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SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 


 

FORM 10-Q

 


 

Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended March 31, 2005

 

Commission File Number 000-31050

 


 

Waste Industries USA, Inc.

(exact name of Registrant as specified in its charter)

 


 

North Carolina   56-0954929

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

3301 Benson Drive, Suite 601

Raleigh, North Carolina

(Address of principal executive offices)

 

27609

(Zip Code)

 

(919) 325-3000

(Registrant’s telephone number, including area code)

 


 

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

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, No Par Value   13,670,926 shares
(Class)   (Outstanding at May 13, 2005)

 



PART I – FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

 

WASTE INDUSTRIES USA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

    

December 31,

2004


  

March 31,

2005


          Unaudited

ASSETS

             

Current assets:

             

Cash and cash equivalents

   $ 2,445    $ 940

Accounts receivable - trade, net of allowance for uncollectible accounts of $2,259 and $ 2,502 at December 31, 2004 and March 31, 2005, respectively

     30,134      27,141

Accounts receivable - other

     1,468      1,599

Inventories

     1,526      1,473

Deferred income taxes

     2,740      2,740

Prepaid expenses and other current assets

     2,762      2,948
    

  

Total current assets

     41,075      36,841
    

  

Property and equipment, net

     198,551      199,066

Goodwill, net

     87,902      89,808

Other intangible assets, net

     4,800      4,902

Other noncurrent assets

     4,720      4,471
    

  

Total assets

   $ 337,048    $ 335,088
    

  

 

See Notes to Unaudited Consolidated Financial Statements.

 

2


WASTE INDUSTRIES USA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

    

December 31,

2004


  

March 31,

2005


          Unaudited

LIABILITIES AND SHAREHOLDERS’ EQUITY

             

Current liabilities:

             

Accounts payable - trade

   $ 14,627    $ 12,796

Accrued liabilities and other payables

     6,336      7,348

Current maturities of long-term debt

     10,733      10,733

Accrued wages and benefits

     3,717      3,601

Closure/post-closure liabilities

     3,162      3,122

Reserve for self-insurance

     3,406      3,851

Deferred revenue

     5,949      3,722
    

  

Total current liabilities

     47,930      45,173
    

  

Long-term debt, net of current maturities

     145,930      140,358

Noncurrent deferred income taxes

     22,629      23,716

Other long-term liabilities

     2,848      3,349

Commitments and contingencies (Note 9)

     —        —  

Shareholders’ equity:

             

Common stock, no par value, shares authorized - 80,000,000 shares issued and outstanding: December 31, 2004 - 13,494,869, March 31, 2005 - 13,650,380

     39,308      40,550

Paid-in capital

     7,342      7,690

Retained earnings

     71,005      73,777

Unrealized gains on cash flow hedges

     56      475
    

  

Total shareholders’ equity

     117,711      122,492
    

  

Total liabilities and shareholders’ equity

   $ 337,048    $ 335,088
    

  

 

See Notes to Unaudited Consolidated Financial Statements.

 

3


WASTE INDUSTRIES USA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

    

Three Months Ended

March 31,


 
     2004

    2005

 

Revenues:

                

Service revenues

   $ 69,021     $ 71,873  

Equipment sales

     219       154  
    


 


Total revenues

     69,240       72,027  
    


 


Operating costs and expenses:

                

Operating (exclusive of depreciation and amortization shown below)

     45,551       48,389  

Equipment sales

     127       106  

Selling, general and administrative

     9,413       9,461  

Depreciation and amortization

     7,339       7,078  

Gain on sale of property and equipment

     (117 )     (25 )

Impairment of property and equipment and other assets

     —         126  
    


 


Total operating costs and expenses

     62,313       65,135  
    


 


Operating income

     6,927       6,892  
    


 


Interest expense

     2,564       2,342  

Interest income

     (22 )     (11 )

Other

     (65 )     (21 )
    


 


Total other expense, net

     2,477       2,310  
    


 


Income before income taxes

     4,450       4,582  

Income tax expense

     1,625       1,810  
    


 


Net income

   $ 2,825     $ 2,772  
    


 


 

See Notes to Unaudited Consolidated Financial Statements.

