a portion of our operations until resolved.

ITEM 2. PROPERTIES

Our principal executive offices are in Houston, Texas where we lease
approximately 400,000 square feet under leasing arrangements expiring at various
times through 2010. We also have U.S. field-based administrative offices in
California, Illinois, Pennsylvania, New Hampshire and Georgia and a field-based
administrative office in Ontario, Canada.

Our principal property and equipment consist of land (primarily landfills,
transfer stations and bases for collection operations), buildings, waste
treatment or processing facilities (other than landfills) and vehicles and
equipment. 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.

At December 31, 2001, of the 302 Company operated landfills, we owned or
operated through lease agreements 253 active sites in North America. These sites
control approximately 134,000 acres of land, including approximately 33,000
permitted acres and approximately 6,000 acres we consider to be probable
expansion acreage for landfill use. Additionally, we operate 49 landfills
through contractual agreements, primarily with municipalities. At December 31,
2001, in North America we operated approximately 300 transfer stations, over 190
MRFs and 18 secondary processing facilities. We also owned, or operated through
agreements, 16 waste-to-energy facilities and eight IPPs in North America as of
December 31, 2001.

15

We believe that our vehicles, equipment, and operating properties are
adequately maintained and adequate 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 the "Management's Discussion and
Analysis of Financial Condition and Results of Operations" section of this
report.

ITEM 3. LEGAL PROCEEDINGS

Information regarding our legal proceedings can be found under the
"Litigation" section of Note 20, "Commitments and Contingencies," 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 2001.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is traded on the 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 Composite Tape.

On March 8, 2002, the closing sale price as reported on the NYSE was $27.46
per share. The number of holders of record of our common stock at March 8, 2002,
was 30,003.

As of December 31, 2001, we have the capacity, under the most restrictive
of our loan covenant financial tests, to make dividend payments or repurchase
shares in the aggregate amount of up to approximately $1.5 billion, plus 25% of
future net retained earnings. We declared and paid cash dividends of $0.01 per
share, or approximately $6 million, during each of 2000 and 2001. See Note 12 to
the consolidated financial statements.

16

ITEM 6. SELECTED FINANCIAL DATA

The information below was derived from the audited consolidated financial
statements included in this report and in reports we have previously filed with
the SEC. This information should be read together with those financial
statements and the notes to the financial statements. For more information
regarding this financial data, see the "Management's Discussion and Analysis"
section also included in this report.

17

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Below is a discussion of our operations for the three years ended December
31, 2001. This discussion may contain forward-looking statements that anticipate
results based on management's plans that are subject to uncertainty. The Company
discusses in more detail various factors that could cause actual results to
differ from expectations in Item 1, under the section "Factors Influencing
Future Results and Accuracy of Forward-Looking Statements" of this report. This
discussion should be read in light of that disclosure and together with the
consolidated financial statements and the notes to the consolidated financial
statements.

Critical Accounting Estimates and Assumptions

As further discussed in Note 4 to the consolidated financial statements, in
preparing our financial statements, we make several estimates and assumptions
that affect our reported amounts of assets and liabilities and revenues and
expenses. However, the most difficult, subjective and complex estimates, and the
assumptions that deal with the greatest amount of uncertainty, are related to
our accounting for landfills and environmental liabilities.

Landfill Airspace Amortization and Final-Closure/Post-Closure Costs -- We
expense amounts for landfill airspace usage and landfill final closure and
post-closure costs for each ton of waste accepted for disposal at our landfills.
In determining the amount to expense for each ton of waste accepted, we estimate
the total cost to develop each landfill site to its final capacity and the total
final closure and post-closure costs for each landfill site. Our engineers also
estimate the tonnage capacity of the landfill. The expense for each ton is then
calculated based on the total costs remaining and the total remaining tonnage
capacity. Estimates for projected landfill site costs and for final closure and
post-closure costs are developed using input from the Company's engineers and
accountants and are reviewed by management, typically at least once per year.
The estimates for landfill final closure and post-closure costs also consider
when the costs would actually be paid and factor in, where appropriate,
inflation and discount rates.

As of December 31, 2001 and 2000, the net book value recorded for
capitalized landfill site costs was $4.7 billion and $4.9 billion, respectively.
While the precise amount of these future costs cannot be determined with
certainty, we expect to incur $7.1 billion related to future construction
activities during the remaining operating lives of the disposal sites. The
future costs will be capitalized as incurred and expensed over the useful lives
of the disposal sites as airspace is consumed. The average landfill airspace
amortization cost per ton for the 302 landfills operating at December 31, 2001
was $3.70 per ton as compared to $3.84 for the 305 landfills at December 31,
2000. As of December 31, 2001 and 2000, we had recorded landfill final closure
and post-closure liabilities of $625 million and $613 million, respectively.
While the precise amount of these future costs cannot be determined with
certainty, we estimate that the aggregate cost of landfill final closure and
post-closure as of December 31, 2001 is approximately $2.4 billion. Additional
closure and post-closure costs in excess of those recorded at December 31, 2001
will be accrued and charged to expense as airspace is consumed such that the
total present value of estimated final closure and post-closure costs will be
fully accrued for each landfill at the time each site discontinues accepting
waste and is closed. The average landfill final closure and post-closure
expense, on a per ton basis, for the 302 landfills operating at December 31,
2001 was $0.24 per ton as compared to $0.30 for the 305 landfills at December
31, 2000. This decrease in average landfill final closure and post-closure rates
from 2000 to 2001 was caused primarily by three facilities with significantly
higher than normal per ton amortization rates. As these three facilities neared
closure in 2000, based on specific facts and circumstances, we were required to
increase their final closure and post-closure rates in order to be adequately
accrued for final closure and post-closure at the time the landfills closed.

In determining the amounts to expense for airspace amortization and final
closure and post-closure costs, our engineers estimate the unused permitted
airspace at each landfill. We will also consider expansion airspace in our
estimate of available airspace when we believe the success of obtaining such an
airspace expansion is probable. The criteria we use for evaluating the
probability of obtaining an expansion permit to landfill airspace at existing
sites are as follows:

- Personnel are actively working to obtain land use and local and state
approvals for an expansion of an existing landfill;
18

- At the time the expansion is added to the permitted site life, it is
probable 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;

- Either we or the respective landfill owners 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 final closure and
post-closure costs, have been estimated based on conceptual design.

Additionally, to include airspace associated with an expansion effort, the
expansion permit application must generally be expected to be submitted within
one year, and the expansion permit must be expected to be received within two to
five years. Exceptions to these criteria must be approved through a
landfill-specific approval process that includes the approval from the Chief
Financial Officer and a review by the Audit Committee of the Board of Directors
on a quarterly basis. Of the 105 landfills with probable expansions included in
the landfill airspace calculations at December 31, 2001, 27 probable landfill
expansions required the Chief Financial Officer to approve an exception to the
criteria. Approximately two-thirds of these exceptions were due to legal or
community issues that could impede the expansion process, while the remaining
were primarily due to permit application processes beyond the one-year limit,
which in most cases were due to state-specific permitting procedures.

We have generally been successful in receiving approvals for expansions
pursued; however, there can be no assurance that we will be successful in
obtaining landfill expansions in the future. In some cases we may be
unsuccessful in obtaining an expansion permit or we may determine that an
expansion permit that we previously thought was probable becomes unlikely. The
estimates and assumptions used in developing this information are reviewed by
our engineers and accountants at least annually, and we believe them to be
reasonable. However, to the extent that such estimates, or the assumptions used
to make those estimates, prove to be incorrect, or our belief that we will
receive an expansion permit changes to remote, the costs incurred in the pursuit
of the expansion will be charged against earnings, net of any capitalized
expenditures and advances that will be recoverable, through sale or otherwise.
Additionally, the landfill's future operations will typically reflect lower
profitability due to higher amortization rates, final closure and post-closure
rates, and expenses related to the removal of previously included expansion
airspace. The landfill may also become subject to impairment, which could be
material to the results of operations of any individual reporting period.

Environmental Remediation Liabilities -- Under current laws and
regulations, we may have liability for environmental damage caused by our
operations, or for damage caused by conditions that existed before we acquired a
particular site. We estimate costs required to remediate sites where liability
is probable based on site specific facts and circumstances. Cost estimates to
remediate each specific site are developed by assessing (i) the scope of our
contribution to the environmental matter, (ii) the scope of the anticipated
remediation and monitoring plan, and (iii) the extent of other parties' share of
responsibility. While the precise amount of these future remediation costs
cannot be determined with absolute certainty, we have estimated that the
aggregate cost as of December 31, 2001 is approximately $376 million. As of
December 31, 2001 and 2000,
we had recorded liabilities of $321 million and $349 million, respectively, for
the present value of remediation costs of our sites.

Our engineers and accountants also specifically review the estimates and
assumptions related to environmental remediation liabilities at least annually.
In many circumstances the actual costs related to these liabilities which we
have estimated or assumed may not be known for decades into the future. However,
we believe that based on our extensive experience in the environmental services
business and the large number of sites we have dealt with, we have the ability
to reasonably estimate our aggregate liability. As additional information
becomes available, estimates are adjusted as necessary. It is possible that
technological, regulatory
19

or enforcement developments, the results of environmental studies, the
nonexistence or inability of other potentially responsible third parties to
contribute to the settlements of such liabilities, or other factors could prove
our estimates to be inaccurate, necessitating the recording of additional
liabilities, which could have a material adverse impact on our financial
statements.

1999 ACCOUNTING CHARGES AND ADJUSTMENTS

In 1999, we initiated a comprehensive internal review of our accounting
records, systems, processes and controls at the direction of our Board of
Directors. As discussed below, and in Note 2 to the consolidated financial
statements, we experienced significant difficulty in the integration and
conversion of information and accounting systems after the WM Holdings Merger,
which was accounted for as a pooling of interests. As a result of these systems
and process issues, and other issues raised during the 1999 accounting review,
certain charges and adjustments were recorded, as discussed below. The review
was completed such that we were able to record related adjustments in our
financial statements for the quarter ended September 30, 1999. The amounts we
recorded as a result of the review had a material effect on our financial
statements for the year ended December 31, 1999.

The following is a summary of charges attributable to this review, which
were recorded for the quarter ended September 30, 1999 (in millions):

Operations held-for-sale adjustments........................ $ 414
Increase to allowance for doubtful accounts and other
accounts receivable adjustments........................... 212
Asset impairments (excluding held-for-sale adjustments)..... 178
Insurance reserves and other insurance adjustments.......... 148
Legal, severance and consulting accruals.................... 142
Merger and acquisition related costs........................ 32
Other charges and adjustments, including:
Account reconciliations................................... 348
Loss contract reserve adjustments......................... 49
Increase in environmental liabilities..................... 49
Other..................................................... 191 637
--- ------
Impact of charges before income tax benefit................. 1,763
Income tax benefit.......................................... (537)
------
After-tax charges........................................... $1,226
======

20

The charges described above include both recurring and nonrecurring items,
which have been aggregated for this presentation, and are reflected in our
financial statements for the year ended December 31, 1999 as follows (in
millions):

Subsequent to the completion of the accounting review, and in conjunction
with the process of preparing our monthly financial statements during the fourth
quarter of 1999 and our financial statements at December 31, 1999, additional
adjustments attributable to the reconciliation of intercompany accounts, cash,
accounts receivable, fixed assets, accounts payable and certain other accounts
were recorded. See Note 2 to the consolidated financial statements for
additional discussion of the 1999 accounting charges and adjustments.

21

RESULTS OF OPERATIONS

The following table presents, for the periods indicated, the period to
period change in dollars (in millions) and percentages for the various statement
of operations line items.

See Management's Discussion and Analysis -- 1999 Accounting Charges and
Adjustments.

22

The following table presents, for the periods indicated, the percentage
relationship that the various statement of operations line items bear to
operating revenues:

See Management's Discussion and Analysis -- 1999 Accounting Charges and
Adjustments.

23

RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 2001

OPERATING REVENUES

Our operating revenues in 2001 were $11.3 billion, compared to $12.5
billion in 2000 and $13.1 billion in 1999. Our revenues decreased in 2000 and
2001 primarily because we sold our international operations outside of North
America, most of our non-solid waste businesses, and certain non-integrated NASW
operations pursuant to our strategic plan. As shown below, NASW is our principal
reportable segment. Our "Other" segment was reported in previous years as WM
International and Non-Solid Waste. Beginning in 1999, and continuing through
2000 and into 2001, we sold all operations that had previously been reported in
WM International and most of the operations that had been reported in Non-Solid
Waste.

Operating revenues by reportable segment (in millions):

OPERATING REVENUES

[CHART]

NASW operating revenue mix (in millions):

[CHART]

24

Our NASW operating revenues generally come from fees charged for our
collection, disposal, and transfer station services. A portion of the fees we
charge to our customers for collection services is billed in advance; a
liability for future service is recorded upon receipt of payment and operating
revenues are recognized as services are actually provided. Revenues from our
disposal operations consist of tipping fees charged to third parties based on
the volume of waste being disposed of at our disposal facilities and are
normally billed monthly or semi-monthly. Fees charged at transfer stations are
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. Intercompany
revenues between our operations have been eliminated in the consolidated
financial statements.

NASW revenues decreased by $208 million in 2001 from 2000 due primarily to
the sales of our non-integrated NASW operations during 2000 and, to a lesser
extent, in 2001. Additionally, we experienced negative internal growth in our
NASW operations of 0.7% (or $78 million) in 2001. Internal growth was negatively
impacted by declines in the prices of recyclable commodities of 1.5% (or $161
million) as well as lower volumes of 0.7% (or $80 million) compared to 2000. The
negative volume is largely attributable to the overall slowing of the North
American economy, our terminating unprofitable accounts, and the impact of our
policy change for third party brokers, which required more stringent contract
requirements, thereby resulting in the loss of some brokered waste. Also
contributing to the decline in NASW operating revenues were fluctuations in the
foreign currency exchange rate of the Canadian dollar, which reduced revenues by
$20 million. In addition, in 2001 the Company recognized negative fair market
value adjustments of $11 million for pulp and paper commodity derivatives with
Enron as the counterparty. These derivatives were intended to mitigate the price
risk associated with pulp and paper commodities that we process and sell to
third parties. Offsetting these revenue declines were the acquisition of certain
NASW operations in 2001 and the year-over-year effect of acquisitions of NASW
operations in 2000.

Our NASW operating revenues increased by $533 million in 2000 as compared
to 1999 mostly because we had internal growth in comparable operations. We had a
1.4% (or $150 million) increase in revenues from pricing increases and a 2.5%
(or $267 million) increase in revenues from volume increases. During the first
half of 2000, the pricing in the recyclable materials markets favorably impacted
overall pricing increases, but those improvements were offset by the significant
recyclable materials market downturn in the second half of 2000. Additionally,
we implemented a fuel surcharge in March 2000 to mitigate the significant
increase in the cost of fuel. If we excluded the effects of the price increases
for recyclable materials and the fuel surcharge, there was a price increase of
0.6% in 2000 compared to 1999. Acquisitions of NASW businesses in 2000 and the
full year effect of acquisitions that were completed in 1999 increased NASW
operating revenue by 2.7% in 2000 as compared to 1999, but that increase was
offset by the sales of the non-integrated NASW operations. Foreign currency
fluctuations with the Canadian dollar also negatively impacted operating
revenues during 2000.

OPERATING COSTS AND EXPENSES (EXCLUSIVE OF DEPRECIATION AND AMORTIZATION SHOWN
BELOW)

Our operating costs and expenses include direct and indirect labor and
related taxes and benefits, fuel, maintenance and repairs of equipment and
facilities, tipping fees paid to third party disposal facilities and transfer
stations, and accruals for future landfill final closure and post-closure costs
and environmental remediation. Certain direct landfill development expenditures
are capitalized and amortized over the estimated useful life of a site as
capacity is consumed, and include acquisition, engineering, upgrading,
construction, capitalized interest, and permitting costs. All indirect expenses,
such as administrative salaries and general corporate overhead, are expensed in
the period incurred. We sometimes receive reimbursements from insurance carriers
relating to environmentally related remedial, defense and tort claim costs at a
number of our sites. Such recoveries are included in operating costs and
expenses as an offset to environmental expenses. Our operating costs and
expenses decreased 11.6% in 2001 as compared to 2000, and decreased 8.8% in 2000
as compared to 1999. As a percentage of operating revenues, operating costs and
expenses decreased from 63.0% in 1999, to 60.4% in 2000 and decreased again to
58.9% in 2001.

The year-to-year decline in operating costs and expenses between 1999 and
2001 was primarily caused by the sales of our WM International, Non-Solid Waste
and non-integrated NASW operations. These sales
25

occurred throughout 2000 and into 2001. Adding to the decrease was the effect of
the volume declines in 2001 as compared to 2000 as described in the discussion
of NASW operating revenues.

As a percentage of revenues, operating costs and expenses were
exceptionally high in 1999 because of the difficulties we had integrating
operations after the WM Holdings Merger. In 2000, operating costs and expenses
decreased as we started improving our procurement practices and developing more
standardized operating procedures, although the decrease as a percentage of
revenue was not as great due to the decrease in revenues in the same period. Our
improvements continued and caused further decreases in operating costs and
expenses into 2001. Additionally, in 2001 we implemented market strategy and
procurement initiatives, as well as other cost saving initiatives, such as
preventative maintenance programs that created an overall reduction in repair
and maintenance costs. Finally, in 2001 we aggressively pursued our claims
against insurers for reimbursement of environmental expenses, recovering
approximately $105 million in 2001 as compared to $2 million in 2000 and $7
million in 1999. These recoveries of environmental expenses are recorded as an
offset to operating costs and expenses. If we excluded the insurance recoveries,
operating costs and expenses as a percentage of revenues were unaffected in 1999
and 2000, and would have been 59.8% in 2001.

As part of our ongoing operations, we review our requirements for
remediation and other environmental liabilities based on an analysis of, among
other things, the regulatory context surrounding landfills, site-specific
environmental issues and remaining airspace capacity in light of changes to
operational efficiencies. Accordingly, revisions to remediation liability
requirements may result in upward or downward adjustments to income from
operations in any given period. Adjustments for final closure and post-closure
estimates are accounted for prospectively over the remaining capacity of the
operating landfill. There was no impact on operating costs and expenses as a
percentage of revenues for revisions to remedial environmental and similar
liabilities in 2001 or 2000, and there was a decrease of 0.5% in 1999.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Our selling, general and administrative expenses include management
salaries, clerical and administrative costs, professional services, facility
rentals, provision for doubtful accounts and related insurance costs, as well as
costs related to our marketing and sales force.

Our selling, general and administrative expenses decreased $182 million, or
9.5%, in 2000 compared to 1999 and decreased $116 million, or 6.7%, in 2001
compared to 2000. As a percentage of operating revenues, our selling, general
and administrative expenses were 14.3% for 2001, 13.9% for 2000 and 14.6% for
1999.

