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SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission file number 1-12154

Waste Management, Inc.

1001 Fannin

(713) 512-6200

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

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934.)     Yes þ          No o

      The number of shares of Common Stock, $0.01 par value, of the registrant outstanding at April 28, 2003 was 591,373,508 (excluding treasury shares of 38,908,953).

PART I

WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS

See notes to condensed consolidated financial statements.

1

WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See notes to condensed consolidated financial statements.

2

WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to condensed consolidated financial statements.

3

WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

See notes to condensed consolidated financial statements.

4

WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

      The condensed consolidated financial statements of Waste Management, Inc., a Delaware corporation, and subsidiaries presented herein are unaudited. When the terms “Waste Management,” “WMI,” the “Company,” “we,” “us” or “our” are used in this document, those terms refer to Waste Management, Inc., its consolidated subsidiaries and predecessors, unless the context requires otherwise. 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 our Annual Report on Form 10-K for the year ended December 31, 2002.

      The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our 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 the estimates and assumptions that we use in the preparation of our financial statements. Additionally, the estimates and assumptions used in determining landfill airspace amortization rates per ton, final capping, closure and post-closure liabilities as well as environmental remediation liabilities require significant engineering and accounting input. We review 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 first quarter of 2003, we adopted certain changes in accounting principles that impact the comparability of the financial information presented herein. See Note 1 for information regarding these changes.

      Reclassifications — On January 1, 2003, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. 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 (“APB”) Opinion No. 30. Upon the adoption of SFAS No. 145, we reclassified first quarter 2002 losses on the extinguishment of debt of $1 million that had previously been reported as extraordinary. The impact of this reclassification on the results of operations for the quarter ended March 31, 2002 was a $2 million increase in interest expense and a $1 million decrease in the tax provision.

      Additionally, certain reclassifications have been made in the prior period condensed consolidated statement of cash flows in order to conform to the current period presentation.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

1.     2003 Accounting Changes

      The following table summarizes the pro forma impact to income before cumulative effect of changes in accounting principles and earnings per common share for the three months ended March 31, 2002 of the accounting changes implemented beginning January 1, 2003 (in millions, except per share amounts).

     Repairs and Maintenance

      Through December 31, 2002, we accrued in advance for major repairs and maintenance expenditures and we deferred costs associated with annual plant outages at our waste-to-energy facilities and independent power production plants (“IPPs”). Effective January 1, 2003, we changed our policy from this method to one that expenses these costs as they are incurred. In the first quarter of 2003, we recorded approximately $25 million, net of taxes, or $0.04 per diluted share, as a credit to cumulative effect of changes in accounting principles. We believe this accounting change is preferable because it (i) provides operating results that more clearly reflect the timing and amount of required expenditures, (ii) more clearly reflects our assets and liabilities, and (iii) reduces the need to make additional estimates and assumptions. The effect of this change in accounting principle is immaterial to our results of operations for the three months ended March 31, 2003.

     Loss Contracts

      Through December 31, 2002, we accrued for future losses under customer contracts that over the contract life were projected to have direct costs greater than revenues. Effective January 1, 2003, we changed our policy from this method to one that expenses these losses as they are incurred. In the first quarter of 2003, we recorded approximately $30 million, net of taxes, or $0.05 per diluted share, as a credit to cumulative effect of changes in accounting principles. We believe this accounting change is preferable because it (i) provides operating results that more clearly reflect the timing and amount of contract losses generated, (ii) more clearly reflects our liabilities, and (iii) reduces the need to make additional estimates and assumptions. The effect of this change in accounting principle is immaterial to our results of operations for the three months ended March 31, 2003.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

     Adoption of SFAS No. 143 — Accounting for Asset Retirement Obligations

      In connection with the adoption of SFAS No. 143, Accounting for Asset Retirement Obligations, we recorded approximately $101 million, including tax benefit, or $0.17 per diluted share, in the first quarter of 2003 as a charge to cumulative effect of changes in accounting principles. Substantially all of this charge was related to changes in accounting for landfill final capping, closure and post-closure costs. The effect of applying the provisions of SFAS No. 143 was a reduction in income before cumulative effect of changes in accounting principles for the three months ended March 31, 2003 of approximately $8 million, including tax benefit, or $0.01 per diluted share.