 

4


WASTE INDUSTRIES USA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

    

Three Months Ended

March 31,


     2004

   2005

Earnings per share:

             

Basic

   $ 0.21    $ 0.20
    

  

Diluted

   $ 0.21    $ 0.20
    

  

Weighted-average number of common shares outstanding:

             

Basic

     13,493      13,538

Diluted

     13,658      13,774

 

See Notes to Unaudited Consolidated Financial Statements.

 

5


WASTE INDUSTRIES USA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

     Three Months Ended
March 31,


 
     2004

    2005

 

Operating Activities:

                

Net income

   $ 2,825     $ 2,772  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Depreciation and amortization

     7,339       7,078  

Amortization of debt issuance costs

     186       181  

Asset impairment

     —         126  

Gain on sale of property and equipment

     (117 )     (25 )

Stock compensation expense

     5       14  

Provision for deferred income taxes

     1       829  

Provision for doubtful accounts

     470       595  

Changes in operating assets and liabilities, net of effects from acquisition and disposition of related businesses:

                

Receivables

     604       1,878  

Prepaid expenses and other current assets

     (296 )     352  

Other assets

     (366 )     (295 )

Accounts payable and accrued liabilities

     2,875       (1,121 )

Deferred revenue and other liabilities

     (3,418 )     (1,735 )
    


 


Net cash provided by operating activities

     10,108       10,649  
    


 


Investing Activities:

                

Acquisitions of related businesses, net of cash acquired

     (430 )     (2,510 )

Settlement of acquisition liabilities

     (107 )     (298 )

Proceeds from sale of property and equipment

     760       392  

Purchases of property and equipment

     (4,020 )     (6,782 )

Collection of notes receivable

     —         1,060  

Proceeds from sale of insurance policy

     —         164  
    


 


Net cash used in investing activities

     (3,797 )     (7,974 )
    


 


Financing Activities:

                

Proceeds from issuance of long-term debt

     3,000       5,000  

Principal payments of long-term debt

     (11,571 )     (10,572 )

Principal payments of capital lease obligations

     (109 )     (56 )

Financing costs

     (3 )     —    

Net proceeds from exercise of stock options

     27       1,448  
    


 


Net cash used in financing activities

     (8,656 )     (4,180 )
    


 


DECREASE IN CASH AND CASH EQUIVALENTS

     (2,345 )     (1,505 )

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     4,127       2,445  
    


 


CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 1,782     $ 940  
    


 


Supplemental disclosures of cash flow information:

                

Cash paid for interest

   $ 2,380     $ 2,147  
    


 


Cash paid for income taxes

   $ 2,116     $ 1,940  
    


 


 

Supplemental disclosure of noncash transactions-

During the first quarter of 2005, the Company acquired approximately $346 of fixed assets by entering into a capital lease.

During the first quarter of 2005, the Company sold an insurance policy in exchange for 17,617 shares of the Company’s common stock with a fair value of approximately $220. (see Note 7.)

 

See Notes to Unaudited Consolidated Financial Statements.

 

6


WASTE INDUSTRIES USA, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

1. BASIS OF PRESENTATION AND RECENT DEVELOPMENTS

 

Basis of Presentation

 

The unaudited consolidated financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. As applicable under such regulations, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The Company believes that the presentations and disclosures in the financial statements included herein are adequate to make the information not misleading. The unaudited consolidated financial statements reflect normal adjustments that are necessary for a fair statement of the results for the interim periods presented. Operating results for interim periods are not necessarily indicative of the results for full years or other interim periods.

 

The unaudited consolidated financial statements included herein should be read in conjunction with the consolidated financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

 

New Accounting Pronouncements

 

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Emerging Issues Task Force (“EITF”) Issue No. 03-13, Applying the Conditions in Paragraph 42 of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, In Determining Whether to Report Discontinued Operations. The Task Force reached a consensus that classification of a disposed component as a discontinued operation is appropriate only if the ongoing entity:

 

  has no continuing direct cash flows (and further clarifies what constitutes a direct cash flow); and

 

  does not retain an interest, contract, or other arrangement sufficient to enable it to exert significant influence over the disposed component’s operating and financial policies after the disposal transaction.

