SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

ý   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended September 30, 2004

 

or

 

o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transaction period from            to           

 

Commission File Number: 333-98657

 

 

IESI CORPORATION

(Exact Name of Registrant as Specified in its Charter)

 

 

(817) 632-4000

(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 o No ý

 

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

 

The number of shares of the Registrant’s Class A voting common stock, par value $.01 per share, and Class B non-voting common stock, par value $.01 per share, outstanding as of November 1, 2004 were 142,000 and 112,980.2, respectively.  There is no trading market for any class of equity securities of the Registrant.

 

 

IESI CORPORATION

 

TABLE OF CONTENTS

 

Part I. Financial Information
Item 1. Financial Statements
	Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003
	Consolidated Statements of Operations for the Nine and Three Months Ended September 30, 2004 and 2003
	Consolidated Statement of Stockholders’ Equity (Deficit) for the Nine Months Ended September 30, 2004
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003
	Notes to Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II. Other Information
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
Signatures

 

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Part I.  Financial Information

 

Item 1.  Financial Statements

 

IESI CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

 

		September 30, 2004			December 31, 2003
		(unaudited)
Current assets:
Cash and cash equivalents		$	4,091,964		$	4,197,157
Accounts receivable-trade, less allowance of $1,638,000 and $2,397,000 at September 30, 2004 and December 31, 2003, respectively		37,035,056			30,585,797
Deferred income taxes		1,356,471			1,356,471
Prepaid expenses and other current assets		6,245,237			4,782,446
Total current assets		48,728,728			40,921,871
Property and equipment, net of accumulated depreciation of $154,547,000 and $110,218,000 at September 30, 2004 and December 31, 2003, respectively		495,241,121			488,659,850
Goodwill		138,903,734			138,335,715
Other intangible assets, net		28,342,060			32,986,163
Other assets		4,113,667			2,143,616
Total assets		$	715,329,310		$	703,047,215
Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable—trade		$	20,085,857		$	27,448,950
Accrued expenses and other current liabilities		35,623,789			17,512,525
Deferred revenue		1,711,409			1,231,758
Current portion of long-term debt		2,061,274			2,731,595
Total current liabilities		59,482,329			48,924,828
Long-term debt		372,628,495			378,129,393
Accrued environmental and landfill costs		50,382,304			47,456,769
Deferred income taxes		11,614,566			9,949,611
Other liabilities		1,362,353			1,282,992
Total liabilities		495,470,047			485,743,593
Commitments and contingencies
Redeemable preferred stock:
Redeemable Series A Convertible Preferred Stock, 32,000 shares authorized, issued and outstanding, liquidation preference of $40,000,000 at September 30, 2004 and December 31, 2003		39,683,637			39,683,637
Redeemable Series B Convertible Preferred Stock, 20,100 shares authorized, issued and outstanding, liquidation preference of $25,125,000 at September 30, 2004 and December 31, 2003		24,808,636			24,808,636
Redeemable Series C Convertible Preferred Stock, 55,000 shares authorized, issued and outstanding, liquidation preference of $117,607,613 and $105,448,126 at September 30, 2004 and December 31, 2003, respectively		115,565,152			103,405,665
Redeemable Series D Convertible Preferred Stock, 55,000 shares authorized, shares issued and outstanding, liquidation preference of $73,890,308 and $68,655,338 at September 30, 2004 and December 31, 2003, respectively		71,270,431			66,035,461
Redeemable Series E Convertible Preferred Stock, 55,000 shares authorized, 49,660 shares issued and outstanding, liquidation preference of $54,633,207 and $50,762,561 at September 30, 2004 and December 31, 2003, respectively		52,991,535			49,120,889
Total redeemable preferred stock		304,319,391			283,054,288
Stockholders’ equity (deficit):
Common stock, par value $.01 at September 30, 2004 and December 31, 2003, respectively:  Authorized shares:  Class A—4,200,000 and 4,200,000, Class B Convertible—450,000 and 450,000, at September 30, 2004 and December 31, 2003 respectively; issued and outstanding shares:  Class A—142,000, Class B Convertible—112,980, at September 30, 2004 and December 31, 2003		2,550			2,550
Additional paid-in capital		—			—
Accumulated deficit		(84,892,400		)	(65,753,216		)
Cumulative other comprehensive income		429,722			—
Total stockholders’ equity (deficit)		(84,460,128		)	(65,750,666		)
Total liabilities and stockholders’ equity (deficit)		$	715,329,310		$	703,047,215

 

See accompanying notes.

 

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IESI CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 

		Nine Months Ended September 30,						Three Months Ended September 30,
		2004			2003			2004			2003
Services revenue		$	241,982,271		$	180,488,860		$	85,087,575		$	64,175,475
Costs and expenses:
Operating		138,901,832			118,344,703			48,651,860			41,711,267
General and administrative		29,523,584			23,004,009			10,513,403			8,207,212
Depreciation, depletion and amortization		47,390,298			26,148,547			16,934,212			9,562,973
		215,815,714			167,497,259			76,099,475			59,481,452
Income from operations		26,166,557			12,991,601			8,988,100			4,694,023
Interest expense, net		(20,651,130		)	(13,778,137		)	(6,882,375		)	(4,820,285		)
Other income (expense), net		(611,669		)	(260,227		)	83,470			(146,772		)
Income (loss) before income taxes		4,903,758			(1,046,763		)	2,189,195			(273,034		)
Income tax expense		(2,777,839		)	(2,314,080		)	(1,707,747		)	(2,562,975		)
Income (loss) before cumulative effect of change in accounting principle		2,125,919			(3,360,843		)	481,448			(2,836,009		)
Cumulative effect of change in accounting principle net of income tax benefit of $0		—			(1,530,708		)	—			—
Net income (loss)		$	2,125,919		$	(4,891,551	)	$	481,448		$	(2,836,009	)

 

See accompanying notes.

 

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IESI CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT)
(UNAUDITED)

 

		Common Stock					Additional						Cumulative Other
		Shares		Par Amount			Paid-In Capital			Accumulated Deficit			Comprehensive Income			Total
Balance at December 31, 2003		254,980		$	2,550		—			$	(65,753,216	)	—			$	(65,750,666	)
Comprehensive income:
Net income		—		—			—			2,125,919			—			2,125,919
Other comprehensive income:
Unrealized gain on market value of interest rate swaps, net of tax expense of $221,338		—		—			—			—			429,722			429,722
Comprehensive income		—		—			—			—			—			2,555,641
Accretion of dividends on Series C, D and E Redeemable Preferred Stock		—		—			—			(21,265,103		)	—			(21,265,103		)
Balance at September 30, 2004		254,980		$	2,550		$	—		$	(84,892,400	)	$	429,722		$	(84,460,128	)

 

See accompanying notes.

