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 SEPTEMBER 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 October 28, 2002 was 608,679,670 (excluding treasury shares of
21,628,363).

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PART I

ITEM 1. FINANCIAL STATEMENTS.

WASTE MANAGEMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AND PAR VALUE AMOUNTS)

See notes to condensed consolidated financial statements.
1

WASTE MANAGEMENT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

See notes to condensed consolidated financial statements.
2

WASTE MANAGEMENT, INC.

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

See notes to condensed consolidated financial statements.
3

WASTE MANAGEMENT, INC.

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

See notes to condensed consolidated financial statements.
4

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED 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 condensed 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") and determined to change its previous accounting by
recording the assets and liabilities associated with these arrangements 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 included the then current
portion of approximately $20 million that was paid in the third quarter of
2002); and an increase in other liabilities of $5 million. The Company also
recognized income of $5 million for the quarter ended June 30, 2002 for the
adjustments to the accounting for the contractual arrangements. As of September
30, 2002, approximately $94 million of debt, of which $6 million is current,
associated with this agreement has been included in the condensed consolidated
balance sheet.

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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED 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"). During the third quarter of 2002 the credit capacity of
the Three Year Revolver was increased to $650 million. 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 September 30, 2002. The Three Year
Revolver matures in June 2005 and the Five Year Revolver matures in June 2006.
As of September 30, 2002, the Company had letters of credit in the aggregate
amount of approximately $1,600 million (of which approximately $1,490 million
were issued under the revolving credit facilities) that generally have terms
allowing automatic renewal after a year. At September 30, 2002, the Company had
unused and available credit capacity under these facilities of approximately
$910 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 utilized the remaining proceeds along with
cash on hand to pay the $285.7 million of 7.7% senior notes that matured on
October 1, 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 $350 million of 6.5% senior notes due December 15, 2002.
The Company also has $450 million of 7.1% senior notes due August 1, 2026 that
are subject to early redemption on August 1, 2003 at the option of the holder.
The Company has classified these borrowings as long-term at September 30, 2002
based upon its ability to use its revolving credit facilities, which are both
long-term, to refinance these borrowings at their respective maturity or
repayment dates. The Company intends to pursue other sources of

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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

long-term financing to refinance the borrowings; however, in the event other
sources of long-term financing are not available, the Company intends to use its
revolving credit facilities.

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 September 30, 2002. Interest rate
swap agreements that were outstanding as of December 31, 2001 and September 30,
2002 are set forth in the table below (dollars in millions):

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(a) The fair value for interest rate derivatives is included in the Company's
balance sheet as components of other long-term assets and other long-term
liabilities.

(b) The interest rate contract's terms do not qualify for hedge accounting.
Therefore, the contract is accounted for using mark-to-market accounting and
changes in fair value are immediately recognized in interest expense.

(c) The terms of the interest rate contracts and the underlying debt instruments
are identical. Accordingly, these interest rate contracts 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.

(d) The fair value for these interest rate derivatives at December 31, 2001, is
comprised of $20 million long-term risk management assets and $20 million
long-term risk management liabilities.

In July 2002, the Company elected to terminate several interest rate swap
agreements with a notional amount of $600 million prior to the scheduled
maturities and received cash of $55 million (which is comprised of $43 million
for the fair value of the swaps that were terminated and $12 million of accrued
but unpaid interest receivable) from the counterparties to the interest rate
swaps. Under the hedge method of accounting for these types of derivatives, the
unamortized adjustment to long-term debt for the terminated swaps remains
classified as long-term debt. The proceeds received from the termination of the
interest rate swap agreements have been classified as a change in other assets
or other liabilities within operating activities in the accompanying condensed
consolidated statement of cash flows.

The carrying value of debt instruments have been increased by approximately
$255 million and $62 million as of September 30, 2002 and December 31, 2001,
respectively, related to the accounting for interest rate swap contracts. The
following table summarizes the accumulated fair value adjustments from interest
rate swap agreements by underlying debt instrument category (in millions):

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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Interest rate swap agreements reduced interest expense by $21 million and
$64 million for the three and nine months ended September 30, 2002,
respectively, and $16 million and $21 million for the three and nine months
ended September 30, 2001, respectively.

The Company also entered into hedging agreements 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 September 30, 2002,
these cash flow hedges resulted in a deferred loss, net of taxes, of $50
million, which is included in accumulated other comprehensive income. The $50
million deferred loss includes $8 million for hedges that have terminated
concurrently with a senior unsecured note issuance. Of this $8 million, $1
million (on a pre-tax basis) is scheduled to be reclassified into interest
expense over the next 12 months.

During June 2002, the Company entered into forward contracts, which expire
in December 2002 and 2003, and cross-currency swaps, which expire in May 2004,
with net 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. At September 30, 2002, these derivatives have
a net fair value of approximately $3 million and are included in other long-term
assets. The Company had no foreign currency derivatives outstanding at December
31, 2001.