The decrease in selling, general and administrative expenses in 2001 as
compared to 2000 is due mostly to the divestitures that we completed throughout
2000. In addition, as discussed below, we had significant costs in 2000 related
to accounting and process improvement initiatives. These costs were not as
significant in 2001, as we were able to stabilize our accounting systems and
substantially complete our process improvement initiatives in the second half of
2000. Offsetting these decreases were costs related to corporate staffing
increases, which began primarily in 2000 and continued in 2001.

In 2000, we incurred significant costs for our process improvement
initiatives and the accounting assistance that began as part of our 1999
accounting review. These costs were mainly in the first half of 2000 because, by
the second half of 2000, we had stabilized our accounting systems and completed
our process improvement initiatives, which significantly reduced our ongoing
need for these services. In 2000, we incurred approximately $196 million for
professional accounting and process improvement consulting services and
consulting services related to the implementation of new enterprise information
systems. Approximately $51 million related to our divestitures, improvements to
our billing systems and verification of our customer base, and legal fees
related to certain stockholder litigation and other SEC matters was also
recorded in 2000. However, in 2000 we were successful in collecting certain
accounts that were reserved for in 1999, favorably impacting our provision for
bad debt in 2000, which decreased from $268 million in 1999 to $14 million in
2000. We also experienced permanent staffing increases at our corporate office
throughout 2000, particularly in the area of information systems and corporate
accounting and finance.

26

Selling, general and administrative expenses for 1999 included $403 million
in adjustments resulting from the 1999 accounting review, some of which are
recurring in nature and should be expected in future periods. These significant
adjustments include an increase of $168 million relative to the allowance for
doubtful accounts and $63 million in costs for insurance adjustments,
accounting, legal and other professional services. These costs were primarily
related to litigation and investigations we conducted in 1999 in connection with
the announcements of our lower expectations for earnings per share in July and
August 1999. Additionally, our administrative costs in 1999, particularly in the
third and fourth quarters, were exceptionally high due to the increased costs to
perform administrative functions attributable to our integration problems after
the WM Holdings Merger.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization includes (i) amortization of goodwill on a
straight-line basis over a period of 40 years or less, commencing on the dates
of the respective acquisitions; (ii) amortization of other intangible assets on
a straight-line basis from 3 to 40 years; (iii) depreciation of property and
equipment on a straight-line basis from 3 to 50 years; and (iv) amortization of
landfill costs on a units-of-consumption method as landfill airspace is consumed
over the estimated remaining capacity of a site.

Depreciation and amortization expense decreased 4.1% in 2001 as compared to
2000 and decreased 11.5% in 2000 as compared to 1999. As a percentage of
operating revenues, depreciation and amortization expense was 12.1% in 2001,
11.4% in 2000 and 12.3% in 1999.

The decrease in depreciation and amortization in 2001 is attributable to
the amortization expense of goodwill on operations that were divested throughout
2000, more cost-effective use of our landfill assets in 2001 and a temporary
increase in fully depreciated trucks and other equipment associated with delays
in receiving new equipment in the first half of 2001.

As a percentage of operating revenues, depreciation and amortization
expense decreased in 2000 compared to 1999 primarily because of the full year
suspension of depreciation in 2000 on fixed assets which were held-for-sale. The
depreciation suspension for 2000 for these held-for-sale operations prior to
those operations being sold was $99 million, or 0.8% of operating revenues. The
depreciation suspended in 1999 for operations held-for-sale, which all occurred
in the fourth quarter of 1999, was $46 million, or 0.3% of operating revenue.
However, the decreases in depreciation and amortization expense were partially
offset by increased landfill airspace amortization in 2000 due to increases in
disposal volumes at our landfills. We also experienced higher airspace
amortization expense in 2000 as compared to the prior years, due to higher
airspace amortization rates as a result of our more stringent criteria for
evaluating the probability of obtaining airspace expansions, which was effective
starting in the third quarter of 1999. Included in depreciation and amortization
expense for 1999 are adjustments resulting from the 1999 accounting review.
These adjustments primarily included adjustments to increases to landfill
amortization expenses as a result of the comprehensive review of the NASW
landfill expansion projects.

MERGER AND ACQUISITION RELATED COSTS, ASSET IMPAIRMENTS AND UNUSUAL ITEMS

In 2001, 2000 and 1999, we had significant charges related to merger and
acquisition related costs, asset impairments and unusual items. In 1999, these
were charges that we identified during our 1999 accounting review, or that
resulted from our losses from businesses sold and held-for-sale adjustments for
businesses to be sold. In 2000, these costs were primarily due to our sale of
our international operations outside of North America and the termination of WM
Holdings' defined benefit pension plan, which are more fully described in Notes
2 and 17 to the consolidated financial statements.

In 2001, expenses included in this category were primarily attributable to
the agreement that was reached to settle the stockholder class action lawsuit
filed against us in July 1999 alleging violations of the federal securities laws
which, net of the recovery from the stockholders derivative suit against the
Company's auditor, resulted in a charge of $374 million. The settlement of the
class action, which is subject to court approval, provides for our payment to
the class of $457 million. We believe the payment, which is expected to be made
in the second half of 2002, will result in a net cash outflow of approximately
$230 to $240 million after
27

considering insurance, tax deductions and related settlement costs. In addition,
we recorded a held-for-sale adjustment of approximately $15 million related to
our international operations outside of North America along with a held-for-sale
adjustment for an investment in an operation in Mexico of approximately $28
million. Offsetting this expense was a net gain of $24 million (comprised of the
reversal of the held-for-sale impairment of $109 million and a held-for-use
impairment of $85 million) from our decision during the third quarter of 2001
not to sell all but one of our IPPs, and the reclassification in the third
quarter of 2001 of all but one of our IPPs from held-for-sale to held-for-use.
Also included in asset impairments and unusual items for 2001 are reversals of
certain loss contract reserves of $13 million that we determined to be in excess
of current requirements, and other unusual items.

INTEREST EXPENSE

Our interest expense decreased in 2001 and 2000 as compared to 1999 because
we paid down debt throughout 2000 and 2001 with proceeds from our divestitures
and our cash flows from operations. In addition, contributing to the decrease
was a $39 million offset to interest expense for interest rate swaps we used to
manage our interest rate exposure. Partially offsetting the overall decrease in
interest expense was a decrease in capitalized interest recorded from period to
period due to an overall decrease in interest rates. We capitalized interest of
$16 million, $22 million and $34 million in 2001, 2000 and 1999, respectively.

PROVISION FOR INCOME TAXES

We recorded a provision for income taxes of $284 million, $418 million and
$232 million for 2001, 2000 and 1999, respectively, resulting in an effective
income tax rate of 36.1%, 130.2% and 142.3% for each of the three years,
respectively. The difference in federal income taxes computed at the federal
statutory rate and reported income taxes for these years is primarily due to
state and local income taxes; non-deductible costs related to acquired
intangibles; non-deductible costs associated with the impairment and divestiture
of certain businesses and other charges and adjustments related to the 1999
accounting review as discussed in Note 2 to the consolidated financial
statements, and; the cost associated with remitting the earnings of certain
foreign subsidiaries that are no longer permanently reinvested. Additionally, in
2001 scheduled Canadian federal and provincial tax rate reductions resulted in a
benefit of $42 million, which was offset in part by an expense of $24 million
related to our plan to repatriate certain capital and earnings previously deemed
permanently invested in Canada. The non-recurring $42 million benefit arising
from the change in Canadian tax rates resulted in a 5.3% reduction in the
Company's overall effective income tax rate in 2001.

LIQUIDITY AND CAPITAL RESOURCES

The Company operates in a capital intensive business and continuing access
to various financing sources is vital to our operations. In the past, we have
been successful in obtaining financing from a variety of sources on terms we
consider attractive and we expect to continue to maintain access to capital
sources in the future. There are several key factors considered by credit rating
agencies and financial markets to be important in determining our future access
to financing. These factors include:

- the essential nature of the services we provide and our large and diverse
customer base;

- our ability to generate strong and consistent cash flows;

28

- our asset base; and

- our commitment to maintaining a moderate financial profile and
disciplined capital allocation.

In addition to our working capital needs for ongoing operations, we have
capital requirements for (i) capital expenditures for construction and expansion
of landfill sites, as well as new trucks and equipment for collection
operations, (ii) refurbishments and improvements at waste-to-energy facilities
and (iii) business acquisitions. For 2002, we currently expect to spend
approximately $1.3 billion for capital expenditures and approximately $250
million for the purchases of businesses. The following table summarizes our
contractual obligations as of December 31, 2001 (in millions) and the
anticipated effect of these obligations on our liquidity in future years:

- ---------------

(a) These contractual obligations do not include our accounts payable and
accrued liabilities (other than environmental liabilities) which we expect
to be paid in 2002, nor do they include other long-term liabilities which
we generally expect to be settled over the next several years.

Our strategy is to meet our capital needs and contractual obligations first
from internally generated funds. Historically, we have also, when appropriate,
obtained financing from issuing debt and common stock.

The following is a summary of our cash balances and cash flows for the
years ended December 31, 2001, 2000 and 1999 (in millions):

In 1999, cash flows from operations were negatively impacted by our
integration efforts in connection with the WM Holdings Merger and the merger
with Eastern Environmental Services, Inc. ("Eastern") (the "Eastern Merger"),
which both occurred in 1998, and the subsequent operational and administrative
difficulties we had. In 1999 we spent approximately $1.3 billion on acquisitions
of businesses and approximately $1.3 billion on capital expenditures. We funded
these investing activities with cash flows from operations, net debt borrowings
of approximately $259 million, other net financing activities of $167 million
and proceeds from sales of assets of approximately $651 million.

In 2000, we spent $231 million to acquire businesses, $1.3 billion in
capital expenditures and $3.3 billion on net debt reductions. We financed these
cash expenditures primarily with $2.1 billion of cash flows from operations and
$2.6 billion of proceeds from our divestitures. A tax refund of approximately
$200 million and our improvements in accounts receivable average days sale
outstanding favorably impacted cash flows from operations in 2000.

In 2001, we generated cash flows from operations of approximately $2.4
billion. Favorably impacting cash flows from operations was cash received of $59
million for the settlement of environmental related claims that we had against
certain insurance carriers and $64 million that we received from counterparties
when we terminated certain interest rate swap agreements prior to the scheduled
maturities. Included in our investing activities was $1.3 billion of capital
expenditures and $116 million for acquisitions of solid waste businesses.

29

These expenditures were offset by proceeds from sales of assets and other
investing activities of $212 million. In addition, we used $485 million for
financing activities, which is comprised of $510 million of net debt reductions
and $25 million of other financing activities, offset by proceeds of $50 million
from exercises of common stock options and warrants, and other financing
activities.

The following summary of free cash flows has been prepared to highlight and
facilitate understanding of the primary cash flow elements. It is not intended
to replace the condensed consolidated statements of cash flows for the years
ended December 31, 2001 and 2000, which were prepared in accordance with
generally accepted accounting principles. Adjusted free cash flow in the table
below, which is not a measure of financial performance in accordance with
generally accepted accounting principles, is defined as cash flows from
operations less capital expenditures, adjusted for certain cash flow activity
that we consider as unusual for the respective periods.

The analysis of free cash flows for the years ended December 31, 2001 and
2000 is as follows (in millions):

- ---------------

(a) EBITDA is defined herein as income from operations excluding depreciation
and amortization and asset impairments and unusual items. EBITDA is not a
measure of financial performance under generally accepted accounting
principles, but we have provided it here because we understand that such
information is used by certain investors when analyzing our financial
position and performance.

On June 29, 2001, we replaced our prior bank credit facilities with a $750
million syndicated line of credit (the "Line of Credit") and a $1,750 million
syndicated revolving credit facility (the "Revolver"). The Line of Credit
requires annual renewal by the lender, and if it is not renewed, we have the
option of converting the balance outstanding, if any, as of June 28, 2002 into a
one-year term loan. The Revolver matures in June 2006. As of December 31, 2001,
we had letters of credit in the aggregate amount of $1.6 billion, (of which
approximately $1.5 billion are issued under our Revolver), that generally have
terms allowing automatic renewal after a year. At December 31, 2001 and March 8,
2002, we had unused and available credit capacity under the bank credit
facilities of approximately $994 million and $950 billion, respectively.

30

In February 2001, we issued $600 million of 7 3/8% senior unsecured notes
due August 1, 2010. Interest is payable semi-annually on February 1 and August
1. The net proceeds from the offering of the notes were approximately $593
million, after deducting discounts to the underwriters and expenses. We used the
net proceeds from this offering, together with cash from operations, to repay
$600 million of senior notes that matured during the second quarter of 2001.

In March 2001, we worked with local governmental authorities to refinance
$339 million of fixed-rate, tax-exempt bonds maturing through 2008 with $326
million of variable-rate, tax-exempt bonds maturing through 2011 and $17 million
of fixed-rate bonds maturing through 2001. The new borrowings include $4 million
of related financing costs. We recorded a net extraordinary loss of $1 million
in the first quarter of 2001 for the remaining unamortized premium and issuance
costs related to the retired debt.

In November 2001, we issued $400 million of 6 1/2% senior unsecured notes
due November 15, 2008. Interest on the notes is payable semi-annually on May 15
and November 15. The net proceeds from the offering, after deducting discounts
to the underwriters and expenses, were approximately $396 million.

In the fourth quarter of 2001, we repurchased $108 million of our 4%
convertible subordinated notes due February 1, 2002. At the maturity date, we
redeemed the remaining $427 million outstanding primarily using cash obtained
from the November 2001 6 1/2% senior note issuance.

On July 17, 1998, we issued $600 million of 6 1/8% mandatorily tendered
senior notes, due July 15, 2011. The notes were subject to certain mandatory
tender features as described in the indenture, which allowed us to repurchase
all of the outstanding notes on July 15, 2001. We used available cash on hand
along with funds from the Line of Credit to repurchase the notes in July 2001.
During the third quarter of 2001, we recorded an extraordinary loss of
approximately $1 million, net of taxes, for the retirement of this debt.

In addition, we have $300 million of 6.625% senior notes due July 15, 2002,
$285.7 million of 7.7% senior notes due October 1, 2002 and $350 million of 6.5%
senior notes due December 15, 2002. We have classified these borrowings as
long-term at December 31, 2001 based upon our ability to use our Line of Credit
and/or Revolver, which are both considered long-term facilities, to refinance
these borrowings. We intend to pursue other sources of long-term financing to
refinance these borrowings; however, in the event other sources of long-term
financing are not available, we have the intent and ability to use our Line of
Credit and/or Revolver.

At December 31, 2001, we had interest rate swap agreements with third
parties with a notional amount of $1.8 billion. These agreements were
established to manage the interest rate risk of our senior note obligations and
at December 31, 2001, these interest rate swap agreements had a net negative
fair value of $2 million. Under the hedge method of accounting for these types
of derivatives, the fair value of these interest rate swap agreements is
recorded as either a risk management asset or liability with an offsetting
adjustment to the carrying value of the long-term debt, which is the hedged
instrument. Our reported long-term debt does not include such an adjustment at
December 31, 2000, since we adopted the Statement of Financial Accounting
Standards 133, Accounting for Derivative Instruments and Hedging Activities, as
of January 1, 2001.

In early October, we elected to terminate certain of our interest rate swap
agreements and we received cash of $72 million (which is comprised of $64
million for the fair value of the swaps that were terminated and $8 million for
interest expense offsets previously accrued for settlements) from the
counterparties. Under the hedge method of accounting for these types of
derivatives, the unamortized adjustment to long-term debt for these terminated
swaps of $60 million at December 31, 2001 remains in long-term debt and will be
amortized until the maturity of the related senior note obligation, the interest
rate risk of which the hedge was established to manage. Approximately $16
million of this adjustment to long-term debt will be amortized as an offset to
interest expense in 2002.

In November 2001, we announced that we had entered into an agreement to
settle the class action lawsuits filed against us in July 1999 alleging
violations of the federal securities laws. Under the settlement agreement, which
is subject to court approval, we agreed to pay $457 million to the class. We
expect our net cash outflow, after considering insurance, tax deductions and
related settlement costs, to be approximately $230 to $240 million. The
settlement will most likely be paid in the second half of 2002, with a minimal
level of additional borrowing necessary to fund the settlement.
31

In February 2002, we announced that our Board of Directors had approved a
stock buy back program. Under the program, we will buy back up to $1 billion of
our common stock each year. The purchases will be made in open market purchases
or privately negotiated transactions using cash flow from operations.

SPECIAL PURPOSE ENTITIES

On June 30, 2000, two limited liability companies ("LLCs") were established
to purchase interests in existing leveraged lease financings at three of our
waste-to-energy facilities. John Hancock Life Insurance Company ("Hancock") has
99.5% ownership in one of the LLCs. The second LLC is 99.5% collectively owned
by Hancock and the CIT Group ("CIT"). We have a 0.5% interest in both LLCs.
Hancock and CIT made an initial investment of approximately $167 million in the
LLCs. Under the LLC agreements the LLCs shall be dissolved upon the occurrence
of any of the following events: (i) a written decision of all the members of the
LLCs to dissolve the LLCs, (ii) December 31, 2063, (iii) the entry of a decree
of judicial dissolution under the Delaware Limited Liability Company Act, or
(iv) the LLCs cease to own any interest in these waste-to-energy facilities.
Additionally, income, losses and cash flows are allocated to the members based
on their initial capital account balances until Hancock and CIT achieve targeted
returns; thereafter, the amounts will be allocated 20% to Hancock and CIT and
80% to us. We do not expect Hancock and CIT to achieve the targeted returns in
2002. We account for the underlying leases as operating leases. The remaining
aggregate lease commitments are $400 million related to these waste-to-energy
facilities.

Under the LLC agreements, if we exercise certain renewal options under the
leases, we will be required to make capital contributions to the LLCs for the
difference, if any, between fair market rents and the scheduled renewal rents.
We are required under certain circumstances to make capital contributions to the
LLCs in the amount of the difference between the stipulated loss amounts and
termination values under the LLC agreements to the extent they are different
from the underlying lease agreements. We believe that the occurrence of these
circumstances is remote.

We are the manager of the LLCs but there are significant limitations on the
powers of the manager per the LLC agreements. Accordingly, we account for our
interest in the LLCs under the equity method of accounting. These investments
have a carrying value of approximately $1 million at both December 31, 2001 and
2000, respectively. If we were required to consolidate the LLCs, we would record
approximately $425 million in assets, and $221 million of debt as of December
31, 2001. The remaining balance which would be recorded is primarily minority
interest. During 2001 and 2000, the LLC received lease payments of $63 million
and $35 million respectively, from the three waste-to-energy facilities and made
distributions during the same periods to members of the LLCs of $13 million and
$11 million, respectively.