 

3

 

IESI CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

 

		For the Nine Months Ended September 30,
		2004			2003
Operating Activities:
Net income (loss)		$	2,125,919		$	(4,891,551	)
Cumulative effect of change in accounting principle		—			1,530,708
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation, depletion and amortization		47,390,298			26,148,547
Amortization of deferred financing costs		1,766,378			1,947,633
Capping, closure and post-closure accretion		1,518,705			912,869
Provision for doubtful accounts		1,931,797			1,207,195
Write off of costs associated with transactions in process		877,020			—
Unrealized loss on commodity swap		320,000			—
Deferred income tax expense		1,450,725			1,702,245
Changes in operating assets and liabilities, net of effects of acquired waste management operating assets and liabilities:
Accounts receivable		(8,417,132		)	(5,491,814		)
Prepaid expenses and other current assets		(2,571,409		)	(1,601,934		)
Accounts payable		(7,363,093		)	4,264,594
Accrued expenses and other liabilities		10,693,731			4,545,583
Capping, closure and post closure expenditures		(2,549,536		)	(641,725		)
Net cash provided by operating activities		47,173,403			29,632,350
Investing Activities:
Purchases of property and equipment		(36,456,944		)	(34,502,731		)
Acquisitions of waste management operations		(1,609,692		)	(25,385,508		)
Initial development costs for newly acquired permitted landfills		—			(6,018,195		)
Capitalized interest		(1,908,740		)	(1,368,009		)
Deferred costs associated with transactions in process		(602,105		)	(1,776,663		)
Net cash used in investing activities		(40,577,481		)	(69,051,106		)
Financing Activities:
Borrowings under long-term debt		26,500,000			50,500,000
Payments on long-term debt		(33,201,115		)	(10,044,741		)
Debt issue costs		—			(451,366		)
Net cash (used in) provided by financing activities		(6,701,115		)	40,003,893
Net (decrease) increase in cash and cash equivalents		(105,193		)	585,137
Cash and cash equivalents at beginning of period		4,197,157			2,589,726
Cash and cash equivalents at end of period		$	4,091,964		$	3,174,863

 

See accompanying notes.

 

4

 

IESI CORPORATION AND SUBSIDIARIES NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Notes to Consolidated Financial Statements

 

1.                                      Business and Organization

 

IESI Corporation (IESI) is a Delaware holding company founded in 1995.  IESI, together with its subsidiaries (collectively, the Company), is a regional, integrated non-hazardous solid waste management company that provides collection, transfer, disposal, and recycling services to commercial, industrial and residential customers. The Company was formed in order to participate in the consolidation of the fragmented solid waste industry. The Company is executing this strategy through an acquisition program, which targets businesses in two principal geographic regions, the Northeast and the South United States. The Company is currently operating in nine states: Arkansas, Louisiana, Maryland, Missouri, New Jersey, New York, Oklahoma, Pennsylvania, and Texas.

 

The accompanying unaudited consolidated financial statements include the accounts of IESI and its subsidiaries. All significant inter-company accounts and transactions have been eliminated. Certain information related to the Company’s organization, significant accounting policies and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted.  In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments necessary to fairly state the financial position and the results of operations for the periods presented, and the disclosures herein are adequate to make the information presented not misleading.  Operating results for interim periods are not necessarily indicative of the results for full years.  These interim unaudited consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2003 and the related notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

 

The unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles and necessarily include amounts based on estimates and assumptions made by management.  Actual results could differ from these amounts.  Significant items subject to such estimates and assumptions include the depletion and amortization of landfill development costs, accruals for final closure and post-closure costs, valuation allowances for accounts receivable, liabilities for potential litigation, claims and assessments, and liabilities for environmental remediation, deferred taxes and self-insurance.

 

Additionally, certain adjustments have been made in the prior period consolidated financial statements in order to reflect changes recorded by the Company in the fourth quarter of 2003 as follows:

 

1.               The first nine months of 2003 results include a net of tax charge of approximately $1,531,000 related to the cumulative effect of a change in accounting principle for the initial adoption of SFAS No. 143.  Included in this amount is $54,000 recorded by the Company in the fourth quarter of 2003 due to a revision in the cumulative effect adjustment recorded in the first quarter.  For purposes of quarterly reporting, the Company has revised its net loss amount previously reported in the Company’s September 30, 2003 quarterly report for the nine months then ended.

 

2.               In the fourth quarter of 2003 the Company recorded approximately $2,168,000 of expenses related to misconduct of a manager in the Company’s South Region.  For purposes of quarterly reporting the Company has revised its net loss amount previously

 

5

 

reported in the Company’s September 30, 2003 quarterly report to reflect the allocation of $168,550 and $418,550 of such expenses to the third quarter and first nine months of 2003, respectively.

 

2.                                      New Accounting Pronouncements

 

For a description of new accounting pronouncements that affect the Company, please see Note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.  There were no new accounting pronouncements during the nine months ended September 30, 2004 which the Company expects to have a material effect on the Company’s consolidated financial statements.

 

3.                                      Summary of Significant Accounting Policies

 

Accounts Receivable

 

The Company’s accounts receivable are recorded when billed or accrued, and represent claims against third parties that will be settled in cash.  The carrying value of the trade receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value.  The Company estimates the allowance for doubtful accounts based on historical collection trends, type of customer, such as municipal or non-municipal, the age of outstanding trade receivables, and existing economic conditions.  If circumstances indicate that specific accounts receivable balances may be impaired, further consideration is given to the collectibility of those balances and the allowance is adjusted accordingly.  Past due trade receivable balances are written off when the Company’s internal collection efforts have been unsuccessful in collecting the amount due. Credit losses have been within management’s expectations.

 

Property and Equipment

 

Property and equipment are stated at cost. Improvements or betterments, which significantly extend the life, or add to the utility, of an asset, are capitalized. Expenditures for maintenance and repair costs are charged to operations as incurred. The cost of assets retired or otherwise disposed of, and the related accumulated depreciation is eliminated, from the accounts in the period of disposal, and any resulting gain or loss is reflected in the Consolidated Statements of Operations.

 

The Company revises the estimated useful lives of property and equipment acquired through business acquisitions to conform with its policies regarding property and equipment. Depreciation is calculated on the straight-line method over the estimated useful lives of the related assets, which generally range from three to five years for furniture and fixtures and computer equipment, five to 10 years for containers, compactors, trucks and collection equipment, and 10 to 40 years for buildings and improvements. The Company assumes no salvage value for its depreciable property and equipment. Depreciation expense on property and equipment was approximately $18,591,000 and $15,537,000 for the nine months ended September 30, 2004 and 2003, respectively, and approximately $6,298,000 and $5,450,000 for the three months ended September 30, 2004 and 2003, respectively.

 

Landfills and landfill improvements are stated at cost, and are depleted based on consumed airspace. Landfill improvements include direct costs incurred to obtain landfill permits, and direct costs incurred to construct and develop the site.  All indirect landfill development costs are expensed as incurred.  Depletion expense was approximately $25,456,000 and $7,939,000 for the nine months ended September 30, 2004 and 2003, respectively, and approximately $9,547,000 and $3,178,000 for the three months ended September 30, 2004 and 2003, respectively. Interest is capitalized on certain projects under

 

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development including landfill projects and probable landfill expansion projects and on certain assets under construction, including operating landfills.  The capitalization of interest for operating landfills is based on the costs incurred on discrete cell construction projects.  Interest capitalized was approximately $1,909,000 and $1,368,000 for the nine months ended September 30, 2004 and 2003, respectively, and $734,000 and $347,000 for the three months ended September 30, 2004 and 2003, respectively.  The Company assesses whether property and equipment are impaired on an annual basis.