2. INCOME TAXES

The current and deferred tax obligations associated with the provision for
income taxes recorded in the statement of operations are reflected in the
accompanying condensed consolidated balance sheets as a component of accrued
liabilities and deferred income taxes, respectively. The difference in federal
income taxes computed at the federal statutory rate and reported income taxes
for the three and nine months ended September 30, 2002 is primarily due to state
and local income taxes, offset in part by non-conventional fuel tax credits. In
addition, the Company recognized a tax benefit of approximately $12 million in
the third quarter of 2002 due to the anticipated capital gain from a fourth
quarter 2002 sale which enables the Company to utilize a previously fully
reserved capital loss that arose from a divestiture that occurred earlier in
2002. The remaining benefit will be recognized in the fourth quarter. For the
three and nine months ended September 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.

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.

In March of 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 82 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
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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

used to be profit centers, became cost centers. The largest Market Areas are
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 into ten newly established Market Areas 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.

The Company recorded $1 million and $38 million of pre-tax charges for
costs associated with the implementation of the new structure for the three and
nine months ended September 30, 2002, respectively. These charges include $36
million for employee severance and benefit costs and $2 million related to
abandoned operating lease agreements. The Company expects to incur an additional
$3 million of restructuring expenses in the last quarter of 2002 primarily
related to the relocation of employees and the consolidation of facilities to
support the new organizational structure.

Under the new structure approximately 1,900 field-level administrative and
operational positions have been eliminated. The Company's obligation for
severance payments will continue during the last quarter of 2002 and, in some
cases, into 2003. As of September 30, 2002, payments of $29 million for employee
severance and benefits and for abandoned leases had been recorded against the
restructuring liability that was previously established.

4. EARNINGS PER SHARE

The following reconciles income before extraordinary item and cumulative
effect of changes in accounting principle as presented on the condensed
consolidated statements of operations with diluted net income for the purposes
of calculating diluted earnings per common share (in millions):

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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following reconciles the number of common shares outstanding at
September 30 of each year to the weighted average number of common shares
outstanding and the weighted average number of common and dilutive potential
common shares outstanding for the purposes of calculating basic and diluted
earnings per common share (shares in millions):

For the three months ended September 30, 2002 and the three and nine months
ended September 30, 2001, the effect of the Company's convertible subordinated
notes is excluded from the diluted earnings per share calculation because its
inclusion would be antidilutive.

At September 30, 2002, there were approximately 47 million shares of common
stock potentially issuable with respect to stock options, warrants and
convertible debt, of which approximately 25 million shares were not included in
the diluted earnings per share computation because their exercise price was
greater than the average per share market price of the Company's stock for the
three and nine months ended September 30, 2002. Including the impact of these
potentially issuable shares in the current period calculations would have been
antidilutive for the periods presented, but could further dilute earnings per
share in the future.

In the third quarter of 2002, the Company declared an annual cash dividend
of $0.01 per share, or approximately $6 million, to stockholders of record on
September 30, 2002, which was paid on October 15, 2002.

5. DERIVATIVE INSTRUMENT POTENTIALLY SETTLED IN COMMON STOCK

In the first quarter of 2002, the Company entered into a transaction to
purchase stock under an accelerated stock repurchase master agreement,
purchasing approximately 10.9 million shares at $27.46 per share for a total of
approximately $300 million. Under the agreement, if the weighted average daily
market price at the end of the valuation period times the number of shares
initially purchased exceeded the approximately $300 million paid by the Company,
the difference would have been paid by the Company to the counterparty. However,
if at the end of the valuation period the weighted average daily market price
times the number of shares initially purchased was less than the amount paid by
the Company, this deficiency would be paid by the counterparty to the Company.
The Company accounted for the initial payment as a purchase of treasury stock
and classified the future settlement with the counterparty as an equity
instrument because the Company had the option under the agreement to settle its
obligations, if it had any obligations, in shares of its common stock.

The weighted average daily market price of the stock during the valuation
period times the number of shares initially purchased by the Company was
approximately $18 million less than the approximately $300 million the Company
paid for the repurchase. Therefore, during the third quarter of 2002 the
counterparty paid the Company approximately $18 million in cash to settle the
agreement. The Company accounted for the cash receipt as an adjustment to the
carrying value of treasury stock and has therefore

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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

included it in common stock repurchases within financing activities in the
accompanying condensed consolidated statement of cash flows.

6. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) 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 other operational and maintenance costs to be incurred after the
site discontinues accepting waste, which is

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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 $220 million higher on a
discounted basis in the aggregate than the estimate recorded in the consolidated
financial statements as of September 30, 2002. As used in this context,
"reasonably possible" means the Company believes it is more than remote but less
than likely.

As of September 30, 2002, the Company or its subsidiaries had been notified
that they are potentially responsible parties in connection with 75 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 75 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
Company believes that the remediation costs associated with the 17 NPL sites it
currently owns are accrued for adequately. The 58 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

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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED 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 increased for inflation 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 September 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. This practice, as it relates
to operating landfills, will change upon the Company's adoption of Statement of
Financial Accounting Standards No. 143, Accounting for Asset Retirement
Obligations ("SFAS No. 143"). See Note 12 for additional comments on this
pronouncement.

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):

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(a) The Company has recorded a reclassification entry since December 31, 2001
of approximately $56 million to increase its environmental liabilities,
with the offset primarily being an increase to other long-term assets.

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, and considering

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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the Company's current financial position, 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 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 various levels of 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 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.