      Effective January 1, 2003, our method of accounting for landfill closure and post-closure, as well as landfill final capping, changed as a result of our adoption of SFAS No. 143. SFAS No. 143 does not change the basic landfill accounting that we and others in the waste industry have followed historically. Through December 31, 2002, the waste industry generally recognized expenses associated with (i) amortization of capitalized and future landfill asset costs and (ii) future closure and post-closure obligations on a units-of-consumption basis as airspace was consumed over the life of the related landfill. This practice, referred to as life cycle accounting within the waste industry, continues to be followed. The table below compares our historical practices and current practices of accounting for landfill final capping, closure and post-closure activities.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      We amortize landfill retirement costs arising from closure and post-closure obligations, which are capitalized as part of the landfill asset, using our historical landfill accounting practices. We amortize landfill

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

retirement costs arising from final capping obligations, which are also capitalized as part of the landfill asset, on a units-of-consumption basis over the number of tons of waste that each final capping event covers.

      The following table summarizes the balance sheet impact of the adoption of SFAS No. 143 (in millions):

     Landfill

      We have material financial commitments for final capping, closure and post-closure obligations with respect to our landfills. We develop our estimates of final capping, closure and post-closure obligations using input from our engineers and accountants. Our estimates are based on our interpretation of current requirements and proposed regulatory changes and are intended to approximate fair value. Absent quoted market prices, the estimate of fair value should be based on the best available information, including the results of present value techniques. In general, we contract with third parties to fulfill most of our obligations for final capping, closure and post-closure. Accordingly, the fair value of these obligations is based upon quoted and actual prices paid for similar work. We intend to perform some of these capping, closure and post-closure activities using internal resources. Where internal resources are expected to be used to fulfill an asset retirement obligation, we have added a profit margin to the estimated cost of such services to better reflect their fair value. When we then perform these services internally, the added profit margin is recognized as a component of operating income in the period earned. An estimate of fair value should include the price that marketplace participants are able to receive for bearing the uncertainties in cash flows. However, when utilizing discounted cash flow techniques, reliable estimates of market premiums may not be obtainable. In the waste industry, there is no market that exists for selling the responsibility for final capping, closure and post-closure independent of selling the landfill in its entirety. Accordingly, we believe that it is not possible to develop a methodology to reliably estimate a market risk premium and have excluded a market risk premium from our determination of expected cash flows for landfill asset retirement obligations.

      Once we have determined the final capping, closure and post-closure costs, we then inflate those costs to the expected time of payment and discount those expected future costs back to present value. We inflate these costs in current dollars until the expected time of payment using an inflation rate of 2.5% and discount these costs to present value using a credit-adjusted, risk-free discount rate of 7.25%. We reviewed the inflation rate to be used for 2003 and determined that a rate of 2.5%, which is the rate used by most waste industry participants, was appropriate. The credit-adjusted, risk-free rate is based on the risk-free interest rate on obligations of similar maturity adjusted for our own credit rating. Changes in our credit-adjusted, risk-free rate do not change recorded liabilities, but subsequently recognized obligations are measured using the revised credit-adjusted risk-free rate.

      Management reviews the estimates of our obligations at least annually. Significant changes in inflation rates and the amount and timing of future final capping, closure and post-closure cost estimates typically result in both (i) a current adjustment to the recorded liability (and corresponding adjustment to the landfill asset), based on the landfill’s capacity consumed, and (ii) a change in liability and asset amounts to be recorded

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

prospectively over the remaining capacity of the landfill. Any change related to the capitalized and future cost of the landfill asset is then recognized in amortization expense prospectively over the remaining capacity of the landfill.

      We record the estimated fair value of final capping, closure and post-closure liabilities for our landfills based on the respective final capping or landfill capacities consumed through the current period. The liability and corresponding asset are recorded on a per-ton basis. The estimated fair value of each final capping event will be fully accrued when the tons associated with such capping event have been disposed in the landfill. Additionally, the estimated fair value of total final capping, closure and post-closure costs will be fully accrued for each landfill at the time the site discontinues accepting waste and is closed. Closure and post-closure accruals consider estimates for methane gas control, leachate management and ground-water monitoring and other operational and maintenance costs to be incurred after the site discontinues accepting waste, which is generally expected to be for a period of up to thirty years after final site closure. Daily maintenance activities, which include many of these costs, are incurred during the operating life of the landfill and are expensed as incurred. Daily maintenance activities include leachate disposal; surface water, groundwater, and methane gas monitoring and maintenance; other pollution control activities; mowing and fertilizing the landfill final cap; fence and road maintenance; and third party inspection and reporting costs. For purchased disposal sites, we assess and record final capping, closure and post-closure liabilities at the time we assume such responsibilities. Such liabilities are based on the estimated fair value of final capping, closure and post-closure costs and the percentage of airspace consumed related to such obligations as of the date we assumed the responsibility. Thereafter, we account for the landfill and related final capping, closure and post-closure obligations consistent with the policy described above.