 

Property and equipment consisted of the following at September 30, 2004 and December 31, 2003:

 

		September 30, 2004			December 31, 2003
Land		$	9,573,407		$	9,189,881
Landfills		423,936,829			389,028,075
Vehicles		94,809,031			90,346,853
Containers and compactors		57,283,775			52,677,979
Machinery and equipment		37,373,604			33,085,294
Buildings and improvements		19,992,632			18,722,952
Furniture and office equipment		6,819,254			5,826,441
		649,788,532			598,877,475
Less accumulated depreciation and depletion		154,547,411			110,217,625
		$	495,241,121		$	488,659,850

 

Landfill Accounting

 

The Company uses life cycle accounting and the units-of-consumption method to recognize certain landfill costs. In life cycle accounting, all costs to acquire, construct, close and maintain a site during the post-closure period are capitalized or accrued and charged to expense based upon the consumption of cubic yards or tons of available airspace. Costs and airspace estimates are developed annually by independent engineers together with the Company’s engineers. These estimates are used by the Company’s operating and accounting personnel to annually adjust the Company’s rates used to expense capitalized costs and accrue closure and post-closure costs. Changes in these estimates primarily relate to changes in available airspace, future closure and post-closure costs, the Company’s credit adjusted risk free rate, inflation rates and applicable regulations. Changes in available airspace primarily include changes due to the addition of airspace lying in expansion areas deemed probable to be permitted.

 

Goodwill and Other Intangible Assets

 

Intangible assets consist primarily of the cost of acquired businesses in excess of the fair value of net assets acquired (goodwill). Other intangibles consist of values assigned to customer lists and covenants not-to-compete, costs incurred to obtain debt financing and other separately identifiable intangible assets.  Other intangibles are recorded at cost and, except for debt issue costs, amortized over periods generally ranging from five to seven years, computed on the straight-line method. Amortization expense was approximately $3,343,000 and $2,672,000 for the nine months ended September 30, 2004 and 2003, respectively, and $1,089,000 and $935,000 for the three months ended September 30, 2004 and 2003, respectively.  The Company defers costs related to incurring debt and amortizes, as additional interest expense, these costs over the term of the related debt using the effective interest method.  Other intangible assets consisted of the following at September 30, 2004 and December 31, 2003:

 

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		September 30, 2004			December 31, 2003
Customer lists		$	24,070,149		$	23,707,139
Noncompetition agreements		7,367,604			7,277,689
Debt issue costs		22,011,381			22,007,533
Other		935,577			951,088
		54,384,711			53,943,449
Less accumulated amortization		26,042,651			20,957,286
		$	28,342,060		$	32,986,163

 

The Company assesses whether goodwill is impaired on an annual basis.  Upon determining the existence of goodwill impairment, the Company measures that impairment based on the amount by which the book value of goodwill exceeds its implied fair value.  The implied fair value of goodwill is determined by deducting the fair value of a reporting unit’s identifiable assets and liabilities from the fair value of the reporting unit as a whole, as if that reporting unit had just been acquired and the purchase price were being initially allocated.  Additional impairment assessments may be performed on an interim basis if the Company encounters events or changes in circumstances that would indicate, more likely than not, the book value of goodwill has been impaired.

 

On an ongoing basis, management reviews the valuation and amortization of other intangible assets with consideration toward recovery through future operating results.  The Company periodically evaluates the value and future benefits of its other intangible assets.  The Company assesses recoverability from future operations using cash flows of the related asset as measures.  In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the carrying value would be reduced to estimated fair value if it becomes probable that the Company’s estimate for expected future cash flows of the related asset would be less than the carrying amount of the related intangible assets.  There have been no adjustments to the carrying amount of intangible assets resulting from these evaluations as of September 30, 2004 and December 31, 2003.

 

Remaining scheduled estimated amortization of other intangible assets is as follows:

 

2004		$	2,488,385
2005		6,530,231
2006		5,358,296
2007		4,941,146
2008		3,843,844
Thereafter		5,180,158
		$	28,342,060

 

Accrued Expenses and Other Current Liabilities

 

The following is a summary of accrued expenses and other current liabilities at September 30, 2004 and December 31, 2003:

 

		September 30, 2004			December 31, 2003
Acquisition related accrued liabilities		$	8,993,766		$	1,489,429
Interest		6,920,383			2,104,923

 

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		September 30, 2004			December 31, 2003
Accrued insurance liabilities		6,465,682			5,062,902
Accrued payroll and other employee related liabilities		4,713,147			3,613,059
Accrued franchise fee and royalties		2,766,386			1,154,276
Other		5,764,425			4,087,936
		$	35,623,789		$	17,512,525

 

Income Taxes

 

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

 

The difference in income taxes computed at the statutory rate and reported income taxes for the three and nine months ended September 30, 2004 and 2003 is due primarily to state and local income taxes and adjustments to the valuation allowance related to deferred tax assets and a revision of the estimated pre-tax income for the fiscal year ending December 31, 2004.

 

4.                                      Acquisitions

 

All acquisitions are accounted for as purchases and, accordingly, only the operations of the acquired companies since the acquisition dates are included in the accompanying unaudited consolidated financial statements.

 

During the nine months ended September 30, 2004, the Company acquired the hauling assets of five solid waste management companies for an aggregate purchase price of approximately $1,790,000 consisting of cash and liabilities assumed.  In connection with the acquisitions, the Company recorded approximately $568,000 of goodwill, all of which is expected to be deductible for tax purposes, and approximately $454,000 of definite-lived intangible assets.  The definite-lived intangible assets consist of $364,000 related to customer lists with generally a seven year amortization period and $90,000 related to non-competition agreements with generally two to five year amortization periods.  The pro forma effects of the acquisitions are not significant to the Company’s operating results.

 

The allocation of the purchase price for the Seneca Meadows, Inc. (SMI) acquisition, which was consummated in October 2003, was preliminary and has been finalized upon completion of valuation analyses of certain assets and liabilities associated with the landfill owned by SMI.  During the three months ended September 30, 2004, the Company recorded an estimated liability and capitalized additional landfill costs of approximately $7.7 million related primarily to a contractual obligation of the Company to reimburse the selling shareholder of SMI for any additional federal and state taxes incurred by the selling shareholder as a result of the election by the Company to treat the stock acquisition of SMI as an asset acquisition for tax reporting purposes in accordance with the Internal Revenue Code Section 338(h)(10), and also includes a payment relating to a contractual liability to pay New York state real estate transfer taxes on behalf of the selling shareholder of SMI.

 

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5.                                      Landfill and Accrued Environmental Costs

 

The Company has material financial commitments for final capping, closure and post-closure obligations with respect to its landfills.  The Company develops its estimates of final capping, closure and post-closure obligations using input from its engineers and accountants.  The Company’s estimates are based on its interpretation of current requirements and are intended to approximate fair value.  Absent quoted market prices, the estimate of fair value is based on the best available information, including the results of present value techniques.  In general, the Company contracts with third parties to fulfill most of its 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.  The Company intends 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, the Company has added a profit margin to the estimated cost of such services to better reflect their fair value.  When the Company then performs these services internally, the added profit margin is recognized as a component of operating income in the period earned.  An estimate of fair value includes 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, the Company believes that it is not possible to develop a methodology to reliably estimate a market risk premium and has excluded a market risk premium from its determination of expected cash flows for landfill asset retirement obligations.