 

The Company adopted EITF Issue No. 03-13 on January 1, 2005 and will apply it to material components that are disposed of from that date forward. For the three months ended March 31, 2005, there were no components disposed of by the Company. Exchanges of assets that occurred in 2004 were not required to be reported as discontinued operations, based on the Company’s interpretation of Statement of Financial Accounting Standards (“SFAS”) No. 144.

 

New Accounting Pronouncements Not Yet Adopted

 

In March 2005, the FASB issued FASB Interpretation No. 47 (“FIN 47”), Accounting for Conditional Asset Retirement Obligations, which requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred which is generally upon acquisition, construction, or development and/or through the normal operation of the asset. FIN 47 clarifies the term ‘conditional asset retirement obligation’ as used in FASB No. 143 and clarifies when an entity would have sufficient information to reasonably estimate the fair value of the asset retirement obligation. FIN 47 becomes effective for the Company for the fourth quarter of 2005. The Company intends to adopt FIN 47 in the fourth quarter of 2005 and does not believe it will have a material impact on the Company’s financial position.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”). SFAS 123R requires all entities to recognize compensation expense in their statements of operations for all share-based payments (e.g., stock options and restricted stock) granted to employees based upon the fair value of the award on the grant date. The cost of the employee services is recognized as compensation cost over the period that an employee provides service in exchange for the award. Pro forma disclosure is no longer permitted.

 

7


SFAS 123R is now effective for issuers as of the beginning of the first fiscal year beginning after June 15, 2005, instead of at the beginning of the first quarter after June 15, 2005 as originally prescribed. Accordingly, the required effective date of SFAS 123R for calendar year-end public companies is January 1, 2006 instead of July 1, 2005. We expect to adopt the pronouncement on January 1, 2006. As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using the intrinsic value method under Accounting Principles Board (“APB”) No. 25, Accounting For Stock Issued To Employees, and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123R’s fair value method may have a significant impact on the Company’s results of operations, although it will have no impact on the Company’s overall cash flows or financial position. The impact of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described below in our pro forma net income and earnings per share calculation.

 

Stock Based Compensation

 

Until the effective date of SFAS 123R, the Company will continue to account for employee stock compensation in accordance with APB No. 25. Under APB No. 25, the total compensation expense, which is recognized over the vesting period of the award, is equal to the intrinsic value at the measurement date, which is the first date that both the exercise price and number of shares to be issued is known.

 

SFAS No. 123, Accounting For Stock-based Compensation, requires disclosure of stock-based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the options awarded.

 

Had compensation cost for the Company’s stock been determined based on the fair value at the grant dates for awards under the stock plan consistent with the methods required by SFAS No. 123, the Company’s net income and earnings per share for the three-month periods ended March 31, 2004 and 2005 would have been reduced to the pro forma amounts indicated below (in thousands, except per share data):

 

    

Three Months Ended

March 31,


 
     2004

    2005

 

Net income:

                

As reported

   $ 2,825     $ 2,772  

Deduct - total stock based compensation determined under fair value based method for all awards

     (67 )     (91 )
    


 


Pro forma

   $ 2,758     $ 2,681  
    


 


Earnings per share:

                

Basic:

                

As reported

   $ 0.21     $ 0.20  

Pro forma

   $ 0.20     $ 0.20  

Diluted:

                

As reported

   $ 0.21     $ 0.20  

Pro forma

   $ 0.20     $ 0.19  

 

8


2. BUSINESS ACQUISITIONS AND DISPOSITION

 

During the three-month period ended March 31, 2005, the Company made the following acquisitions:

 

On March 2, 2005, the Company acquired three waste companies in the Atlanta, Georgia region with an aggregate purchase price of approximately $2.5 million. The results of these operations have been included in the consolidated financial statements since that date. These acquisitions were funded primarily with cash provided by operating activities.

 

As of March 31, 2005, the recorded purchase price allocation for these acquisitions was as follows (in thousands):

 

Tangible Assets (Liabilities) Acquired at Fair Value:

        

Accounts receivable

   $ 261  

Property and equipment

     561  

Liabilities assumed

     (723 )
    


Total net tangible assets acquired

     99  

Intangible Assets Acquired at Fair Value:

        

Customer lists

     405  

Noncompete agreements

     1  

Goodwill

     1,946  
    


Total net assets acquired at fair value

   $ 2,451  
    


 

The Company had no dispositions in the current period.