The Company is one of the defendants in a class action lawsuit arising from
events related to its earnings announcements in July and August of 1999. 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
14

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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. The payment provided for by the settlement agreement is included in the
accompanying condensed consolidated balance sheets as a component of accrued
liabilities. A hearing was held April 29, 2002 at which the settlement was
approved. There is currently pending before the court a motion to vacate the
final approval order brought by a non-class member whose motion to intervene was
disallowed by the court. The same would-be intervener, along with one other
person (both former participants in WM Holdings' ERISA plans), has also filed a
separate case in Washington, D.C. against the Company and others attempting to
increase the recovery of a class of ERISA plan participants based on allegations
related to both the events alleged in and the settlements relating to the class
action against WM Holdings that was settled in 1998 and the complaint in this
action.

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 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 settlement amount will not be paid and the receivable that the
Company has recorded will not be collected. Any prolonged delay 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 and are pursuing their claim as individuals
and not as a class action. The case is still at a relatively early stage, and
the amount of damages, if any, cannot yet be determined.

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.

15

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 September 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) improperly operated a solid
waste landfill by failing to maintain required records, properly place and cover
waste and adhere to proper leachate levels, (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, individually or
in the aggregate, have a material adverse effect on the Company's financial
condition or results of operations.

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 of these matters may have a material adverse
impact on the Company's 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 Company does not believe that any of these
matters will 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. Results of the audit assessments 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 North America solid
waste ("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.

16

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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
facilities and its IPPs. 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."

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 treasury, legal, information technology,
tax, insurance, management of closed landfills and related insurance
recoveries, centralized service center and other typical administrative
functions. Corporate functions' loss from operations for the three and nine
months ended September 30, 2001 includes a $374 million charge to asset
impairments and unusual items which is attributable to agreements that were
reached to settle shareholder class action and shareholder derivative
litigation. For discussion related to the settlement see Note 8.

(b) Other operations are net of intersegment revenue with NASW of $1 million
for the nine months ended September 30, 2002 and $15 million and $34
million for the three and nine months ended September 30, 2001,
respectively. 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 $43 million for the three and nine
months ended September 30, 2002, respectively, and $13 million and $41
million for the corresponding periods of 2001. Additionally, NASW
(excluding WTI) operations are net of intrasegment revenue with WTI of $6
million and $16 million for the three and nine months ended September 30,
2002, respectively, and $6 million and $18 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) For those items included in the determination of income from operations,
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. Income from operations in 2001 included goodwill
amortization of $39 million and $117 million for the three and nine months
ended September 30, 2001, respectively, of which $29 million and $87
million for the three and nine months ended September 30, 2001 was in the
NASW (excluding WTI) operations, $8 million and $23 million

17

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

for the three and nine months ended September 30, 2001 was in the WTI
operations, and $2 million and $7 million for the three and nine months
ended September 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 nine months ended September 30, 2002, this charge increased income from
operations for the corporate functions by $38 million and $111 million,
respectively, and decreased income from operations for the WTI operations
by $8 million and $23 million, respectively, and the NASW (excluding WTI)
operations by $30 million and $88 million, respectively.

The mix of NASW operating revenues for the three and nine months ended
September 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 (in millions).

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

(a) Intercompany revenues between operations have been eliminated in the
consolidated financial statements.

10. PAPER DERIVATIVES AND HEDGING ACTIVITIES

All derivative transactions are subject to the Company's risk management
policy. Swap agreements expose the Company to credit risk to the extent the
counterparty is unable to meet its monthly settlement commitment. The Company
carefully monitors the creditworthiness of each counterparty.

The Company enters into paper swap agreements 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's paper swap agreements have an average term of approximately two years
with the maximum term being five years. The terms of the agreements represent
the span of time over which the Company is hedging its exposure to variability
in future cash flows from the sale of waste paper products. The Company accounts
for these derivatives as cash flow hedges. In addition, the Company has entered
into paper swap agreements with the objective of generating profits from
exposure to changes in market prices of waste paper and other paper products.

As of September 30, 2002, the net fair value of the Company's paper
derivatives was approximately a $1 million net asset. As of September 30, 2002,
the Company has included in accumulated other comprehensive income a net
deferred loss of $1 million, which is net of taxes, on derivative commodity
financial instruments designated as cash flow hedges. The Company's long-term
position is a gain, however, its current position is a loss and will require
approximately $4 million (on a pre-tax basis) of deferred loss to be
reclassified as offsets to revenues over the next 12 months.

For the Company's waste paper swap agreements not designated as hedges, the
Company experienced almost no earnings impact for the three months ended
September 30, 2002. However, for the nine months

18

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

ended September 30, 2002, the Company increased revenues by approximately $3
million for waste paper swap agreements not designated as hedges.

For the three and nine months ended September 30, 2001 the Company recorded
a loss of approximately $1 million and a gain of $5 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 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. Due to the
uncertainty of Enron's ability to satisfy all of its financial commitments, the
Company determined that all of its 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, net of
tax, as of September 30, 2002, which is included in accumulated other
comprehensive income, of approximately $3 million related to the 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 and approximately $2
million (on a pre-tax basis) is expected to be reclassified into earnings over
the next twelve months.