SEASONALITY AND INFLATION

Our operating revenues tend to be somewhat lower in the winter months,
which corresponds with our first and fourth quarters. This is mostly because (i)
the volume of construction and demolition waste is lower in the winter because
there is less construction activity and (ii) the volume of industrial and
residential waste in certain regions where the Company operates tends to
decrease during the winter months.

We do not believe that inflation has, nor do we expect it to have, any
material adverse effect on our results of operations in the near future.

NEW ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, Accounting for Business Combinations
("SFAS No. 141"), and Statement of Financial Accounting Standards No. 142,
Accounting for Goodwill and Other Intangible Assets ("SFAS No. 142"). SFAS No.
141 requires that all business combinations be accounted for using the purchase
method of accounting and prohibits the pooling-of-interests method for business
combinations initiated after June 30, 2001. According to SFAS No. 142, goodwill
that arises from purchases after June 30, 2001 cannot be amortized. In addition,
SFAS No. 142 requires the continuation of the amortization of goodwill and all
intangible assets through December 31, 2001, but provides that amortization of
existing goodwill will cease on
32

January 1, 2002. Entities must use their current goodwill impairment approach
through December 31, 2001, and begin to apply the new impairment approach on
January 1, 2002. SFAS No. 142 requires a two-step impairment approach for
goodwill. Companies must first determine whether goodwill is impaired and if so,
they must value that impairment based on the amount by which the book value
exceeds the estimated fair value. Companies have six months from the date they
initially apply SFAS No. 142 to test goodwill for impairment and any impairment
charge resulting from the initial application of the new rule must be classified
as the cumulative effect of a change in accounting principle. Thereafter,
goodwill should be tested for impairment annually and impairment losses should
be presented in the operating section of the income statement unless they are
associated with a discontinued operation. In those cases, any impairment losses
will be included, net of tax, within the results of discontinued operations.

During 2001, all of our business combinations were accounted for by using
the purchase method of accounting. In accordance with our adoption of SFAS No.
141, we will continue to use the purchase method of accounting for our business
combinations. In accordance with SFAS No. 142, we have not amortized goodwill
from any acquisitions that occurred after June 30, 2001. We have no intangible
assets, other than goodwill, that will cease being amortized upon adoption of
SFAS 142. We have recalculated our basic and diluted earnings per share for
2001, 2000 and 1999 excluding goodwill amortization, as follows (dollars in
millions):

The effect of adopting SFAS No. 141 will also require us to write-off net
negative goodwill of approximately $2 million, which will be recorded as a
credit to cumulative effect of this change in accounting principle in the first
quarter of 2002. In accordance with SFAS No. 142, goodwill is required to be
tested for impairment at the reporting unit, which is defined as a company's
operating segment or one level below the operating segment. For the purposes of
applying SFAS No. 142, we have defined our reporting units to be our six
individual NASW areas and our NASW recycling operations that are not included in
any of our NASW areas. Although we currently expect no impairment of goodwill
upon the initial adoption of SFAS No. 142, there can be no assurance that
goodwill will not be impaired upon the initial adoption of SFAS No. 142 or at
any time subsequent to the adoption of SFAS No. 142.

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations ("SFAS No. 143"). SFAS No. 143 covers all legally enforceable
obligations associated with the retirement of tangible long-lived assets and
provides the accounting and reporting requirements for such obligations. SFAS
No. 143 is effective for us beginning January 1, 2003. Our management has not
yet determined the impact that the adoption of SFAS No. 143 will have on our
consolidated financial statements.

33

In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets ("SFAS No. 144") which supersedes Statement of
Financial Accounting Standards No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. SFAS No. 144
establishes a single accounting method for long-lived assets to be disposed of
by sale, whether previously held and used or newly acquired, and extends the
presentation of discontinued operations to include more disposal transactions.
SFAS No. 144 also requires that an impairment loss be recognized for assets
held-for-use when the carrying amount of an asset (group) is not recoverable.
The carrying amount of an asset (group) is not recoverable if it exceeds the sum
of the undiscounted cash flows expected to result from the use and eventual
disposition of the asset (group), excluding interest charges. Estimates of
future cash flows used to test the recoverability of a long-lived asset (group)
must incorporate the entity's own assumptions about its use of the asset (group)
and must factor in all available evidence. SFAS No. 144 is effective for us on
January 1, 2002. As of December 31, 2001, the primary components within our
operations held-for-sale were certain non-solid waste operations, certain NASW
operations and our surplus real estate portfolio. Upon adoption of SFAS No. 144,
any held-for-sale operations that do not meet SFAS No. 144 criteria must be
classified as held-for-use. We expect $14 million of held-for-sale assets to not
meet SFAS No. 144 criteria. These assets will be reclassified to held-for-use in
the first quarter of 2002. This reclassification will have no earnings impact.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

In the normal course of business, we are exposed to market risk, including
changes in interest rates, certain commodity prices and certain equity prices.
From time to time, we and certain of our subsidiaries use derivatives to manage
some portion of these risks. Our derivatives are simple agreements with
independent third parties that provide for payments based on the notional
amount, with no multipliers or leverage. As of December 31, 2001, all of the
derivatives were related to actual or anticipated exposures of our transactions,
with the exception of two derivatives related to the pulp and paper commodity
markets that were entered into for trading purposes. We are exposed to credit
risk in the event of non-performance by counterparties to derivatives. However,
we monitor our derivative positions by regularly evaluating our positions and
the credit worthiness of the counterparties, all of whom we either consider
credit worthy, or who have issued letters of credit to support their credit
worthiness. See Note 11 to the consolidated financial statements for discussion
on the handling of the Enron North America Corp. ("Enron") waste paper swap
agreements.

We have performed sensitivity analyses to determine how market rate changes
will affect the fair value of our Company's market risk sensitive derivatives
and related positions. This analysis is inherently limited because it represents
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 sensitivity analysis. 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 mainly
denominated in U.S. dollars. In addition, we generally use interest rate swaps
to either lock-in or limit the variability in the interest expense of certain
floating rate debt obligations or to manage the mix of fixed and floating rate
debt obligations. An instantaneous, one percentage point increase in interest
rates across all maturities and applicable yield curves would increase the fair
value of our combined debt and interest rate swap positions at December 31, 2001
and 2000 by approximately $394 million and $403 million, respectively. This
analysis does not reflect the effect that declining interest rates would have on
other items, such as new borrowings, nor the favorable impact they would have on
interest expense and cash payments for interest. Since a significant portion of
our debt is at fixed rates, changes in market interest rates would not
significantly impact operating results until and unless our fixed rate debt
would need to be refinanced at maturity.

Commodities Price Exposure. We market recycled paper products like old
newspaper ("ONP") and old corrugated containers ("OCC"). We started entering
into financial swaps in 1999 in an effort to mitigate the risk of recyclable
paper price fluctuations. Under these financial swap agreements, we generally
transfer a
34

floating market price for a fixed price for a fixed period of time. We and the
counterparty agree to use a market index as an indicator of the market price
during the term of the swap. At December 31, 2001, all, except two, of our waste
paper swap agreements were with Enron. Due to Enron's financial situation,
collectibility of the funds associated with these instruments is not probable at
December 31, 2001 and therefore these instruments were estimated to have no fair
value. The derivatives with Enron were subsequently terminated in early 2002.
The net fair value of two derivatives entered into for trading purposes was $7
thousand at December 31, 2001 and therefore not material.

Equity Price Exposure. We are also subject to equity price exposure from
our debt issues that are convertible into our own common stock. These debt
issues had an aggregate carrying value of $458 million and $566 million as of
December 31, 2001 and 2000, respectively. An instantaneous, ten percent decrease
in our stock price on December 31, 2001 and 2000 would decrease the fair value
to a third party holder of our convertible debt by approximately $1 million and
$11 million, respectively. The exposure at December 31, 2001 has been
substantially reduced due to the maturity and our payment of $427 million to
redeem our 4% convertible subordinated notes due on February 1, 2002.

See Note 11 to the consolidated financial statements for further discussion
of the use of and accounting for derivative instruments.

35

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS

36

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors of Waste Management, Inc.:

We have audited the accompanying consolidated balance sheets of Waste
Management, Inc., a Delaware corporation, and subsidiaries (the "Company"), as
of December 31, 2001 and 2000, and the related consolidated statements of
operations, cash flows and stockholders' equity for each of the years in the
three year period ended December 31, 2001. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audits 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 financial position of Waste Management, Inc. and
subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the years in the three year period
ended December 31, 2001, in conformity with accounting principles generally
accepted in the United States.

ARTHUR ANDERSEN LLP

Houston, Texas
February 25, 2002

37

WASTE MANAGEMENT, INC.

CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AND PAR VALUE AMOUNTS)

See notes to consolidated financial statements.
38

WASTE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)

See notes to consolidated financial statements.
39

WASTE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN MILLIONS)

See notes to consolidated financial statements.
40

WASTE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(IN MILLIONS, EXCEPT SHARES IN THOUSANDS)

See notes to consolidated financial statements.
41

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(DOLLARS IN MILLIONS EXCEPT PER SHARE DATA)

1. BUSINESS

Business -- Waste Management, Inc., a Delaware corporation, and
subsidiaries ("Waste Management" or the "Company") is its industry's leading
provider of integrated waste services in North America. Through its
subsidiaries, the Company provides collection, transfer, recycling and resource
recovery, and disposal services. The Company is also a leading developer,
operator and owner of waste-to-energy facilities in the United States. The
Company also had similar operations outside of North America, however, as
discussed in Notes 5 and 21, pursuant to the Company's 1999 strategic plan, the
Company divested all of its international operations outside of North America as
of December 31, 2001. The Company also divested most of its non-solid waste
operations as of December 31, 2001. Included in the remaining non-solid waste
operations are independent power production plants ("IPPs"), which include the
operation and, in some cases, the ownership of IPPs that either cogenerate
electricity and thermal energy or generate electricity alone for sale to
customers, including public utilities and industrial customers. Also included in
the remaining non-solid waste operations are the Company's geosynthetic
manufacturing and installation services, which generally involve the making and
installing of landfill liners. These services were classified as held-for-sale
at December 31, 2001 and were sold in the first quarter of 2002.

2. 1999 ACCOUNTING CHARGES AND ADJUSTMENTS

In 1999, the Company initiated a comprehensive internal review of its
accounting records, systems, processes and controls at the direction of its
Board of Directors. As discussed below, the Company experienced significant
difficulty in the integration and conversion of information and accounting
systems after the Company, then known as USA Waste Services, Inc., completed its
merger with Waste Management, Inc., whose name changed to Waste Management
Holdings, Inc. ("WM Holdings") at the time of the merger. The merger, which was
accounted for as a pooling-of-interests, was completed in July 1998 (the "WM
Holdings Merger"). As a result of these systems and process issues and other
issues raised during the 1999 accounting review, certain charges and adjustments
were recorded, as discussed below. The review was completed in time such that
the Company was able to record related adjustments in its financial statements
for the quarter ended September 30, 1999. The amounts recorded by the Company as
a result of the review had a material effect on its financial statements for the
year ended December 31, 1999. The following is a summary of charges attributable
to this review which were recorded for the quarter ended September 30, 1999:

Operations held-for-sale adjustments........................ $ 414
Increase to allowance for doubtful accounts and other
accounts receivable adjustments........................... 212
Asset impairments (excluding held-for-sale adjustments)..... 178
Insurance reserves and other insurance adjustments.......... 148
Legal, severance and consulting accruals.................... 142
Merger and acquisition related costs........................ 32
Other charges and adjustments, including:
Account reconciliations................................... 348
Loss contract reserve adjustments......................... 49
Increase in environmental liabilities..................... 49
Other..................................................... 191 637
--- ------
Impact of charges before income tax benefit................. 1,763
Income tax benefit.......................................... (537)
------
After-tax charges........................................... $1,226
======

42

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In August 1999, the Company's Board of Directors adopted a strategic plan
that included the divestiture of its international operations outside of North
America and certain other businesses. See Note 16, "Segment and Related
Information," and Note 21, "Operations Held-for-Sale," for further discussion.
Based primarily on preliminary bids from interested parties, these and certain
other assets which were identified as held-for-sale during the third quarter of
1999 were written down to estimated fair value less estimated cost to sell, in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of, resulting in a pre-tax charge of approximately $414 at September
30, 1999. These assets were considered to be held-for-use for periods prior to
the third quarter of 1999 and did not meet the criteria for impairment
recognition as a "held-for- use" asset, and therefore, were not considered
impaired for periods prior to the third quarter of 1999. The assets which were
identified as held-for-sale and subject to adjustment include, among others, the
Company's international operations outside of North America, certain of the
Company's non-solid waste operations and certain North American solid waste, or
"NASW," operations that were not essential parts of the Company's network.
Revisions to the third quarter estimates were required due to revisions in
estimated proceeds and certain changes in business plans during the fourth
quarter of 1999, as further discussed in Note 17, "Merger and Acquisition
Related Costs; Asset Impairments and Unusual Items." See Notes 5 and 21 for a
discussion of operations divested in 2000 and 2001.

In 1999, subsequent to the WM Holdings Merger, the Company experienced
significant difficulty in the conversion from the WM Holdings' information
systems to the systems used by the Company, resulting in delays and errors,
particularly with respect to the Company's billing systems, including delays in
submitting bills to customers and errors in both computing and delivering bills.
Staffing levels were insufficient to address customer complaints and disputes
and did not support timely follow-up with customers. Billing system issues
initially became evident in the second quarter of 1999, as receivable aging
levels continued to rise. At that time, management believed that the increase in
receivables was a short-term issue, receivables would return to historical
levels once the billing system conversions were complete and there was not a
significant collectability issue with its recorded receivables. In connection
with the 1999 accounting review, the Company concluded that certain of these
accounts had deteriorated to the point that they may be uncollectible, and
therefore, recorded an increase in the allowance for doubtful accounts in the
third quarter of 1999. Beginning in the third quarter of 1999, the Company
increased its resources dedicated to receivable collection efforts. In addition,
the Company performed a review of notes and other receivable-related balances in
connection with this review. Taken together, the Company recorded
receivable-related pre-tax charges of $212 in the third quarter of 1999.

As a result of the review, the Company also recorded asset impairments of
$178 related to several landfill sites and certain other operating assets in the
third quarter of 1999. Included in the amount is $76 relating to the abandonment
or closure of facilities resulting both from the Company's decisions regarding
the best operating strategies for specific markets and consideration of other
new facts and circumstances during the review. Also included in the amount is
$40, which is primarily the result of permit denials and other regulatory
problems in the third quarter of 1999, which is one of the many types of facts
and circumstances that may from time to time trigger impairments, and which may
occasionally overlap with other triggering events or result in abandonment or
closure. The Company performs a comprehensive, centrally coordinated review of
its North American landfills on an annual basis. During the third quarter of
1999, that review included an evaluation of potential landfill expansion
projects, with newly refined and more stringent criteria for evaluating the
probability of obtaining expansions to existing sites, which had the effect of
excluding certain expansions that met the Company's previous criteria. For
further discussion on this criteria, refer to Note 3.

The exclusion of these expansions due to the more stringent criteria and
related business judgements regarding probable success of obtaining expansions
increased depreciation and amortization and the provision for final closure and
post-closure costs (included in operating expense). Impairments resulting from
the

43

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

application of the criteria and other new considerations comprise the remaining
$62 of impairments included in the $178 of impairments disclosed above.

The Company historically estimated its insurance-related liabilities for
its ongoing programs based on an analysis of insurance claims submitted for
reimbursement, plus an estimate for liabilities incurred as of the balance sheet
date but not yet reported to the Company. This is the estimation method that had
been used by WM Holdings prior to the WM Holdings Merger, and that method was
continued by the Company for that pool of pre-merger WM Holdings' claims. In
connection with the 1999 accounting review, the Company evaluated the adequacy
of its self-insurance liabilities and changed the manner in which it estimates
its insurance-related liabilities for its ongoing property and casualty
insurance programs. Both of these approaches result in acceptable estimates, but
during the review, the Company noted that the actuarially determined estimates
using a fully-developed method provided a better estimate of the ultimate costs
of the claims than a claims made plus incurred but not reported method.
Accordingly, in the third quarter of 1999, the Company began estimating all
insurance-related liabilities based on actuarially determined estimates of
ultimate losses. This change in estimate resulted in an increased pre-tax
expense of $44 for the third quarter of 1999. In addition, the Company increased
its insurance-related liabilities based on its assessment of current and
expected claims activity and unfavorable claims experience, resulting in an
additional pre-tax charge of $104 in the third quarter of 1999.

The Company recorded pre-tax charges related to legal, severance and
consulting costs incurred in the third quarter of 1999, including increases in
legal accruals and related charges of $96 principally related to developments in
various legal proceedings brought against WM Holdings by its stockholders in
connection with its restatement of earnings in February 1998. These legal
developments caused the Company to evaluate the numerous stockholder cases filed
against WM Holdings and to reassess their range of exposure. Additionally, the
charges included $25 related to severance costs, principally for executives who
left the Company in the third quarter of 1999, and $21 of professional fees
related primarily to the accounting review and related matters.

The Company recorded $32 of merger and acquisition related costs, which are
required to be expensed as incurred, during the third quarter of 1999. These
costs consisted of $13 related to a third quarter purchase business combination
and $19 related to the costs incurred by the Company related to the WM Holdings
Merger and the merger with Eastern Environmental Services, Inc. (the "Eastern
Merger").

The Company's results of operations for 1999 reflect pre-tax charges of
approximately $348 recorded in the third quarter 1999 attributable to the
reconciliation of intercompany accounts, cash, accounts receivable, fixed asset,
accounts payable and certain other accounts at the Company's operating districts
and other locations resulting from the 1999 accounting review. The Company's
1999 accounting review included a detailed review of substantially all of the
districts' and other locations' financial and accounting records. That work
necessitated a number of adjustments affecting transactions related to the
current period and to periods prior to the quarter ended September 30, 1999
involving many different accounts. Although some portion of the charges of $348
may have related to a number of periods, the Company did not have sufficient
information to identify all specific charges attributable to individual prior
periods. Furthermore, producing the required information to perform such an
identification of these charges would have been cost prohibitive and disruptive
to operations. In connection with the preparation of its third quarter of 1999
financial statements, the Company concluded that, based on its quantitative and
qualitative analysis of available information, and after consultation with its
independent public accountants, it did not have, nor was it able to obtain,
sufficient information to conclude what amount of charges related to any
individual prior year, although qualitative analysis indicated that these
charges were principally related to 1999. Accordingly, the Company concluded
that these charges are appropriately reflected in the 1999 annual financial
statements.

