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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 July 26, 2004 was 579,867,019 (excluding treasury shares of 50,415,442).

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PART I.

WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS

See notes to condensed consolidated financial statements.

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WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See notes to condensed consolidated financial statements.

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WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to condensed consolidated financial statements.

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WASTE MANAGEMENT, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

See notes to condensed consolidated financial statements.

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WASTE MANAGEMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

      The condensed financial statements presented herein represent the consolidation of Waste Management, Inc., a Delaware corporation, its majority-owned subsidiaries and entities required to be consolidated pursuant to the Financial Accounting Standards Board (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”) (see Note 9). Waste Management, Inc. is a holding company that conducts all of its operations through its subsidiaries. When the terms “the Company,” “we,” “us” or “our” are used in this document, those terms refer to Waste Management, Inc. and all of its consolidated subsidiaries. When we use the term “WMI,” we are referring only to the parent holding company.

      The condensed consolidated financial statements as of and for the three and six months ended June 30, 2004 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 our Annual Report on Form 10-K for the year ended December 31, 2003.

      In preparing our financial statements, we make several estimates and assumptions that affect the accounting for and recognition of assets, liabilities, stockholders’ equity, revenues and expenses. We must make these estimates and assumptions because certain of the information that we use is dependent on future events, cannot be calculated with a high degree of precision from data available or simply cannot be readily calculated based on generally accepted methodologies. In some cases, these estimates are particularly difficult to determine and we must exercise significant judgment. Actual results could differ materially from the estimates and assumptions that we use in the preparation of our financial statements.

      Accounting change — The FASB’s December 2003 revision to FIN 46 deferred until March 31, 2004 our application of the Interpretation to non-special purpose type variable interest entities created on or before January 31, 2003. Our application of FIN 46 to this type of entity resulted in the consolidation of certain trusts established to support the performance of closure, post-closure and environmental remediation activities. On March 31, 2004, we recorded an increase in our net assets and a credit to cumulative effect of changes in accounting principles of approximately $8 million, net of taxes, to consolidate these variable interest entities. The consolidation of these trusts has not had, nor is it expected to have, a material effect on our financial position, results of operations or cash flows. The impact of our implementation of FIN 46 is discussed further in Note 9.

      In the first quarter of 2003, we recorded a $46 million, net of tax, cumulative effect of changes in accounting principles for the adoption of the (i) Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations; (ii) a change in our accounting for major repairs and maintenance expenditures and deferred costs associated with annual plant outages at our waste-to-energy facilities and independent power production plants; and (iii) a change in accounting for future losses under customer contracts that over the contract life are projected to have direct costs greater than revenues. These accounting changes do not affect the comparability of our financial position or income before cumulative effect of changes in accounting principles as presented herein.

      Reclassifications — As a result of internal review processes, we identified certain mandatory fees and taxes that have historically been treated as pass-through costs that actually represent direct obligations of the Company. Effective January 1, 2004, we began recording all mandatory fees and taxes that create direct obligations for us as operating expenses and recording revenue when the fees and taxes are billed to our customers. We have conformed the prior year’s presentation of our revenues and expenses with the current year’s presentation by increasing both our revenue and our operating expenses by approximately $19 million

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

for the three months ended June 30, 2003 and by approximately $35 million for the six months ended June 30, 2003.

      Through our internal review processes, we also determined that certain cash accounts with negative balances and no legal right of offset had been included in cash and cash equivalents on our balance sheet in prior periods. As a result, we have increased both our cash and cash equivalents and accounts payable balances at December 31, 2003 by approximately $82 million to properly reflect our gross cash balances and current liabilities. We determined that these changes in our accounts payable balances during each reporting period should be treated as financing activities within the statement of cash flows. Accordingly, the $25 million decrease in the amount payable (from $95 million at December 31, 2002 to $70 million at June 30, 2003) has been reflected as a component of other within cash used in financing activities for the six months ended June 30, 2003.

      We have various investments in unconsolidated entities that we account for using the equity method. Our equity in the earnings of these entities has historically been presented as a component of other income in our statements of operations and the related cash flow impact has been reflected as a component of the change in other assets within our statements of cash flows. As a result of investments we made during the first and second quarters of 2004, as described in Note 4, this activity has become a more significant component of our net income and operating cash flow activity. Accordingly, we have shown equity in the earnings and losses of unconsolidated entities as a separate component within our statement of operations and equity in earnings and losses of unconsolidated entities, net of distributions, as a separate component of cash provided by operating activities. Prior periods have been reclassified to conform to the current periods’ presentation.