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
September 30, 2002 and the condensed consolidating balance sheet as of December
31, 2001, the unaudited condensed consolidating statements of operations for the
three and nine months ended September 30, 2002 and 2001, along with the related
unaudited condensed consolidating statements of cash flows for the nine months
ending September 30, 2002 and 2001, have been provided below (in millions).

19

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING BALANCE SHEETS
SEPTEMBER 30, 2002
(UNAUDITED)

DECEMBER 31, 2001

20

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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

THREE MONTHS ENDED SEPTEMBER 30, 2001
(UNAUDITED)

21

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2002
(UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2001
(UNAUDITED)

22

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2002
(UNAUDITED)

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2001
(UNAUDITED)

23

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED 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.

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.

24

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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

The Company's intangible assets as of September 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 on a combined basis with other 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 September 30, 2002, the amount of goodwill attributable to WTI was
approximately $783 million. The remaining goodwill balance of approximately
$4,264 million was attributable to NASW (excluding WTI).

SFAS NO. 143

In June 2001, the Financial Accounting Standards Board issued SFAS No. 143,
which applies to all legally enforceable obligations associated with the
retirement of tangible long-lived assets and provides the

25

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 Standards No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets ("SFAS No. 144"), which supersedes Statement of
Financial Accounting Standards No. 121. 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, 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 Standards 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
26

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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. The implementation of SFAS No.
146 will not require the restatement of previously issued financial statements.
Implementation of the pronouncement will therefore have no impact on the current
year financial statements of the Company. See Note 3 for discussion on the
restructuring initiated by the Company in March 2002.

13. SUBSEQUENT EVENTS

In August 2002, DLJ Brand Services, Inc. ("DLJ Brand"), a holding company
whose wholly owned subsidiary Brand Services, Inc. provides scaffolding services
in North America, entered into a plan and agreement of merger pursuant to which
DLJ Brand would be merged into an entity owned by J.P. Morgan Partners, LLC. The
Company owned approximately 17% of the shares of DLJ Brand before the merger. In
October 2002, the merger was completed, and the Company received approximately
$33 million in cash, a note receivable of approximately $4 million and warrants
to purchase securities in the merged entity. The Company also received
approximately $21 million for the repayment of a subordinated note that came due
upon the change of control of DLJ Brand. The Company expects to record a pre-tax
gain of approximately $40 million in the fourth quarter of 2002 related to this
transaction.

27

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
over which we have no control. Any of these factors, either alone or taken
together, could have a material adverse effect on us and could change whether
any forward-looking statement ultimately turns out to be true. Additionally, we
assume no obligation to update any forward-looking 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 for asset 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 or when the approval of the $457 million class action lawsuit
settlement will become final and non-appealable;

- 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;

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

- 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;

28

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

- possible errors or problems with our enterprise-wide software and
technology systems or the deployment of our billing and accounts
receivable 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 and governmental
entities.

Our collection services involve picking up and transporting waste from
where it was generated to a disposal site. We also operate transfer stations,
which are facilities located near residential and commercial collection routes
where collection trucks take the solid waste that has been collected. The solid
waste is then transferred via transfer trucks, barges, or rail to disposal
sites. These disposal sites include landfills, which are the main depository for
solid waste in North America, as well as waste-to-energy facilities. As of
September 30, 2002, we owned or operated 294 solid waste landfills, five
hazardous waste landfills and 16 waste-to-energy facilities. The solid waste and
hazardous landfills are where solid and hazardous waste, respectively, is
deposited into the ground, and the waste-to-energy facilities are where solid
waste is burned to produce steam that is used to generate electricity. In
addition to disposing of waste, we offer recycling services, which involve the
removal of reusable materials from the waste stream for processing or resale.

We also operate methane gas recovery projects at some of our landfills,
where we collect the methane gas that is generated at the landfill by
decomposing waste and process it for sale where it is used to fuel electricity
generators. We also rent and service portable toilet facilities, provide street
sweeping services, and provide full service waste services at customers'
industrial plants, known as "in-plant services." Finally, we own and operate
independent power production plants that cogenerate electricity for sale to
customers.

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

29

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 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 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 96 landfill sites with
expansions at September 30, 2002, 29 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.
30

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 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 $220 million higher on a discounted basis in the aggregate than
the estimate recorded in the consolidated financial statements as of September
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
31

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 impairment indicator occurs.

Typical indicators that an asset may be impaired include:

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

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

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

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

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

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

If any of these or other indicators occur, 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.

32

RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 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
condensed consolidated statements of operations line items.

33

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

OPERATING REVENUES

Revenues for the three months ended September 30, 2002 were substantially
unchanged from the comparable prior year period. During this period, revenues
from our NASW operations increased $44 million, which was offset by a decrease
in revenues from divestitures of non-NASW operations. Our operating revenues
decreased by $201 million, or 2.4%, for the nine months ended September 30, 2002
as compared with the corresponding prior year period. This decrease was
attributable to an $82 million decrease in revenues from our NASW operations
along with a decrease in revenues of $119 million in our non-NASW operations due
to the divestiture of those operations throughout 2001 and into early 2002.

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 when we bill the customer 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 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, generally disposing of the solid waste at a disposal site.
Intercompany revenues between our operations have been eliminated in the
consolidated financial statements.