44

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company also evaluated significant contracts under which it provides
services. As a result of that review, the Company recorded a pre-tax provision
of $49 related to contracts, which were determined to be in a loss position,
including revisions to previously established reserves based on new facts and
circumstances.

The Company increased its estimate of the ultimate costs required for final
closure and post-closure obligations at certain landfills which were either
closed or near final closure by $33. That increase, and provisions related to
various other environmental matters, totaled $49 as a result of the 1999
accounting review.

In addition to the charges described above, the Company recorded additional
pre-tax charges of $191 as a result of the 1999 accounting review. These
additional charges involved many different issues at all levels of the Company,
including, for example, adjustments to reserves for specific business disputes,
adjustments of over- or under- accruals not described elsewhere herein, and
numerous other items.

The charges described above, which include both recurring and nonrecurring
items that have been aggregated for this presentation, are reflected in the
Company's financial statements for the year ended December 31, 1999, as follows:

Subsequent to the completion of the accounting review, and in conjunction
with the process of preparing its monthly financial statements during the fourth
quarter of 1999 and its financial statements at December 31, 1999, additional
adjustments attributable to the reconciliation of intercompany accounts, cash
accounts receivable, fixed assets, accounts payable and certain other accounts
were recorded.

45

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of consolidation -- The accompanying consolidated financial
statements include the accounts of the Company and its majority-owned
subsidiaries after elimination of all material intercompany balances and
transactions. Investments in affiliated companies in which the Company has a
controlling interest are consolidated for financial reporting purposes.
Investments in affiliated entities in which the Company does not have a
controlling interest are accounted for under either the equity method or cost
method of accounting, as appropriate. These investments are regularly reviewed
for impairment issues and propriety of current accounting treatment.

Reclassifications -- Certain reclassifications have been made to the prior
year balance sheet to conform to the current year presentation.

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.

Concentrations of credit risk -- Financial instruments that potentially
subject the Company to concentrations of credit risk consist primarily of cash
and cash equivalents and accounts receivable. The Company places its cash and
cash equivalents with high quality financial institutions and limits the amount
of credit exposure with any one institution. Concentrations of credit risk with
respect to accounts receivable are limited because a large number of
geographically diverse customers comprise the Company's customer base, thus
spreading the trade credit risk. At December 31, 2001 and 2000, no single group
or customer represents greater than 5% of total accounts receivable. The Company
controls credit risk through credit evaluations, credit limits, and monitoring
procedures. The Company performs credit evaluations for commercial and
industrial customers and performs ongoing credit evaluations of its customers,
but generally does not require collateral to support accounts receivable. Credit
risk relating to derivative instruments results from the fact the Company enters
into interest rate and commodity price swap agreements with various
counterparties. However, we monitor our derivative positions by regularly
evaluating our positions and the credit worthiness of the counterparties, all of
whom we consider credit worthy, or who have issued letters of credit to support
their credit worthiness. See Note 11 for discussion on the handling of the Enron
North America Corp. ("Enron") waste paper swap agreements.

Operations held-for-sale -- It is the Company's policy to classify the
businesses that the Company is marketing for sale and the portfolio of real
estate that the Company considers surplus and is marketing for sale, as
operations held-for-sale. The carrying values of these assets are written down
to estimated fair value, less estimated costs to sell. These charges are based
on estimates and certain contingencies that could materially differ from the
actual results and resolution of any such contingencies. The Company
discontinues depreciation on fixed assets for businesses that are classified as
held-for-sale. In August 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets ("SFAS No. 144"). SFAS No. 144 is
effective for the Company on January 1, 2002 and will impact the Company's
policy for operations held-for-sale. See Note 21 for further discussion of
operations held-for-sale and Note 24 for further discussions regarding SFAS No.
144.

Property and equipment -- Property and equipment are recorded at cost.
Except for the Company's waste-to-energy and IPPs, expenditures for major
additions and improvements are capitalized, while minor replacements,
maintenance and repairs are charged to expense as incurred. At the Company's
waste-to-energy facilities and IPPs, the Company accrues for major maintenance
expenditures. Such accruals are based upon planned maintenance expenditures and
are classified as current or non-current liabilities based on the expected
timing of the expenditures.

When property and equipment are retired, sold, or otherwise disposed of,
the cost and accumulated depreciation are removed from the accounts and any
resulting gain or loss is included in the results of
46

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

operations as increases or offsets to operating expense for the respective
period. Depreciation is provided over the estimated useful lives of the related
assets using the straight-line method. The Company assumes no salvage value for
its depreciable North American fixed assets. The estimated useful lives for
significant property and equipment categories are as follows (in years):

The Company capitalizes certain costs associated with developing or
obtaining internal-use software. These costs include external direct costs of
materials and services used in developing or obtaining the software, payroll and
payroll-related costs for employees directly associated with the software
development project. For the years ended December 31, 2001 and 2000, the Company
capitalized $63 and $21, respectively, of software development costs that are
primarily related to the development of the Company's enterprise-wide software
systems. Capitalized costs related to the Company's enterprise-wide software
systems are depreciated over 5 years. There were no internal-use software
development costs capitalized in 1999.

Landfill accounting -- Capitalizable landfill site costs are recorded at
cost. Capitalized landfill site costs, net of recorded amortization, are added
to estimated projected capitalizable costs to be incurred over the remaining
life of the landfill, to determine the amount to be amortized over the remaining
estimated useful life of a site. Estimated projected costs are developed using
input from the Company's engineers and accountants and are reviewed by
management, typically at least once per year. Amortization is recorded on a
units of consumption basis, typically applying cost as a rate per ton. Landfill
site costs are amortized to expected net realizable value upon final closure of
a landfill. Costs associated with the ongoing operation of the landfill are
charged to expense as incurred.

The Company has material financial commitments for the costs associated
with its future obligations for final closure and post-closure obligations with
respect to the landfills it owns or operates as prescribed by the EPA's
Subtitles C and D regulations. Estimates for final closure and post-closure
costs are developed using input from the Company's engineers and accountants and
are reviewed by management, typically at least once per year. These estimates
involve projections of costs that will be incurred after the landfill ceases
operations and during the legally required post-closure monitoring period. The
difference between the present value of a landfill's estimated total final
closure and post-closure costs and amounts accrued to date is accrued
prospectively on a units of consumption basis by applying a rate per ton over
the remaining capacity of the landfill. The present value of final closure and
post-closure costs are fully accrued for each landfill once the site
discontinues accepting waste and are included in environmental liabilities.

The remaining capacity of a landfill is determined by the unused permitted
airspace and expansion airspace when the success of obtaining an expansion
permit is probable. Remaining capacity is estimated in cubic yards and converted
to tons using a landfill-specific airspace utilization factor. These factors are
developed by the Company's engineers and are reviewed by management, typically
at least once per year.

The Company's criteria for evaluating the probability of obtaining an
expansion permit to landfill airspace at existing sites are as follows:

- Personnel are actively working to obtain land use and local and state
approvals for an expansion of an existing landfill;

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

- At the time the expansion is added to the permitted site life, it is
probable 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;

- The respective landfill owners, or the Company, 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 final closure and
post-closure costs, have been estimated based on conceptual design.

Additionally, to include airspace from an expansion effort, the expansion
permit application must generally be expected to be submitted within one year,
and the expansion permit must be expected to be received within two to five
years. Exceptions to these criteria must be approved through a landfill-specific
approval process that includes an approval from the Company's Chief Financial
Officer and review by the Audit Committee of the Board of Directors on a
quarterly basis. Of the 105 landfill sites with expansions at December 31, 2001,
27 landfill locations required the Company's Chief Financial Officer to approve
an exception to the criteria. Approximately two-thirds of these exceptions were
due to legal or community issues that could impede the expansion process, while
the remaining were primarily due to permit application processes beyond the
one-year limit, which in most cases were due to state-specific permitting
procedures.

The Company has generally been successful in receiving approvals for
expansions pursued; however, there can be no assurance that the Company will be
successful in obtaining landfill expansions in the future. In some cases the
Company may be unsuccessful in obtaining an expansion permit or the Company may
determine that an expansion permit that the Company previously thought was
probable becomes unlikely. The estimates and assumptions used in developing this
information are reviewed by the Company's engineers and accountants at least
annually, and the Company believes them to be reasonable. However, to the extent
that such estimates, or the assumptions used to make those estimates prove to be
incorrect, or the Company's beliefs that it will receive an expansion permit
changes to remote, the costs incurred in the pursuit of the expansion will be
charged against earnings, net of any capitalized expenditure and advances that
will be recoverable, through sale or otherwise. Additionally, the landfill's
future operations will typically reflect lower profitability due to higher
amortization rates, final closure and post-closure rates, and expenses related
to the removal of previously included expansion airspace. The landfill may also
become subject to impairment, which could be material to the results of
operations of any individual reporting period.

Additionally, as disposal volumes are affected by seasonality and
competitive factors, airspace amortization expense varies between fiscal
quarters due to change in volumes of waste disposal at the Company's landfills.
Airspace amortization expense is also affected by changes in engineering costs
and estimates.

Business combinations -- All acquisitions during 2001 and 2000 have been
accounted for using the purchase method of accounting. The Company allocates the
cost of the acquired business to the assets acquired and the liabilities assumed
based on estimates of fair values thereof. These estimates are revised during
the allocation period as necessary if, and when, information regarding
contingencies becomes available to further define and quantify assets acquired
and liabilities assumed. The allocation period generally does not exceed one
year. To the extent contingencies such as preacquisition environmental matters,
litigation and related legal fees are resolved or settled during the allocation
period, such items are included in the revised allocation of the purchase price.
After the allocation period, the effect of changes in such contingencies is

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

included in results of operations in the periods in which the adjustments are
determined. The Company does not believe potential differences between its fair
value estimates and actual fair values are material.

In certain business combinations, the Company agrees to pay additional
amounts to sellers contingent upon achievement by the acquired businesses of
certain negotiated goals, such as targeted revenue levels, targeted disposal
volumes or the issuance of permits for expanded landfill airspace. Contingent
payments, when incurred, are recorded as purchase price adjustments or
compensation expense, as appropriate, based on the nature of each contingent
payment.

Goodwill and other intangible assets -- Goodwill is the excess of cost over
net assets of acquired businesses. In accordance with the Statement of Financial
Accounting Standards No. 142, Accounting for Goodwill and Other Intangible
Assets ("SFAS No. 142"), the Company did not amortize goodwill that arose from
purchases after June 30, 2001. In addition, the Company continued through
December 31, 2001 the amortization of goodwill which arose from purchase
business combinations completed prior to or on June 30, 2001. For further
discussion, refer to Note 7. Other intangible assets consist primarily of
customer lists, covenants not-to-compete, licenses and permits. Other intangible
assets are recorded at cost and amortized on a straight-line basis. Customer
lists are generally amortized over five to seven years. Covenants not-to-
compete are amortized over the term of the agreement, which is generally three
to five years. Licenses, permits and contracts are amortized over the shorter of
the definitive terms of the related agreements or 40 years.

Restricted funds held by trustees -- Restricted funds held by trustees of
$326 and $275 at December 31, 2001 and 2000, respectively, are included in other
non-current assets and consist principally of funds deposited in connection with
landfill final closure and post-closure obligations, insurance escrow deposits,
and funds held in trust for the construction of landfills. Amounts are
principally invested in fixed income securities of federal, state, and local
governmental entities and financial institutions.

Long-lived assets -- Long-lived assets consist primarily of property and
equipment, goodwill and other intangible assets. The recoverability of
long-lived assets is evaluated periodically at the operating unit level by an
analysis of operating results and consideration of other significant events or
changes in the business environment. If an operating unit has indications of
possible impairment, such as current operating losses, the Company will evaluate
whether impairment exists on the basis of undiscounted expected future cash
flows from operations for the remaining amortization period. If an impairment
loss exists, the carrying amount of the related long-lived assets is reduced to
its estimated fair value.

Income taxes -- Deferred income taxes are determined based on the
difference between the financial reporting and tax bases of assets and
liabilities. Deferred income tax provision represents the change during the
reporting period in the deferred tax assets and deferred tax liabilities, net of
the effect of acquisitions and dispositions. Deferred tax assets include tax
loss and credit carryforwards and are reduced by a valuation allowance if, based
on available evidence, it is more likely than not that some portion or all of
the deferred tax assets will not be realized.

Foreign currency -- The functional currency of the Company's foreign
operations is the local currency of the country in which the Company operates.
Adjustments resulting from the translation of financial information are included
in comprehensive income.

Revenue recognition -- The Company recognizes revenues on service contracts
as services are provided. Amounts billed and collected prior to services being
performed are included in deferred revenues. Results from long-term contracts
for construction projects at certain municipal-owned, Company operated waste-to-
energy facilities are recorded on the percentage-of-completion basis. Changes in
project performance and conditions, estimated profitability and final contract
settlements may result in future revisions to long-term construction contract
costs and income.

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Loss contracts -- The Company reviews its revenue-producing contracts in
the ordinary course of business to determine if the direct costs, exclusive of
any non-variable costs, to service the contractual arrangements exceed the
revenues to be produced by the contract. Any resulting net loss over the life of
the contract is expensed at the time of such determination. During the life of a
contract that is deemed to be a loss contract, the Company may estimate
intermittent periods of contract profitability. Intermittent profitability
projected or realized on loss contracts is deferred to offset future projected
losses.

Derivative financial instruments -- Statement of Financial Accounting
Standards 133, Accounting for Derivative Instruments and Hedging Activities
("SFAS No. 133") as amended by SFAS Nos. 137 and 138, became effective for the
Company on January 1, 2001. These statements establish accounting and reporting
standards requiring that all derivative instruments, including certain
derivative instruments embedded in other contracts, be recorded as either assets
or liabilities measured at fair value. These statements also require that
changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. See further discussion at
Note 11.

Capitalized interest -- Interest is capitalized on certain projects under
development including landfill projects and probable landfill expansion
projects, and on certain assets under construction, including operating
landfills and waste-to-energy facilities. The capitalization of interest for
operating landfills is based on the costs incurred on discrete cell construction
projects, plus an allocated portion of the common site costs. The common site
costs include the development costs of a landfill project or the purchase price
of an operating landfill, and the ongoing infrastructure costs benefiting the
lifecycle of the landfill. Cell construction costs include the construction of
cell liners and final capping during the operating life of the site. During
2001, 2000 and 1999, total interest costs were $557, $770 and $804,
respectively, of which $16, $22 and $34, respectively, were capitalized
primarily for landfill construction costs.

4. USE OF ESTIMATES AND ASSUMPTIONS

The Company's preparation of its financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make certain estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets and liabilities and disclosure
of the contingent assets and liabilities at the date of the financial
statements. The estimates and assumptions will also affect the reported amounts
for certain revenues and expenses during the reporting period. Listed below are
the estimates and assumptions that the Company considers to be significant in
the preparation of its financial statements.

- Allowance for Doubtful Accounts -- The Company estimates losses for
uncollectible accounts based on the aging of the accounts receivable and
the evaluation of the likelihood of success in collecting the receivable.

- Recovery of Long-Lived Assets -- The Company evaluates the recovery of
its long-lived assets periodically by analyzing its operating results and
considering significant events or changes in the business environment.

- Operations Held-for-Sale -- The Company writes down the carrying value of
its held-for-sale operations to the estimate of the fair value of such
operations.

- Loss Contracts -- The Company evaluates its revenue-producing contracts
to determine whether the projected revenues of such contracts exceed the
direct costs to service such contracts. These evaluations include
estimates of future revenues and expenses. Accruals for loss contracts
are adjusted upward or downward based on these evaluations.

- Acquisition Accounting -- The Company estimates the fair value of assets
and liabilities when allocating the purchase price of an acquisition.

50

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

- Income Taxes -- The Company assumes the deductibility of certain costs in
its income tax filings and estimates the future recovery of deferred tax
assets.

- Legal Accruals -- The Company estimates the amount of potential exposure
it may have with respect to litigation, claims and assessments.

- Self Insurance Reserves -- Through the use of actuarial calculations, the
Company estimates the amounts required to settle insurance claims.

- Airspace Amortization and Final-Closure/Post-Closure Rate Per Ton -- The
Company expenses amounts for landfill airspace usage and landfill final
closure and post-closure costs for each ton of waste accepted for
disposal at its landfills. In determining the amount to expense for each
ton of waste accepted, the Company estimates the total cost to develop
each landfill site to its final capacity and the total final closure and
post-closure costs for each landfill site. The Company's engineers also
estimate the tonnage capacity of the landfill. The expense for each ton
is then calculated based on the total costs remaining to be provided and
the total remaining tonnage capacity. Estimates for projected landfill
site costs and for final closure and post-closure costs are developed
using input from the Company's engineers and accountants and are reviewed
by management, typically at least once per year. The estimates for
landfill final closure and post-closure consider when the costs would
actually be paid and, where appropriate, inflation and discount rates.

- Environmental Remediation Liabilities -- The Company estimates and
accrues the costs required to remediate a specific site depending on
site-specific facts and circumstances. Cost estimates to remediate each
specific site are developed by assessing (i) the scope of the Company's
contribution to the environmental matter, (ii) the scope of the
anticipated remediation and monitoring plan, and (iii) the extent of
other parties' share of responsibility.

- Derivative Financial Instruments -- In order to estimate the fair market
value of derivative financial instruments to be recorded on the balance
sheet, the Company estimates future prices of commodity waste paper
products.

Actual results could differ materially from the estimates and assumptions
that the Company uses in the preparation of its financial statements. As it
relates to estimates and assumptions in rates per ton and environmental
remediation liabilities, significant engineering and accounting input is
required. The Company reviews these estimates and assumptions no less than
annually. In many circumstances, the ultimate outcome of these estimates and
assumptions may not be known for decades into the future. Actual results could
differ materially from these estimates and assumptions due to changes in
environmental-related regulations, changes in future operational plans, and
inherent imprecision associated with estimating environmental matters so far
into the future.

5. BUSINESS COMBINATIONS AND DIVESTITURES

PURCHASE ACQUISITIONS

During 2001 and 2000, the Company consummated over 50 and 70 acquisitions,
respectively, of NASW operations that were accounted for under the purchase
method of accounting. The total cost of acquisitions was approximately $116 and
$234 for 2001 and 2000, respectively, which included cash paid, common stock
issued and debt assumed.

DIVESTITURES

The Company's 1999 strategic plan included marketing for sale its
international operations outside of North America, its domestic non-solid waste
operations and selected NASW operations. Note 21 discusses

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the remaining operations held-for-sale which the Company believes will be
divested prior to December 31, 2002 and Note 25 discusses operations that were
sold in the first quarter of 2002.