 

Once the Company has determined the final capping, closure and post-closure costs, the Company then inflates those costs to the expected time of payment and discounts those expected future costs back to present value.  The Company inflates these costs in current dollars until the expected time of payment using an annual inflation rate and discounts these costs to present value using a credit-adjusted, risk-free discount rate.  The Company reviewed the inflation rate to be used for 2004 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 the Company’s credit rating.  Changes in the Company’s credit-adjusted, risk-free rate do not change recorded liabilities, but subsequently recognized obligations are measured using the revised credit-adjusted risk-free rate.  During the three months and nine months ended September 30, 2004, the Company used a credit-adjusted risk free rate of 7.86% Management reviews the estimates of the Company’s 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 prospectively over the remaining capacity of the landfill.

 

The Company records the estimated fair value of final capping, closure and post-closure liabilities for its 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 include 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

 

10

 

maintenance; other pollution control activities; mowing and fertilizing the landfill cap; fence and road maintenance; and third party inspection and reporting costs.  For purchased disposal sites, the Company assesses and records final capping, closure and post-closure costs and the percentage of airspace consumed related to such obligations as of the date it assumed the responsibility.  Thereafter, the Company accounts for the landfill and related final capping, closure and post-closure obligations consistent with the policy described above.

 

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 Environmental Protection Agency’s (EPA) Subtitle 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 following is a roll-forward of amounts accrued for final closure and post-closure costs and environmental costs:

 

		Final Closure/ Post-Closure Costs			Environmental Costs			Total
Balance at December 31, 2003		$	19,928,909		$	27,527,860		$	47,456,769
Obligations incurred		2,712,849			303,396			3,016,245
Acquisition related adjustments		679,953			—			679,953
Obligations settled		(336,876		)	(2,212,660		)	(2,549,536		)
Revisions in estimates		261,354			(1,186		)	260,168
Accretion		1,430,325			88,380			1,518,705
Balance at September 30, 2004		$	24,676,514		$	25,705,790		$	50,382,304

 

6.                                      Long-Term Debt

 

Long-term debt consisted of the following at September 30, 2004 and December 31, 2003:

 

		September 30, 2004			December 31, 2003
Revolving credit loan		$	25,100,000		$	29,600,000
Term loan		198,000,000			200,000,000
Senior subordinated notes due June 15, 2012		151,528,495			150,998,599
Other		61,274			262,389
Total long-term debt		374,689,769			380,860,988
Less current portion		2,061,274			2,731,595
		$	372,628,495		$	378,129,393

 

Scheduled maturities of long-term debt are as follows:

 

2004		$	530,480
2005		2,030,794
2006		2,000,000
2007		2,000,000
2008		27,100,000
Thereafter		339,500,000
		$	373,161,274

 

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On October 10, 2003, the Company entered into the Fifth Amended and Restated Revolving Credit and Term Loan Agreement (the Credit Facility).  The Credit Facility is provided by a syndicate of lenders led by Bank of America Corporation (f/k/a Fleet National Bank), as administrative agent (Bank of America), and LaSalle National Bank Association, as syndication agent, and includes a $200,000,000 senior secured term loan, a $200,000,000 senior secured revolving loan, and has a maximum of $80,000,000 letters of credit sub-limit.  Subject to certain conditions, the Company may request an increase in the revolving loan portion or the term loan portion of the Credit Facility of up to $50,000,000, such that the total of the revolving loan and term loan portions would equal $450,000,000.  As of September 30, 2004, there was $25,100,000 (excluding $49,118,000 underlying letters of credit) outstanding under the revolving loan portion of the Credit Facility and $125,782,000 of remaining capacity (of which $49,788,000 was immediately available for borrowing) under the revolving loan portion, plus a maximum of $30,882,000 underlying letters of credit.  In order to borrow under the revolving loan portion of the Credit Facility, the Company must satisfy customary conditions including maintaining certain financial ratios.  If a default under the indenture governing the 10.25% Senior Subordinated Notes due 2012 (Notes) or Credit Facility should occur, the holders of the Notes or the lenders under the Credit Facility could elect to declare all amounts borrowed to be immediately due and payable.  Furthermore, this could result in all amounts borrowed under other instruments, including the indenture governing our Notes or the Credit Facility, that contain cross-acceleration or cross-default provisions being declared immediately due and payable and the lenders could terminate all commitments thereunder.  The Credit Facility is secured by a pledge of the stock of the Company’s direct and indirect subsidiaries and a lien on substantially all of the Company’s direct and indirect subsidiaries’ assets.  The Credit Facility also contains covenants which restrict the Company’s ability to, among other things, incur additional debt, create liens, dispose of assets, make investments, engage in transactions with affiliates, enter into a merger or consolidation, make specified payments, including dividends, repay subordinated indebtedness and enter into certain franchise agreements.  These limitations are subject to certain qualifications and exceptions.

 

Pursuant to the terms of the Credit Facility, during each 12-month period commencing on October 1 and ending on September 30, the Company is required to repay 1.0% (except for the 12-month period prior to maturity when it is required to repay 94.0%) of the principal amount of the term loan portion of its senior credit facility in quarterly installments payable on the last business day of each calendar quarter.  In addition, the Company’s senior credit facility requires it to prepay the term loan with, subject to certain conditions and exceptions, 100.0% of the net cash proceeds it receives from any disposition of assets in excess of $5.0 million in the aggregate per year, 100.0% of the net cash proceeds it receives from the incurrence of any permitted indebtedness (other than up to $100.0 million of additional subordinated indebtedness) and 50.0% of the net cash proceeds it receives in connection with any issuance of the Company’s equity (other than equity the Company issues (i) in an aggregate amount not to exceed $100.0 million, (ii) as payment in a permitted acquisition or (iii) to employees, consultants or directors in connection with the exercise of options under bona fide option plans).  The Company is also required to prepay the term loan with the percentage of excess consolidated operating cash flow (to be calculated for each fiscal year, and which includes, generally, consolidated Earning Before Interest, Taxes, Depreciation and Amortization (EBITDA), plus or minus net working capital changes and extraordinary cash items, less the sum of (a) capital expenditures, (b)  the cash purchase price of any permitted acquisitions, (c)  cash payments for taxes, (d) cash payments of interest and (e)  the scheduled principal repayments of indebtedness, in each case of clauses (a) through (e), paid during such period) corresponding to the applicable leverage ratio set forth below:

 

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Leverage Ratio		Percentage of Excess Consolidated Operating Cash Flow Required as Mandatory Prepayment of Term Loan
> 3.50:1.00		50%
>3.00:1.00 and <3.50:1.00		25%
<3.00:1.00		0%

 

The Credit Facility permits borrowings at floating interest rates based, at the Company’s option, on the designated Eurodollar interest rate, which generally approximates LIBOR, or the Bank of America prime rate, in each case, plus an applicable margin, and requires payment of an annual commitment fee based on the unused portion of the revolving loan portion.  As of September 30, 2004, the interest rate applicable to $17.1 million outstanding under the revolving loan portion of our senior credit facility was LIBOR plus 325 basis points, or 4.83% and the interest rate applicable to $8.0 million then outstanding under the revolving loan portion was base, or 6.0%.  As of September 30, 2004, the interest rate applicable to $196.5 million outstanding under the term loan portion of our senior credit facility was LIBOR plus 300 basis points, or 4.61% and the interest rate applicable to $1.5 million then outstanding under the term loan portion was base, or 5.75%.  The revolving loan portion of the Credit Facility expires on September 30, 2008 and the term loan portion of the Credit Facility expires on September 30, 2010.