34

The mix of NASW operating revenues for the three and nine months ended
September 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 increase of $44 million and decrease of $82 million in NASW revenues
for the three and nine months ended September 30, 2002, respectively, is
reflected in the table below (in millions).

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

(a) Our internal growth calculation methodology has been modified to remove the
impact of differences in the comparable number of days per quarter. This
change affects only the commercial and residential operations in the
collection business. Our previous calculation attributed the difference
related to work days between the quarter into the price change calculation.
This revised methodology impacts first quarter 2002 results. First quarter
internal growth results were reported as a 1.6% other price increase, which
excludes the effect of commodity, electricity and fuel price impacts, and a
3.3% volume decrease. Our revised calculation modifies first quarter to be a
0.9% other price increase, excluding the effect of commodity, electricity
and fuel price impacts, and a 2.6% volume decrease.

We experienced positive internal growth for the three months ended
September 30, 2002 of $26 million, or 0.9%, as compared with the same period
last year. Revenue growth from price increases for the three months ended
September 30, 2002 was $42 million, or 1.5%. Revenue increased $34 million for
the three months ended September 30, 2002 due to recycling commodity increases,
which were attributable to the significant increase in old corrugated cardboard
("OCC") and old newsprint ("ONP") commodity prices

35

beginning in the second quarter of 2002. OCC prices increased from an average of
$49 per ton for the three months ended September 30, 2001 to an average price of
$102 per ton for the three months ended September 30, 2002. Other price driven
revenue increases of $14 million, or 0.5%, for the three months ended September
30, 2002 were primarily driven by our collection business, particularly the
commercial and residential operations, and includes an increase related to a
disposal tax in Pennsylvania that is charged back in part to our customers,
offset partially by decreased revenue due to pricing in our landfill business,
particularly special waste. The decline in revenue due to volume for the three
months ended September 30, 2002 can be attributed primarily to the collection
and landfill businesses. These volume driven revenue decreases were principally
in the eastern and western portions of the United States; however, they were
partially offset by volume increases in the recycling, transfer station and
waste-to-energy businesses.

Negative internal growth for the nine months ended September 30, 2002, as
compared with the same period last year, was $127 million, or 1.5%, which was
substantially volume related. Revenue change due to volume declines for the nine
months ended September 30, 2002, which was largely related to the commercial and
industrial collection operations, was experienced throughout the Company's
operations, with the exception of the southern portion of the United States,
where we realized slight volume increases. Additionally, landfill revenues
declined due to volume primarily in the eastern and western portions of the
United States. We believe that the overall decreased volumes, particularly in
the higher margin commercial and industrial collection operations, were
attributable to the lagging economy and increased competition. The decrease in
revenue due to lower construction activities at certain of the waste-to-energy
facilities that we operate but do not own accounted for $24 million of this
overall volume decline.

Revenue increased due to pricing for the nine months ended September 30,
2002, as compared with the same period of the prior year, by $17 million, or
0.2%. Revenue increases from commodity prices were $25 million and were
attributable to the significant increase in OCC commodity prices beginning in
the second quarter of 2002. Reduced electricity rates in California and reduced
diesel fuel surcharges negatively impacted the revenue change due to price for
the nine months ended September 30, 2002 by $62 million. Other revenue increases
due to price of $54 million, or 0.6%, for the nine months ended September 30,
2002 were primarily attributable to our commercial and residential collection
operations, and our transfer station business. These revenue increases were
offset partially by decreased revenue from price in the landfill business,
particularly special waste.

Revenues increased $21 million and $59 million for the three and nine
months ended September 30, 2002, respectively, when compared with the same
periods of last year due to acquisitions of NASW business during 2002 and the
full year effect of acquisitions that were completed in 2001. We also
experienced a decrease in revenue of $3 million and $14 million for the three
and nine months ended September 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 increased $53 million, or 3.1%, and decreased
$71 million, or 1.4%, for the three and nine months ended September 30, 2002,
respectively, compared to the prior year periods. As a percentage of operating
revenues, operating costs and expenses were 60.3% and 60.0% for the three and
nine months ended September 30, 2002, respectively, and 58.4% and 59.4% for the
corresponding prior year periods.

For the three months ended September 30, 2002, costs increased as compared
with the same period of the prior year due to several factors, including
increases in risk management expenses, higher employee benefit costs, higher
costs associated with recycling commodities, subcontractor costs, costs
associated with acquisi-
36

tions consummated since the third quarter of 2001, and disposal costs. The
increased risk management expense is driven primarily by increased workers'
compensation costs. The increased costs associated with recycling commodities
were due primarily to an increase in market prices paid for OCC and ONP and the
rebates paid to customers as a result of the higher prices. The subcontractor
cost increase is due in part to increased utilization of subcontractors for
certain of our national account customers in areas where services are not
provided by us and in part to increased third party transportation of waste to
disposal facilities, particularly in the midwest and western portions of the
United States. Contributing to the increase in disposal costs was the increased
tax on disposal of waste in Pennsylvania incurred by us. Additionally, the
operating costs and expenses increase reflects approximately $19 million
included in the third quarter of 2001 as an offset to environmental expenses
related to the Company's recovery of amounts in connection with its claims
against insurance carriers for reimbursement of environmental expenses. The
increased operating costs and expenses were offset in part by the effect of
divestitures in 2002.