      Interest accretion on final capping, closure and post-closure liabilities is recorded using the effective interest method and is recorded as final capping, closure and post-closure expense, which is included in operating costs on the income statement.

      In the United States, the 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.

     Environmental

      We routinely review and evaluate sites that require remediation, including sites listed on the EPA’s National Priorities List, or NPL. 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. We also review the same information with respect to other named and unnamed PRPs, or potentially responsible parties. We then review the estimated cost for the likely remedy, which we base on (i) management’s judgment and experience in remediating such sites; (ii) information available from regulatory agencies as to costs of remediation; (iii) the number, financial resources and relative degree of responsibility of other PRPs who may be liable for remediation of a specific site; and (iv) the typical allocation of costs among PRPs. These estimates are sometimes a range of “reasonably possible” outcomes, meaning outcomes that we believe to be more than remote but less than likely. 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 such ranges in accordance with SFAS No. 5, Accounting for Contingencies and its interpretations. Were we to use the high ends of such ranges, our potential liability would be approximately $210 million higher on a discounted basis in the aggregate than the estimate recorded in the consolidated financial statements as of March 31, 2003.

      As of March 31, 2003, we had been notified that we are a PRP in connection with 75 locations listed on the NPL. Through various acquisitions we have come to own 17 of these sites, although they were initially developed by others as disposal facilities. We are working in conjunction with the government to characterize

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

or remediate identified site problems and have either agreed with other legally liable parties on an arrangement for sharing the costs of remediation or are pursuing resolution of an allocation formula. We generally expect to receive any amounts due from these parties at, or near, the time that we make remedial expenditures. Claims have been made against us at another 58 sites we do not own where we have been an operator, transporter or generator of waste. These claims are at different procedural stages under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, which is also known as Superfund. At some of these sites, our liability is well defined as a consequence of a governmental decision and an agreement among liable parties as to the allocation of costs. At others where no remedy has been selected or the liable parties have been unable to agree on an appropriate allocation, our future costs are uncertain. Any of these matters could have a material adverse effect on our consolidated financial statements.

      Estimates of our 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 inability of other PRPs to contribute to the settlements of such liabilities, or other factors could require us to record additional liabilities that could be material. Additionally, our ongoing review of our 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 we believe that both the amount of a particular environmental liability and the timing of the payments are reliably determinable, we inflate the cost in current dollars (2.5% at March 31, 2003 and 2.0% at December 31, 2002) until the expected time of payment and discount the cost to present value using a risk-free discount rate with a term approximating the weighted average period until settlement of the underlying obligation (4.0% at March 31, 2003 and 5.0% at December 31, 2002). We review the inflation rate and discount rate, which are based on the rates for United States Treasury bonds, on an annual basis. For remedial liabilities that have been discounted, we include interest accretion, based on the effective interest method, in operating costs and expenses.

      Liabilities for landfill and environmental remediation costs are presented in the table below (in millions):

	a)	As of March 31, 2003, landfill liabilities include our final capping, closure and post-closure obligations under the provisions of SFAS No. 143. Final capping obligations to be discharged during the operating lives of landfills are not included in landfill liabilities as of December 31, 2002.

11

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

     The changes to landfill and environmental remediation liabilities for the three months ended March 31, 2003 and March 31, 2002 are as follows (in millions):

      The fair value of assets that are legally restricted for purposes of settling closure and post-closure obligations was approximately $105 million at March 31, 2003, and included as other long-term assets in our condensed consolidated balance sheets.

3.     Debt and Interest Rate Derivatives

     Debt

      Debt consisted of the following (in millions):

	a)	As of March 31, 2003, we have $434 million of 6.375% senior notes due December 1, 2003. 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 holders. We classified approximately $830 million of these borrowings as long-term at March 31, 2003 based upon our available capacity of $830 million at March 31, 2003 under our two 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.
	b)	We have $498 million of tax-exempt bonds at March 31, 2003 that mature through 2031 that are remarketed weekly by a remarketing agent. If the remarketing agent is unable to remarket the bonds, then the remarketing agent can put the bonds to the Company. We have obtained letters of credit, issued under our revolving credit facilities, to guarantee repayment of the

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

		bonds in this event. We classified these borrowings as long-term at March 31, 2003 because the borrowings are supported by letters of credit issued under our two revolving credit facilities, which are both long-term.
	c)	As of December 31, 2002, we had $434 million of 6.375% senior notes due December 1, 2003. We also had $450 million of 7.1% senior note due August 1, 2026 that are subject to early redemption on August 1, 2003 at the option of the holders. We have classified $770 million of these borrowings as long-term at December 31, 2002 based upon our available capacity of $770 million at December 31, 2002 under our two 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.