 

In June 2002, the Company issued $150,000,000 of the Notes in a private placement and registered the Notes under the Securities Act of 1933 in December 2002.  Interest is payable semi-annually on June 15th and December 15th.  The Notes are guaranteed by all of IESI’s current subsidiaries, all of which are 100% owned by IESI.  Condensed consolidating financial information is not provided because IESI has no independent assets or operations, the subsidiary guarantees are full and unconditional and joint and several, and there are no significant restrictions on the ability of the Company or any subsidiary guarantor to obtain funds from its subsidiaries by dividend or loan.

 

In August 2002, the Company entered into two interest rate swap agreements, which are effective through June 15, 2012, with two financial institutions.  Under each swap agreement, the fixed interest rate on $25,000,000 of the Notes effectively was converted to an interest rate of 5.275% and 5.305%, respectively, plus an applicable floating rate margin that is based on six month LIBOR which is readjusted semiannually on June 15 and December 15 of each year.  On September 30, 2004, the six month LIBOR rate was 1.86%.

 

In January 2004, the Company entered into four interest rate swap agreements, which are effective through January 2007, with four financial institutions.  Under each swap agreement, the variable interest rate on $25,000,000 outstanding under the Credit Facility effectively was converted to a fixed interest rate of 2.58%, 2.61%, 2.71% and 2.75%, respectively, plus an applicable LIBOR margin.  On September 30, 2004, the three month LIBOR rate was 1.59%.

 

7.                                      Commitments and Contingencies

 

The Company’s business activities are conducted in the context of a developing and changing statutory and regulatory framework.  Governmental regulation of the waste management industry requires the Company to obtain and retain numerous governmental permits to conduct various aspects of its operations.  These permits are subject to revocation, modification or denial.  The costs and other capital expenditures, which may be required to obtain or retain the applicable permits or comply with applicable regulations, could be significant.  Any revocation, modification or denial of permits could have a material adverse effect on the Company.

 

13

 

The Company is subject to liability for any environmental damage that its solid waste disposal facilities may cause to neighboring landowners or residents, particularly as a result of the contamination of soil, groundwater or surface water, including, in some cases, damage resulting from conditions existing prior to the acquisition of such facilities by the Company.  The Company may also be subject to liability for any off-site environmental contamination caused by pollutants or hazardous substances whose transportation, treatment or disposal was arranged by the Company or its predecessors.

 

Any substantial liability for environmental damage incurred by the Company could have a material adverse effect on the Company’s financial condition, results of operations or cash flows.  As of September 30, 2004, the Company was not aware of any such environmental liabilities (other than those recorded in the Company’s consolidated financial statements).

 

In the normal course of its business, and as a result of the extensive governmental regulation of the solid waste industry, the Company is subject to various judicial and administrative proceedings involving federal, state or local agencies. In these proceedings, an agency may seek to impose fines on the Company or to revoke or deny renewal of an operating permit held by the Company.  From time to time, the Company may also be subject to actions brought by citizens’ groups or adjacent landowners or residents in connection with the permitting and licensing of landfills and transfer stations, or alleging environmental damage or violations of the permits and licenses pursuant to which the Company operates.

 

In addition, the Company may become party to various claims and suits pending for alleged damages to persons and property, alleged violations of certain laws and alleged liabilities arising out of matters occurring during the normal operation of the waste management business. However, as of September 30, 2004, there were no proceedings or litigation involving the Company that the Company believed would have a material adverse impact on its business, financial condition, results of operations or cash flows.

 

8.                                      Redeemable Preferred Stock

 

The Company had redeemable preferred stock on its balance sheet of approximately $304,319,000 as of September 30, 2004 and $283,054,000 as of December 31, 2003, representing the carrying value of its preferred stock as of such dates.  In accordance with Emerging Issues Task Force (EITF) Topic No. D-98, Classification and Measurement of Redeemable Securities, the Company has classified its preferred stock outside of permanent equity because, pursuant to the terms of such preferred stock, such preferred stock is redeemable upon the occurrence of certain transactions deemed to be liquidation events.  Such redemption is not deemed to be solely within the Company’s control because holders of the Company’s preferred stock currently control a majority of the votes of the Company’s board of directors.

 

9.                                      Comprehensive Income

 

The Company had comprehensive income including unrealized gains on the market value of interest rate swaps of approximately $88,000 and $2,556,000 for the three and nine months ended September 30, 2004, respectively.

 

10.                               Segment Reporting

 

The Company’s two geographic regions are the Company’s reportable segments. The segments provide integrated waste management services consisting of collection, transfer, disposal, and recycling services to commercial, industrial, municipal, and residential customers. Summarized financial

 

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information concerning the Company’s reportable segments for the three and nine-month periods ended September 30 is shown in the following table:

 

		South Region			Northeast Region			Corporate Functions			Total
Nine Months Ended September 30, 2004
Outside revenues
Collection		$	118,146,063		$	26,715,861		$	—		$	144,861,924
Transfer		3,338,393			32,207,055			—			35,545,448
Disposal		9,041,775			44,491,876			—			53,533,651
Recycling		2,577,217			3,489,106			—			6,066,323
Other		613,230			1,361,695			—			1,974,925
Total outside revenues		133,716,678			108,265,593			—			241,982,271
Income (loss) from operations		7,036,718			26,731,491			(7,601,652		)	26,166,557
Depreciation, depletion and amortization		22,769,122			24,111,670			509,506			47,390,298
Purchases of property and equipment including capitalized interest		17,548,966			20,158,856			657,862			38,365,684
Acquisitions of waste operations and initial development costs for newly acquired permitted landfills		1,609,692			—			—			1,609,692
Goodwill acquired		568,019			—			—			568,019
Goodwill		91,275,538			47,628,196			—			138,903,734
Total assets		305,869,686			391,371,019			18,088,605			715,329,310
Nine Months Ended September 30, 2003
Outside revenues
Collection		$	102,620,766		$	25,095,442		$	—		$	127,716,208
Transfer		3,541,630			30,903,613			—			34,445,243
Disposal		6,883,534			6,019,247			—			12,902,781
Recycling		2,018,283			2,748,531			—			4,766,814
Other		524,446			133,368			—			657,814
Total outside revenues		115,588,659			64,900,201			—			180,488,860
Income (loss) from operations		10,870,243			8,450,352			(6,328,994		)	12,991,601
Depreciation, depletion and amortization		19,209,860			6,409,253			529,434			26,148,547
Purchases of property and equipment including capitalized interest		26,691,069			9,007,519			172,152			35,870,740
Acquisitions of waste operations and initial development costs for newly acquired permitted landfills		31,403,703			—			—			31,403,703
Goodwill acquired		7,895,077			—			—			7,895,077
Goodwill		90,079,715			47,628,196			—			137,707,911
Total assets		306,929,082			157,952,997			16,946,861			481,828,940

 