      We have material financial commitments at our landfills for final capping, closure and post-closure activities, as described below:

	•	Final capping — Involves the installation of flexible membrane and geosynthetic clay liners, drainage equipment and compacted soil layers and topsoil over areas of a landfill where total airspace capacity has been consumed. Final capping asset retirement obligations are recorded on a units-of-consumption basis as airspace is consumed within each discrete capping event with a corresponding increase in the landfill asset until all airspace related to each discrete capping event has been consumed.
	•	Closure — Includes the construction of the final portion of methane gas collection systems (when required), demobilization and routine maintenance costs. These are costs incurred after the site stops accepting waste, but before the landfill is certified as closed by the applicable regulatory agency. Closure obligations are accrued as an asset retirement obligation on a units-of-consumption basis as airspace is consumed over the life of the landfill with a corresponding increase in the landfill asset.
	•	Post-closure — Once a landfill is certified closed by the applicable regulatory agency, we are required to maintain and monitor the site over a period of time, which is generally 30 years. These maintenance and monitoring costs are accrued as an asset retirement obligation on a units-of-consumption basis as airspace is consumed over the life of the landfill with a corresponding increase in the landfill asset.

      We develop our estimates of these obligations using input from our operations personnel, engineers and accountants. Our estimates are based on our interpretation of legal and regulatory requirements and are intended to approximate fair value under the provisions of SFAS No. 143. An estimate of fair value under SFAS No. 143 should include the premium that a third party would receive for bearing the uncertainty in cash outflows. However, when using discounted cash flow techniques, reliable estimates of market premiums are not available because there is no market for selling the responsibility for final capping, closure and post-closure

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

obligations independent of selling the landfill in its entirety. Accordingly, we do not believe that it is possible to develop a methodology to estimate a market risk premium and therefore no market risk premium is included in our determination of expected cash outflows for landfill asset retirement obligations. The specific methods used to calculate the fair value for final capping, closure and post-closure and the method of accruing for these balances are explained in detail in our Annual Report on Form 10-K for the year ended December 31, 2003.

      We inflate estimated final capping, closure and post-closure costs to the expected time of payment using an inflation rate of 2.5% and discount those expected future costs back to present value using a credit-adjusted, risk-free discount rate, which was 6.25% for liabilities incurred during the six months ended June 30, 2004. Our credit-adjusted, risk-free discount 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 discount rate do not change recorded liabilities, but subsequently recognized obligations are measured using the revised discount rate. We determine the inflation rate and our credit-adjusted, risk-free discount rate on an annual basis unless there have been interim changes in either rate that would significantly impact our results of operations.

      We routinely review and evaluate sites that require remediation and determine our estimated cost for the likely remedy based on several estimates and assumptions. These estimates are sometimes a range of “reasonably possible” outcomes. “Reasonably possible” outcomes are those outcomes that are considered more than remote and less than likely. In cases where our estimates are a range, 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 low end of the range in accordance with SFAS No. 5, Accounting for Contingencies, and its interpretations. If we used the high ends of such ranges, our aggregate potential liability would be approximately $175 million higher on a discounted basis than the $325 million recorded in our condensed consolidated financial statements as of June 30, 2004.

      As of June 30, 2004, we had been notified that we are a potentially responsible party in connection with 71 locations listed on the NPL, which is the EPA’s National Priorities List. Through various acquisitions, we have come to own 16 of these sites that were initially developed by others. We are working with the government to characterize or remediate identified site problems and have either agreed with other parties on an arrangement for sharing the costs of remediation or are pursuing resolution of an allocation formula. We generally expect to receive any agreed-upon amounts due from these parties at, or near, the time that we make environmental remediation expenditures. Claims have been made against us at another 55 sites that we do not own but 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 known as CERCLA or Superfund. At some of these sites, our liability is well defined as a consequence of a governmental decision and an agreement among the parties involved as to the allocation of costs. At others where no remedy has been selected or the potentially responsible parties have been unable to agree on an appropriate allocation, our future costs are uncertain, and any of these matters could have a material adverse effect on our condensed consolidated financial statements.

