WASTE MANAGEMENT INC - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES 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
SUITE 4000
HOUSTON, TEXAS 77002
(Address of principal executive offices)

(713) 512-6200
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

The number of shares of Common Stock, $.01 par value, of the registrant
outstanding at July 31, 2002 was 611,658,364 (excluding treasury shares of
18,658,919).

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PART I

ITEM 1. FINANCIAL STATEMENTS.

WASTE MANAGEMENT, INC.

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

See notes to consolidated financial statements.
1

WASTE MANAGEMENT, INC.

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

See notes to consolidated financial statements.
2

WASTE MANAGEMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)

See notes to consolidated financial statements.
3

WASTE MANAGEMENT, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN MILLIONS, EXCEPT SHARES IN THOUSANDS)
(UNAUDITED)

See notes to consolidated financial statements.
4

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The consolidated financial statements of Waste Management, Inc., a Delaware
corporation, and subsidiaries ("Waste Management" or the "Company") presented
herein are unaudited. In the opinion of management, these financial statements
include all adjustments, which, except as described elsewhere herein, are of a
normal recurring nature, necessary for a fair presentation of the financial
position, results of operations, and cash flows for the periods presented. The
results for interim periods are not necessarily indicative of results for the
entire year. The financial statements presented herein should be read in
connection with the financial statements included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2001.

The preparation of 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. These estimates
and assumptions will also affect the reported amounts of certain revenues and
expenses during the reporting period. Actual results could differ materially
based on any changes in estimates and assumptions that the Company uses in the
preparation of its financial statements. Additionally, the estimates and
assumptions used in landfill airspace amortization and final closure and
post-closure rates per ton and environmental remediation liabilities require
significant engineering and accounting input. 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 or future
operational plans, and the inherent imprecision associated with estimating
matters so far into the future. See "Management's Discussion and Analysis"
elsewhere herein.

In the Company's Annual Report on Form 10-K for the year ended December 31,
2001, the Company reported accrued interest of $137 million as a component of
accounts payable. In its Quarterly Report on Form 10-Q for the quarter ended
March 31, 2002, the Company started reporting accrued interest as a component of
accrued liabilities instead of accounts payable. In order to conform the prior
period presentation of accrued interest to the current period presentation, the
Company has reclassified the $137 million of accrued interest at December 31,
2001 to accrued liabilities in the consolidated balance sheet presented
elsewhere herein.

During the second quarter of 2002, the Company reviewed the accounting and
reporting for certain contractual arrangements entered into in the mid-1980s
relating to a waste-to-energy plant owned by a subsidiary of Wheelabrator
Technologies Inc. ("WTI"). The Company acquired a majority interest in WTI, and
thus, the subsidiary plant in 1990. In 1998, the Company became the 100% owner
of WTI, and thus, the subsidiary plant. Under the arrangements, WTI's subsidiary
owns and operates the plant, but the contracting communities that the plant
serves pay all debt and debt service related to the plant. Although the
contracting communities have funded all of the debt payments during the
seventeen years of operation of the plant, WTI's subsidiary is the borrower
under the debt. Therefore, the Company has concluded that the assets and
liabilities associated with these arrangements should be reflected on the
Company's balance sheet. As a result, the Company recorded an increase in
property, plant and equipment in the second quarter of 2002 of approximately $72
million; an increase in other long-term assets of approximately $52 million; an
increase in debt of approximately $114 million (which includes the current
portion of approximately $20 million); and an increase in other liabilities of
$5 million. The Company also recognized income of $5 million in the current
period. The current arrangements with the contracting communities expire in 2005
at which time the debt will be paid in full. Upon expiration of those
arrangements WTI's subsidiary will retain ownership of the plant.

5

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. LONG-TERM DEBT

Long-term debt consisted of the following (in millions):

On June 27, 2002, the Company replaced its $750 million syndicated 364 day
line of credit with a $620 million syndicated revolving credit facility (the
"Three Year Revolver"). The Company maintained its $1.75 billion syndicated
revolving credit facility (the "Five Year Revolver"). No balances were
outstanding from the Company's revolving credit facilities as of December 31,
2001 or June 30, 2002. The Three Year Revolver matures in June 2005 and the Five
Year Revolver matures in June 2006. As of June 30, 2002, the Company had letters
of credit in the aggregate amount of approximately $1,570 million (of which
approximately $1,450 million were issued under the revolving credit facilities)
that generally have terms allowing automatic renewal after a year. At June 30,
2002, the Company had unused and available credit capacity under these
facilities of approximately $920 million.

In May 2002, the Company privately placed $500 million of 7 3/4% senior
unsecured notes due May 15, 2032. Interest on the notes is due on November 15
and May 15 of each year. The net proceeds of the offering were approximately
$498 million, after deducting underwriters' discounts and expenses. The Company
used a portion of these proceeds to pay the $300 million of 6.625% senior notes
that matured on July 15, 2002, and has invested the remaining proceeds in cash
equivalent investments pending their expected use for repayment of a portion of
senior notes that will mature during 2002.

During the first quarter of 2002, the Company refinanced approximately $49
million of fixed-rate tax-exempt bonds maturing in 2011 with variable-rate
tax-exempt bonds maturing in 2022. As a result, the Company incurred prepayment
penalties and other fees for a total extraordinary item charge, net of tax
benefit, of approximately $1 million. Also, in the first quarter of 2002, the
Company retired its 4% convertible subordinated notes due February 2002 by
payment of $427 million to the holders of the outstanding notes.

The Company has $285.7 million of 7.7% senior notes due October 1, 2002 and
$350 million of 6.5% senior notes due December 15, 2002. The Company has
classified these borrowings as long-term at June 30, 2002 and December 31, 2001
based upon its ability to use its revolving credit facilities, which are both
long-term, to refinance these borrowings. The Company intends to use the
remaining funds received from its May 2002 $500 million senior issuance and
other sources of long-term financing to refinance the borrowings. However, if
other sources of long-term financing are not available, the Company intends to
use its revolving credit facilities.

6

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company manages its debt portfolio by using interest rate derivatives
to achieve a desired position of fixed and floating rate debt, which is
approximately 65% fixed and 35% floating at June 30, 2002. Interest rate swap
agreements that were outstanding as of December 31, 2001 and June 30, 2002 are
set forth in the table below (in millions):

The significant terms of the interest rate contracts and the underlying
debt instrument are identical. Accordingly, the interest rate contracts for
which we receive a fixed rate and pay a floating rate are recorded at fair value
and changes in fair value of these interest rate contracts are deferred as an
adjustment to the carrying value of the underlying debt instruments and
recognized in interest expense over the life of the underlying debt instruments.

The carrying value of senior notes and debentures have been increased by
approximately $102 million and $60 million as of June 30, 2002 and December 31,
2001, respectively, related to the accounting for interest rate swap contracts.
As of June 30, 2002 and December 31, 2001, $50 million and $60 million,
respectively, of this increase related to remaining unamortized accumulated fair
value adjustments from interest rate swaps that were terminated in 2001.
Approximately $2 million is included as an increase to the tax-exempt and
project bonds classification at both June 30, 2002 and December 31, 2001,
respectively, for swaps that were terminated in 2001. Interest rate contracts
reduced interest expense by $23 million and $43 million for the three and six
months ended June 30, 2002, respectively, and $5 million and $6 million for the
three and six months ended June 30, 2001, respectively.

The Company also entered into financing transactions in February 2001 and
during the second quarter of 2002 to secure the then current market interest
rate in anticipation of senior unsecured note issuances. At June 30, 2002, these
cash flow hedges resulted in a deferred loss, net of taxes, of $22 million,
which is included in accumulated other comprehensive income. Approximately $1
million of this deferred loss is expected to be reclassified into interest
expense over the next 12 months.

During June 2002, the Company entered into forward contracts and
cross-currency swaps with notional amounts of $165 million Canadian dollars to
mitigate the risk of foreign currency exchange rate fluctuations associated with
the conversion of Canadian dollars into US dollars. The current fair value of
these cash flow hedges at June 30, 2002 are not material to the Company's
financial statements. The Company had no foreign currency derivatives
outstanding at December 31, 2001.

2. INCOME TAXES

The difference in federal income taxes computed at the federal statutory
rate and reported income taxes for the three and six months ended June 30, 2002
is primarily due to state and local income taxes, offset in part by
non-conventional fuel tax credits. For the three and six months ended June 30,
2001, the difference is primarily due to state and local income taxes,
non-deductible costs related to acquired intangibles and non-deductible costs
associated with the impairment and divestiture of certain businesses.
Additionally, in the second quarter of 2001, scheduled Canadian federal and
provincial tax rate reductions resulted in a tax benefit of $42 million, which
was offset in part by a tax expense of $30 million related to the Company's plan
to repatriate certain Canadian capital and earnings previously deemed
permanently invested in Canada.