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		South Region			Northeast Region			Corporate Functions			Total
Three Months Ended September 30, 2004
Outside revenues
Collection		$	40,241,189		$	9,029,940		$	—		$	49,271,129
Transfer		1,123,474			11,395,810			—			12,519,284
Disposal		3,721,895			16,934,029			—			20,655,924
Recycling		998,278			1,147,358			—			2,145,636
Other		188,358			307,244			—			495,602
Total outside revenues		46,273,194			38,814,381			—			85,087,575
Income (loss) from operations		1,911,550			10,057,924			(2,981,374		)	8,988,100
Depreciation, depletion and amortization		7,871,667			8,890,965			171,580			16,934,212
Purchases of property and equipment including capitalized interest		5,550,708			8,314,350			105,283			13,970,341
Acquisitions of waste operations and initial development costs for newly acquired permitted landfills		421,939			—			—			421,939
Goodwill acquired		51,535			—			—			51,535
Three Months Ended September 30, 2003
Outside revenues
Collection		$	36,682,503		$	8,558,112		$	—		$	45,240,615
Transfer		1,144,682			10,869,123			—			12,013,805
Disposal		2,828,644			2,345,555			—			5,174,199
Recycling		683,597			840,586			—			1,524,183
Other		180,742			41,931			—			222,673
Total outside revenues		41,520,168			22,655,307			—			64,175,475
Income (loss) from operations		3,574,775			3,333,248			(2,214,000		)	4,694,023
Depreciation, depletion and amortization		6,995,263			2,394,619			172,991			9,562,873
Purchases of property and equipment including capitalized interest		11,211,912			4,749,199			—			15,961,111
Acquisitions of waste operations and initial development costs for newly acquired permitted landfills		19,115,085			—			—			19,115,085
Goodwill acquired		1,429,524			—			—			1,429,524

 

Seasonality and weather can temporarily affect some of the Company’s revenue and expenses.  The Company generally experiences lower construction and demolition waste volumes during the winter months when the construction industry slows down.  Frequent and/or heavy snow and ice storms can affect the productivity of the Company’s operations in both its South and Northeast Regions.  Additionally, in the Company’s South Region, higher than normal rainfall or more frequent rain storms over a 30 to 90 day period can put additional stress on the construction industry, lowering the volumes of waste the Company handles.  Significantly below normal rainfall can lead to higher levels of construction activity, increasing the Company’s volumes.

 

11.                               Stock Options

 

On January 28, 2004, the Compensation Committee of the Board of Directors of the Company granted non-qualified stock options to purchase an aggregate of 103,300 shares of the Company’s Class A voting common stock to certain employees and directors of the Company pursuant to the Company’s 1999 Stock Option Plan, as amended (the Plan).  The options were granted at an exercise price of $100.00 per share, which was equal to or greater than the estimated fair value of the underlying shares.  On the same date, the Board of Directors also approved an amendment to the Plan increasing the number of options authorized to be granted thereunder from 250,000 to 400,000.  Options granted under the Plan expire 10 years from the date of grant and generally become fully vested over periods ranging from 5 to 8 years.

 

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The following schedule reflects the pro forma impact on net income (loss) of accounting for the Company’s 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.

 

		2004			2003
For the nine months ended September 30,
Reported net income (loss)		$	2,125,919		$	(4,891,551	)
Less: compensation expense per SFAS No. 123		170,363			112,646
Pro forma net income (loss)		$	1,955,556		$	(5,004,197	)
For the three months ended September 30,
Reported net income (loss)		$	481,448		$	(2,836,009	)
Less: compensation expense per SFAS No. 123,		64,360			41,882
Pro forma net income (loss)		$	417,088		$	(2,877,891	)

 

17

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

You should read the following discussion in conjunction with our unaudited consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q.

 

General

 

We are one of the leading regional, non-hazardous solid waste management companies in the United States.  We provide collection, transfer, disposal and recycling services in two geographic regions: our South Region, consisting of Texas, Louisiana, Oklahoma, Arkansas and Missouri; and our Northeast Region, consisting of New York, New Jersey, Pennsylvania and Maryland.  In 2003, we were the tenth largest service provider based on revenue in the approximately $42.0 billion non-hazardous solid waste management industry in the United States, and would have been the eighth largest provider after giving the full-year effect to our 2003 acquisitions.

 

Critical Accounting Policies

 

Our consolidated financial statements are based on the selection of accounting policies and application of significant accounting estimates, which require management to make significant estimates and assumptions.  For a detailed discussion of our critical accounting estimates, please refer to Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2003. There were no material changes relating to our critical accounting estimates during the three months ended September 30, 2004.

 

Sources of Revenue

 

Our revenue consists primarily of fees we charge customers for solid waste collection, transfer and disposal and recycling services.  We frequently perform these services under service agreements with businesses, contracts with municipalities, landlords or homeowners’ associations, or subscription arrangements with homeowners.

 

The table below shows, for the periods indicated, the percentage of our total reported revenue attributable to each of our services:

 

		Nine Months Ended September 30,				Three Months Ended September 30,
		2004(1)		2003		2004(2)		2003
Collection		59.9	%	70.8	%	57.9	%	70.5	%
Transfer		14.7	%	19.1	%	14.7	%	18.7	%
Disposal		22.1	%	7.1	%	24.3	%	8.1	%
Recycling		2.5	%	2.6	%	2.5	%	2.4	%
Other		0.8	%	0.4	%	0.6	%	0.3	%
Total		100.0	%	100.0	%	100.0	%	100.0	%

 

(1)          The increase in the percentage of our total reported revenue attributable to our disposal services during the nine months ended September 30, 2004 primarily resulted from our acquisition on October 9, 2003 of the Seneca Falls, New York landfill in our Northeast Region, and the addition in our South Region of three operating landfills, including two greenfield sites acquired in 2002, which we opened in August 2003, and an operating landfill which we purchased in July 2003.  Excluding the effects of these four landfills, the disposal percentage

 

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for the nine months ended September 30, 2004 would have been substantially the same as the disposal percentage for the nine months ended September 30, 2003.  During the nine months ended September 30, 2004, our total revenue increased by an aggregate of $61.5 million from the corresponding nine-month period in 2003.  This increase resulted from increases in our revenue from collection services ($17.2 million increase from the corresponding nine-month period in 2003), transfer services ($1.1 million increase from the corresponding nine-month period in 2003), disposal services ($40.6 million increase from the corresponding nine-month period in 2003), recycling services ($1.3 million increase from the corresponding nine-month period in 2003) and other services ($1.3 million increase from the corresponding nine-month period in 2003).

 

(2)          The increase in the percentage of our total reported revenue attributable to our disposal services during the three months ended September 30, 2004 primarily resulted from our acquisition on October 9, 2003 of the Seneca Falls, New York landfill in our Northeast Region, and the addition in our South Region of two greenfield sites acquired in 2002, which we opened in August 2003.  Excluding the effects of these three landfills, the disposal percentage for the three months ended September 30, 2004 would have been substantially the same as the disposal percentage for the three months ended September 30, 2003.  During the three months ended September 30, 2004, our total revenue increased by an aggregate of $20.9 million from the corresponding three-month period in 2003.  This increase resulted from increases in our revenue from collection services ($4.0 million increase from the corresponding three-month period in 2003), transfer services ($0.5 million increase from the corresponding three-month period in 2003), disposal services ($15.5 million increase from the corresponding three-month period in 2003), recycling services ($0.6 million increase from the corresponding three-month period in 2003) and other services ($0.3 million increase from the corresponding three-month period in 2003).