The approximate aggregate sales prices for divestitures in 2001 was $23,
which was comprised substantially of cash proceeds. The following is a summary
of the divestitures of businesses completed at December 31, 2000, by segment:

- ---------------

(a) Approximate sales price includes cash proceeds, note receivables and a
long-term prepaid disposal agreement.

(b) Approximate sales price includes cash proceeds and assumed debt.

6. PROPERTY AND EQUIPMENT

Property and equipment at December 31 consisted of the following:

Depreciation and amortization expense for property and equipment for 2001,
2000 and 1999 was $1,178, $1,210 and $1,344, respectively.

Rental expense for leased properties was $162, $186 and $189 during 2001,
2000 and 1999, respectively. These amounts primarily include rents under
long-term leases and rents charged as a percentage of revenue, but are exclusive
of financing leases which are capitalized for accounting purposes. Payments due
during the next five years and thereafter on long-term rental obligations are as
follows:

SPECIAL PURPOSE ENTITIES

On June 30, 2000, two limited liability companies ("LLCs") were established
to purchase interests in existing leveraged lease financings at three of the
Company's waste-to-energy facilities. John Hancock Life Insurance Company
("Hancock") has a 99.5% ownership in one of the LLCs. The second LLC is 99.5%
collectively owned by Hancock and the CIT Group ("CIT"). The Company has a 0.5%
interest in both LLCs. Hancock and CIT made an initial investment of
approximately $167 in the LLCs. Under the LLC agreements, the LLCs shall be
dissolved upon the occurrence of any of the following events: (i) a written

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

decision of all the members of the LLCs to dissolve the LLCs, (ii) December 31,
2063, (iii) the entry of a decree of judicial dissolution under the Delaware
Limited Liability Company Act, or (iv) the LLCs cease to own any interest in
these waste-to-energy facilities. Additionally, income, losses and cash flows
are allocated to the members based on their initial capital account balances
until Hancock and CIT achieve targeted returns; thereafter, the amounts will be
allocated 20% to Hancock and CIT and 80% to the Company. The Company does not
expect Hancock and CIT to achieve the targeted returns in 2002.

The Company accounts for the underlying leases as operating leases. The
aggregate lease commitments of $400 related to these waste-to-energy facilities
are included in the table above. Under the LLC agreements, if the Company
exercises certain renewal options under the leases, it will be required to make
capital contributions to the LLCs for the difference, if any, between fair
market rents and the scheduled renewal rents. The Company is also required under
certain circumstances to make capital contributions to the LLCs in the amount of
the difference between the stipulated loss amounts and termination values under
the LLC agreements to the extent they are different from the underlying lease
agreements. The Company believes that the occurrence of these circumstances is
remote.

The Company is the manager of the LLCs but there are significant
limitations on the powers of the manager per the LLC agreements. Accordingly,
the Company accounts for its interest in the LLCs under the equity method of
accounting. These investments have a carrying value of approximately $1 at both
December 31, 2001 and 2000, respectively. If the Company were required to
consolidate the LLCs, the Company would record approximately $425 in assets, and
$221 of debt as of December 31, 2001. The remaining balance which would be
recorded is primarily minority interest. During 2001 and 2000, the LLC received
lease payments of $63 and $35 respectively, from the three waste-to-energy
facilities and made distributions during the same periods to members of the LLCs
of $13 and $11, respectively.

7. GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and other intangible assets at December 31 consisted of the
following:

Amortization expense for goodwill and other intangible assets was $193,
$219 and $270 for 2001, 2000 and 1999, respectively. In accordance with SFAS No.
142, the Company did not amortize goodwill which arose from purchases after June
30, 2001. In addition, the Company continued, through December 31, 2001, the
amortization of goodwill that was recorded prior to July 1, 2001. Amortization
of goodwill will cease on January 1, 2002. Other intangibles will continue to be
amortized. See Note 24 for further discussion.

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. LONG-TERM DEBT

Long-term debt at December 31 consisted of the following:

The schedule of long-term debt (including the current portion) for the next
five years and thereafter is as follows:

- ---------

(a) The Company has $300 of 6.625% senior notes due July 15, 2002, $285.7 of
7.7% senior notes due October 1, 2002 and $350 of 6.5% senior notes due
December 15, 2002. The Company has classified these borrowings as long-term
at December 31, 2001 based upon its ability to use its Line of Credit
and/or Revolver, which are both long-term facilities, to refinance these
borrowings. The Company intends to pursue other sources of long-term
financing to refinance these borrowings; however, in the event other
sources of long-term financing are not available, the Company has the
intent and ability to use its Line of Credit and/or Revolver.

On June 29, 2001, the Company replaced its prior bank credit facilities
with a $750 syndicated line of credit (the "Line of Credit") and a $1,750
syndicated revolving credit facility (the "Revolver"). The Line of Credit
requires annual renewal by the lender, and if not renewed, the Company has the
option of converting the balance outstanding, if any, as of June 28, 2002 into a
one-year term loan. The Revolver matures in June 2006. The Line of Credit and
the Revolver are available for borrowings, including letters of credit, and for
supporting the issuance of commercial paper. The covenant restrictions for the
Line of Credit and the Revolver include, among others, interest coverage, debt
to earnings ratio, minimum net worth, and limitations on investments, additional
indebtedness and liens.

At December 31, 2001, the Company had no borrowings outstanding under the
Line of Credit or the Revolver. The facility fees were 0.175% and 0.225% per
annum under the Line of Credit and Revolver, respectively, at December 31, 2001.
The Company had issued letters of credit of approximately $1,506 under the
Revolver, leaving unused and available aggregate credit capacity of
approximately $994 at December 31, 2001.

In February 2001, the Company issued $600 of 7 3/8% senior unsecured notes
due August 1, 2010. Interest is payable semi-annually on February 1 and August
1. The net proceeds from the offering of the notes were approximately $593,
after deducting discounts to the underwriters and expenses. The Company used the
net proceeds from this offering, together with cash from operations, to repay
$600 of senior notes which matured during the second quarter of 2001.

In March 2001, the Company worked with local governmental authorities to
refinance $339 of fixed-rate tax-exempt bonds maturing through 2008 with $326 of
variable-rate tax-exempt bonds maturing through 2011 and $17 of fixed-rate bonds
maturing through 2001. The new borrowings include $4 of related financing costs.

54

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company recorded an extraordinary loss of $1, net of taxes, in the first
quarter of 2001 for the remaining unamortized premium and issuance costs related
to the retired debt.

On July 17, 1998, the Company issued $600 of 6 1/8% mandatorily tendered
senior notes, due July 15, 2011. The notes were subject to certain mandatory
tender features as described in the indenture, which allowed the Company to
purchase all of the outstanding notes on July 15, 2001. The Company used
available cash on hand along with funds from the Company's Line of Credit to
repurchase the notes in July 2001. During the third quarter of 2001, the Company
recorded an extraordinary loss of $1, net of taxes, for the retirement of this
debt.

In November 2001, the Company issued $400 of 6 1/2% senior unsecured notes
due November 15, 2008. Interest on the notes is payable semi-annually on May 15
and November 15. The net proceeds from the offering, after deducting discounts
to the underwriters and expenses, were approximately $396.

In the fourth quarter of 2001, the Company repurchased $108 of its 4%
convertible subordinated notes due February 1, 2002. At the maturity date, the
Company redeemed the remaining $427 outstanding primarily using cash obtained
from the November 2001 6 1/2% senior note issuance.

The Company's 5.75% convertible subordinated notes due 2005 are
subordinated to all existing and future senior indebtedness of the Company. Each
note bears cash interest at the rate of two percent per annum of the one
thousand dollar principal amount at maturity, payable semi-annually. The stated
discount is two hundred eighty-two dollars and twenty cents. At the option of
the holder, each note was redeemable for cash by the Company on March 15, 2000,
at eight hundred forty-three dollars and three cents along with the related
accrued unpaid interest. The notes have been callable by the Company since March
15, 2000, for cash at the stated issue price plus accrued stated discount and
accrued interest through the date of redemption. In addition, each note is
convertible at any time prior to maturity into approximately 18.9 shares of the
Company's common stock, subject to adjustment upon the occurrence of certain
events. Upon any such conversion, the Company will have the option of paying
cash equal to the market value of the shares which would otherwise be issuable.
In December of 1999, the Company began repurchasing its 5.75% convertible notes.
During 2000, the Company repurchased approximately $397 of the remaining
outstanding notes. In 2001, the Company made no repurchases of these notes.

The Company engages in various interest rate swap agreements which are
accounted for as derivatives. Interest rate swap agreements with a net notional
amount of $1,750 at December 31, 2001 were used to manage the interest rate risk
of senior note obligations. At December 31, 2001, the net fair value of these
derivatives was $2 and is included in other long-term liabilities. Under the
hedge method of accounting for these types of derivatives, the change in the
fair value of these interest rate swap agreements is recorded with an offsetting
adjustment to the carrying value of the hedged instrument. Approximately $2 is
included in the tax-exempt and project bonds as of December 31, 2001. In
addition, approximately $60 is included in the senior notes and debentures
classification as of December 31, 2001, which primarily consists of the
remaining unamortized accumulated adjustment of terminated interest rate swaps.
Debt does not include such an adjustment at December 31, 2000 as the Company
adopted SFAS No. 133, as of January 1, 2001. See Note 11 for further discussion.

9. ENVIRONMENTAL LIABILITIES

The Company has material financial commitments for the costs associated
with its future obligations for final closure and post-closure obligations with
respect to the landfills it owns or operates. Estimates for final closure and
post-closure costs are developed using input from the Company's engineers and
accountants and are reviewed by management, typically at least once per year.
The estimates are based on the Company's interpretation of current requirements
and proposed regulatory changes. For landfills, the present value of final
closure and post-closure liabilities is accrued using the calculated rate per
ton and charged to expense as

55

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

airspace is consumed. The present value of total estimated final closure and
post-closure cost will be fully accrued for each landfill at the time the site
discontinues accepting waste and is closed. Final closure and post-closure
accruals consider estimates for the final cap and cover for the site, methane
gas control, leachate management and groundwater monitoring, and other
operational and maintenance costs to be incurred after the site discontinues
accepting waste, which is generally expected to be for a period of up to thirty
years after final site closure. For purchased disposal sites, the Company
assesses and records a present value-based final closure and post-closure
liability at the time the Company assumes closure responsibility. This liability
is based on the estimated final closure and post-closure costs and the
percentage of airspace used as of the date the Company has assumed the closure
responsibility. Thereafter, the difference between the final closure and
post-closure liability recorded at the time of acquisition and the present value
of total estimated final closure and post-closure costs to be incurred is
accrued using the calculated rate and charged to operating costs as airspace is
consumed.

In the United States, the final closure and post-closure requirements are
established by the EPA's Subtitles C and D regulation, as implemented and
applied on a state-by-state basis. The costs to comply with these requirements
could increase in the future as a result of legislation or regulation.

The Company routinely reviews and evaluates sites that require remediation,
including sites listed on the EPA's National Priorities List ("NPL sites"). The
Company considers whether the Company was an owner, operator, transporter, or
generator at the site, the amount and type of waste hauled to the site, the
number of years the Company was connected with the site, as well as reviewing
the same information with respect to other named and unnamed potentially
responsible parties ("PRPs"). The Company then reviews the estimated cost for
the likely remedy, which is based on management's judgment and experience in
remediating such sites for the Company as well as for unrelated parties,
information available from regulatory agencies as to costs of remediation, and
the number, financial resources and relative degree of responsibility of other
PRPs who may be liable for remediation of a specific site, as well as the
typical allocation of costs among PRPs. These estimates are sometimes a range of
possible outcomes. In those cases, the Company provides for the amount within
the range which constitutes its best estimate. If no amount within the range
appears to be a better estimate than any other amount, the Company provides for
the minimum amount within the range in accordance with SFAS No. 5, Accounting
for Contingencies. The Company believes that it is "reasonably possible," as
that term is defined in SFAS No. 5 ("more than remote but less than likely"),
that its potential liability, at the high end of such ranges, would be
approximately $254 higher on a discounted basis in the aggregate than the
estimate that has been recorded in the consolidated financial statements as of
December 31, 2001.

Estimates of the extent of the Company's degree of responsibility for
remediation of a particular site and the method and ultimate cost of remediation
require a number of assumptions and are inherently difficult, and the ultimate
outcome may differ materially from current estimates. However, the Company
believes that its extensive experience in the environmental services business,
as well as its involvement with a large number of sites, provides a reasonable
basis for estimating its aggregate liability. As additional information becomes
available, estimates are adjusted as necessary. It is possible that
technological, regulatory or enforcement developments, the results of
environmental studies, the non-existence or inability of other PRPs to
contribute to the settlements of such liabilities, or other factors could
necessitate the recording of additional liabilities which could be material.

As part of its ongoing operations, the Company reviews its reserve
requirements for remediation and other environmental matters based on an
analysis of, among other things, the regulatory context surrounding landfills
and remaining airspace capacity in light of changes to operational efficiencies.
Accordingly, revisions to remediation reserve requirements may result in upward
or downward adjustments to income from operations, which may be material, in any
given period. Adjustments for final closure and post-closure estimates are
accounted for prospectively over the remaining capacity of the landfill.

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Where the Company believes that both the amount of a particular
environmental liability and the timing of the payments are reliably
determinable, the cost in current dollars is inflated (at 2% and 2.5% at
December 31, 2001 and 2000, respectively) until expected time of payment and
then discounted to present value (at 5.5% and 6.0% at December 31, 2001 and
2000, respectively). The accretion of the interest related to the discounted
environmental liabilities is included in the annual calculation of the
landfill's final closure and post-closure cost per ton and is charged to
operating costs as landfill airspace is consumed. The portion of the Company's
recorded environmental liabilities that has never been subject to inflation or
discounting was approximately $108 and $136 at December 31, 2001 and 2000,
respectively. Had the Company not discounted any portion of its liability, the
amount recorded would have been increased by approximately $410 at December 31,
2001.

Liabilities for final closure, post-closure and environmental remediation
costs consisted of the following:

The changes to environmental liabilities are as follows:

Anticipated payments (based on current costs) of currently identified
environmental liabilities for the next five years and thereafter are as follows:

In addition to the amounts above, the Company has perpetual care
obligations at a site of approximately $1 per year.

The Company has filed suit against numerous insurance carriers seeking
reimbursement for environmentally related remedial, defense and tort claim costs
at a number of sites. Carriers involved in these matters have typically denied
coverage and are defending against the Company's claims. While the Company is

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

vigorously pursuing such claims, it regularly considers settlement opportunities
when appropriate terms are offered. Any amounts the Company recoups are included
as reductions to operating costs and expenses. For 2001, 2000, and 1999, the
Company recorded approximately $105, $2, and $7, respectively, of such
recoveries from insurance carriers.

10. FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value amounts of the Company's financial instruments
have been determined by the Company using available market information and
commonly accepted valuation methodologies. However, considerable judgement is
required in interpreting market data to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts that the Company or holders of the instruments could realize in a
current market exchange. The use of different assumptions and/or estimation
methodologies may have a material effect on the estimated fair values. The fair
value estimates presented herein are based on information available to
management as of December 31, 2001 and 2000. Such amounts have not been revalued
since those dates, and current estimates of fair value may differ significantly
from the amounts presented herein.

The carrying values of cash and cash equivalents, short-term investments,
trade accounts receivable, trade accounts payable, financial instruments
included in notes and other receivables and financial instruments included in
other assets or other liabilities are estimated to approximate their fair values
principally because of the short-term maturities of these instruments. At
December 31, 2001 and 2000, the carrying amount of debt was $8,224 and $8,485,
and the fair value of debt was estimated at $8,190 and $8,281, respectively.

11. DERIVATIVES AND HEDGING ACTIVITIES

SFAS Nos. 133, 137 and 138, were effective for the Company on January 1,
2001. These statements establish accounting and reporting standards requiring
that all derivative instruments, including certain derivative instruments
embedded in other contracts, be recorded as either assets or liabilities
measured at fair value. These statements also require that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. The criteria for cash flow and fair value
hedges require that hedging relationships must be designated and documented upon
inception. The documentation must include the consideration of the hedged item,
the specific risk being hedged, identification of the hedging instrument, the
Company's risk management strategy, and how effectiveness of the hedge will be
assessed. The hedge effectiveness assessment must have a historical basis that
supports the assertion that the hedge will be effective prospectively. Any
ineffectiveness in a hedging relationship is recognized currently in earnings.
Gains and losses from derivative financial instruments designated as qualifying
hedge relationships are categorized in the statement of cash flows as cash flow
from operating activities, as are the gains and losses associated with the
hedged items, and are recorded in the period in which the cash is received.

When a termination of a cash flow hedge occurs, the Company continues to
include in accumulated other comprehensive income the deferred gain or deferred
loss that arose before the date the hedge was terminated if it is still probable
that the forecasted transactions will occur. Prospectively, the deferred gain or
deferred loss included in accumulated other comprehensive income is amortized
into earnings as the forecasted transactions occur. In a termination of a fair
value hedge, any risk management assets or liabilities previously recognized are
marked to zero fair value and the accumulated adjustment to the original
carrying value of the hedged instrument is amortized over the remaining term of
the hedged instrument.

The Company engages in interest rate swaps in order to maintain a
fixed-to-floating rate debt ratio that management believes is most appropriate
for the Company. The Company enters into interest rate swap agreements with
credit worthy, highly regarded financial institutions and the Company monitors
their financial condition. By managing the fixed-to-floating rate ratio of the
existing debt portfolio, the Company is able to take advantage of lower interest
rates on floating rate debt while limiting interest rate exposure through the
use
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

of fixed rate debt instruments. Also, prior to the issuance of debt instruments,
the Company may secure the current market interest rate in order to hedge the
exposure of an increase in interest rates. The Company recorded a gain of
approximately $8 during 2001 related to its fair value adjustment of interest
rate swaps, which is included as an offset to interest expense. Also in 2001,
the Company recorded offsets to interest expense of approximately $31 related to
monthly settlements with the counterparties of interest rate swaps.

The Company entered into a financing transaction in January 2001 to secure
the then current market interest rate in anticipation of its February 2001
issuance of $600 of 7 3/8% senior unsecured notes due August 1, 2010. The
Company recorded a deferred loss of approximately $6, included in accumulated
other comprehensive income, of which approximately $5 remains at December 31,
2001. Approximately $1 of this deferred loss is expected to be reclassified into
interest expense as a yield adjustment in 2002.

In October 2001 the Company elected to terminate certain of its interest
rate swap agreements prior to the scheduled maturities and received cash of $72
(which is comprised of $64 for the fair value of the swaps that were terminated
and $8 for interest expense offsets previously accrued for settlements) from the
counterparties to the interest rate swaps. Under the hedge method of accounting
for these types of derivatives, the unamortized adjustment to long-term debt for
these terminated swaps of $60 at December 31, 2001 remains in long-term debt and
will be amortized as a credit against interest expense over the remaining term
of the underlying debt. Approximately $16 of this adjustment to long-term debt,
due to the terminated interest rate swaps, will be amortized as an offset to
interest expense in 2002.