7

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. 2002 RESTRUCTURING

In March 2002, the Company adopted a new organizational structure designed
to better align collection, transport, recycling and disposal resources within
market areas. The Company believes the new structure will yield a number of
benefits, including clearer accountability and responsibility for business
performance and profitability in specific markets; simplification of structure;
cost savings through consolidation of duplicate administrative and other support
functions; improved utilization of operating assets; and better customer
responsiveness.

As of June 30, 2002, all of the Company's operations other than WTI and
Canadian Waste Services ("CWS") were restructured to reduce the number of field
layers of management from four to three and the number of field layers that have
administrative and functional staff from four to two. Under the new structure,
the Company's approximately 1,200 operating sites, including waste collection
depots, transfer stations, landfills and recycling facilities, were restructured
into approximately 85 newly established Market Areas. These Market Areas are
responsible for the sales and marketing of the Company's services and for
directing the delivery of service by the districts. The Market Area is also the
profit center, and the districts, all of which used to be profit centers, became
cost centers. Each large Market Area is headed by a Vice President and the
others are headed by a General Manager. The Market Areas consolidate 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, engineering, regulatory compliance, safety
and public affairs to support the districts. These Market Areas all report to
one of four Groups that divide the United States geographically, and which were
formerly known as the Company's "Areas." CWS, which was restructured in July
2002, and WTI were the fifth and sixth Groups under the previous structure and
continue as the fifth and sixth Groups under the new structure.

In March 2002, the Company recorded a $37 million pre-tax charge for costs
associated with the implementation of the new structure, including $34 million
for employee severance and benefit costs and $3 million related to abandoned
operating lease agreements. Under the new structure, approximately 1,800
field-level administrative and operational positions have been eliminated. The
Company's obligation for severance payments will continue during the second half
of 2002 and, in some cases, into 2003. As of June 30, 2002, payments of $22
million for employee severance and benefits and for abandoned leases had been
recorded against the liability that was established in March 2002.

The Company expects to incur an additional $5 million of restructuring
expenses in the second half of 2002 primarily related to the relocation of
employees and the consolidation of facilities to support the new organizational
structure, which includes organizational changes in the third quarter of 2002 to
the Company's CWS operations.

4. EARNINGS PER SHARE

The following reconciles the number of common shares outstanding at June 30
of each year to the weighted average number of common shares outstanding and the
weighted average number of common and

8

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

dilutive potential common shares outstanding for the purposes of calculating
basic and diluted earnings per common share (shares in millions):

For the six months ended June 30, 2002, interest expense (net of taxes) of
$1 million has been added to net income for the diluted earnings per share
calculation. For the three months ended June 30, 2001, interest expense (net of
taxes) of $3 million has been added to net income for the diluted earnings per
share calculation. For the six months ended June 30, 2001 and for the three
months ended June 30, 2002, the effect of the Company's convertible subordinated
notes are excluded from the diluted earnings per share calculation because the
inclusion of such items would be antidilutive.

At June 30, 2002, there were approximately 48.2 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.

5. DERIVATIVE INSTRUMENT POTENTIALLY SETTLED IN COMMON STOCK

In March 2002, the Company entered into an accelerated stock repurchase
master agreement to facilitate the repurchase of shares of its common stock
under its stock buy back program announced in February 2002. The transactions
under the agreement may, as described below, be settled in shares of the
Company's common stock.

Pursuant to the agreement, the Company may from time to time enter into
transactions to purchase shares from the counterparty for a notional amount
equal to the fair market value of the shares on the date that it elects to
purchase. Six months from the date of purchase, the parties enter into a
settlement pursuant to which, if the weighted average daily market prices for
the stock during such six month period (other than certain days during which the
Company is entitled to purchase in the market) times the number of shares
initially purchased is greater than the notional amount, the Company will pay
the counterparty the difference. If the weighted average daily market price for
the valuation period times the number of shares initially purchased is less than
the notional amount, the counterparty will pay the Company the difference.
Subject to certain conditions, the Company has the option of paying its
settlement amount, if any, in shares of its common stock or with cash. Were the
Company to settle in shares of common stock, it would issue those shares out of
treasury.

In the first quarter of 2002, the Company entered into a transaction to
purchase stock under the agreement, purchasing approximately 10.9 million shares
at $27.46 per share for a total of approximately $300 million. The Company
accounted for the initial payment as a purchase of treasury stock and has
classified the future settlement with the counterparty as an equity instrument.
Under the agreement, the number of shares to be issued by the Company, if the
Company were required to pay the counterparty and elected to net settle in
shares, is capped at ten million shares. The settlement will not occur until
September 2002, and therefore, the Company is unable at this time to predict the
number of shares, if any, it would have to issue were it to elect that payment
option.

9

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Based on the Company's weighted average stock price through June 30, 2002,
the Company would receive in cash approximately $6 million from the counterparty
to settle the contracts. However, for every one dollar of change in the weighted
average price of the Company's common stock during the valuation period, the
settlement amount would change by $10.9 million.

6. COMPREHENSIVE INCOME

Comprehensive income is as follows (in millions):

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

7. ENVIRONMENTAL LIABILITIES

The Company has material financial commitments for final closure and
post-closure obligations with respect to the landfills it owns or operates.
Estimates of 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. Adjustments for final closure and post-closure
estimates are accounted for prospectively over the remaining capacity of the
landfill. 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 a calculated rate
per ton and charged to expense as airspace is consumed. Each year the Company
revises its calculated rate per ton to reflect accretion on the present value of
the liability. The revised rate per ton is calculated by dividing the revised
present value of the liability, less the accumulated liability recognized to
date, by the estimated remaining capacity of the landfill. The present value of
total estimated final closure and post-closure costs 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

10

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 regulations, 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 and the
number of years the Company was connected with the site. The Company also
reviews 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 uses the amount within the range
that constitutes its best estimate. If no amount within the range appears to be
a better estimate than any other, the Company uses the amounts that are the low
ends of the ranges in accordance with Statement of Financial Accounting
Standards No. 5, Accounting for Contingencies, and its interpretations. Were the
Company to use the high ends of such ranges, it is reasonably possible that the
Company's potential liability would be approximately $258 million higher on a
discounted basis in the aggregate than the estimate recorded in the consolidated
financial statements as of June 30, 2002. As used in this context, "reasonably
possible" means the Company believes it is more than remote but less than
likely.

As of June 30, 2002, the Company or its subsidiaries had been notified that
they are potentially responsible parties in connection with 77 locations listed
on the NPL at which the Company's liability has not been rendered remote as a
result of a settlement, judgment or other facts. Of the 77 NPL sites at which
claims remain unliquidated, 17 are sites that the Company currently owns. All of
the NPL sites owned by the Company were initially developed by others as
landfill disposal facilities. At each of the 17 owned facilities, the Company is
working with the appropriate government agency to characterize or remediate
identified site problems. In addition, at these 17 owned facilities, the Company
has either agreed with other liable parties on an arrangement for sharing the
costs of remediation or is pursuing resolution of an allocation formula. The 60
NPL sites at which claims against the Company remain unliquidated 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
governmental decisions as to the appropriate remedy and agreements 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,
and as they become estimable, could have a material adverse effect on the
Company's financial statements.

Estimates 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. It is possible that technological, regulatory
or enforcement developments, the results of environmental studies, the inability
to identify other PRPs, the

11

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

inability of other PRPs to contribute to the settlements of such liabilities, or
other factors could necessitate the recording of additional liabilities that
could be material. Additionally, the Company's ongoing review of its remediation
liabilities could result in revisions that could cause upward or downward
adjustments to income from operations. These adjustments could be material in
any given period.

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 until expected time of
payment and then discounted to present value. The inflation rate and discount
rate, which are based on the rates for United States Treasury bonds, are
reviewed on an annual basis. At both June 30, 2002 and December 31, 2001, the
inflation rate and discount rate were 2.0% and 5.5%, respectively. The accretion
of the interest related to the discounted environmental liabilities for
operating landfills 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.

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

The changes to environmental liabilities are as follows (in millions):

8. COMMITMENTS AND CONTINGENCIES

Financial instruments -- The Company has provided letters of credit,
performance bonds, trust agreements, financial guarantees and insurance policies
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, 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 generally has available alternative
bonding mechanisms. Because virtually no claims have been made against these
financial instruments in the past, management does not expect that these
instruments will have a material adverse effect on the Company's consolidated
financial statements. The Company has not experienced any unmanageable
difficulty in obtaining performance bonds or letters of credit for its current
operations. However, the tragic events of September 11, 2001, as well as
recently publicized financial difficulties of several large public companies,
have had an impact on the financial status of a number of insurance, surety and
reinsurance providers, which could cause an increase in the cost

12

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

and a decrease in the availability of surety and insurance coverages available
to the Company in the future. The Company has arranged for new sources of
bonding capacity and continues to evaluate a number of options for further
capacity increases.