For the nine months ended September 30, 2002, costs decreased as compared
to the same period of the prior year due primarily to the effect of divestitures
in 2002, reduced maintenance costs, lower fuel costs, and lower construction
services at certain of the waste-to-energy facilities that we operate but do not
own. The decreases have been offset somewhat by several factors, including those
affecting the third quarter as discussed above. Factors affecting the nine month
period include increased risk management expense, higher employee benefit costs,
increased costs associated with acquisitions that have been consummated since
the third quarter of 2001, subcontractor costs and increased disposal costs.
Additionally, the operating costs and expenses increase reflects approximately
$19 million included in the third quarter of 2001 as an offset to environmental
expenses as discussed above.

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 $7 million, or 1.8%,
and $48 million, or 4.1%, for the three and nine months ended September 30,
2002, respectively, as compared to the prior year corresponding periods. In
addition, as a percentage of operating revenues, our selling, general and
administrative expenses decreased from 13.2% to 13.0% for the three months ended
September 30, 2001 and 2002, respectively, and decreased from 13.7% to 13.5% for
the nine months ended September 30, 2001 and 2002, respectively.

The decrease in costs is primarily attributable to reduced spending on
professional fees, reductions associated with the March 2002 restructuring and
the effect of divestitures of operations in 2002. These reductions were offset
partially by increased litigation expense and an increase in contract labor (net
of capitalization) related to enterprise systems development. Cost reductions
for the nine months ended September 30, 2002 as compared to the same period of
2001 were also offset by increased bad debt expense of $16 million.

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 $41 million, or 11.6%, and
$110 million, or 10.7% for the three and nine months ended September 30, 2002,
respectively, compared to the same three and nine month periods of 2001. As a
percentage of operating revenues, depreciation and amortization expense was
10.7% and 11.0% for the three and nine months ended September 30, 2002,
respectively, and 12.2% and 12.1%

37

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 nine
months ended September 30, 2001 was $39 million, or 1.3% of operating revenues,
and $117 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 decreased 0.1% and increased 0.3% from the
three and nine months ended September 30, 2001, respectively, compared to the
corresponding periods of 2002.

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.

In March of 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 82 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.
The largest Market Areas are 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.

We recorded $1 million and $38 million of pre-tax charges for costs
associated with the implementation of the new structure for the three and nine
months ended September 30, 2002, respectively. These charges include $36 million
for employee severance and benefit costs and $2 million related to abandoned
operating lease agreements. We expect to incur an additional $3 million of
restructuring expenses in the last quarter of 2002 primarily related to the
relocation of employees and the consolidation of facilities to support the new
organizational structure.

Under the new structure approximately 1,900 field-level administrative and
operational positions have been eliminated. Our obligation for severance
payments will continue during the last quarter of 2002 and, in some cases, into
2003. As of September 30, 2002, payments of $29 million for employee severance
and benefits and for abandoned leases had been recorded against the
restructuring liability that was previously established.

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. During the third quarter of 2002, we recorded a net credit to asset
impairments and unusual items of approximately $3 million primarily due to the
reversal of a loss contract reserve that was originally recorded in asset
impairments and unusual items.

For the three and nine months ended September 30, 2001, we recorded a
charge to asset impairments and unusual items expense of $354 million and $362
million, respectively. The expense was primarily attributable
38

to agreements that were reached to settle the shareholder class action lawsuit
filed against us in July 1999 alleging violations of the federal securities laws
and the shareholders derivative suit against our former independent auditor,
which resulted in a net charge of $374 million. Offsetting this expense, we
recorded a net gain of $24 million (comprised of the reversal of the
held-for-sale impairments of $109 million and a held-for-use impairment of $85
million) from our re-evaluation of our business alternatives related to our IPPs
during the third quarter of 2001. Based on these assessments, we decided not to
sell our IPPs with the exception of one facility. Accordingly, we reclassified
all but one of our IPPs from held-for-sale to held-for-use in the third quarter
of 2001. Also included in asset impairments and unusual items are reversals of
loss contract reserves that were determined to be in excess of current
requirements and other unusual items of $4 and $12 million for the three and
nine months ended September 30, 2001, respectively.

INTEREST EXPENSE

Interest expense decreased by $6 million and $75 million for the three and
nine months ended September 30, 2002, respectively, as compared to the
corresponding periods in 2001. The primary factor for the decrease in interest
expense is the overall positive position of the Company's interest rate
derivative contracts. Interest rate derivative contracts reduced interest
expense by $21 million and $64 million for the three and nine months ended
September 30, 2002, respectively, and $16 million and $21 million for the
corresponding prior year periods. The remaining decrease in interest expense
between 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 (BENEFIT FROM) INCOME TAXES

We recorded a provision for income taxes of $121 million and $340 million
for the three and nine months ended September 30, 2002, respectively, and a $32
million benefit from income taxes and a $170 million provision for income taxes
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 nine months ended September 30, 2002 is primarily due to state and local
income taxes, offset in part by non-conventional fuel tax credits. In addition,
we recognized a tax benefit of approximately $12 million in the third quarter of
2002 due to the anticipated capital gain from a fourth quarter 2002 sale which
enables the Company to utilize a previously fully reserved capital loss that
arose from a divestiture that occurred earlier in 2002. The remaining benefit
will be recognized in the fourth quarter. For the three and nine months ended
September 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.