 

In accordance with SFAS No. 141, Business Combinations, the purchase price has been allocated to the underlying assets and liabilities based on their respective fair values at the date of acquisition. These

 

9


purchase price allocations are preliminary estimates, based on available information and certain assumptions that management believes are reasonable. Accordingly, these purchase price allocations are subject to finalization.

 

The following unaudited pro forma results of operations for the three-month periods ended March 31, 2004 and 2005 assume that the acquisitions described above had occurred as of January 1, 2004 (amounts in thousands):

 

     2004

   2005

Total revenues

   $ 69,919    $ 72,480
    

  

Operating income

   $ 7,115    $ 7,016
    

  

Net income

   $ 2,910    $ 2,826
    

  

Earnings per common share:

             

Basic:

             

Net income

   $ 0.22    $ 0.21
    

  

Diluted:

             

Net income

   $ 0.21    $ 0.21
    

  

 

The pro forma financial information does not purport to be indicative of the results of operations that would have occurred had the acquisitions taken place at the beginning of the periods presented or of future operating results.

 

3. INTANGIBLE ASSETS

 

Intangible assets primarily consist of goodwill, customer lists and noncompete agreements acquired in business combinations. Intangible assets are net of accumulated amortization. The following table summarizes the activity related to goodwill for the three-month period ended March 31, 2005 (in thousands):

 

Beginning balance - January 1, 2005

   $ 87,902  

Acquisitions

     1,946  

Post-closure purchase accounting adjustments

     (40 )
    


Ending balance - March 31, 2005

   $ 89,808  
    


 

10


Other intangible assets consisted of the following at March 31, 2005 and December 31, 2004 (in thousands):

 

     March 31, 2005

     Gross Carrying
Value


   Accumulated
Amortization


   Net Carrying
Value


Customer lists

   $ 6,004    $ 1,424    $ 4,580

Noncompete agreements

     1,086      764      322
    

  

  

     $ 7,090    $ 2,188    $ 4,902
    

  

  

     December 31, 2004

     Gross Carrying
Value


   Accumulated
Amortization


   Net Carrying
Value


Customer lists

   $ 5,717    $ 1,258    $ 4,459

Noncompete agreements

     1,085      744      341
    

  

  

     $ 6,802    $ 2,002    $ 4,800
    

  

  

 

Amortization expense for customer lists and noncompete agreements for the three months ended March 31, 2004 and 2005 was $186,000 and $253,000, respectively. The weighted average amortization period for customer lists and noncompete agreements is 6.5 years. Estimated future amortization expense associated with customer lists and noncompete agreements at March 31, 2005 was as follows (in thousands):

 

Year


  

Amortization

Expense


Remainder 2005

   $ 738

2006

     1,050

2007

     1,011

2008

     742

2009

     637

2010

     446

Thereafter

     278
    

Total

   $ 4,902
    

 

4. EARNINGS PER SHARE

 

Basic and diluted earnings per share computations are based on the weighted-average common stock outstanding and include the dilutive effect of stock options using the treasury stock method.

 

11


Earnings per share is calculated as follows (in thousands, except per share amounts):

 

    

Three Months Ended

March 31,


     2004

   2005

Net income

   $ 2,825    $ 2,772
    

  

Denominator used for basic earnings per share - Weighted average number of shares outstanding

     13,493      13,538
    

  

Denominator used for diluted earnings per share:

             

Denominator used for basic earnings per share

     13,493      13,538

Dilutive impact of stock options outstanding

     165      236
    

  

Weighted average number of shares outstanding

     13,658      13,774
    

  

Earnings per share:

             

Basic:

             

Net income

   $ 0.21    $ 0.20
    

  

Diluted:

             

Net income

   $ 0.21    $ 0.20
    

  

Antidilutive options to purchase common stock not included in earnings per share calculation

     118      57
    

  

 

The antidilutive options were excluded from the earnings per share calculation as the exercise price of the options exceeded the fair value of the common stock during the above periods.