 

We estimate that more than 40% of our South Region’s revenue was generated from 273 municipal contracts during 2003 and during the first nine months of 2004.  Our contracts with New York City represented, in the aggregate, approximately 30% of our Northeast Region’s, and approximately 11% of our overall, revenue in 2003 and approximately 20% of our Northeast Region’s, and approximately 9% of our overall, revenue in the first nine months of 2004.  Contracts with municipalities provide relatively consistent cash flow during their terms.  Our municipal contracts generally last from three to five years and usually have renewal options.  Many of our municipal contracts are franchise agreements that give us the exclusive right to provide specified waste services within a specified territory during the contract term.  These exclusive arrangements are typically awarded, at least initially, on a competitive bid basis or through a formalized proposal and subsequently on a bid or negotiated renewal basis.  Collection fees are paid either by the municipalities from their tax revenue or directly by the residents receiving the services.  Depending on fluctuating commodity prices, we sometimes also generate revenue from the sale of recyclable commodities; however, such revenue does not represent a significant part of our total recycling revenue.  After recyclables are collected, they are delivered to other sorting facilities operated by third parties.

 

We typically determine the prices for our collection services by the collection frequency and level of service, route density, volume, weight and type of waste or recyclable material collected, type of equipment and containers that we furnish, the distance to the disposal or processing facility, the cost of disposing or processing, and prices charged by competitors for similar services.  The terms of our contracts sometimes limit our ability to pass on cost increases.  Long-term solid waste collection contracts typically contain a formula, usually based on the consumer price index, which automatically adjusts fees, usually on an annual basis, to cover increases in some, but not all of our operating costs.

 

We charge transfer station and landfill customers a “tipping fee” either on a per-ton or per-yard basis for disposal of their municipal solid waste, or MSW, construction and demolition, or C&D, waste or both at the transfer stations and landfills we operate.  We generally base our transfer station “tipping fees” on market factors and the cost of processing the waste deposited at the transfer station, the cost of transporting the waste to a disposal facility and the cost of disposal.  We generally base our landfill “tipping fees” on market factors and the type and weight or volume of the waste deposited and the type and size of the vehicles used in the transportation of the waste.

 

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Many of our landfills are assessed state, county or local community fees based on the volume of tons or yards disposed of during a defined period, usually either monthly or quarterly.  The types and amounts of fees charged can vary widely, but typically a state fee is uniformly charged to all landfills within a state.  We report our landfill revenue net of all these fees.  Since July 2002, the Commonwealth of Pennsylvania has imposed an additional disposal fee of $4.00 per ton on all solid waste disposed of at MSW landfills in Pennsylvania, raising the total disposal fees assessed on MSW landfill operators under Pennsylvania state law to a minimum of $7.25 per ton.  In addition, Pennsylvania and Virginia are both currently considering new legislation that would impose a new fee of up to an additional $5.00 on each ton of waste disposed of at landfills in their respective states.  Other states could follow this trend as well.

 

Effective September 2003, New York City revised its waste collection services maximum rate to permit haulers to charge commercial customers either the pre-existing $12.20 per loose yard or a new rate of $160.00 per ton.  The disposal facilities in and around New York City charge by the ton.  However, prior to September 2003, the maximum rate was imposed on a per loose yard basis only.  Accordingly, it was not economical for us to service customers whose waste was particularly dense.  As a result, until recently, our New York City collection operations focused on customers with light loose garbage and customers with a large paper recycling component, which enabled us to reduce our cost of disposal.  The new tonnage rate will enable our New York City collection operations to service all customers in all areas in which we operate.

 

New York City awarded us two new three-year contracts, effective November 2003, each with two optional one-year renewals, at the option of the City, which collectively provide for us to transfer and dispose of up to an aggregate of 1,500 tons of MSW per day collected by the City.  The new contracts replaced our prior contracts with New York City which expired in 2003.  New York City’s trucks collect primarily residential waste in Brooklyn and deliver it to two of our Brooklyn transfer stations.  In 2003, New York City delivered average daily volumes of waste of approximately 1,330 tons pursuant to these contracts.

 

During 2002, New York City announced changes to its Solid Waste Management Plan, pursuant to which it planned to utilize and upgrade its existing marine transfer station system instead of private transfer stations to process and transfer its residential waste stream of between 11,000 and 12,000 tons of MSW per day.  New York City initially intended to implement these changes by retrofitting and repermitting its marine transfer stations by 2008 so that the stations could containerize the City’s residential MSW on site and then transport the loaded containers to ultimate disposal sites by alternative transportation methods, such as barge, rail and truck.  However, during 2003, New York City determined that this plan was not feasible based on estimates of costs necessary to complete the plan, and decided to seek proposals from private industry with respect to the transfer and disposal of New York City’s residential waste stream.  In early 2004, New York City requested proposals to receive, transfer, transport and dispose the City’s residential waste stream.  New York City also requested expressions of interest to provide waste disposal capacity in New York State.  We submitted our proposals in late March 2004, and the City is currently evaluating all proposals and expressions of interest.  New York City has not provided timelines for award or implementation dates.

 

Cost Structure

 

Our operating expenses include labor, fuel, equipment maintenance, “tipping fees” paid to third-party transfer stations and disposal facilities, workers’ compensation, vehicle insurance, third-party transportation expenses and accretion expense.

 

We monitor the fluctuation in fuel prices and, from time to time, if this cost increases at a higher rate than inflation, we generally pass the additional cost on to our customers.

 

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Our business strategy is to develop vertically integrated operations to internalize the waste that we handle and thus realize higher margins from our operations.  By disposing of waste at our landfills, we retain the margin generated through disposal operations that would otherwise be earned by third-party landfills.  As of September 30, 2004, we internalized approximately 61% of the solid waste that we handled and delivered the rest to third-party disposal facilities.  Some of our municipal contracts require us to provide only collection services and to dispose of the collected waste at a designated third-party disposal facility (at no cost to us) with whom the municipality has contracted directly.

 

If the operators of third-party landfills increase their “tipping fees,” we would seek to pass along these increases to our customers, but if we were unable to do so, our profitability would be adversely affected.  If these operators discontinue their arrangements with us and we cannot find alternative disposal sites with favorable arrangements, our costs of disposal may rise.  Also, our failure to obtain the required permits to establish new landfills and transfer stations or expand our existing landfills and transfer stations could hinder our business strategy to develop vertically integrated operations.  Failure to expand capacity could lead to decreased profitability as a result of the increased “tipping fees” we would have to pay to third-party landfills.

 

We operate 23 transfer stations, which reduce our costs by allowing us to use collection personnel and equipment more efficiently and to consolidate waste to gain volume discounts on disposal rates.

 

General and administrative expenses include management, clerical and administrative compensation and overhead costs associated with our marketing and sales force, professional services and community relations expenses.