On July 17, 1998, we issued $600 million of 6 1/8% mandatorily tendered
senior notes, due July 15, 2011. The notes were subject to certain mandatory
tender features as described in the indenture, which allowed us to purchase all
of the outstanding notes on July 15, 2001. We used available cash on hand along
with funds from

39

the Company's credit facility to purchase the notes in July 2001. During the
third quarter of 2001, we recorded an extraordinary loss of approximately $1
million, net of taxes, for the retirement of this debt.

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
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 nine
months ended September 30, 2002 and 2001 (in millions):

We generated cash flows from operations of $1.5 billion for the nine months
ended September 30, 2002. During that period, we spent $783 million for
investing activities, which was comprised of capital expenditures of $914
million and acquisitions of businesses of $125 million, offset by proceeds from
sales of assets and cash generated from other investing activities of $256
million. In addition, we used $819 million for financing activities, which
included $561 million spent to repurchase 21.3 million shares under our stock
buyback program, $283 million of net debt repayments and $25 million in proceeds
from exercises of common stock options and warrants.

For the nine months ended September 30, 2001, we generated cash flows from
operations of approximately $1.5 billion. We used $787 million for investing
activities during the nine months ended September 30, 2001. Capital expenditures
of $843 million were included in our investing activities for the nine months
ended September 30, 2001 along with acquisitions of solid waste businesses of
$95 million offset by proceeds from sales of assets and other investing
activities of $151 million. In addition, we used $738 million for financing
activities which is primarily comprised of $765 million of net debt repayments,
offset by proceeds of $27 million from exercises of common stock options and
warrants and other financing activities.

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

40

- 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 and, when appropriate, will obtain
financing from issuing debt or common stock.

As of September 30, 2002, we had a $650 million syndicated revolving credit
facility (the "Three Year Revolver"), and a $1.75 billion syndicated revolving
credit facility (the "Five Year Revolver"). No balances were outstanding under
the Company's revolving credit facilities as of December 31, 2001 or September
30, 2002. The Three Year Revolver matures in June 2005 and the Five Year
Revolver matures in June 2006. As of September 30, 2002, we had letters of
credit in the aggregate amount of approximately $1,600 million (of which
approximately $1,490 million are issued under the revolving credit facilities)
that generally have terms allowing automatic renewal after a year. At September
30, 2002, we had unused and available credit capacity under these facilities of
approximately $910 million.

The financial covenants we are required to maintain under our credit
facilities include (i) an interest coverage ratio; (ii) total debt to EBITDA
and; (iii) minimum net worth. The interest coverage ratio requires that at the
end of any fiscal quarter we will not permit the ratio of (A) our consolidated
net income plus interest expense and income taxes ("EBIT") for the four fiscal
quarters then ending to (B) consolidated total interest expense for such period
to be less than 2.5 to 1 for quarters ending on or before December 31, 2002 and
3 to 1 thereafter. The total debt to EBITDA covenant requires that at the end of
any fiscal quarter, we will not permit the ratio of (A) all indebtedness and
certain contingent liabilities such as financial guarantees to (B) EBIT plus
depreciation and amortization expense ("EBITDA") for the four fiscal quarters
then ending to exceed 3 to 1. Our minimum net worth covenant requires that we
will not allow the sum of stockholders' equity to be less than $3.5 billion plus
75% of our cumulative consolidated net income for each fiscal quarter, beginning
with the first fiscal quarter ended March 31, 2001. At September 30, 2002, we
are in compliance with all covenants under our credit facilities.

We manage our debt portfolio by using interest rate derivatives. Our
position of fixed and floating rate debt is approximately 65% fixed and 35%
floating at September 30, 2002. In addition, we periodically enter into
financing transactions to secure the then current market interest rate in
anticipation of senior debt issuances.

We currently intend to refinance certain of our senior notes that mature in
the fourth quarter with a new senior note issuance. In anticipation of the
issuance, we entered into a hedging agreement during the second quarter of 2002
to secure the underlying treasury rates. These hedging agreements will be
settled concurrently with the senior note issuance. If we had settled this
agreement on October 28, 2002, we would have paid approximately $50 million to
the counterparties, however, the fair values may fluctuate until settlement
actually occurs. To offset this anticipated cash payment, we plan to terminate
several interest rate swap agreements with favorable fair value positions in the
fourth quarter of 2002. The anticipated net cash settlement of the interest rate
financing agreement and interest rate swap agreement terminations will be
reflected within operating activities in our consolidated statement of cash
flows. As of October 29, 2002, we have received cash of $27 million for fourth
quarter 2002 terminations of interest rate swap agreements.

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 these proceeds to
pay the $300 million of 6.625% senior notes that matured on July 15, 2002 and a
portion of the $285.7 million of 7.7% senior notes that matured on October 1,
2002.

Additionally, through September 30, 2002 we have issued industrial revenue
bonds that are primarily used in the construction of various facilities.
Proceeds of the financing arrangements are deposited into trust funds upon
receipt and we do not have the ability to utilize the funds in regular operating
activities. Therefore, the funds are treated as non-cash investing and financing
activities in the cash flow statement.