As of December 31, 2001, interest rate swap agreements in notional amounts
and with terms set forth in the following table were outstanding:

- ---------------

(a) The net fair value for interest rate derivatives is comprised of $20
long-term risk management assets (included in other long-term assets) and
$22 long-term risk management liabilities (included in other long-term
liabilities).

In addition, the Company currently enters into waste paper swap agreements
and other derivative instruments in order to secure margins on certain paper
items to be sold from its material recovery facilities. The objective is
expected to be achieved by entering into the transaction to mitigate the
variability in cash flows from sales of paper products at floating prices,
resulting in a fixed price being received from sales of such products. At
December 31, 2001, all but two of the Company's waste paper derivatives were
with Enron. From January 2001 to November 2001, the Company, through the monthly
settlement process, collected cash of $13 from Enron related to these waste
paper derivatives. On December 2, 2001, Enron declared bankruptcy under Chapter
11 of the Bankruptcy Code of 1978, as amended (the "Bankruptcy Code"). Due to
the uncertainty of Enron's ability to satisfy all of its financial commitments,
the Company determined that these waste paper derivatives, which had a fair
value to the Company of $19 at September 30, 2001, had no fair value at December
31, 2001.

As a result, the Company realized a loss, which is included as an offset to
revenue, of approximately $11 in 2001 for fair value adjustments for these waste
paper derivatives. These waste paper gains and losses were previously reported
as offsets to or increases in cost of sales. In the fourth quarter of 2001 the
Company elected to reclassify to revenue approximately $5 representing
mark-to-market adjustments previously reported in 2001 as cost of sales. In
addition, through November 2001, the Company carried a deferred gain, which is
included in accumulated other comprehensive income, of approximately $7 related
to its waste paper derivatives with Enron that had qualified as cash flow
hedges. This deferred gain is to be amortized into earnings as the forecasted
transactions that were previously hedged actually occur. The deferred gain
related

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

to waste paper derivatives that previously qualified as hedges that are expected
to be reclassified into earnings in 2002 is approximately $3.

As of December 31, 2001, the Company had two pulp and paper financial swap
transactions with counterparties other than Enron. These counterparties issued
letters of credit to support their credit worthiness. These transactions were
entered into for trading purposes. The fair value of these swaps was not
material to the Company.

As of December 31, 2001 waste paper derivatives in notional amounts and
with terms as set forth in the following table were outstanding:

In February 2002, the Company terminated its derivative instruments with
Enron. The total notional tons as of December 31, 2001 associated with these
derivative instruments was 54,322.

The effect of adopting SFAS No. 133 on January 1, 2001 was a gain, net of
taxes, for waste paper hedges of $3 and a loss, net of taxes, of $1 for interest
rate derivatives. The net gain of $2 is reflected as a cumulative effect of
change in accounting principle for 2001.

12. CAPITAL STOCK

The Board of Directors is authorized to issue preferred stock in series,
and with respect to each series, to fix its designation, relative rights
(including voting, dividend, conversion, sinking fund, and redemption rights),
preferences (including dividends and liquidation), and limitations. The Company
has ten million shares of authorized $0.01 par value preferred stock, none of
which is currently outstanding.

The Company declared cash dividends of $0.01 per common share, or
approximately $6 during each of 2001, 2000 and 1999. As of December 31, 2001,
the Company has the capacity, under its most restrictive loan covenant financial
tests, to make dividend payments and repurchase shares in the aggregate amount
of up to approximately $1,500, plus 25% of future net retained earnings.

13. COMMON STOCK OPTIONS AND WARRANTS

The Company accounts for its stock-based compensation using the intrinsic
value method prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," as amended, under which no
compensation cost for stock options is recognized when granted with an exercise
price at least equal to fair market value. SFAS No. 123, Accounting for
Stock-Based Compensation, established accounting and disclosure requirements,
which are shown below, using a fair-value-based method of accounting.

Under the Company's 1993 Stock Option Incentive Plan and the Company's 2000
Stock Option Incentive Plan, options to purchase 26.5 million and 29.0 million
shares, respectively, of the Company's common stock may be granted to officers,
directors, and key employees. Options are granted under these plans at exercise
prices at least equal to the fair market value on the date of grant. The option
plans have various vesting periods, and expire up to ten years from the date of
grant. The Company also has a 2000 Broad-Based Employee Plan under which options
to purchase an aggregate of 3.0 million shares can be granted to any non-
officer employees. The exercise prices for options under the Broad-Based Plan
are at least equal to the fair market value on the date of grant, may vest over
various periods, and expire up to ten years from the date of grant.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

During 1999 and the majority of 2000, the Company issued common stock upon
exercises of stock options and warrants. Beginning in the fourth quarter of 2000
and continuing throughout 2001, the Company issued treasury stock upon exercises
of stock options and warrants. When issuing shares of treasury stock, the
difference between the stock option exercise price and the average treasury
stock cost is recorded as an addition to or deduction from additional
paid-in-capital.

Stock options granted by the Company in 2001, 2000 and 1999 generally have
ten year terms and vest over four or five years. WM Holdings' options granted
after March 10, 1998 generally continued to vest in accordance with their
original vesting schedule of three years. Generally, all other stock options
granted by merged entities continue to vest under varying vesting periods
ranging from immediate vesting to five years following the date of the grant.

Under the 1996 Stock Option Plan for Non-Employee Directors, the Company's
outside directors receive an annual grant of 10,000 options on each January 1.
In accordance with the plan, options to purchase up to 2.4 million shares of the
Company's common stock may be granted, with one-year vesting periods and
expiration dates ten years from the date of grant. The options are granted at
exercise prices equal to the fair market value of the common stock on the date
of grant.

The Company also has outstanding options and warrants related to various
predecessor plans acquired through merger and acquisition activity.

The following table summarizes common stock option and warrant transactions
under the aforementioned plans and various predecessor plans for 2001, 2000 and
1999 (shares in thousands):

In addition to the amounts in the table above, at December 31, 2001 and
2000, the Company had approximately one million warrants outstanding at a
weighted average exercise price of $22.02 and $20.96 per share, respectively.
The warrants were issued by a previously acquired company to non-employees in
connection with services provided to that company. These warrants expire between
August 2002 and April 2009.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Outstanding and exercisable stock options and warrants at December 31,
2001, were as follows (shares in thousands):

The weighted average fair value per share of common stock options and
warrants granted during 2001, 2000 and 1999 were $10.83, $6.78 and $16.17,
respectively. The fair value of each common stock option or warrant granted to
employees or directors during 2001, 2000 and 1999 is estimated utilizing the
Black-Scholes option-pricing model. The following weighted average assumptions
were used: dividend yield of 0%, risk-free interest rates which vary for each
grant and range from 3.42% to 6.19%, expected life of four to seven years for
all grants, and stock price volatility primarily ranging from 23.7% to 50.4% for
all four to seven year grants. Black-Scholes is a formula that calculates an
assumed value of stock options based on appreciation and interest rate
assumptions and therefore, the fair value calculation of a stock option using
Black-Scholes is not necessarily indicative of the actual value of a stock
option.

If the Company applied the recognition provisions of SFAS No. 123, the
Company's net income (loss) and income (loss) per common share for 2001, 2000
and 1999 would approximate the pro forma amounts shown below:

The effects of applying SFAS No. 123 in this pro forma disclosure are not
necessarily indicative of future results or performance.

In November 1999, the Company's President, CEO, and Chairman of the Board
was granted 650,000 stock options upon joining the Company. The options, which
are included in the above tables, vest according to certain performance goals in
lieu of the normal vesting schedules. Notwithstanding these performance goals,
all of these options will vest no later than five years from the date of grant.

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. EMPLOYEE BENEFIT PLANS

The Waste Management Retirement Savings Plan ("Savings Plan") covers
employees (except those working subject to collective bargaining agreements,
which do not provide for coverage under such plans) following a 90 day waiting
period after hire, and allows eligible employees to contribute up to 15% of
their annual compensation, as limited by IRS regulations. Under the Savings
Plan, the Company matches in cash employee contributions up to 3% of their
eligible compensation and matches 50% of employee contributions in excess of 3%
but no more than 6% of eligible compensation. Both employee and Company
contributions vest immediately. Charges to operations for the Company's defined
contribution plans were $41, $38 and $49, during 2001, 2000 and 1999,
respectively.

During 2000, the Company sold its foreign subsidiaries that participated in
both defined benefit and defined contribution retirement plans. The annual
activity of these plans is not included in the tables below primarily due to
their insignificance and sale of the related operating companies in 2000.
Company subsidiaries participate in various multi-employer pension plans and in
two instances, site or contract specific plans, covering certain employees not
covered under the Company's pension plans. These multi-employer plans are
generally defined benefit plans; however, in many cases, specific benefit levels
are not negotiated with or known by the employer contributors. The projected
benefit obligation, plan assets and unfunded liability of the site or contract
specific plans are not material and are not included in the tables below.
Contributions of $23, $28 and $31 for subsidiaries' defined benefit plans were
charged to operations in 2001, 2000 and 1999, respectively.

WM Holdings had a qualified defined benefit pension plan (the "Plan") for
all eligible non-union domestic employees of WM Holdings which was terminated as
of October 31, 1999 in connection with the WM Holdings Merger. The Company
contributed approximately $145 to the Plan's trusts during 2000 and contributed
approximately $14 in 2001 related to the final liquidation of the Plan. The
Company recorded an expense for this Plan during 2000 of approximately $197,
which was included in asset impairment and unusual items. No expense was
recorded in 2001.

Also in conjunction with the WM Holdings Merger, the Company terminated
certain non-qualified supplemental benefit plans for certain officers and
non-officer managers, the most significant plan being the WM Holdings'
Supplemental Executive Retirement Plan ("SERP") (collectively the "Supplemental
Plans"). The Company had a pension liability as of December 31, 2000 equal to
the settlement which was paid in 2001. The Plan and Supplemental Plans are
combined under the caption "Pension Benefits" in the tables that follow.

WM Holdings and certain of its subsidiaries provided post-retirement health
care and other benefits to eligible employees. In conjunction with the WM
Holdings Merger, the Company limited participation in these plans to
participating retired employees as of December 31, 1998. The Company had a
pension liability for the remaining benefits under the Supplemental Plans as of
December 31, 2000 equal to the settlement which was paid in 2001. These plans
are combined under the caption "Other Benefits" in the tables that follow.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following tables provide a reconciliation of the changes in the plans'
benefit obligations and the fair value of plan assets over the two-year period
ended December 31, 2001, and a statement of the funded status for both years:

The following table provides the amounts recognized in the consolidated
balance sheets as of December 31 of both years:

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table provides the components of net periodic benefit cost
for 2001, 2000 and 1999:

The assumptions used in the measurement of the Company's benefit
obligations are shown in the following table (weighted average assumptions as of
December 31):

The assumptions used for discount rate and expected long-term rate of
return on assets in the 2000 disclosure reflect the weighted average assumptions
for the terminated and ongoing plans. Since the Plan and Supplemental Plans were
terminated during 2000 and were larger than the ongoing union plan, the
assumptions applicable to those plans are the main factors in these weighted
average assumptions. The assumptions for the Plan and the Supplemental Plans
reflect the assumptions used in settling these plan obligations (lump sum
interest rates and annuity purchase rates) and the return on the immunized
assets for the plan. A discount rate of 7.5% and an expected long-term rate of
return of 9.0% were used for the ongoing union plan in the 2000 disclosure.

The principal element of the "other benefits" referred to above is the
post-retirement health care plan. Participants in the WM Holdings
post-retirement plan (one of two plans that comprise the "other benefits"
information) contribute to the cost of the benefit, and for retirees since
January 1, 1992, the Company's contribution is capped at between $0 and $600 per
month per retiree, based on years of service. For measurement purposes, a 10.0%
annual rate of increase in the per capita cost of covered health care claims was
assumed for 2001 (being an average of the rate used by all plans); the rate was
assumed to decrease to 6.0% in 2005 and remain at that level thereafter.

A 1% change in assumed health care cost trend rates would have the
following effects:

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On July 1, 2000, WM Holdings terminated the Waste Management Benefits Stock
Trust (the "Trust"). In 1994, the Trust (which was created by WM Holdings)
purchased, in exchange for a promissory note, all of the outstanding treasury
shares of WM Holdings to fund various of its benefit plans. Pursuant to the WM
Holdings Merger, all of the shares held by the Trust were converted into shares
of the Company's common stock. In accordance with the termination of the Trust,
the shares previously owned by it were returned to the Company as payment for
the outstanding amount of the promissory note. The 7,892,612 shares returned to
the Company were recorded as treasury shares.

15. INCOME TAXES

For financial reporting purposes, income (loss) before income taxes and
extraordinary item and cumulative effect of change in accounting principle,
showing domestic and international sources, was as follows:

The provision for income taxes before extraordinary item and cumulative
effect of change in accounting principle consisted of the following:

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The federal statutory rate is reconciled to the effective rate as follows:

The components of the net deferred tax assets (liabilities) at December 31
are as follows:

At December 31, 2001 the Company's subsidiaries have approximately $20 of
federal net operating loss ("NOL") carryforwards, $3,400 of state NOL
carryforwards, and $113 of foreign NOL carryforwards. The NOL carryforwards have
expiration dates through the year 2019. The Company's subsidiaries have
approximately $1 of alternative minimum tax credit carryforwards that may be
used indefinitely; state tax credit carryforwards of $12; and foreign tax credit
carryforwards of $33.

Valuation allowances have been established for uncertainties in realizing
the benefit of tax loss and credit carryforwards. While the Company expects to
realize the deferred tax assets, net of the valuation allowances, changes in
estimates of future taxable income or in tax laws may alter this expectation.
The valuation allowance increased approximately $10 and $116 in 2001 and 2000,
respectively, primarily due to the uncertainty of realizing foreign and state
NOL carryforwards and tax credits.

Prior to the Company's August 1999 decision to divest its international
operations outside of North America, the Company did not provide for United
States income taxes on unremitted earnings of foreign subsidiaries as it was the
intention of management to reinvest the unremitted earnings in its foreign
operations. As a result of the August 1999 decision, the Company provided $13 in
1999 of United States income tax for

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the repatriation of earnings from divested operations outside of North America.
With respect to its Canadian operations, the Company provided $24 for the
repatriation of $230 of capital and $9 for the repatriation of $58 of capital in
2001 and 2000, respectively. Unremitted earnings in foreign operations were
approximately $146 at December 31, 2001, which the Company intends to reinvest.
It is not practicable to determine the amount of United States based income
taxes that would be payable upon remittance of the assets that represent those
earnings.

The Company is currently under audit by the Internal Revenue Service and
from time to time is audited by other taxing authorities. The Company is fully
cooperating with all audits, but plans to defend its positions vigorously. These
audits are in various stages of completion. An unfavorable audit assessment by
the taxing authorities could have a material effect on the Company's financial
statements.

16. SEGMENT AND RELATED INFORMATION

The Company's NASW operations is the Company's principal reportable segment
and is comprised of six operating Areas with similar economic characteristics.
This segment provides integrated waste management services consisting of
collection, transfer, disposal (solid waste landfill, hazardous waste landfill
and waste-to-energy facilities), recycling, and other miscellaneous services to
commercial, industrial, municipal and residential customers in North America,
including the United States, Puerto Rico and Canada. As discussed in Notes 5 and
21, pursuant to the Company's 1999 strategic plan, the Company has divested all
of its international operations outside of North America and most of its
non-solid waste operations. These operating units, which were disclosed
separately in the Company's Form 10-K for the year ended December 31, 2000, are
now aggregated in a single column ("Other") for this reporting presentation.
Included in the Company's remaining non-solid waste operations are the Company's
IPPs, which include the operation and, in some cases, the ownership of
independent power projects that either cogenerate electricity and thermal energy
or generate electricity alone for sale to customers, including public utilities
and industrial customers. The Company's other non-solid waste business is a
geosynthetic manufacturing and installation service, which generally involves
the making and installing of landfill liners. This operation was classified as
held-for-sale in the Company's financial statements and was sold in the first
quarter of 2002. See Note 25 for further discussion.

Summarized financial information concerning the Company's reportable
segments for the respective years ended December 31 is shown in the following
table. Prior period information has been restated to conform to the current year
presentation.

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- ---------------

(a) Corporate functions include the corporate treasury function, legal
function, information technology function, corporate tax function, the
corporate insurance function, management of the closed landfill and related
insurance recovery functions, centralized service center functions along
with other typical administrative functions.

(b) Other operations are net of intersegment revenue with NASW of $44, $37 and
$46 in 2001, 2000 and 1999, respectively. There are no other significant
sales between segments.

(c) EBIT is defined as "Earnings Before Interest and Taxes." EBIT is an
earnings measurement used by management to evaluate operating performance.

(d) For those items included in the determination of EBIT, the accounting
policies of the segments are generally the same as those described in the
summary of significant accounting policies. See Note 3.

(e) There are no material asymmetrical allocations of EBIT versus assets
between segments or corporate.

(f) For operations classified as held-for-sale, the Company suspends
depreciation on fixed assets. Had the Company not classified any operations
as held-for-sale, depreciation expense would have been greater by $7, $99
and $46 for 2001, 2000, and 1999 respectively. The Company re-evaluated its
business alternatives related to its IPPs during the third quarter of 2001,
and based on these assessments, the Company decided not to sell its IPPs
with the exception of one facility. Accordingly, the Company reclassified
all but one of its IPPs from held-for-sale to held-for-use in the third
quarter of 2001. As a result of this reclassification, the Company recorded
$6 of depreciation that had been suspended throughout the held-for-sale
period. See Note 21.

The reconciliation of total EBIT reported above to net income (loss) is as
follows:

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The table below shows the total revenues contributed by the Company's
principal lines of business within the NASW segment.

Revenues decreased from 1999 to 2001 due to the Company selling its
international operations outside of North America on a country by country basis
throughout 2000 and 2001. At December 31, 2001, the Company had divested all of
its international operations outside of North America. As of December 31, 2000,
the Company's operations outside of North America included certain operations in
Sweden, and operations in Argentina and Israel. The Company's international
operations outside of North America, as well as certain of the Company's
operations in Mexico (which is considered non-solid waste), had their property
and equipment reflected in current operations held-for-sale at December 31, 2000
and 1999. Operating revenues and property and equipment (net) relating to
operations in the United States and Puerto Rico, Europe, Canada and all other
geographic areas ("other foreign") are as follows.