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 of 1978, as amended (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.

Environmental matters -- The Company's business 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 it
generally 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.

For more information regarding commitments and contingencies with respect
to environmental matters, see Note 7.

Litigation -- A group of companies that sold assets in exchange for common
stock in March 1996 to Waste Management Holdings, Inc. ("WM Holdings"), which
was acquired by the Company in July 1998 (the "WM Holdings Merger"), brought an
action against the Company in March 2000 for breach of contract and fraud, among
other things. The parties have agreed to resolve this dispute through
arbitration, which is currently scheduled for November 2002. The extent of
damages, if any, 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' former auditor, Arthur Andersen
LLP ("Andersen"), 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 is
currently in the discovery stage and the extent of possible damages, if any, has
not yet been determined.

To the extent that the Company is liable for any damages in the lawsuits
described above, it may be able to seek reimbursement of some of these damages
from a third party. However, it is reasonably possible that if any such
reimbursement is ultimately sought, the Company would not be successful in
collecting such amounts, and the Company would be required to recognize an
additional loss.

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 pre-tax
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

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WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 $1.76 billion 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 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 in this case, resolving all claims against it as
well as claims against its current and former officers and directors. The
agreement provides for a payment of $457 million to members of the class and for
the Company to consent to the certification of a class for the settlement of
purchasers or acquirers of the Company's securities from June 11, 1998 through
November 9, 1999. Additionally, as part of the settlement agreement, the Company
presented, and its stockholders approved at the 2002 annual meeting of
stockholders, a binding proposal to amend the Company's certificate of
incorporation so that all directors are elected annually. A hearing was held
April 29, 2002 at which the settlement was approved. The settlement approval is
still subject to any appeals that may be filed within thirty days of the
approval becoming final. There is currently a motion to vacate pending before
the court, and the appeal period will begin to run once that motion has been
decided.

Also on November 7, 2001, the Company announced that it would receive $20
million (less fees of approximately $5 million awarded to counsel for the
derivative plaintiffs) as a result of a settlement reached between the
derivative plaintiffs and Andersen in a stockholder derivative suit filed on
July 3, 2001 in Texas state court against Andersen, as the Company's independent
auditor. The Company has recorded a receivable from Andersen in the amount of
approximately $20 million. The derivative plaintiffs alleged, among other
things, that Andersen engaged in professional malpractice in connection with
certain services that it performed for the Company. Andersen informed the
Company that neither the complaint nor the settlement affected its independence
in 2001 or prior years, when Andersen served as the Company's independent
auditor. The settlement was approved in May 2002. Andersen's payment will become
due at the same time the Company's payment to the plaintiffs in settlement of
the class action lawsuit described above becomes due, which is the date that all
time periods for appeal have lapsed or the judgment becomes final after all
appeals have been exhausted. Because of current motions before the Court and the
possible appeals process, the Company cannot predict when the class action
payment will be due, and thus cannot predict when the Andersen receivable will
become due. Although Andersen has experienced highly publicized negative events
and has recently announced significant curtailments in its business, the Company
presently has no reason to believe that the

14

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

settlement amount will not be paid and the receivable that the Company has
recorded will not be collected. Any prolonged delays in the payment ultimately
becoming due could make such payment more uncertain, depending on Andersen's
financial status at such time. If such uncertainties develop in the future, it
is reasonably possible that the Company will be required to write down the
receivable up to the full amount due from Andersen.

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. The named plaintiffs in the Delaware case have excluded themselves from
the Texas class action settlement. The case is still at a relatively early
stage, and the amount of damages, if any, cannot yet be determined.

Three 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 plaintiff in the
Virginia case has excluded himself from the Texas class action settlement. 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 Company
reached a settlement with the plaintiffs in the Michigan state and federal
lawsuits in April 2002. The third seller's lawsuit was brought in California
state court in July 2001, with an amended complaint filed in December 2001. The
parties to this lawsuit entered into a settlement agreement in April 2002.

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 stockholders of the Company's common
stock who intended to sell their stock in 1999, or to otherwise protect
themselves 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 or not to take other
measures. Plaintiffs assert that the value of their retained stock declined
dramatically. Plaintiffs assert claims for fraud, negligent misrepresentation,
and conspiracy. The Texas state court granted the Company's motion for summary
judgment in the first of these cases in March 2002, which the plaintiffs have
appealed. The second of these cases is in an early stage, and the extent of
damages, if any, cannot yet be determined.

The Company's business is intrinsically connected with the protection of
the environment, and 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 June 30, 2002, there were nine
proceedings involving Company subsidiaries where the sanctions involved in each
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, (iv) are responsible for late performance of work
required under a Unilateral Administrative Order, (v) improperly operated a
solid waste landfill and caused excess odors, (vi) failed to monitor leachate
flow in a timely fashion and operated a solid waste landfill that potentially
had a compromised leachate collection system, (vii) violated the state's clean
water act, (viii) under-reported solid waste volumes that were received at a
municipal solid waste landfill, and (ix) did not comply with air regulations
requiring control of emissions at a closed landfill. The Company does not
believe that the fines or other penalties in these matters will,

15

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

individually or in the aggregate, have a material adverse effect on the
Company's financial condition or results of operations.

On April 23, 2002, the EPA and the United States Department of Justice
filed a consent decree in federal court finalizing a settlement agreement
reached between Waste Management of Massachusetts, Inc. ("WMMA") and the EPA
arising out of violations relating to management of chlorofluorocarbons ("CFCs")
that were alleged to have occurred in periods prior to July 1998. Under the
consent decree, which was entered in July 2002, WMMA will pay a $0.8 million
civil penalty and spend $2.6 million on environmental projects that involve the
installation of pollution control devices on 150 Boston school buses and the
payment for the supply of cleaner burning low sulfur fuel for the buses, as well
as the creation of a recreational open space area on a 4.5 acre waterfront
property owned by the City of Boston.

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.

Other -- The Company is a party to an agreement pursuant to which it is
obligated to purchase certain operating assets in Canada no later than December
2005. However, there is an option in the agreement that allows either party to
cause an earlier purchase. 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. The
Company does not currently believe that the purchase or other liabilities
associated with its relationship with this third party will have a material
effect on its financial statements.

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.

9. SEGMENT AND RELATED INFORMATION

The Company's one reportable segment consists of its NASW operations. The
NASW operations provide integrated waste management services consisting of
collection, transfer, disposal (solid waste landfill, hazardous waste landfill
and waste-to-energy facilities), recycling, independent power production plants
("IPPs"), and other miscellaneous services to commercial, industrial, municipal
and residential customers throughout the United States, Puerto Rico and Canada.
The Company has broken out its one reportable segment in the table shown below
into "NASW (excluding WTI)" and "WTI," to provide more detailed information.
NASW (excluding WTI) includes the Company's Eastern, Midwest, Western, Southern
and CWS Groups plus its national recycling operations. WTI is the Company's
sixth Group and consists of the Company's waste-to-energy and independent power
production facilities. The Company's previously reported segment that consisted
of waste management services in international markets outside of North America
and non-solid waste services, all of which were divested by March 31, 2002, is
shown in the table below as "Other."

16

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Summarized financial information concerning the Company's reportable
segments is shown in the following table (in millions). Prior period information
has been restated to conform to the current year presentation.

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

(a) Corporate functions include the corporate treasury, legal, information
technology, corporate tax, corporate insurance, management of closed
landfills and related insurance recoveries, centralized service center and
other typical administrative functions.

(b) Other operations are net of intersegment revenue with NASW of $0 and $1
million for the three and six months ended June 30, 2002, respectively, and
$13 million and $19 million for the corresponding periods of 2001. There
are no other significant sales between reportable segments. However, WTI
operations are net of intrasegment revenue with NASW (excluding WTI) of $14
million and $29 million for the three and six months ended June 30, 2002,
respectively, and $12 million and $27 million for the corresponding periods
of 2001. Additionally, NASW (excluding WTI) operations are net of
intrasegment revenue with WTI of $5 million and $10 million for the three
and six months ended June 30, 2002, respectively, and $6 million and $12
million for the corresponding periods of 2001.

(c) The Company's operating revenues tend to be somewhat lower in the winter
months, primarily due to the lower volume of construction and demolition
waste. The volumes of industrial and residential waste in certain regions
where the Company operates also tends to decrease during the winter months.
The Company's 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.