     As of March 31, 2003, we had a three year, $650 million syndicated revolving credit facility and a five year, $1.75 billion syndicated revolving credit facility. The three year revolver matures in June 2005 and the five year revolver matures in June 2006. As of March 31, 2003, we had letters of credit in the aggregate amount of approximately $1.70 billion (of which approximately $1.57 billion are issued under the revolving credit facilities) that generally have terms allowing automatic renewal after one year. At March 31, 2003, no balances were outstanding under our revolving credit facilities and we had unused and available credit capacity under these facilities of approximately $830 million.

      As of March 31, 2003, we are required to maintain the following financial covenants under our revolving credit facilities: (i) an interest coverage ratio; (ii) total debt to EBITDA; and (iii) minimum net worth, all as defined in the credit facilities solely for the purpose of determining compliance with the covenants. 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 3 to 1. 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 3.25 to 1. Our minimum net worth covenant restricts us from allowing 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. We are in compliance with all covenants under our revolving credit facilities and all other debt instruments.

      Our tax-exempt and project bonds are primarily related to industrial revenue bonds issued for the construction of various facilities. Proceeds from these financing arrangements are treated as non-cash financing activities for purposes of the statement of cash flows as the proceeds are directly deposited into trust funds, and we do not have the ability to utilize the funds in regular operating activities. Accordingly, our March 2003 issuance of approximately $37 million of tax-exempt bonds maturing through 2028 was treated as a non-cash financing activity.

      Our debt balances are generally unsecured, except for approximately $612 million of the tax-exempt and project bonds outstanding at March 31, 2003 that are issued by certain of our subsidiaries within the Wheelabrator Group and secured by the related subsidiary’s assets and revenue.

     Interest rate swaps

      We manage the interest rate risk of our debt portfolio principally by using interest rate derivatives to achieve a desired position of fixed and floating rate debt, which was approximately 67% fixed and 33% floating

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

at March 31, 2003. Interest rate swap agreements outstanding as of December 31, 2002 and March 31, 2003 are set forth in the table below (dollars in millions):

	a)	The fair value of interest rate derivatives is included in our balance sheets as components of other long-term assets and other long-term liabilities. Fair values of these interest rate derivatives are based on third party pricing models.
	b)	The terms of this interest rate derivative contract do not qualify for hedge accounting. Therefore, the contract is accounted for at fair value with changes in fair value recognized immediately in interest expense.
	c)	These interest rate derivatives qualify for hedge accounting. Therefore, changes in fair value of these interest rate swap contracts are deferred and recognized as an adjustment to interest expense over the remaining life of the hedged instrument.
	d)	The fair value of these interest rate derivatives is a net fair value asset of $31 million that is comprised of $36 million of other long-term assets and $5 million of other long-term liabilities.

     In March 2003, we elected to terminate interest rate swap agreements with a notional amount of $400 million prior to the scheduled maturities and received cash of $27.3 million (which is comprised of $24.9 million for the fair value of the swaps terminated and $2.4 million of accrued but unpaid interest receivable) from the counterparties to the interest rate swaps. We had designated these swap agreements as fair value hedges, and as such the unamortized adjustment to long-term debt for the change in fair value of the swaps remains classified with 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.

      Fair value hedge accounting for interest rate swap contracts increased the carrying value of debt instruments by approximately $251 million as of March 31, 2003 and $239 million as of December 31, 2002. The following table summarizes the accumulated fair value adjustments from interest rate swap agreements by underlying debt instrument category (in millions):

	a)	Of these amounts, $41 million (on a pre-tax basis) is scheduled to be reclassified as a credit to interest expense over the next twelve months.