 

5. LONG TERM DEBT

 

Long-term debt consisted of the following at December 31, 2004 and March 31, 2005 (in thousands):

 

    

December 31,

2004


   

March 31,

2005


 

Credit Facilities:

                

Term facility

   $ 39,286     $ 35,714  

Revolving credit facility

     77,000       75,000  

Bonds

     40,355       40,355  

Other

     22       22  
    


 


Total long-term debt

     156,663       151,091  

Less current portion

     (10,733 )     (10,733 )
    


 


Long-term debt, net of current maturities

   $ 145,930     $ 140,358  
    


 


 

12


The Company and all of its subsidiaries are co-borrowers on a revolving credit agreement with a syndicate of lending institutions for which Fleet National Bank, N.A. (“Fleet”) acts as agent. This credit facility provides up to $175 million through February 2007. Virtually all of the assets of the Company and its subsidiaries, including the Company’s ownership interest in the equity securities of its subsidiaries, secure the Company’s obligations under the revolver. Pursuant to an intercreditor agreement with Fleet, Prudential Insurance Company of America (“Prudential”) shares in the collateral pledged under the revolver. The revolver bears interest at a rate per annum equal to, at the Company’s option, either a Fleet base rate or at the Eurodollar rate (based on Eurodollar interbank market rates) plus, in each case, a percentage rate that fluctuates, based on the ratio of the Company’s funded debt to EBITDA (income before income taxes plus interest expense and depreciation and amortization), from 0.25% to 1.25% for base rate borrowings and 1.75% to 2.75% for Eurodollar rate borrowings. The revolver requires the Company to maintain certain financial ratios and satisfy other predetermined requirements, such as minimum net worth, net income, and limits on capital expenditures and indebtedness. The Company was in compliance with these financial covenants as of December 31, 2004 and March 31, 2005. It also requires the lenders’ approval of acquisitions in some circumstances. As of March 31, 2005, $75 million was outstanding under the revolver. The average interest rate on outstanding borrowings under the revolver was approximately 4.4% and 4.8% at December 31, 2004 and March 31, 2005, respectively. Availability was approximately $42.3 million under the revolver as of March 31, 2005.

 

The Prudential term loan facility consists of three term loans of $25 million each. Prior to 2000, the Company had fully drawn on all three of the facilities. Principal repayments are due annually on each of the $25 million term facilities. The Prudential term facilities require the Company to maintain certain financial ratios, such as debt to earnings and fixed charges to earnings, and satisfy other predetermined requirements, such as minimum net worth and net income. The Company was in compliance with these financial covenants as of December 31, 2004 and March 31, 2005. In addition, the Company’s subsidiaries have guaranteed the Company’s obligations under the Prudential term loan facilities. Interest on the three Prudential term facilities is paid quarterly, based on fixed rates of 7.53%, 7.21% and 7.09%, respectively. Of the Company’s outstanding Prudential facilities, $7.1 million fully matures by April 2006, $14.3 million fully matures by June 2008, and $14.3 million fully matures by February 2009.

 

The Company entered into a $9.5 million variable rate bond with Sampson County, North Carolina on September 10, 2003 for the funding of expansion at its landfill in that county. This bond expires in 2023. This bond is in addition to the Company’s existing $30.9 million Sampson facility, which expires in 2021. Both facilities are backed by a letter of credit issued by Wachovia Bank N.A. (“Wachovia”) as a participating lender under the revolver. The average interest rate on outstanding borrowings under both Sampson facilities was approximately 4.0% at December 31, 2004 and March 31, 2005.

 

Aggregate principal maturities of long-term debt at March 31, 2005 were as follows (in thousands):

 

Current

   $ 10,733

13 to 24 months

     82,147

25 to 36 months

     10,714

37 to 48 months

     7,142

49 to 60 months

     —  

Thereafter

     40,355
    

Total

   $ 151,091
    

 

13


Based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of long-term debt was $160.2 million and $153.5 million at December 31, 2004 and March 31, 2005, respectively.