      Where we believe that both the amount of a particular environmental remediation liability and the timing of the payments are reliably determinable, we inflate the cost in current dollars until the expected time of payment and discount the cost to present value using a risk-free discount rate, which is based on the rate for United States Treasury bonds with a term approximating the weighted average period until settlement of the underlying obligation. As of June 30, 2004, we are using an inflation rate of 2.5% and a risk-free discount rate of 4.25% to record our estimated environmental remediation obligations. We determine the inflation rate and the risk-free discount rate on an annual basis unless there have been interim changes in either rate that would significantly impact our results of operations.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

      The changes to landfill and environmental remediation liabilities for the six months ended June 30, 2004 and 2003 are reflected in the tables below (in millions):

      At several of our landfills, we provide financial assurance by depositing cash into escrow accounts or trust funds that are legally restricted for purposes of settling closure, post-closure and environmental remediation obligations. The fair value of these escrow accounts and trust funds was approximately $200 million at June 30, 2004, and is primarily included as other long-term assets in our condensed consolidated balance sheet. Balances maintained by us in trust funds and escrow accounts restricted for closure, post-closure and environmental remediation activities will fluctuate based on (i) changes in statutory requirements; (ii) the ongoing use of funds for qualifying closure, post-closure and environmental remediation activities; (iii) acquisitions or divestitures of landfills; and (iv) changes in the fair value of the underlying financial instruments.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Debt consisted of the following (in millions):

	a)	As of June 30, 2004, 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. These facilities have generally been used to support letters of credit issued to support our bonding and financial assurance needs. As of June 30, 2004, no borrowings were outstanding under these facilities, and we had unused and available credit capacity of $969 million.
	b)	We are required to maintain the following financial covenants under our revolving credit facilities: (i) an interest coverage ratio in excess of 3 to 1; (ii) total debt to EBITDA ratio of less than 3.25 to 1; and (iii) minimum net worth of at least $3.5 billion plus 75% of cumulative consolidated net income beginning with the quarter ended March 31, 2001, all as defined in the credit facilities for the purpose of determining compliance with the covenants. The credit facilities state that the calculations must be based on generally accepted accounting principles promulgated by the FASB that were in effect as of the last fiscal year before the date we entered into these facilities. We therefore calculate our covenants based on GAAP as of December 31, 2000 and 2001 for the five-year revolver and the three-year revolver, respectively, and our adoption or implementation of accounting pronouncements or interpretations effective on or after those dates does not impact the calculation of the financial covenants defined above. As of June 30, 2004 and December 31, 2003, we were in compliance with all covenants under our revolving credit facilities and all other debt instruments.
	c)	During March 2004, we issued $350 million of 5.0% senior notes due March 15, 2014. Interest on the notes is payable on March 15 and September 15 of each year. The net proceeds of the offering were approximately $346 million after deducting underwriters’ discounts and expenses. These proceeds were used to pay $150 million of 8.0% senior notes due April 30, 2004 and $200 million of 6.5% senior notes due May 15, 2004. As discussed in further detail below, there has been a $69 million decrease in the carrying value of our senior notes from December 31, 2003 as a result of hedge accounting for our interest rate derivatives.
	d)	Proceeds from tax-exempt bond issues are treated as non-cash financing activities and are excluded from cash provided by financing activities in our cash flow statement as the proceeds are deposited directly into trust funds and may only be used for the specific purpose for which the money was raised, which is generally the construction of collection and disposal facilities. Accordingly, our 2004 issuances of approximately $163 million of tax-exempt bonds maturing through 2033 were treated as non-cash financing activities.
	e)	Our debt obligations as of June 30, 2004 include approximately $416 million of fixed rate tax-exempt bonds subject to re-pricing within the next twelve months, which is prior to their scheduled maturities. If the re-offering of the bonds is unsuccessful, then the bonds can be put to us, requiring immediate repayment. These bonds are not backed by letters of credit that would serve to guarantee repayment in the event of a failed re-offering and are, therefore, considered a current obligation. Approximately

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

		$277 million of these bonds has been classified as long-term in our condensed consolidated balance sheet as of June 30, 2004. The classification of these obligations as long-term was based upon our intent to refinance the borrowings with other long-term financings in the event of a failed re-offering and our ability, in the event other sources of long-term financing are not available, to use our five-year revolving credit facility, which is long-term.

	f)	At June 30, 2004, we have $590 million of tax-exempt bonds and $46 million of tax-exempt project bonds that are remarketed either daily or weekly by a remarketing agent to effectively maintain a variable yield. If the remarketing agent is unable to remarket the bonds, then the remarketing agent can put the bonds to us. We have obtained letters of credit to guarantee repayment of the bonds in this event. We classified these borrowings as long-term in our condensed consolidated balance sheet at June 30, 2004 because the borrowings are supported by letters of credit issued under our five-year revolving credit facility, which is long-term.

     Our debt balances are generally unsecured, except for approximately $473 million of the tax-exempt project bonds outstanding at June 30, 2004 that are issued by certain subsidiaries within our Wheelabrator Group. These bonds are secured by both assets of the related subsidiaries that have a carrying value of approximately $673 million and the related subsidiaries’ future revenue. Additionally, our consolidated variable interest entities have approximately $171 million of outstanding borrowings that are collateralized by assets of those entities. These assets have a carrying value of approximately $395 million as of June 30, 2004.