 

Depreciation, depletion and amortization expenses include depreciation of fixed assets over their estimated useful lives using the straight-line method, depletion of landfill costs using life cycle accounting and the units-of-consumption method, and amortization of intangible assets other than goodwill using the straight-line method.  In allocating the purchase price of an acquired company among its assets, we first assign value to the tangible assets, followed by intangible assets, including non-competition covenants and certain contracts that are determinable both in terms of size and life.  We determine the value of the intangible assets other than goodwill by considering, among other things, the present value of the cash flows associated with those assets.

 

We capitalize some third-party expenditures related to pending acquisitions and development projects, such as legal and engineering expenses.  We expense indirect acquisition costs, such as executive and corporate overhead, public relations and other corporate services, as we incur them.  We charge against net income any unamortized capitalized expenditures and advances, net of any portion that we believe we may recover through sale or otherwise, that relate to any operation that is permanently shut down and any pending acquisition or landfill development project that is not expected to be completed.  We routinely evaluate all capitalized costs and expense those related to projects that we believe are not likely to be completed.

 

Effective January 1, 2003, we adopted SFAS No. 143, “Accounting for Asset Retirement Obligations.”  Under SFAS No. 143, costs associated with final capping activities that occur during the operating life of a landfill, as well as closure and post-closure activities, are accounted for as asset retirement obligations on a discounted basis.  We recognize landfill retirement obligations that relate to closure and post-closure activities over the operating life of a landfill as landfill airspace is consumed and the obligation is incurred.  We recognize our final capping obligations on a discrete basis for each expected future final capping event over the number of tons of waste that each final capping event is expected to cover.  The landfill retirement obligations are initially measured at estimated fair value.  Fair value is measured on a present value basis, using a credit-adjusted, risk-free rate of 7.86% during 2004. 

 

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Accretion is recorded on all landfill retirement obligations using the effective interest method.  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 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.

 

We periodically evaluate the value and future benefits of our property and equipment, goodwill and other intangible assets.  For property and equipment and intangible assets other than goodwill, we assess the recoverability from future operations using cash flows of the related assets as measures.  Under this approach, the carrying value is reduced if it becomes probable that our best estimate of expected future cash flows from the related assets would be less than the carrying amount of the assets.  As of September 30, 2004, there were no adjustments to the carrying amounts of property and equipment and intangibles other than goodwill resulting from these evaluations.

 

We test goodwill for impairment using the two-step process prescribed in SFAS No. 142.  The first step is a screen for potential impairment and the second step measures the amount of the impairment, if any.  We performed our annual impairment test during the fourth quarter of 2003 and incurred no impairment.  As of September 30, 2004, goodwill and other intangible assets represented approximately 23.4% of total assets, 55.0% of redeemable preferred stock and 76.1% of the sum of our redeemable preferred stock and stockholders’ equity (deficit).

 

Seasonality

 

Seasonality and weather can temporarily affect our revenue and expenses.  We generally experience lower C&D waste volumes during the winter months when the construction industry is less active.  Frequent and/or heavy snow and ice storms can adversely affect our revenue in both our South and Northeast Regions, primarily by interfering with our transfer station and landfill operations which are volume based, and the productivity of our collection operations.  Additionally, in our South Region, higher than normal rainfall and more frequent rain storms over a 30 to 90 day period can put additional stress on the construction industry, lowering the volumes of waste we handle.  Significantly below normal rainfall can lead to higher levels of construction activity, increasing our volumes.

 

Impact of Inflation

 

To date, inflation has not significantly affected our operations.  Consistent with industry practice, many of our contracts allow us to pass through certain costs to our customers, including increases in landfill “tipping fees” and, in some cases, fuel costs.  Accordingly, we believe that we would be able to increase prices to offset many cost increases that result from inflation.  However, competitive pressures and the terms of certain of our long-term contracts may require us to absorb at least part of these cost increases, particularly during periods of high inflation.

 

Acquisitions

 

Our integration plan for acquisitions contemplates certain cost savings, including through the elimination of duplicative personnel and facilities.  Unforeseen factors may offset the estimated cost savings or other components of our integration plan, in whole or in part, and, as a result, we may not realize any cost savings or other benefits from future acquisitions, and we may experience a net increase in costs.

 

In accordance with GAAP, we capitalize some expenditures and advances relating to pending acquisitions.  For any pending acquisition that is not consummated, we charge any such expenditures and

 

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advances against earnings.  Therefore, we may incur charges against earnings in future periods, which could have a material adverse effect on our business, financial condition and results of operations.

 

All of our acquisitions have been accounted for as purchases and, accordingly, only the operations of acquired companies since their respective acquisition dates are included in our consolidated financial statements.  These acquisitions were financed through a combination of funds borrowed under our senior credit facility and proceeds from private offerings of shares of our preferred stock.  We expect to be able to finance any future acquisitions with cash provided from operations, borrowings under our senior credit facility, debt or equity offerings, or some combination of the foregoing.

 

2004.  During the nine months ended September 30, 2004, the Company acquired the hauling assets of five solid waste management companies for an aggregate purchase price of approximately $1.8 million consisting of cash paid and liabilities assumed.

 

Results of Operations

 

The following table sets forth, for the periods indicated, selected consolidated statement of operations data (in thousands) and the percentage relationship that such data bear to our revenue:

 

		Nine Months Ended September 30,								Three Months Ended September 30,
		2004				2003				2004				2003
		$		%		$		%		$		%		$		%
South Region revenue		133,717		55.3		115,589		64.0		46,273		54.4		41,520		64.7
Northeast Region revenue		108,265		44.7		64,900		36.0		38,815		45.6		22,655		35.3
Services revenue		241,982		100.0		180,489		100.0		85,088		100.0		64,175		100.0
Operating expense		138,902		57.4		118,345		65.6		48,652		57.2		41,711		65.0
General and administrative		29,523		12.2		23,004		12.7		10,514		12.3		8,207		12.8
Depreciation, depletion and amortization		47,390		19.6		26,148		14.5		16,934		19.9		9,563		14.9
Income from operations		26,167		10.8		12,992		7.2		8,988		10.6		4,694		7.3
Interest expense, net		(20,651	)	(8.5	)	(13,778	)	(7.7	)	(6,882	)	(8.1	)	(4,820	)	(7.5	)
Other income (expense), net		(612	)	(0.3	)	(261	)	(0.1	)	83		0.1		(147	)	(0.2	)
Income tax expense		(2,778	)	(1.1	)	(2,314	)	(1.3	)	(1,708	)	(2.0	)	(2,563	)	(4.0	)
Cumulative effect of change in accounting principle		—		—		(1,531	)	(0.8	)	—		—		—		—
Net income (loss)		2,126		0.9		(4,892	)	(2.7	)	481		0.6		(2,836	)	(4.4	)

 

Three Months Ended September 30, 2004 Compared With Three Months Ended September 30, 2003

 

Revenue.  Our revenue increased by $20.9 million, or 32.6%, to $85.1 million during the three months ended September 30, 2004 from $64.2 million during the three months ended September 30, 2003.  Acquisitions completed since July 2003 contributed $13.5 million, or 21.0%, to the increase in our revenue during the three months ended September 30, 2004.  Excluding incremental revenue from acquisitions, our revenue increased by $7.4 million, or 11.6%.  Our new business, from both new municipal contracts and increased sales from existing operations, contributed 6.5% of such increase, while price increases contributed 5.1%.  In our South Region, our revenue increased by $4.8 million, or

 

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