(d) EBIT is defined as "Earnings Before Interest and Taxes" and equals income
from operations on the consolidated statements of operations. EBIT is an
earnings measurement used by management to evaluate operating performance.

(e) 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 in the Company's Form 10-K for
the year ended December 31, 2001, except as it relates to goodwill. EBIT in
2001 included goodwill amortization of $39 million and $78 million for the
three and six months ended June 30, 2001, respectively, of which $29
million and $58 million for the three and six months ended June 30, 2001
was in the NASW (excluding WTI) operations, $8 million and $16 million for
the three and six months ended June 30, 2001 was in the WTI operations, and
$2 million and $4 million for the three and six months ended June 30, 2001
was in the corporate function. As discussed in Note 12, the Company ceased
the amortization of its goodwill in conjunction with the adoption of SFAS
No. 142 on January 1, 2002. In 2002, the Company's corporate functions
began charging its NASW operations an expense similar to what those NASW
operations' goodwill amortization would have been had the Company not been
required to adopt SFAS No. 142. For the three and six months ended June 30,
2002, this charge increased EBIT for the corporate functions by $37 million
and $73 million, respectively, and decreased EBIT for the WTI operations by
$8 million and $15 million, respectively, and the NASW (excluding WTI)
operations by $29 million and $58 million, respectively.

17

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. WASTE PAPER DERIVATIVES AND HEDGING ACTIVITIES

The Company enters into waste paper swap agreements and other derivative
instruments to secure margins on certain paper products to be sold from its
material recovery facilities. The Company expects to achieve the margins by
entering into transactions to mitigate the variability in cash flows from sales
of waste paper products at floating prices, resulting in a fixed price being
received from sales of such products. The Company accounts for these derivatives
as cash flow hedges. As of June 30, 2002, the net fair value of these
derivatives was a $5 million liability.

In addition, the Company has entered into waste paper swap agreements for
trading purposes with certain counterparties that have issued letters of credit
to the Company to support their credit worthiness. For both the three and six
months ended June 30, 2002, the Company increased revenues by approximately $3
million for waste paper swap agreements not designated as hedges.

For the three and six months ending June 30, 2001 the Company recorded a
gain of $1 million and $7 million, respectively, related to derivative
agreements with Enron North America Corp. ("Enron") as an offset to operating
expenses. In the fourth quarter of 2001, the Company reclassified its
year-to-date net waste paper swap mark-to-market adjustments to be an adjustment
to revenue instead of operating expenses. 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 all of its waste paper
derivatives with Enron had zero fair value at December 31, 2001. In February
2002, the Company terminated its derivative instruments with Enron. The Company
carries a deferred gain as of June 30, 2002, which is included in accumulated
other comprehensive income, of approximately $5 million related to its waste
paper derivatives with Enron that had qualified through November 2001 as cash
flow hedges. This deferred gain is being amortized into earnings as the
forecasted transactions that were previously hedged actually occur. The deferred
gain related to waste paper derivatives that previously qualified as hedges that
are expected to be reclassified into earnings over the next twelve months is
approximately $3 million.

11. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

WM Holdings ("Guarantor"), which is 100% owned by the Company ("Parent"),
has fully and unconditionally guaranteed all of the senior indebtedness of the
Parent, as well as the Parent's 4% convertible subordinated notes that matured
and were repaid in February 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-Guarantors").
Accordingly, the following unaudited condensed consolidating balance sheet as of
June 30, 2002 and the condensed consolidating balance sheet as of December 31,
2001, the unaudited condensed consolidating statements of operations for the
three and six months ended June 30, 2002 and 2001, along with the related
unaudited condensed consolidating statements of cash flows, have been provided
below (in millions).

18

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING BALANCE SHEETS
JUNE 30, 2002
(UNAUDITED)

DECEMBER 31, 2001

19

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2002
(UNAUDITED)

THREE MONTHS ENDED JUNE 30, 2001
(UNAUDITED)

20

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2001
(UNAUDITED)

21

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2001
(UNAUDITED)

22

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. NEW ACCOUNTING PRONOUNCEMENTS

SFAS NO. 141 AND SFAS NO. 142

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 arose from business combinations after June 30, 2001 cannot be amortized.
In addition, SFAS No. 142 required the continuation of the amortization of
goodwill and all intangible assets through December 31, 2001. The amortization
of existing goodwill ceased 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 accounting pronouncement must be classified as the cumulative effect of
a change in accounting principle. Thereafter, goodwill must be tested for
impairment annually and impairment losses must 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.

23

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In accordance with the Company's adoption of SFAS No. 141, the Company
utilizes the purchase method of accounting for its business combinations. In
accordance with the Company's adoption of 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 have ceased being
amortized upon adoption of SFAS No. 142.

Adopting SFAS No. 141 required the Company to write-off net negative
goodwill of approximately $2 million, which was 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 generally defined as an operating
segment or a component of an operating segment in certain circumstances. For the
purposes of applying SFAS No. 142, the Company has identified seven reporting
units , which are the six components in NASW (excluding WTI) and WTI, as
described in Note 9, Segment and Related Information. The Company incurred no
impairment of goodwill upon its initial adoption of SFAS No. 142. However, there
can be no assurance that goodwill will not be impaired at any time in the
future.

The following schedule reflects the three and six months ended June 30,
2001 adjusted net income (excluding goodwill and negative goodwill amortization)
as compared to the results of operations for the three and six months ended June
30, 2002 (in millions, except per share amounts).

The Company's intangible assets as of June 30, 2002 were comprised of the
following (in millions):

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 other intangible assets are
amortized over the terms of the related agreement or the Company's estimate of
the useful life if there are no definite terms.

24

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Landfill operating permits are not presented above and are included in landfill
assets and amortized using the Company's landfill amortization method. The
intangible asset amortization expense estimated as of December 31, 2001, for the
five years following 2001 is as follows (in millions):

As of June 30, 2002, the amount of goodwill attributable to WTI was
approximately $783 million. The remaining goodwill balance of approximately
$4,252 million was attributable to NASW (excluding WTI).

SFAS NO. 143

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 applies to 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 requires amounts initially recognized as an asset retirement obligation
to be measured at fair value. The recognized asset retirement cost is
capitalized as part of the cost of the asset and is depreciated over the useful
life of the asset. The Company expects to adopt SFAS No. 143 beginning January
1, 2003 and to record a cumulative effect of a change in accounting principle.

SFAS No. 143 will impact the Company's accounting for its landfill
operations. Costs associated with future capping activities that occur during
the operating life of a landfill, which are currently recognized on an
undiscounted basis over the operating life of the landfill as airspace is
consumed, will be accounted for as an asset retirement obligation under SFAS No.
143, on a discounted basis. The Company expects to recognize landfill retirement
obligations, which relate to capping, other closure and post-closure activities,
over the operating life of a landfill as landfill airspace is consumed. These
obligations will be initially measured at estimated fair value. Fair value will
be measured on a present value basis, using a credit-adjusted, risk-free rate,
which will be a higher rate than the risk-free rate the Company currently uses
for discounting its final closure and post-closure obligations. Interest will be
accreted on landfill retirement obligations using the effective interest method.
Landfill retirement costs, which will be capitalized as part of the landfill
asset, will be amortized using the Company's existing landfill accounting
practices. The Company is addressing which of its other assets may be affected
by the provisions of SFAS No. 143. The Company's management has not yet
determined the pro forma, cumulative or future effects of the adoption of SFAS
No. 143 on its results of operations or financial position. The adoption of SFAS
No. 143 will have no effect on the Company's cash flow.

SFAS NO. 144

In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets ("SFAS No. 144"), which supersedes Statement of
Financial Accounting Standards 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 divestiture transactions. SFAS No. 144
also requires that an impairment loss be recognized for assets held-for-use when
the carrying amount of an asset, or group of assets if the cash flows from those
assets cannot be independently and separately identified, is not recoverable.
The carrying amount of an asset or 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 or asset group, excluding interest charges.
Estimates of future cash flows used to test the recoverability of a long-lived
asset or asset group must incorporate a company's own assumptions about its use
of the asset or asset group and must factor in all available evidence. The
Company adopted SFAS No. 144 on January 1,

25

WASTE MANAGEMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2002. Upon initial application of SFAS No. 144, certain previously held-for-sale
assets did not meet SFAS No. 144 criteria to be held-for-sale because their
anticipated sale is in 2003. However, under the transition provisions of SFAS
No. 144, the Company has until December 31, 2002 to either sell these assets or
meet the new held-for-sale criteria to avoid reclassifying the assets to
held-for-use.