     Interest rate swap agreements reduced net interest expense by $24 million for the three months ended March 31, 2003 and $20 million for the three months ended March 31, 2002. The significant terms of the interest rate contracts and the underlying debt instruments are identical and therefore, no ineffectiveness has been realized.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      During 2002 and 2001, we entered into cash flow hedges to secure the underlying interest rates in anticipation of our senior note issuances. These hedging agreements resulted in a deferred loss, net of taxes, of $39 million at March 31, 2003, which is included in accumulated other comprehensive income. Of this amount, $5 million (on a pre-tax basis) is scheduled to be reclassified into interest expense over the next twelve months.

      We are a market maker in over-the-counter derivatives for waste paper and other paper commodities (“fiber derivatives”). As there is no regulated exchange market for these commodities, fair value assessments of our fiber derivatives are based on information from independent, third party broker dealers, alternate price sources, and our view of the market’s economic fundamentals. Although these assessments represent our best estimates on any given day, the values, as reported on March 31, 2003, will change over time due to subsequent fluctuations in market conditions. As of March 31, 2003, the net fair value of our fiber derivatives was a net liability of approximately $7 million.

      We enter into fiber swap agreements to mitigate the variability in cash flows of certain waste paper products expected to be sold from our material recovery facilities and account for these derivatives as cash flow hedges. Our fiber derivatives designated as hedges 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 we are hedging our exposure to variability in future cash flows from the sale of waste paper products. As of March 31, 2003, we have included a net deferred loss on these cash flow hedges of approximately $5 million, net of taxes, in accumulated other comprehensive income. We expect to reclassify approximately $7 million (on a pre-tax basis) of deferred loss as a reduction in revenues over the next twelve months. The ineffective portion of our fiber hedges was immaterial in both 2002 and 2003.

      We have also entered into certain fiber swap agreements with the objective of generating profits from changes in market prices of waste paper and other paper products. These derivatives are not designated as hedges and are accounted for at fair value, with changes in fair value reflected immediately in earnings. These derivatives reduced revenues by approximately $300,000 for the three months ended March 31, 2003 and $200,000 for the corresponding prior year period.

      All of our derivative transactions are subject to our risk management policy, which includes careful monitoring of the credit worthiness of each counterparty. To the extent a counterparty in these transactions is unable to meet its monthly settlement commitments, our exposure to credit risk increases.

      The current tax obligations associated with the provision for income taxes recorded in the statements of operations are reflected in the accompanying condensed consolidated balance sheets as a component of accrued liabilities, and the deferred tax obligations are reflected in deferred income taxes. The difference in federal income taxes computed at the federal statutory rate and reported income taxes for the three months ended March 31, 2003 and March 31, 2002 is primarily due to state and local income taxes, offset in part by non-conventional fuel tax credits.

      Comprehensive income represents the change in our equity from transactions and other events and circumstances from non-owner sources and includes all changes in equity except those resulting from investments by owners and distributions to owners.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Comprehensive income for the three months ended March 31, 2003 and March 31, 2002 was as follows (in millions):

      The components of accumulated other comprehensive loss were as follows:

      The following reconciles the number of common shares outstanding at March 31 of each year presented to the weighted average number of common shares outstanding and to 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 each of the periods presented above, we excluded the effect of our convertible subordinated notes from the diluted earnings per share calculation because the inclusion of this item would have been antidilutive. For the three months ended March 31, 2003, we have included in our weighted average diluted common shares outstanding approximately 200,000 shares that are contingently issuable. The contingent issuance of our common stock is based upon an obligation that may be incurred to settle our March 2003 private accelerated common stock repurchase in May 2003. For further discussion see Note 8.

      At March 31, 2003, there were approximately 53.7 million shares of common stock potentially issuable with respect to stock options, warrants and convertible debt. We excluded approximately 33.3 million of these

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

shares from the diluted earnings per share computation because their exercise price was greater than the average per share market price of our stock for the three month period ended March 31, 2003. Including the impact of these potentially issuable shares in the current period calculations would have been antidilutive at March 31, 2003, but may dilute earnings per share in future periods.

      We account for our stock-based compensation using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, as amended. Pursuant to APB No. 25, we recognize no compensation cost for our stock option grants because the number of shares potentially issuable is fixed, and the exercise price of all of our stock options is fixed and equal to the fair market value of the underlying stock on the date of grant.

      The following schedule reflects the pro forma impact on net income and earnings per common share of accounting for our stock option grants using SFAS No. 123, Accounting for Stock-Based Compensation, which would result in the recognition of compensation expense for the fair value of stock option grants as computed using the Black-Scholes option-pricing model (in millions, except per share amounts).