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, income tax and other
41

obligations, acquisitions and our share repurchases that are 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 $300
million for capital expenditures and approximately $60 million for the purchases
of businesses during the final quarter of 2002.

We have $350 million of 6.5% senior notes due December 15, 2002. We also
have $450 million of 7.1% senior notes due August 1, 2026 that are subject to
early redemption on August 1, 2003 at the option of the holder. We have
classified these borrowings as long-term at September 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 at their respective maturity or
repayment date. We intend to pursue other sources of long-term financing to
refinance the borrowings; however, in the event other sources of long-term
financing are not available, we intend to use our revolving credit facilities.

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 either open market 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 under the
stock buy back program we announced in February 2002. 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 classified the future settlement with the counterparty as
an equity instrument because we had the option under the agreement to settle our
obligations, if we had any obligation, in shares of our common stock.

The weighted average daily market price of our stock during the valuation
period times the number of shares we initially purchased was approximately $18
million less than the approximately $300 million we paid for the repurchase.
Pursuant to the terms of the agreement, the counterparty paid us this difference
of approximately $18 million at the end of the valuation period, which occurred
during the third quarter of 2002, to settle the agreement. We accounted for the
cash receipt as an adjustment to the carrying value of treasury stock and have
therefore included it in common stock repurchases within financing activities in
the accompanying condensed consolidated statement of cash flows.

We expect to enter into other such accelerated purchase programs similar to
the program entered into in the first quarter of 2002. We have also engaged in
open market purchases of our common stock during those periods when, according
to Company policy, there is an open trading window. During 2002, excluding the
transaction under the accelerated stock repurchase master agreement, we have
repurchased approximately 10.4 million shares for a total of approximately $279
million. As previously announced, our intention is to repurchase up to $1
billion this year.

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, during the
second quarter of 2002. We currently expect that we will fund the settlement in
the first half of 2003.

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.

42

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 or at any time during the
initial base term of the lease. We account for the underlying leases as
operating leases. As of September 30, 2002, the remaining aggregate lease
commitments related to these waste-to-energy facilities are $374 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 September 30, 2002 and
December 31, 2001. If we were required to consolidate the LLCs, we would record
approximately $418 million in assets, and $201 million of debt as of September
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 September 30, 2002, we had approximately 47 million
stock options and warrants outstanding. The weighted average fair value per
share of stock options and warrants granted during the three and nine months
ended September 30, 2002 was $8.35 and $9.22, 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.

43

The following schedule reflects the impact of the recognition provisions of
SFAS No. 123 on net income and earnings per common share for the three and nine
months ended September 30, 2002 and 2001 (in millions, except per share
amounts).

RECENT DEVELOPMENTS

In August 2002, DLJ Brand Services, Inc. ("DLJ Brand"), a holding company
whose wholly owned subsidiary Brand Services, Inc. provides scaffolding services
in North America, entered into a plan and agreement of merger pursuant to which
DLJ Brand would be merged into an entity owned by J.P. Morgan Partners, LLC. We
owned approximately 17% of the shares of DLJ Brand before the merger. In October
2002, the merger was completed, and we received approximately $33 million in
cash, a note receivable of approximately $4 million and warrants to purchase
securities in the merged entity. We also received approximately $21 million for
the repayment of a subordinated note that came due upon the change of control of
DLJ Brand. We expect to record a pre-tax gain of approximately $40 million in
the fourth quarter of 2002 related to this transaction.

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 Statement of
Financial Accounting Standards No. 141, Accounting for Business Combinations
("SFAS No. 141"), and SFAS No. 142. SFAS No. 141 requires that all business
combinations be accounted for using the purchase method of accounting and
prohibits the pooling-of-interests method for business combinations initiated
after June 30, 2001. According to SFAS No. 142, goodwill that 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
44

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

45

Our intangible assets as of September 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 on 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):

(b) Reports on Form 8-K:

On August 13, 2002, the Company filed a Current Report on Form 8-K, to
state that the Company submitted to the Securities and Exchange Commission the
Statements under Oath of Principal Executive Officer and Principal Financial
Officer in accordance with the Commission's June 27, 2002 Order (File No. 4-460)
requiring the filing of sworn statements pursuant to Section 21(a)(1) of the
Securities and Exchange Act of 1934, as amended.

48

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: November 1, 2002

49

CERTIFICATIONS

I, A. Maurice Myers, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Waste
Management, Inc.;

2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report.

3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in
all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a -- 14 and 15d -- 14) for the registrant
and have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;

b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent functions):

a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

By: /s/ A. MAURICE MYERS
------------------------------------
A. Maurice Myers
President and Chief Executive
Officer

Date: November 1, 2002

50

I, William L. Trubeck, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Waste
Management, Inc.;

2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report.

3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in
all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a -- 14 and 15d -- 14) for the registrant
and have:

a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;

b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and

c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons performing
the equivalent functions):

a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

By: /s/ WILLIAM L. TRUBECK
------------------------------------
William L. Trubeck
Executive Vice President and
Chief Administrative Officer

Date: November 1, 2002

51