SFAS NO. 145

In April 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 145, Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS No.
145"). SFAS No. 145 requires that gains and losses from extinguishment of debt
be classified as extraordinary items only if they meet the criteria in
Accounting Principles Board Opinion No. 30 ("Opinion No. 30"). Applying the
provisions of Opinion No. 30 will distinguish transactions that are part of an
entity's recurring operations from those that are unusual and infrequent and
meet the criteria for classification as an extraordinary item. SFAS No. 145 is
effective for the Company beginning January 1, 2003. Upon the adoption of SFAS
No. 145, the Company will reclassify certain items in its prior period
statements of operations to conform to the presentation required by SFAS No.
145. Under SFAS No. 145, the Company will report gains and losses on the
extinguishment of debt in pre-tax earnings rather than in extraordinary items.

SFAS NO. 146

In July 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, Accounting for Costs Associated with
Exit or Disposal Activities ("SFAS No. 146"). SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities,
such as restructuring, involuntarily terminating employees, and consolidating
facilities, initiated after December 31, 2002.

26

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

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 statements containing any other projections or estimates
about our assumptions relating to these types of statements, we are making
forward-looking statements. The 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 we have no control over. Any of these factors, either alone or taken
together, could have a material adverse effect on us and could change whether
any forward-looking statement ultimately turns out to be true. Additionally, we
assume no obligation to update any forward-looking statements as a result of
future events or developments.

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

- possible changes in our estimates of site remediation requirements,
final closure and post-closure obligations, compliance and other audits
and regulatory developments;

- the possible impact of regulations on our business, including the cost
to comply with regulatory requirements and the potential liabilities
associated with disposal operations, as well as our ability to obtain
and maintain permits needed to operate our facilities;

- the effect of limitations or bans on disposal or transportation of
out-of-state waste or certain categories of waste;

- possible charges against earnings for certain shut down operations and
uncompleted acquisitions or development or expansion projects;

- possible charges to asset impairments or further impairments to
long-lived assets resulting from changes in circumstances or future
business events or decisions;

- the effects that trends toward requiring recycling, waste reduction at
the source and prohibiting the disposal of certain types of wastes could
have on volumes of waste going to landfills and waste-to-energy
facilities;

- the effect the weather has on our quarter to quarter results, as well as
the effect of extremely harsh weather on our operations;

- the effect that price fluctuations on commodity prices may have on our
operating revenues;

- the outcome of litigation;

- whether there will be any appeals to the approval of the $457 million
class action lawsuit settlement;

- the effect competition in our industry could have on our ability to
maintain margins, including uncertainty relating to competition with
governmental sources that enjoy competitive advantages from tax-exempt
financing and tax revenue subsidies;

- our ability to successfully implement our new organization plan, improve
the productivity of acquired operations and use our asset base and
strategic position to operate more efficiently;

- our ability to accurately assess all of the pre-existing liabilities of
companies we have acquired and to successfully integrate the operations
of acquired companies with our existing operations;

- possible diversions of management's attention and increases in operating
expenses due to efforts by labor unions to organize our employees;
27

- possible increases in operating expenses due to fuel price increases or
fuel supply shortages;

- the effects of general economic conditions, including the ability of
insurers to fully or timely meet their contractual commitments and of
surety companies to continue to issue surety bonds;

- possible defaults under our credit agreements if cash flows are less
than we expect or capital expenditures are more than we expect, and the
possibility that we cannot obtain additional capital on acceptable terms
if needed; and

- possible errors or problems with our recently deployed and in process
enterprise-wide software and technology systems.

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.

In addition to our North America solid waste ("NASW") operations, we
previously reported additional operations in our WM International and Non-Solid
Waste segments. All of our WM International operations and most of our Non-Solid
Waste operations were sold in 2000 and 2001. Beginning in 2001, we reported a
segment called "Other," comprised of our remaining non-core operations, which
included our geosynthetic manufacturing and installation services and
independent power production plants ("IPPs"). The geosynthetic manufacturing and
installation services were sold in February 2002. In the third quarter of 2001,
we reclassified all but one of our IPPs from held-for-sale to held-for-use and
in the first quarter of 2002, reclassified the IPPs from the "Other" reportable
segment to the Wheelabrator Technologies Inc. ("WTI") operations included in our
single reportable segment, NASW.

CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS

In preparing our financial statements, we make several estimates and
assumptions that affect our assets and liabilities and revenues and expenses for
our one reportable segment, NASW operations. We must make these estimates and
assumptions because certain of the information that is used in the preparation
of our financial statements is dependent on future events, cannot be calculated
with a high degree of precision from data available or is simply not capable of
being readily calculated based on generally accepted methodologies. In some
cases, these estimates are particularly difficult to determine and we must
exercise significant judgment. 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, environmental liabilities and asset
impairments, as described below.

Accounting for Landfills -- We account for certain costs at our landfills
using the "units-of-consumption" method, which means we expense amounts for
certain landfill costs and landfill final closure and post-closure costs for
each unit of waste as it is accepted for disposal at the landfills. This
accounting method requires us to make estimates and assumptions, as described
below. Any changes in our estimates are made prospectively.

Landfill Costs -- We estimate the total cost to develop each landfill
site to its final capacity. This includes certain projected landfill site
costs that are uncertain because they are dependent on future events that
may or may not occur. These costs include amounts previously capitalized
(net of accumulated airspace amortization), and future projected costs for
common site costs (purchase and development costs), liner construction
costs, operating construction costs, and capitalized interest costs.

Final Closure and Post-Closure Costs -- The costs for final closure and
post-closure obligations at landfills we own or operate are generally
estimated based on our interpretations of current requirements and proposed
or anticipated regulatory changes. 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

28

discount rates. The possibility of changing legal and regulatory
requirements and the forward looking nature of these types of costs make
any estimation or assumption less certain.

Available Airspace -- Our engineers determine the remaining capacity at
our landfills by estimating the available airspace. This is done by using
surveys and other methods to calculate, based on height restrictions and
other factors, how much airspace is left to fill and how much waste can be
disposed of before the landfill has reached its final capacity.

Expansion Airspace -- We will also consider currently unpermitted
airspace in our estimate of remaining capacity in certain circumstances.
First, to include airspace associated with an expansion effort, we must
generally expect the expansion permit application to be submitted within
one year, and the expansion permit to be received within five years.
Second, we must believe the success of obtaining the expansion permit is
probable, using the following criteria:

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

- 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.

These criteria are initially evaluated by our field-based engineers,
accountants, managers and others to identify potential obstacles to
obtaining the permits. However, our policy provides that, based on the
facts and circumstances of a specific landfill, exceptions to these
criteria may be permitted. 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 101 landfill sites with
expansions at June 30, 2002, 27 landfills 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. When we include the expansion
airspace in our calculations of available airspace, we also include the
projected costs for development and final closure and post-closure of the
expansion in the amortization basis of the landfill.

It is possible that our estimates or assumptions will ultimately turn
out to be significantly different from actual results. 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. To the extent that such estimates, or the assumptions used to
make those estimates, prove to be significantly different than actual
results, or our belief that we will receive an expansion permit changes
adversely in a significant manner, the costs of the landfill, including the
costs incurred in the pursuit of the expansion, may be subject to
impairment testing, as described below, and lower profitability may be
experienced due to higher amortization rates, higher final closure and
post-closure rates, and higher expenses or asset impairments related to the
removal of previously included expansion airspace.

After determining the costs at our landfills, including final closure
and post-closure costs, and the available and probable expansion airspace,
we then determine the per ton rate that will be expensed. We
29

look at factors such as the waste stream, geography and rate of compaction,
among others, to determine the number of tons it will take to fill the
available and probable expansion airspace. We then divide our costs by that
number of tons, giving us the rate per ton to expense.

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. Remedial costs are all costs relating to the remedy of any
identified situation that occurs by natural causes or human error not expected
in the normal course of business. These costs include costs relating to legal
defense, potentially responsible party ("PRP") investigation, settlement, and
consultant fees, as well as costs directly associated with site investigation
and clean up, such as materials and incremental internal costs directly related
to the remedy. We estimate costs required to remediate sites where liability is
probable based on site-specific facts and circumstances. We routinely review and
evaluate sites that require remediation, including sites listed on the EPA's
National Priorities List ("NPL sites"). We consider whether we were an owner,
operator, transporter, or generator at the site, the amount and type of waste
hauled to the site and the number of years we were connected with the site.
Next, we review the same information with respect to other named and unnamed
PRPs. We then estimate the cost for the likely remedy, which is based on:

- Management's judgment and experience in remediating our own and
unrelated parties' sites;

- Information available from regulatory agencies as to costs of
remediation;

- The number, financial resources and relative degree of responsibility of
other PRPs who may be liable for remediation of a specific site; and

- The typical allocation of costs among PRPs.