      As part of our operations, and in connection with issuances of tax-exempt bonds, we use letters of credit to support our bonding and financial assurance needs. The following table summarizes our outstanding letters of credit (in millions):

	a)	In June 2003 we entered into a five-year, $15 million letter of credit and term loan agreement, a seven-year, $175 million letter of credit and term loan agreement, and a ten-year, $105 million letter of credit and term loan agreement, which expire in June 2008, 2010, and 2013, respectively.
	b)	In December 2003 we entered into a five-year, $350 million letter of credit facility.

     Our letters of credit generally have terms allowing for automatic renewal after one year. In the event of an unreimbursed draw on a letter of credit, the unreimbursed amount generally converts into a term loan for the remaining term under the respective agreement or facility. Through June 30, 2004, we had not experienced any unreimbursed draws on letters of credit.

      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 63% fixed and 37% floating

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

at June 30, 2004. Interest rate swap agreements outstanding as of December 31, 2003 and June 30, 2004 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 interest rate derivative contract terms do not qualify for hedge accounting. Therefore, the related derivatives are 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 at December 31, 2003 is a net fair value liability of $99 million that is comprised of $2 million of other long-term assets and $101 million of other long-term liabilities. The fair value of these interest rate derivatives at June 30, 2004 is a net fair value liability of $143 million that is comprised of $1 million of other long-term assets and $144 million of other long-term liabilities.

     Fair value hedge accounting for interest rate swap contracts increased the carrying value of debt instruments by approximately $99 million as of June 30, 2004 and $168 million as of December 31, 2003. 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, $44 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 $26 million and $50 million for the three and six months ended June 30, 2004, respectively, and $23 million and $47 million for the three and six months ended June 30, 2003, respectively. The significant terms of the interest rate contracts and the underlying debt instruments are identical and therefore no ineffectiveness has been realized.

      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 and six months ended June 30, 2004 is primarily due to the favorable impact of non-conventional fuel tax credits and favorable audit settlements, offset in part by state and local income taxes. The difference in federal income taxes computed at the federal statutory rate and reported income taxes for the three and six months ended

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

June 30, 2003 is primarily due to state and local income taxes, offset in part by non-conventional fuel tax credits. We continue to evaluate our effective tax rate at each interim period and adjust it accordingly as facts and circumstances warrant.

      In the first and second quarters of 2004, we acquired minority ownership interests in two coal-based synthetic fuel production facilities (the “Facilities”) for approximately $119.7 million, which is comprised primarily of notes payable of $118.5 million, as well as commitments to fund our pro-rata share of the operations of the Facilities. We have also agreed to make additional payments to the seller based on our pro-rata allocation of the tax credits generated by each Facility. The synthetic fuel produced at the Facilities through 2007 qualifies for tax credits pursuant to Section 29 of the Internal Revenue Code (currently credits are not available for fuel produced after 2007). We have been granted private letter rulings from the U.S. Internal Revenue Service confirming that the synthetic fuel produced by the Facilities is a “qualified fuel” under Section 29 of the Internal Revenue Code and that the resulting tax credits may be allocated among the owners of the interests in the Facilities.

      We account for our investment in the Facilities using the equity method of accounting, which results in the recognition of our pro-rata share of the Facilities’ losses, the amortization of our initial investments and other estimated obligations being recorded as equity in losses of unconsolidated entities within our statement of operations. The total loss recognized during the three months ended June 30, 2004 was approximately $26 million, making cumulative losses recognized during the six months ended June 30, 2004 approximately $45 million. We also recognized interest expense related to these investments of approximately $2 million during the three months ended June 30, 2004 and approximately $4 million during the six months ended June 30, 2004. The tax benefits that we will realize as a result of our investments in the Facilities have been reflected as a reduction to our provision for income taxes. This resulted in a decrease in our tax provision of approximately $35 million for the three months ended June 30, 2004 and approximately $54 million for the six months ended June 30, 2004, which more than offset the equity losses and interest expense recognized during each period. The decreases in our tax provision represent an 8.3 percentage point reduction in our effective tax rate for the three months ended June 30, 2004 and a 7.0 percentage point reduction in our effective tax rate for the six months ended June 30, 2004.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Comprehensive income represents all changes in our equity except for changes resulting from investments by, and distributions to, stockholders. Comprehensive income for the three and six months ended June 30, 2004 and June 30, 2003 was as follows (in millions):