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17. MERGER AND ACQUISITION RELATED COSTS; ASSET IMPAIRMENTS AND UNUSUAL ITEMS

MERGER AND ACQUISITION RELATED COSTS

In 1999, the Company incurred $45 in expenses primarily related to
integration costs associated with the WM Holdings Merger and the Eastern Merger.
The Company incurred no such expenses during 2000 and 2001.

ASSET IMPAIRMENTS AND UNUSUAL ITEMS

In 2001, 2000 and 1999, the Company recorded certain charges and credits
for asset impairments and unusual items as follows:

- ---------------

(a) Consisted of held-for-sale adjustments for international operations outside
of North America of approximately $15 along with an adjustment for an
investment in an operation in Mexico of approximately $28. In addition, the
Company recorded a net gain of approximately $24 from the Company's
re-evaluation of its business alternatives related to its IPPs during the
third quarter of 2001 and a gain of approximately $1 for other
held-for-sale impairment adjustments. See Note 21 for further discussion on
IPP re-evaluations.

(b) Primarily attributable to agreements that were reached to settle the
stockholder class action lawsuit filed against the Company in July 1999
alleging violations of the federal securities laws and the stockholder
derivative suit against the Company's independent auditor which resulted in
a net charge of $374.

(c) Consisted of (i) a net gain of $127 on divestitures of certain
international operations, (ii) losses of $524 resulting from the
recognition of currency translation adjustment upon the divestitures of
certain international operations, and (iii) a net loss of $146 on the
impairment of domestic operations, offset partially by certain domestic
gains and other items.

(d) See Note 14 for discussion on the termination of WM Holdings defined
benefit plan.

(e) Based primarily on preliminary bids from interested parties, the Company's
international operations outside of North America, and certain of the
Company's non-solid waste operations and certain NASW operations that are
not essential parts of the Company's operations were identified as
"held-for-sale" during 1999 and were written down to fair value less cost
to sell, in accordance with SFAS No. 121, resulting in a pre-tax charge of
approximately $433. The remaining $10 of held-for sale adjustments
primarily resulted from revisions of estimated proceeds related to surplus
real estate. See Note 21 for further analysis of operations held-for-sale.

(f) See Note 2 for further discussion.

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18. EARNINGS PER SHARE

The following reconciles the number of common shares outstanding at
December 31 of each year to the weighted average number of common shares
outstanding and the weighted average number of common and dilutive potential
common shares outstanding for the purposes of calculating basic and dilutive
earnings per common share (shares in millions):

For all periods presented, the effect of the Company's convertible
subordinated notes and debentures is excluded from the dilutive earnings per
share calculation since inclusion of such items would be antidilutive. For 2000
and 1999, the effect of the Company's common stock options and warrants are
excluded from the dilutive earnings per share calculation since inclusion of
such items would be antidilutive.

At December 31, 2001, there were approximately 52 million shares of common
stock potentially issuable with respect to stock options, warrants, and
convertible debt, which could dilute basic earnings per share in the future.

19. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) represents the change in the Company's equity
from transactions and other events and circumstances from nonowner sources and
includes all changes in equity except those resulting from investments by owners
and distributions to owners. The components of accumulated other comprehensive
income (loss) were as follows:

The change in minimum pension liability adjustment from 1999 to 2000
relates to the Company's settlement of its obligations under the Plan. See
further discussion at Note 14.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

20. COMMITMENTS AND CONTINGENCIES

Financial instruments -- Letters of credit, performance bonds, trust
agreements, financial guarantees and insurance policies have been provided by
the Company to support tax-exempt bonds, contracts, performance of landfill
final closure and post-closure requirements, and other obligations. The Company
also uses captive insurance, or insurance policies issued by a wholly-owned
insurance company subsidiary, the sole business of which is to issue such
policies to the Company, in order to secure such obligations. In those instances
where the use of captive insurance is not acceptable, the Company has available
alternative bonding mechanisms. Because virtually no claims have been made
against these financial instruments in the past, management does not expect
these instruments will have a material adverse effect on the Company's
consolidated financial statements. The Company has not experienced difficulty in
obtaining performance bonds or letters of credit for its current operations.
However, the tragic events of September 11, 2001 have had an impact upon the
financial status of a number of insurance, surety and reinsurance providers,
which could in turn cause an increase in the cost and a decrease in the
availability of surety and insurance coverages available to the Company in the
future.

For the 14 months ended January 1, 2000, the Company insured certain risks,
including auto, general and workers' compensation, with Reliance National
Insurance Company ("Reliance.") On June 11, 2001, the ultimate parent of
Reliance, Reliance Group Holdings, Inc., filed for bankruptcy under Chapter 11
of the Bankruptcy Code. On October 3, 2001, Reliance was placed in liquidation
by a Pennsylvania Court. The Company has determined that it will have coverage
through various state insurance guarantee funds in some, but not all, of the
jurisdictions where it is subject to claims that would have been covered by the
Reliance insurance program. While it is not possible to predict the outcome of
proceedings involving Reliance, the Company believes that because of the various
insurance guarantee funds and potential recoveries from the liquidation, it is
unlikely that events relating to Reliance will have a material adverse impact on
the Company's financial statements.

Credit risk -- During 2000, increases in wholesale power prices far
exceeded the retail prices that certain California utilities were able to charge
customers due to retail rate freezes, resulting in significant under recovery of
costs for those utilities. As a result the utilities have faced severe financial
drains. In April 2001, Pacific Gas and Electric Company ("PG&E") filed for
bankruptcy under Chapter 11 of the Bankruptcy Code, as amended. Certain of the
Company's IPPs sell power to PG&E under long-term contracts and were owed $31
from PG&E as of December 31, 2001. On July 14, 2001, the bankruptcy court
approved an agreement between these IPPs and PG&E whereby PG&E agreed to assume
the contracts and pay the Company in full the past due amounts on the earlier of
the effective date of PG&E's plan of reorganization, which was filed with the
bankruptcy court in October 2001, or July 15, 2005. The Company's IPPs also sell
power to Southern California Edison, Inc. ("SCE") under long-term contracts
similar to those with PG&E. Although SCE has not filed for bankruptcy, it also
faces severe financial difficulties, and the Company's IPPs have a receivable
from SCE of approximately $10 as of December 31, 2001. The Company believes it
will collect all amounts due from PG&E and SCE in 2002 and thus has classified
these receivables as current.

Environmental matters -- The continuing business in which the Company is
engaged is intrinsically connected with the protection of the environment. As
such, a significant portion of the Company's operating costs and capital
expenditures could be characterized as costs of environmental protection. Such
costs may increase in the future as a result of legislation or regulation,
however, the Company believes that in general it tends to benefit when
environmental regulation increases, which may increase the demand for its
services, and that it has the resources and experience to manage environmental
risk.

As part of its ongoing operations, the Company provides for the present
value of estimated final closure and post-closure monitoring costs over the
estimated operating life of disposal sites as airspace is consumed. The Company
has also established procedures to evaluate potential remedial liabilities at
closed sites which it owns or operated, or to which it transported waste,
including 79 sites listed on the EPA's National Priorities
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List ("NPL") as of December 31, 2001. Where the Company concludes that it is
probable that a liability has been incurred, provision is made in the financial
statements.

Estimates of the extent of the Company's degree of responsibility for
remediation of a particular site and the method and ultimate cost of remediation
require a number of assumptions and are inherently difficult, and the ultimate
outcome may differ materially from current estimates. However, the Company
believes that its extensive experience in the environmental services industry,
as well as its involvement with a large number of sites, provides a reasonable
basis for estimating its aggregate liability. As additional information becomes
available, estimates are adjusted as necessary. It is reasonably possible that
technological, regulatory or enforcement developments, the results of
environmental studies, the nonexistence or inability of other potentially
responsible third parties to contribute to the settlements of such liabilities,
or other factors could necessitate the recording of additional liabilities which
could be material.

The Company or certain of its subsidiaries have been identified as
potentially responsible parties in a number of governmental investigations and
actions relating to waste disposal facilities which may be subject to remedial
action under the Comprehensive Environmental Response, Compensation and
Liabilities Act of 1980, as amended ("CERCLA" or "Superfund"), or similar state
laws. The majority of these proceedings involve allegations that certain
subsidiaries of the Company (or their predecessors) transported hazardous
substances to the sites in question, often prior to acquisition of such
subsidiaries by the Company. CERCLA generally provides for liability for those
parties owning, operating, transporting to or disposing at the sites. Such
proceedings arising under Superfund typically involve numerous waste generators
and other waste transportation and disposal companies and seek to allocate or
recover costs associated with site investigation and cleanup, which costs could
be substantial and could have a material adverse effect on the Company's
financial statements.

As of December 31, 2001, the Company or its subsidiaries had been notified
that they are potentially responsible parties in connection with 79 locations
listed on the NPL. Of the 79 NPL sites at which claims have been made against
the Company, 17 are sites which the Company has come to own over time. All of
the NPL sites owned by the Company were initially developed by others as land
disposal facilities. At each of the 17 owned facilities, the Company is working
in conjunction with the government to characterize or remediate identified site
problems. In addition, at these 17 owned facilities, the Company has either
agreed with other legally liable parties on an arrangement for sharing the costs
of remediation or is pursuing resolution of an allocation formula. The 62 NPL
sites at which claims have been made against the Company and that are not owned
by the Company are at different procedural stages under Superfund. At some of
these sites, the Company's liability is well defined as a consequence of a
governmental decision as to the appropriate remedy and an agreement among liable
parties as to the share each will pay for implementing that remedy. At others
where no remedy has been selected or the liable parties have been unable to
agree on an appropriate allocation, the Company's future costs are uncertain.
Any of these matters could have a material adverse effect on the Company's
financial statements.

From time to time, the Company and certain of its subsidiaries are named as
defendants in personal injury and property damage lawsuits, including purported
class actions, on the basis of a Company's subsidiary having owned, operated or
transported waste to a disposal facility which is alleged to have contaminated
the environment or, in certain cases, conducted environmental remediation
activities at sites. Some of the lawsuits may seek to have the Company or its
subsidiaries pay the costs of groundwater monitoring and health care
examinations of allegedly affected persons for a substantial period of time even
where no actual damage is proven. While the Company believes it has meritorious
defenses to these lawsuits, their ultimate resolution is often substantially
uncertain due to the difficulty of determining the cause, extent and impact of
alleged contamination (which may have occurred over a long period of time), the
potential for successive groups of complainants to emerge, the diversity of the
individual plaintiffs' circumstances, and the potential contribution

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or indemnification obligations of co-defendants or other third parties, among
other factors. Accordingly, it is possible such matters could have a material
adverse impact on the Company's financial statements.

For more information regarding commitments and contingencies with respect
to environmental matters, see Note 9.

Litigation -- On July 16, 1998, the Company acquired WM Holdings which was
then known as Waste Management, Inc., but whose name was changed at the time of
the WM Holdings Merger. In July 1998, a seller of a business to WM Holdings in
exchange for WM Holdings common stock filed a class action alleging breach of
warranty. In October 1999, the court certified a class consisting of all sellers
of business assets to WM Holdings between January 1, 1990 and February 24, 1998
whose agreements contained express warranties regarding the accuracy of WM
Holdings' financial statements. The parties to the action settled these claims
by the Company's payment of approximately $25 in the third quarter of 2001.

In March 2000, a group of companies that sold assets to WM Holdings in
exchange for common stock in March 1996 brought a separate action against the
Company for breach of contract and fraud, among other things. The parties have
agreed to resolve this dispute through arbitration. The extent of damages in the
dispute has not yet been determined.

In December 1999, an individual brought an action against the Company, five
former officers of WM Holdings, and WM Holdings' auditor in Illinois state court
on behalf of a proposed class of individuals who purchased WM Holdings common
stock before November 3, 1994, and who held that stock through February 24,
1998, for alleged acts of common law fraud, negligence, and breach of fiduciary
duty. In May 2001, the court granted in part and denied in part the defendants'
motion to dismiss. This action remains in its early stages and the extent of
possible damages, if any, has not yet been determined.

On July 6 and July 29, 1999, the Company announced that it had lowered its
expected earnings per share for the three months ended June 30, 1999. On August
3, 1999, the Company provided additional information regarding its expected
earnings for that period, including that its reported operating income for the
three months ended March 31, 1999 might have included certain unusual pretax
income items. More than 30 lawsuits based on one or more of these announcements
were filed against the Company and certain of its current and former officers
and directors. These lawsuits were consolidated into a single action pending in
the United States District Court for the Southern District of Texas (the
"Southern District of Texas Court"). On May 8, 2000, the court entered an order
appointing the Connecticut Retirement Plan and Trust Funds as lead plaintiff and
appointing the law firm of Goodkind Labaton Rudoff & Suchrow LLP as lead
plaintiff's counsel.

The lead plaintiff filed its Amended Consolidated Class Action Complaint
(the "Complaint") on July 14, 2000. The Complaint pleads claims on behalf of a
putative class consisting of all purchasers and acquirers of Company securities
(including common stock, debentures and call options), and all sellers of put
options, from June 11, 1998 through November 9, 1999. The Complaint also pleads
additional claims on behalf of two putative subclasses: (i) the "Merger
Subclass," consisting of all WM Holdings stockholders who received Company
common stock pursuant to the WM Holdings Merger, and (ii) the "Eastern Merger
Subclass," consisting of all Eastern Environmental Services, Inc. ("Eastern")
stockholders who received Company common stock pursuant to the Company's
acquisition of Eastern on December 31, 1998.

Among other things, the plaintiff alleges that the Company and certain of
its current and former officers and directors (i) made misrepresentations in the
registration statement and prospectus filed with the SEC in connection with the
WM Holdings Merger, (ii) made knowingly false earnings projections for the three
months ended June 30, 1999, (iii) failed to adequately disclose facts relating
to its earnings projections that the plaintiff claims would have been material
to purchasers of the Company's common stock and (iv) made separate and distinct
misrepresentations about the Company's operations and finances on and after July
29, 1999, culminating in the Company's pre-tax charge of $1,763 in the third
quarter of 1999. The plaintiff also alleges that certain of the Company's
current and former officers and directors sold common stock between
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May 10, 1999 and June 9, 1999 at prices known to have been inflated by material
misstatements and omissions. The plaintiff in this action seeks damages with
interest, costs and such other relief as the court deems proper. Defendants
filed a motion to dismiss on October 3, 2000. On August 16, 2001, the court
granted the motion in part and denied it in part, allowing the plaintiff to
replead its claims. On November 7, 2001, the Company announced that it had
reached a settlement agreement with the plaintiff, resolving all claims brought
in the action against the Company as well as claims against current and former
officers and directors of the Company. The settlement agreement originally
required additional confirmatory discovery by the plaintiff, which was completed
in December 2001. The settlement agreement was therefore amended in January 2002
to remove the discovery contingency, but still requires approval by the court,
as well as the Company to consent to the certification of a class for settlement
purposes consisting of certain purchasers or acquirers of Company securities
during the period from June 11, 1998 through November 9, 1999. If the settlement
is approved, the Company will pay $457 to the members of the class and will
present and recommend approval to its shareholders, at or before the 2003 annual
meeting of shareholders, a binding resolution to require that all directors are
elected annually. In anticipation of the settlement agreement, the Company
recorded a charge to asset impairments and unusual items of $389 in the third
quarter 2001.

Also on November 7, 2001, the Company announced that, subject to court
approval and additional confirmatory discovery by the derivative plaintiffs, the
Company will receive $20 (less fees awarded to counsel for the derivative
plaintiffs) as a result of a settlement reached between the derivative
plaintiffs and Arthur Andersen LLP ("Andersen") in a shareholder derivative suit
filed on July 3, 2001 in Texas state court against Andersen, as the Company's
independent auditor. The additional discovery was completed in January 2002,
after which the parties executed an agreement removing this contingency from the
settlement. The Company recorded $15 as an offset to asset impairments and
unusual items in the third quarter 2001 in connection with the settlement
agreement. The derivative plaintiffs alleged that Andersen engaged in
professional malpractice in connection with certain services that it performed
for the Company. Andersen has informed the Company that neither the complaint
nor the settlement will affect its independence as the Company's auditor.

On June 29, 2000, a putative class action was filed against the Company in
Delaware state court by a class of former Eastern stockholders falling within
the scope of the Eastern Merger Subclass described above. The plaintiffs allege
that the Company stock they received in exchange for their Eastern shares was
overvalued for the same reasons alleged in the consolidated class actions in
Texas. On August 4, 2000, the Company removed the case from the state court to
federal court and asked to have the case transferred to the Southern District of
Texas Court where the consolidated Texas class actions are pending.

Certain sellers of individual businesses to the Company or to a company
later acquired by the Company have also brought lawsuits, alleging that for
reasons similar to those in the consolidated Texas class actions described
above, the stock that they received in the sales of their businesses was
overvalued. The first such lawsuit was brought in Virginia state court in July
2000. The Company's demurrer in that case was denied in January 2002. The second
seller's lawsuit was brought in Michigan state court in May 2001. After the
Company removed this case to federal court, the plaintiffs filed another new
lawsuit in Michigan state court alleging only state law claims and also filed a
duplicative complaint in the Southern District of Texas Court. The third
seller's lawsuit was brought in California state court in July 2001, with an
amended complaint filed in December 2001.

On June 14, 2001, the Company filed a motion with the Judicial Panel on
Multidistrict Litigation (the "MDL Panel") to transfer all cases that are
pending or that may be filed in, or removed to, federal courts that relate to
the claims asserted in the consolidated Texas class actions to the Southern
District of Texas Court for coordinated or consolidated pre-trial proceedings.
This motion covered the Delaware putative class action brought by the former
Eastern stockholders and the seller's lawsuit pending in Michigan federal court,
both described above. The MDL Panel granted the Company's motion on November 7,
2001, thereby transferring both of these cases to the Southern District of Texas
Court. The Delaware plaintiffs requested their lawsuit be

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

remanded to state court, which motion was granted in February 2002. The
Company's motion to dismiss the Michigan plaintiffs' federal lawsuit is
currently pending. All of these cases are still at relatively early stages, and
the amount of damages in the various cases cannot yet be determined.

In addition, three derivative lawsuits were filed against certain current
and former officers and directors of the Company alleging derivative claims on
behalf of the Company against these individuals for breaches of fiduciary duty
resulting from their common stock sales during the three months ended June 30,
1999 and/or their oversight of the Company's affairs. Two of the lawsuits, filed
in the Chancery Court of the State of Delaware on July 16, 1999 and August 18,
1999, were consolidated into a single action. The third suit was filed in the
Southern District of Texas Court on July 27, 1999. The lawsuits named the
Company as a nominal defendant and sought compensatory and punitive damages with
interest, equitable and/or injunctive relief, costs and such other relief as the
courts deemed proper. In September 2001, the Delaware court approved a
settlement that provided the Company with a net benefit of approximately $23
through the cancellation of certain payments and benefits to four former
officers. Pursuant to the settlement, the four former officers will, in the
aggregate, forego $8 in severance payments, and approximately $15 of other
benefits (including the cancellation of stock options). As a result of the
settlement, the plaintiffs in the Texas case joined with the Company in a motion
to dismiss the Texas case, which motion was granted in October 2001.