These estimates are sometimes a range of possible outcomes. In those cases,
we use the amount within the range that constitutes our best estimate. If no
amount within the range appears to be a better estimate than any other, we use
the amounts that are the low ends of the ranges in accordance with SFAS No. 5,
Accounting for Contingencies, and its interpretations. Were we to use the high
end of such ranges, it is reasonably possible that our potential liability would
be approximately $258 million higher on a discounted basis in the aggregate than
the estimate recorded in the consolidated financial statements as of June 30,
2002. As used in this context, "reasonably possible" means we believe it is more
than remote but less than likely.

Asset Impairments -- Our long-lived assets, including landfills and
landfill expansions, are carried on our financial statements based on their cost
less accumulated depreciation or amortization. However, accounting standards
require us to write-down these assets if they become impaired. If significant
events or changes in circumstances indicate that the carrying value of an asset
may not be recoverable, we perform a test of recoverability by comparing the
carrying value of the asset or asset group to its undiscounted expected future
cash flows. If the carrying values are in excess of undiscounted expected future
cash flow, we measure any impairment by comparing the fair value of the asset to
its carrying value. Fair value is determined by either an actual third-party
evaluation or an internally developed discounted projected cash flow analysis of
the asset. Cash flow projections are sometimes based on a group of assets,
rather than a single asset. If cash flows cannot be separately and independently
identified for a single asset, we will determine whether an impairment has
occurred for the group of assets for which we can identify the projected cash
flows. If the fair value of an asset is determined to be less than the carrying
amount of the asset or asset group, an impairment in the amount of the
difference is recorded in the period that the triggering event occurs.

Typical indicators that an asset may be impaired include:

- A significant decrease in the market price of an asset or asset group;

- A significant adverse change in the extent or manner in which an asset
or asset group is being used or in its physical condition;

- A significant adverse change in legal factors or in the business climate
that could affect the value of an asset or asset group, including an
adverse action or assessment by a regulator;

30

- An accumulation of costs significantly in excess of the amount
originally expected for the acquisition or construction of a long-lived
asset;

- Current period operating or cash flow loss combined with a history of
operating or cash flow losses or a projection or forecast that
demonstrates continuing losses associated with the use of a long-lived
asset or asset group; or

- A current expectation that, more likely than not, a long-lived asset or
asset group will be sold or otherwise disposed of significantly before
the end of its previously estimated useful life.

If any of these indicators occur, we review the asset to determine whether
there has been an impairment. Several of these indicators are beyond our
control, and we cannot predict with any certainty whether or not they will
occur. Additionally, estimating future cash flows requires significant judgment
and our projections may vary from cash flows eventually realized.

RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001

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

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

OPERATING REVENUES

For the three and six months ended June 30, 2002, our operating revenues
decreased $90 million, or 3.1%, and $200 million, or 3.5%, respectively, as
compared to the corresponding 2001 periods. Of the amounts, $42 million and $126
million, respectively, was attributable to lower operating revenues from our
NASW operations for the three and six months ended June 30, 2002 as compared to
the corresponding prior year periods. The remainder was primarily due to
divestitures of non-NASW operations.

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
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.

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The mix of NASW operating revenues for the three and six months ended June
30, 2002 and 2001 is reflected in the table below. The presentation of prior
period operating revenues has been conformed to the current period presentation:

[CHART]

The change in NASW revenues of $42 million and $126 million for the three
and six months ended June 30, 2002, respectively, is reflected in the table
below (in millions).

We experienced negative internal growth for the three and six months ended
June 30, 2002, as compared to the same periods of the prior year, of $57 million
or 2.0%, and $145 million or 2.6%, for the three and six months ended June 30,
2002, respectively, which is substantially volume related. The volume changes
are largely related to reduced commercial and industrial collection volumes
principally in the eastern and midwestern areas of the United States, and
reduced landfill volumes, substantially attributable to the eastern and western
areas of the United States. The lagging economy and increased competition,
particularly in the higher margin commercial and industrial collection
operations, resulted in reduced volumes. Volumes were also negatively affected
$12 million and $18 million for the three and six months ended June 30, 2002,
respectively, by lower construction activities at certain of our waste-to-energy
facilities.
33

Pricing remained flat for the quarter, but declined $8 million, or 0.2%,
for the six months ended June 30, 2002. Revenue from commodity prices increased
$11 million for the three months ended June 30, 2002 and decreased $9 million
for the six months ended June 30, 2002. The increase in the current quarter is
attributable to the significant increase in OCC commodity prices beginning in
the second quarter of 2002. Reduced electricity rates in 2002 in California
compared with last year have negatively impacted revenue change due to price
from our IPPs by $18 million and $33 million for the three and six months ended
June 30, 2002, respectively. Further, reduced diesel fuel costs in the current
year resulted in revenues related to our fuel surcharge program declining $7
million and $23 million for the three and six months ended June 30, 2002,
respectively. However, we substantially offset these price declines with other
price increases of $13 million, or 0.4%, and $57 million, or 1.0%, for the three
and six months ended June 30, 2002, respectively. These price increases are
reflected primarily in the commercial and residential collection operations and
the transfer station business.

Offsetting this negative internal growth was an increase in revenues of $20
million and $38 million for the three and six months ended June 30, 2002,
respectively, due to acquisitions of NASW business during 2002 and the full year
effect of such acquisitions that were completed in 2001. We also experienced a
decrease in revenue of $4 million and $11 million for the three and six months
ended June 30, 2002, respectively, due to divestitures of NASW operations and
the effect of foreign currency fluctuations related to the Canadian dollar.

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, grading,
construction, capitalized interest, and permitting costs. All indirect expenses,
such as administrative salaries and general corporate overhead, are expensed in
the period incurred.

Operating costs and expenses decreased $43 million, or 2.5%, and $124
million, or 3.7%, for the three and six months ended June 30, 2002,
respectively, compared to the prior year periods. As a percentage of operating
revenues, operating costs and expenses were 59.8% and 59.9% for the three and
six months ended June 30, 2002, respectively, and 59.4% and 60.0% for the
corresponding prior year periods. In March 2002 we implemented cost cutting
initiatives and restructured our field based operations. These savings, as a
percentage of operating revenues, were offset by the effect of reduced revenues
caused by the slowing economy in North America. As a result, operating costs and
expenses as a percentage of revenue were relatively consistent for the
comparative prior periods.

SELLING, GENERAL AND ADMINISTRATIVE

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

Selling, general and administrative expenses decreased $39 million, or
9.8%, and $41 million, or 5.2%, for the three and six months ended June 30,
2002, respectively, as compared to the prior year corresponding period. In
addition, as a percentage of operating revenues, our selling, general and
administrative expenses decreased from 13.7% to 12.7% for the three months ended
June 30, 2001 and 2002, respectively, and decreased from 14.0% to 13.7% for the
six months ended June 30, 2001 and 2002, respectively. This decrease in costs is
primarily attributable to our implementation of cost cutting measures, such as
reducing professional fees, the reductions associated with the March 2002
restructuring, and the effect of divestitures of operations in 2002. These
savings were offset by an increase in bad debt expense of $12 million for the
six months ended June 30, 2002 compared to the same period of 2001.

34

DEPRECIATION AND AMORTIZATION

Depreciation and amortization includes (i) amortization of intangible
assets on a straight-line basis from 3 to 40 years; (ii) depreciation of
property and equipment on a straight-line basis from 3 to 50 years; and (iii)
amortization of landfill costs on a units-of-consumption method as landfill
airspace is consumed over the estimated remaining capacity of a site. In 2001,
depreciation and amortization expense also included the amortization of goodwill
on a straight-line basis over a period of 40 years or less, commencing on the
dates of the respective acquisition.

Depreciation and amortization expense decreased $28 million, or 8.2%, and
$69 million, or 10.2% for the three and six months ended June 30, 2002,
respectively, compared to the same three and six month periods of 2001. As a
percentage of operating revenues, depreciation and amortization expense was
11.1% and 11.2% for the three and six months ended June 30, 2002, respectively,
and 11.7% and 12.0% for the corresponding prior periods. The decrease in
depreciation and amortization expense is primarily attributable to our adoption
of Statement of Financial Accounting Standards No. 142, Accounting for Goodwill
and Other Intangible Assets ("SFAS No. 142"), which required that the
amortization of all goodwill cease on January 1, 2002. Goodwill amortization for
the three and six months ended June 30, 2001 was $39 million, or 1.3% of
operating revenues, and $78 million, or 1.4% of operating revenues,
respectively. Excluding the effect of goodwill amortization expense in 2001,
depreciation and amortization expense as a percentage of revenues increased 0.7%
and 0.6% from the three and six months ended June 30, 2001, respectively,
compared to the corresponding periods of 2002. Higher depreciation expense was
recorded in the first half of 2002 primarily due to significant truck purchases
in the last half of 2001. This was substantially offset by lower landfill
airspace amortization expense recorded in the first half of 2002 attributable to
reduced tonnage accepted at our landfills as compared to the first half of 2001.

RESTRUCTURING

In March 2002, we adopted a new organizational structure to better align
collection, transport, recycling and disposal resources within market areas. We
believe the new structure will yield a number of benefits, including clearer
accountability and responsibility for business performance and profitability in
specific markets; simplification of structure; cost savings through
consolidation of duplicate administrative and other support functions; improved
utilization of operating assets; and better customer responsiveness.

As of June 30, 2002, all of our operations other than WTI and Canadian
Waste Services ("CWS") were restructured to reduce the number of field layers of
management from four to three and the number of field layers that have
administrative and functional staff from four to two. Under the new structure,
our approximately 1,200 operating sites, including waste collection depots,
transfer stations, landfills and recycling facilities, were restructured into
approximately 85 newly established Market Areas. These Market Areas are
responsible for the sales and marketing of our services and for directing the
delivery of service by the districts. The Market Area is also the profit center,
and the districts, all of which used to be profit centers, became cost centers.
Each large Market Area is headed by a Vice President and the others are headed
by a General Manager. The Market Areas consolidate 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, engineering, regulatory compliance, safety and public affairs to
support the districts. These Market Areas all report to one of four Groups that
divide the United States geographically, and which were formerly known as our
"Areas." CWS, which was restructured in July 2002, and WTI were the fifth and
sixth Groups under the previous structure and continue as the fifth and sixth
Groups under the new structure.

In March 2002, we recorded a $37 million pre-tax charge for costs
associated with the implementation of the new structure, including $34 million
for employee severance and benefit costs and $3 million related to abandoned
operating lease agreements. Under the new structure, approximately 1,800
field-level administrative and operational positions have been eliminated. Our
obligation for severance payments will continue during the second half of 2002
and, in some cases, into 2003. As of June 30, 2002, payments of $22 million for
employee severance and benefits and for abandoned leases had been recorded
against the liability that was established in March 2002.

35

We expect to incur an additional $5 million of restructuring expenses in
the second half of 2002 primarily related to the relocation of employees and the
consolidation of facilities to support the new organizational structure, which
includes organizational changes in the third quarter of 2002 to our CWS
operations.

ASSET IMPAIRMENTS AND UNUSUAL ITEMS

During the first quarter of 2002, we recorded a net credit to asset
impairments and unusual items primarily due to a reversal of a loss contract
reserve of approximately $4 million and adjustments of $5 million for revisions
of estimated losses on assets held-for-sale. These amounts were partially offset
by asset impairment charges primarily relating to our 2002 restructuring
efforts. We incurred no such costs during the second quarter of 2002.

For the three and six months ended June 30, 2001, asset impairments and
unusual items were primarily attributable to our divestiture activities, offset
in part by a reversal of a loss contract reserve that was determined to be
excessive after a favorable renegotiation of that specific contract.

INTEREST EXPENSE

Interest expense decreased by $31 million and $69 million for the three and
six months ended June 30, 2002, respectively, as compared to the corresponding
periods in 2001. Interest rate swap contracts reduced interest expense by $23
million and $43 million for the three and six months ended June 30, 2002,
respectively, and $5 million and $6 million for the corresponding prior year
periods. The remaining decrease in interest expense between the second quarter
of 2002 and 2001 is primarily due to the repayment or refinancing of debt
instruments throughout 2001 and into 2002 at lower interest rates.

PROVISION FOR INCOME TAXES

We recorded a provision for income taxes of $135 million and $219 million
for the three and six months ended June 30, 2002, respectively, and $113 million
and $202 million for the corresponding periods of 2001. The difference in
federal income taxes computed at the federal statutory rate and reported income
taxes for the three and six months ended June 30, 2002 is primarily due to state
and local income taxes, offset in part by non-conventional fuel tax credits. For
the three and six months ended June 30, 2001, the difference is primarily due to
state and local income taxes, non-deductible costs related to acquired
intangibles and non-deductible costs associated with the impairment and
divestiture of certain businesses. Additionally, in the second quarter of 2001,
scheduled Canadian federal and provincial tax rate reductions resulted in a tax
benefit of $42 million, which was offset in part by a tax expense of $30 million
related to our plan to repatriate certain Canadian capital and earnings
previously deemed permanently invested in Canada.

EXTRAORDINARY ITEMS

During the first quarter of 2002, we refinanced approximately $49 million
of fixed-rate tax exempt bonds maturing in 2011 with variable-rate tax exempt
bonds maturing in 2022. As a result, we incurred prepayment penalties and other
fees for a total charge, net of tax benefit, of approximately $1 million.

In the first quarter of 2001, the Company, working with local governmental
authorities, refinanced $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 that matured later in 2001. We
recorded a net extraordinary loss of $1 million for the remaining unamortized
premium and issuance costs related to the retired debt.

CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLE

As a result of adopting Statement of Financial Accounting Standards
("SFAS") No. 141, "Accounting for Business Combinations," on January 1, 2002, we
were required to write-off amounts of negative goodwill that had been recorded
in prior periods through purchase accounting. The aggregate amount of negative

36

goodwill was $2 million and was recorded as a credit to cumulative effect of
change in accounting principle in the first quarter of 2002.

SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended, became effective for the Company as of January 1, 2001.
Adoption of SFAS No. 133, as amended, resulted in a gain, net of tax, of
approximately $2 million in the first quarter of 2001.

LIQUIDITY AND CAPITAL RESOURCES

The following is a summary of our cash balances and cash flows for the six
months ended June 30, 2002 and 2001 (in millions):

We generated cash flows from operations of $884 million for the six months
ended June 30, 2002. During that period, we spent $449 million for investing
activities, which was comprised of capital expenditures of $552 million and
acquisitions of businesses of $64 million, offset by proceeds from sales of
assets and cash generated from other investing activities of $167 million. In
addition, we used $447 million for financing activities, which included $500
million spent for our stock buy back program, offset by $30 million of net debt
borrowings and $23 million from exercises of common stock options and warrants.

For the six months ended June 30, 2001, we generated cash flows from
operations of approximately $866 million. We used $449 million for our investing
activities during the six months ended June 30, 2001. Included in our investing
activities for this period were capital expenditures of $474 million and
acquisitions of solid waste businesses of $65 million offset by proceeds from
sales of assets and other investing activities of $90 million. In addition, we
used $114 million for financing activities which is primarily comprised of $133
million of net debt reductions offset by proceeds 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 consolidated statements of cash flows for the six months ended
June 30, 2002 and 2001, 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 and then adjusted for certain cash flow activity that the
Company considers as unusual for the respective periods.

37

The analysis of free cash flows for the six months ended June 30, 2002 and
2001 is as follows (in millions):

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

(a) EBITDA is defined herein as income from operations excluding depreciation
and amortization, asset impairments and unusual items, and restructuring
related expenses. 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 the Company's financial position and performance.

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. Based on several key factors we believe are considered by
credit rating agencies and financial markets to be important in determining our
future access to financing, we expect to continue to maintain access to capital
sources in the future. These factors include:

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

- our ability to generate strong and consistent cash flows;

- our asset base; and

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

Our strategy is to meet our capital needs and contractual obligations first
from internally generated funds. We also have bank borrowings available for our
capital needs and contractual obligations. Finally, we also, when appropriate,
will obtain financing from issuing debt or common stock.

As of June 30, 2002, we had a $620 million syndicated revolving credit
facility (the "Three Year Revolver"), which was increased to $650 million by
August 2002, and a $1.75 billion syndicated revolving credit facility (the "Five
Year Revolver"). No balances were outstanding from the Company's revolving
credit facilities as of December 31, 2001 or June 30, 2002. The Three Year
Revolver matures in June 2005 and the Five Year Revolver matures in June 2006.
As of June 30, 2002, we had letters of credit in the aggregate amount of
approximately $1,570 million (of which approximately $1,450 million are issued
under the revolving credit facilities) that generally have terms allowing
automatic renewal after a year. At June 30, 2002, we had unused and available
credit capacity under these facilities of approximately $920 million.

We manage our debt portfolio by using interest rate derivatives to achieve
our desired position of fixed and floating rate debt of approximately 65% fixed
and 35% floating at June 30, 2002. In addition, we

38

periodically enter into financing transactions to secure the then current market
interest rate in anticipation of senior debt issuances.

In May 2002, we privately placed $500 million of 7 3/4% senior unsecured
notes due May 15, 2032. Interest on the notes is due on November 15 and May 15
of each year. The net proceeds of the offering were approximately $498 million,
after deducting underwriters' discounts and expenses. We used a portion of these
proceeds to pay the $300 million of 6.625% senior notes that matured on July 15,
2002, and have invested the remaining proceeds in cash equivalent investments
pending their expected use for repayment of a portion of senior notes that will
mature during 2002.