Two groups of stockholders have filed separate lawsuits in state courts in
Texas against the Company and certain of its former officers. The petitions
allege that the plaintiffs are substantial shareholders of the Company's common
stock who intended to sell their stock in 1999, or otherwise protect against
loss, but that the individual defendants made false and misleading statements
regarding the Company's prospects that, along with public statements, induced
the plaintiffs to retain their stock. Plaintiffs assert that the value of their
retained stock declined dramatically. Plaintiffs assert claims for fraud,
negligent misrepresentation, and conspiracy. The cases are in early stages and
the extent of damages, if any, cannot yet be determined.

The Company is engaged in a business that is intrinsically connected with
the protection of the environment and for which there is the potential for the
unintended or unpermitted discharge of materials into the environment. From time
to time, the Company pays fines or penalties in environmental proceedings
relating primarily to waste treatment, storage or disposal facilities. As of
December 31, 2001, there were four proceedings involving Company subsidiaries
where the sanctions involved could potentially exceed one hundred thousand
dollars. The matters involve allegations that subsidiaries (i) operated a
hazardous waste incinerator in such a way that its air emissions exceeded permit
limits, (ii) engaged in the importation and disposal of hazardous waste in
contravention of applicable federal regulations, (iii) are responsible for
remediation of landfill gas and chemical compounds required pursuant to a
Unilateral Administrative Order associated with an NPL site and (iv) are
responsible for late performance of work required under a Unilateral
Administrative Order.

On July 29, 1998, the EPA inspected one of the Company's subsidiaries'
operations, and notified the Company of alleged violations relating to the
disposal of chlorofluorocarbons ("CFCs"). In January 1999, the EPA issued an
Administrative Order requiring the Company's subsidiary to comply with the CFC
regulations. In June 1999, the Company was notified that the EPA is conducting a
civil investigation relating to the alleged CFC disposal violations to determine
whether further enforcement measures are warranted. The Company and its
subsidiary are cooperating with the investigation and the Company believes that
the ultimate outcome of this matter will not have a material adverse effect on
the Company's financial statements.

The Company has brought suit against numerous insurance carriers in an
action entitled Waste Management, Inc., et al. v. The Admiral Insurance Company,
et al., pending in the Superior Court in Hudson County, New Jersey. The Company
has been seeking (i) a declaratory judgment that past and future environmental
liabilities asserted against it or its subsidiaries are covered by its insurance
policies and (ii) to recover defense and remediation costs and other damages
incurred as a result of the insurance carriers' denial of coverage of
environmental liabilities. The Company began mediating certain of the claims in
the third
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quarter of 2001. Trial with respect to five of the sites where discovery was
complete began in October 2001 ("Phase I"). To date, the Company has entered
into settlement agreements with substantially all Phase I defendants and has
dismissed its claims as to those defendants. The Company is currently engaged in
the initial stages of preparing for trial in the next phase of the litigation
("Phase II"). In 2001, the Company has recognized approximately $105 in
operating costs and expenses in the consolidated financial statements as an
offset to environmental expenses to reflect these settlements. The Company is
unable to predict the outcome of the remaining proceedings.

It is not possible at this time to predict the impact that the above
lawsuits, proceedings, investigations and inquiries may have on the Company, nor
is it possible to predict whether any other suits or claims may arise out of
these matters in the future. The Company and each of its subsidiaries intend to
defend themselves vigorously in all the above matters. However, it is reasonably
possible that the outcome of any present or future litigation, proceedings,
investigations or inquiries may have a material adverse impact on their
respective financial conditions or results of operations in one or more future
periods.

The Company and certain of its subsidiaries are also currently involved in
other routine civil litigation and governmental proceedings relating to the
conduct of their business. The outcome of any particular lawsuit or governmental
investigation cannot be predicted with certainty and these matters could,
individually or in the aggregate, have a material adverse impact on the
Company's financial statements.

Insurance -- The Company carries a broad range of insurance coverages for
protection of its assets and operations from certain risks including pollution
legal liability insurance for certain of its disposal sites, transfer stations,
recycling and other facilities. Through the date of the WM Holdings Merger,
certain of WM Holdings' auto, general liability, pollution legal liability and
workers' compensation risks were self-insured up to $5 per accident. For such
programs, a provision was made in each accounting period for estimated losses,
including losses incurred but not reported, and the related reserves are
adjusted as additional claims information becomes available. The Company's
ongoing programs carry self-insurance exposures of up to two hundred and fifty
thousand dollars, twenty thousand dollars and one hundred and fifty thousand
dollars per incident with regards to workers compensation, auto and general
liability, respectively. Claims reserves related to WM Holdings were discounted
at 5.5% at December 31, 2001 and 2000. The insurance-related liability for the
ongoing program and the WM Holdings' self-insurance runoff program included in
the accompanying balance sheet in accrued liabilities approximates $128 and $102
at December 31, 2001 and 2000, respectively, and in other long-term liabilities
approximates $253 and $248 at December 31, 2001 and 2000, respectively.

Other -- The Company is also party to an agreement pursuant to which it has
agreed to purchase certain operating assets in Canada no later than December
2005. The purchase price is based on certain calculations of the financial
performance of the assets to be acquired, which will be determined at the time
of purchase. In addition, the Company subcontracted certain business to the
owner of the assets to be purchased. The owner has informed the Company that it
believes the Company is required to repurchase the subcontracted business. The
Company strongly disagrees with this position. In any event, the Company does
not believe that the purchase will have a material effect on its financial
statements.

21. OPERATIONS HELD-FOR-SALE

As discussed in Note 17, the Company recorded charges to write down certain
of the operations the Company had marketed for sale pursuant to its strategic
plan. These charges reflect the excess of the Company's carrying amounts of the
assets over their fair market value. In determining fair value, the Company
considered, among other things the range of preliminary purchase prices being
discussed with potential buyers. These businesses' results of operations were
included in revenues and expenses through the date of disposition in the
accompanying statement of operations. Note 5 discusses operations that were
divested in 2001 and 2000.

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As of December 31, 2001, the primary components within operations
held-for-sale consisted of certain non-solid waste operations, certain NASW
operations and the Company's surplus real estate portfolio. The Company
re-evaluated its business alternatives related to its IPPs during 2001, and
based on these assessments, the Company decided to hold and operate its IPPs
with the exception of one facility. Accordingly, the Company reclassified all
but one of its IPPs from held-for-sale to held-for-use in 2001. As a result of
this reclassification, the Company reversed its previously recorded
held-for-sale impairment of $109 through asset impairments and unusual items and
recorded depreciation that had been suspended through the held-for-sale period.
The Company also subjected its IPPs to impairment testing on a held-for-use
basis which resulted in an impairment of $85, which is also a component of asset
impairments and unusual items.

As of December 31, 2000, the primary components remaining within operations
held-for-sale consisted of the Company's remaining international operations
outside of North America, which included certain operations in Sweden and
operations in Argentina and Israel, and certain other non-core and NASW
operations and the Company's surplus real estate portfolio.

For operations classified as held-for-sale, the Company suspends
depreciation and amortization on the underlying assets. Depreciation suspension
for 2001, 2000 and 1999 for held-for-sale operations was $7, $99 and $46,
respectively. Operating revenues for operations classified as held-for-sale at
December 31, 2001 were $170 and $169 for the years ending December 31, 2001 and
2000, respectively. Of this amount, $148 and $149, respectively, related to the
Company's geosynthetic and installation services that were sold in February of
2002.

22. QUARTERLY FINANCIAL DATA (UNAUDITED)

The following table summarizes the unaudited quarterly results of
operations for 2001 and 2000:

Basic and diluted earnings per common share for each of the quarters
presented above is based on the respective weighted average number of common and
dilutive potential common shares outstanding for each period and the sum of the
quarters may not necessarily be equal to the full year basic and diluted
earnings per common share amounts. For certain periods presented, the effect of
the Company's common stock options and

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warrants and the effect of the Company's convertible subordinated notes and
debentures are excluded from the diluted earnings per share calculations since
inclusion of such items would be antidilutive for that period.

23. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

WM Holdings ("Guarantor"), which is 100% owned by Waste Management, Inc.
("Parent"), has fully and unconditionally guaranteed all of the senior
indebtedness of the Parent, as well as the Parent's 4% convertible subordinated
notes due 2002. The Parent has fully and unconditionally guaranteed all of the
senior indebtedness of WM Holdings, as well as WM Holdings' 5.75% convertible
subordinated debentures due 2005. However, none of the Company's, nor WM
Holdings' debt is guaranteed by any of the Parent's indirect subsidiaries or WM
Holdings' subsidiaries ("Non-Guarantor"). Accordingly, the following condensed
consolidating balance sheets as of December 31, 2001 and 2000 and the related
condensed consolidating statements of operations for 2001, 2000 and 1999, along
with the related statements of cash flows, have been provided below.

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CONDENSED CONSOLIDATING BALANCE SHEETS

DECEMBER 31, 2001

DECEMBER 31, 2000

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CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

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CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

24. NEW ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, Accounting for Business Combinations
("SFAS No. 141"), and SFAS No. 142. SFAS No. 141 requires that all business
combinations be accounted for using the purchase method of accounting and
prohibits the pooling-of-interests method for business combinations initiated
after June 30, 2001. According to SFAS No. 142, goodwill that arises from
purchases after June 30, 2001 cannot be amortized. In addition, SFAS No. 142
requires the continuation of the amortization of goodwill and all intangible
assets through December 31, 2001, but provides that amortization of existing
goodwill will cease on January 1, 2002. Entities must use their current goodwill
impairment approach through December 31, 2001, and begin to apply the new
impairment approach on January 1, 2002. SFAS No. 142 requires a two-step
impairment approach for goodwill. Companies must first determine whether
goodwill is impaired and if so, they must value that impairment based on the
amount by which the book value exceeds the estimated fair value. Companies have
six months from the date they initially apply SFAS No. 142 to test goodwill for
impairment and any impairment charge resulting from the initial application of
the new rule must be classified as the cumulative effect of a change in
accounting principle. Thereafter, goodwill should be tested for impairment
annually and impairment losses should be presented in the operating section of
the income statement unless they are associated with a discontinued operation.
In those cases, any impairment losses will be included, net of tax, within the
results of discontinued operations.

During 2001, all of the Company's business combinations were accounted for
by using the purchase method of accounting. In accordance with its adoption of
SFAS No. 141, the Company will continue to use the purchase method of accounting
for its business combinations. In accordance with SFAS No. 142, the Company has
not amortized goodwill from any acquisitions that occurred after June 30, 2001.
The Company has no intangible assets, other than goodwill, that will cease being
amortized upon adoption of SFAS 142. The effect of adopting SFAS No. 141 will
also require the Company to write-off net negative goodwill of approximately $2,
which will be recorded as a credit to cumulative effect of change in accounting
principle in the first quarter of 2002. In accordance with SFAS No. 142,
goodwill is required to be tested for impairment at the reporting unit, which is
defined as a company's operating segment or one level below the operating
segment. For the purposes of applying SFAS No. 142, the Company has defined its
reporting units to be its six individual NASW areas and its NASW recycling
operations that are not included in any of the NASW areas. Although the Company
currently expects no impairment of goodwill upon the initial adoption of SFAS
No. 142, there can be no assurance that goodwill will not be impaired upon the
initial adoption of SFAS No. 142 or at any time subsequent to the adoption of
SFAS No. 142.

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations ("SFAS No. 143"). SFAS No. 143 covers all legally enforceable
obligations associated with the retirement of tangible long-lived assets and
provides the accounting and reporting requirements for such obligations. SFAS
No. 143 is effective for the Company beginning January 1, 2003. Management has
yet to determine the impact that the adoption of SFAS No. 143 will have on the
Company's consolidated financial statements.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
144 which supersedes SFAS No. 121. SFAS No. 144 establishes a single accounting
method for long-lived assets to be disposed of by sale, whether previously held
and used or newly acquired, and extends the presentation of discontinued
operations to include more disposal transactions. SFAS No. 144 also requires
that an impairment loss be recognized for assets held-for-use when the carrying
amount of an asset (group) is not recoverable. The carrying amount of an asset
(group) is not recoverable if it exceeds the sum of the undiscounted cash flows
expected to result from the use and eventual disposition of the asset (group),
excluding interest charges. Estimates of future cash flows used to test the
recoverability of a long-lived asset (group) must incorporate the entity's own
assumptions about its use of the asset (group) and must factor in all available
evidence. SFAS

84

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

No. 144 is effective for the Company on January 1, 2002. As of December 31,
2001, the primary components within operations held-for-sale consisted of
certain non-solid waste operations, certain NASW operations and the Company's
surplus real estate portfolio. Upon adoption of SFAS No. 144, any held-for-sale
operations that do not meet SFAS No. 144 criteria must be classified as
held-for-use. The Company expects $14 of held-for-sale assets to not meet SFAS
No. 144 criteria. These assets will be reclassified to held-for-use in the first
quarter of 2002. This reclassification will have no earnings impact.

25. SUBSEQUENT EVENTS

In January and February of 2002, the Company completed the divestiture of
its geosynthetic manufacturing and installation services. Pursuant to the sales,
the roofing membrane and products business and assets were sold on January 25,
2002, and the remaining operations, all of which related to the manufacturing of
landfill liners, were sold on February 5, 2002; however the Company retained
certain real estate assets that were a part of the operations. The consideration
received consisted of cash, subject to certain post-closing calculations, and
assumed liabilities. Additionally, in connection with the February sale of the
landfill liner manufacturing operation, the Company entered into a 5-year supply
contract with the purchaser for landfill liner related goods and services.
Pursuant to this agreement, the Company will be required to buy at least 60% of
the Company's landfill liner related goods and services per year from the buyer
of these operations.

On February 1, 2002, the Company redeemed the remaining $427 of its 4%
convertible subordinated notes primarily using cash obtained from its November
2001 6 1/2% senior note issuance.

Subsequent Events (unaudited)

In the first quarter of 2002, the Company announced the approval by its
Board of Directors of a common stock buy back program for up to $1 billion in
annual repurchases. The Company intends to engage in open market or privately
negotiated transactions to execute these repurchases. In March 2002, the Company
repurchased approximately $300 million in a privately negotiated transaction
pursuant to the buy back program.

On March 4, 2002, the Company announced its plan to adopt a new
organizational structure. Under the new structure, the Company will move from
four field layers of management to three, and reduce the number of field layers
that have administrative and functional staff from four to two. This new
structure will refocus the Company's over 1,200 sites, 900 geographically-based
districts and numerous divisions into approximately 1,200 operating units,
including waste collection depots, transfer stations, landfills and recycling
facilities, which will report to 85 newly established Market Areas. These Market
Areas will be responsible for the sales and marketing of the Company's services
and for directing the delivery of service by operating units. Each large Market
Area will be headed by a Vice President and the others will be headed by a
General Manager. They will report to one of the four Groups that divide the
United States geographically and replace the current geographic Areas of the
Company, and will consolidate Market Area financial reporting and provide a
range of assistance in the areas of: finance and accounting, procurement,
people, market planning and development, fleet services, recycling, legal
services, as well as engineering, regulatory compliance, safety and public
affairs. These Groups will report to corporate headquarters in Houston.
Wheelabrator Technologies Inc. and Canadian Waste Services Inc., which currently
comprise the Company's other two Areas, will remain unchanged and will form the
fifth and sixth Groups under the new structure.

85

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item concerning directors of the Company
is set forth under the caption "Election of Directors" in the Company's
definitive Proxy Statement for its 2002 Annual Meeting of Stockholders, to be
filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as
amended, and is incorporated herein by reference.

EXECUTIVE OFFICERS OF THE REGISTRANT

Below are the names and ages, as of December 31, 2001, of the Company's
executive officers and summaries of their business experience for the past 5
years.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is set forth under the caption
-- "Executive Compensation" in the 2002 Proxy Statement and is incorporated
herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is set forth under the caption
"Director and Officer Stock Ownership" in the 2002 Proxy Statement and is
incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is set forth under the caption
"Related Party Transactions" in the 2002 Proxy Statement and is incorporated
herein by reference.

PART IV

ITEM 14. FINANCIAL STATEMENT SCHEDULES, EXHIBITS, AND REPORTS ON FORM 8-K

(a)(1) Consolidated Financial Statements:

Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 2001 and 2000
Consolidated Statements of Operations for the years ended December 31,
2001, 2000 and 1999
Consolidated Statements of Cash Flows for the years ended December 31,
2001, 2000 and 1999
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2001, 2000 and 1999
Notes to Consolidated Financial Statements

(a)(2) Consolidated Financial Statement Schedules:

Schedule II -- Valuation and Qualifying Accounts

All other schedules have been omitted because the required information is
not significant or is included in the financial statements or notes thereto, or
is not applicable.

87

(a)(3) Exhibits:

- ---------------

* In the case of incorporation by reference to documents filed under the
Securities Exchange Act of 1934, the Company's file number under that Act is
1-12154.

(a) Reports on Form 8-K:

None.

89

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.

WASTE MANAGEMENT, INC.

By: /s/ A. MAURICE MYERS
------------------------------------
A. Maurice Myers
President, Chief Executive Officer
and
Chairman of the Board

Date: March 12, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.

90

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors of Waste Management, Inc.:

We have audited in accordance with auditing standards generally accepted in the
United States, the consolidated financial statements of Waste Management, Inc.
and subsidiaries included in this Annual Report on Form 10-K and have issued our
report thereon dated February 25, 2002. Our audit was made for the purpose of
forming an opinion on those statements taken as a whole. Schedule II is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. Schedule II has been subjected to the auditing
procedures applied in the audits of the basic financial statements, and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.

ARTHUR ANDERSEN LLP

Houston, Texas
February 25, 2002

S-1

WASTE MANAGEMENT, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN MILLIONS)

(A) Reserves for doubtful accounts relative to purchase business
combinations, reserves associated with dispositions of businesses, reserves
reclassified to operations held for sale, and reclass among reserve
accounts.

(B) Includes reserves for doubtful long-term notes receivable.

(C) Accruals are included in accrued liabilities and other liabilities. These
accruals represent transaction or deal costs, employee severance,
separation, and transitional costs and restructuring charges.

(D) For major maintenance expenditures at the Company's waste-to-energy and
independent power production plants.

S-2

EXHIBIT INDEX

- ---------------

* In the case of incorporation by reference to documents filed under the
Securities Exchange Act of 1934, the Company's file number under that Act is
1-12154.