We believe that our available short-term and long-term capital resources
are sufficient to fund our capital expenditure and working capital requirements,
scheduled debt payments, interest and income tax obligations and other
obligations including acquisitions and share repurchases described below. Our
capital requirements include (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. We currently expect to spend approximately $700
million for capital expenditures and approximately $185 million for the
purchases of businesses during the final half of 2002.

We have $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 intend to use the
remaining funds received from our May 2002 $500 million senior issuance and
other sources of long-term financing to refinance the borrowings. However, if
other sources of long-term financing are not available, we intend to use our
revolving credit facilities. Consequently, we have classified these borrowings
as long-term at June 30, 2002 and December 31, 2001 based upon our ability to
use our revolving credit facilities, which are both long-term, to refinance
these borrowings.

In February 2002 we announced that our Board of Directors had approved a
stock buy back program for up to $1 billion in annual repurchases for each of
the next three years. The purchases will be made in open market purchases or
privately negotiated transactions primarily using cash flows from operations.

In March 2002, we entered into an accelerated stock repurchase master
agreement to facilitate the repurchase of shares of our common stock. Pursuant
to the agreement, we may from time to time enter into transactions to purchase
shares from the counterparty for a notional amount equal to the fair market
value of the shares on the date that we elect to purchase. Six months from the
date of purchase, the parties enter into a settlement pursuant to which, if the
weighted average daily market prices for the stock during such six month period
(other than certain days during which we are entitled to purchase in the market)
times the number of shares initially purchased is greater than the notional
amount, we will pay the counterparty the difference. If the weighted average
daily market price for the valuation period times the number of shares initially
purchased is less than the notional amount, the counterparty will pay us the
difference. We have the option of paying the settlement amount, if any, in
shares of our common stock or with cash. Were we to settle in shares of common
stock, we would issue those shares out of treasury.

In the first quarter of 2002, we entered into a transaction to purchase
stock under the agreement, purchasing approximately 10.9 million shares at
$27.46 per share for a total of approximately $300 million. We accounted for the
initial payment as a purchase of treasury stock and have classified the future
settlement with the counterparty as an equity instrument. Under the agreement,
the number of shares to be issued, if we were required to pay the counterparty
and elected to net settle in shares, is capped at ten million shares. The
settlement will not occur until September 2002, and therefore, we are unable at
this time to predict the number of shares, if any, we would have to issue were
we to elect that payment option.

Based on our weighted average stock price through June 30, 2002, and July
31, 2002, we would expect to receive in cash approximately $6 million and $14
million, respectively, from the counterparty to settle the contracts. However,
for every one dollar of change in the weighted average price of our common stock
during the valuation period, the settlement amount would change by $10.9
million.

We have also engaged in open market purchases of our common stock during
those periods when, per Company policy, there is an open trading window. During
the second quarter of 2002, excluding the transaction under the accelerated
stock repurchase master agreement, we had repurchased approximately
39

7.3 million shares for a total of approximately $200 million. As previously
announced, our intention is to repurchase up to $1 billion each year, and we
currently expect that we will have purchased very close to that amount at the
end of 2002.

In November 2001, we announced that we had entered into an agreement to
settle the consolidated class action lawsuit filed against us in July 1999
alleging violations of the federal securities laws by payment of $457 million to
the class members. We expect our net cash outflow, after considering insurance,
tax deductions and related settlement costs, to be approximately $230 to $240
million. The Court approved the settlement in April 2002; however, there is
currently a motion to vacate pending before the Court. If the Court denies the
motion, a thirty day appeal period will begin. If an appeal is filed, the
judgment will not become final until all appeals are exhausted or dismissed. We
do not have to pay the settlement until the judgment is final. However, our
settlement fund began to accrue interest, at the Federal Funds rate, beginning
June 30, 2002. We currently expect that we will fund the settlement in late
2002.

SPECIAL PURPOSE ENTITIES

On June 30, 2000, two limited liability companies ("LLCs") were established
to purchase interests in existing leveraged lease financings at three
waste-to-energy facilities that we operate under an agreement with the owner.
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"). We have a 0.5% interest in both LLCs. Hancock and CIT made an
initial investment of approximately $167 million in the LLCs. The LLCs used
these proceeds to purchase the three waste-to-energy facilities that we operate
and assumed the seller's indebtedness related to these facilities. 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. As of June 30,
2002, the remaining aggregate lease commitments related to these waste-to-energy
facilities are $389 million.

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 under 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 June 30, 2002 and
December 31, 2001. If we were required to consolidate the LLCs, we would record
approximately $420 million in assets, and $209 million of debt as of June 30,
2002. The remaining balance that would be recorded would primarily be minority
interest. There would be no material net impact to our results of operations if
we consolidated the LLCs instead of accounting for them under the equity method.

ACCOUNTING FOR STOCK OPTIONS

We account for our 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 equal to fair
value. Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation ("SFAS No. 123"), establishes accounting and annual
disclosure requirements for options granted after 1995 using a fair-value-based
method of accounting. As of June 30, 2002, we had 47.6 million stock options and
warrants

40

outstanding. The weighted average fair value per share of stock options and
warrants granted during the three and six months ended June 30, 2002 was $9.17
and $9.24, respectively. This value is estimated using the Black-Scholes
option-pricing model, a formula that calculates an assumed value of stock
options based on appreciation and interest assumptions. The fair value
calculation using Black-Scholes is not necessarily indicative of the actual
value of a stock option.

If we applied the recognition provisions of SFAS No. 123, we would have
recognized additional compensation expense of approximately $32 million, or
$(0.03) per share, and $59 million, or $(0.06) per share, for the three and six
months ended June 30, 2002, respectively.

SEASONALITY AND INFLATION

Our operating revenues tend to be somewhat lower in the winter months,
primarily due to the lower volume of construction and demolition waste. The
volumes of industrial and residential waste in certain regions where we operate
also tend to decrease 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.

We believe that inflation has not had, and is not expected to have, any
material adverse effect on the results of our operations in the near future.

NEW ACCOUNTING PRONOUNCEMENTS

SFAS NO. 141 AND SFAS NO. 142

In June 2001, the Financial Accounting Standards Board issued 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 arose from purchases after June
30, 2001 cannot be amortized. In addition, SFAS No. 142 required the
continuation of the amortization of goodwill and all intangible assets through
December 31, 2001. The amortization of existing goodwill ceased on January 1,
2002. After 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
accounting pronouncement must be classified as the cumulative effect of a change
in accounting principle. Thereafter, goodwill must be tested for impairment
annually and impairment losses must 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.

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 our adoption of 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 have ceased being amortized upon adoption of SFAS No.
142.

Adopting SFAS No. 141 required us to write-off net negative goodwill of
approximately $2 million, which was 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 generally defined as an operating segment or a component of an
operating segment in certain circumstances. For the purposes of applying SFAS
No. 142, we have identified seven reporting units, which are the six components
of our NASW (excluding WTI) and WTI, as described in Note 9, "Segment and
Related Information" to the financial statements included herein. We incurred no
impairment of goodwill upon our initial adoption of SFAS No. 142. However, there
can be no assurance that goodwill will not be impaired at any time in the
future.

The following schedule reflects the three and six months ended June 30,
2001 adjusted net income (excluding goodwill and negative goodwill amortization)
as compared to the results of operations for the three and six months ended June
30, 2002 (in millions, except per share amounts).

41

Our intangible assets as of June 30, 2002 were comprised of the following
(in millions):

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 other intangible assets are
amortized over the terms of the related agreement or the Company's estimate of
the useful life if there are no definite terms. Landfill operating permits are
not presented above and are recognized in a combined basis with other landfill
assets and amortized using our landfill amortization method. The intangible
asset amortization expense estimated as of December 31, 2001, for the five years
following 2001 is as follows (in millions):

At the same meeting, the following proposals were also adopted by our
stockholders. The voting was as follows:

The following proposal was submitted to our stockholders, but was not
approved. The vote was as follows:

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a)Exhibits:

(b) Reports on Form 8-K:

None.

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SIGNATURES

Pursuant to the requirements 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/ WILLIAM L. TRUBECK
------------------------------------
William L. Trubeck
Executive Vice President and
Chief Administrative Officer
(Principal Financial Officer)

WASTE MANAGEMENT, INC.

By: /s/ ROBERT G. SIMPSON
------------------------------------
Robert G. Simpson
Vice President and
Chief Accounting Officer
(Principal Accounting Officer)

Date: August 2, 2002

45

INDEX TO EXHIBITS