 

6. PROPERTY AND EQUIPMENT

 

Property and equipment consisted of the following at December 31, 2004 and March 31, 2005 (in thousands):

 

    

December 31,

2004


   

March 31,

2005


 

Land, land improvements and buildings

   $ 40,185     $ 41,164  

Landfills and associated land

     109,465       110,305  

Machinery and equipment

     21,095       21,059  

Containers

     94,457       95,496  

Collection vehicles

     97,150       97,425  

Furniture, fixtures, and office equipment

     7,024       7,103  

Construction in progress

     442       2,756  
    


 


Total property and equipment

     369,818       375,308  

Less accumulated depreciation

     (171,267 )     (176,242 )
    


 


Property and equipment, net

   $ 198,551     $ 199,066  
    


 


 

Construction in progress includes equipment not placed in service as of the balance sheet date. Collection vehicles are owned by the Company.

 

Depreciation expense (including software amortization) for the three-month periods ended March 31, 2004 and 2005 was approximately $5.8 million and $5.7 million, respectively. Landfill amortization expense was approximately $1.3 million and $1.1 million for the three-month periods ended March 31, 2004 and 2005, respectively.

 

Pursuant to the provisions of SFAS No. 144, the Company recorded asset impairment charges of approximately $0 and $76,000 for the three-month periods ended March 31, 2004 and 2005, respectively, related to certain excess equipment and vehicles that have been taken out of service. The Company determined fair value based on comparable equipment with similar remaining useful lives.

 

14


7. SHAREHOLDERS’ EQUITY

 

The Company issued 474 and 1,007 shares of common stock with a fair value of approximately $5,100 and $14,000 for the three months ended March 31, 2004 and 2005, respectively, which were recorded as directors’ fees.

 

During the three-month periods ended March 31, 2004 and 2005, stock options totaling 4,292 and 172,121 were exercised with net proceeds of approximately $27,000 and $1.4 million, respectively. As a result of the 2005 option exercises, the Company recorded an income tax benefit of approximately $348,000 as an addition to paid-in-capital.

 

In January 2005, our Chairman, Lonnie C. Poole, Jr., purchased two life insurance policies which were previously assigned to the Company in connection with the settlement of prior loans. To purchase one of the policies, Mr. Poole transferred to the Company 17,617 shares of the Company’s common stock with an approximate value of $219,500 and the Company subsequently cancelled such shares. For more information regarding this transaction, see the Company’s discussion under “Certain Transactions” in the Company’s proxy statement for the 2005 annual meeting of shareholders (the “2005 Proxy Statement”).

 

8. DERIVATIVE FINANCIAL INSTRUMENTS AND OTHER COMPREHENSIVE INCOME

 

The Company utilizes cash flow hedge agreements to manage a portion of its risks related to fluctuations in interest rates and certain commodity prices.

 

Interest Rate Swaps

 

The Company entered into an interest rate swap agreement effective January 1, 2002 to modify the interest characteristics of its outstanding long-term debt and designated the qualifying instrument as a cash flow hedge. Under the agreement, the interest rate swap hedged notional debt values of $50.0 million with a fixed interest rate of 4.2%. The agreement expired November 2004.

 

In March 2004, the Company entered into additional interest rate swaps to hedge notional debt values of $30.0 million and $10.0 million, respectively. These swaps are effective for the period November 2004 through February 2007 with fixed interest rates of 2.7%.

 

The Company measures effectiveness of the interest rate swaps by its ability to offset cash flows associated with changes in the variable LIBOR rate associated with the Company’s credit facility using the hypothetical derivative method. To the extent the interest rate swap is considered to be effective, changes in fair value are recorded, net of income tax, in shareholders’ equity as a component of accumulated other comprehensive income (loss). To the extent the instrument is considered ineffective, any changes in fair value relating to the ineffective portion are immediately recognized in accompanying consolidated statements of operations as interest expense. The interest rate swaps were fully effective during the three months ended March 31, 2004 and 2005.

 

The fair value of the Company’s interest rate swap is obtained from a dealer quote. This value represents the estimated amount the Company would receive or pay to terminate the interest rate swap agreement taking into consideration the difference between the contract rate of interest and rates currently quoted for an agreement of similar term and maturity. The fair value of the interest rate swap agreements represented an asset of approximately $0.6 million and $1.0 million as of at December 31, 2004 and March 31, 2005, respectively.

 

Commodity Swaps

 

The Company entered into two commodity swap contracts effective January 1, 2003 and June 1, 2003, respectively, to hedge its recycling revenue received for old corrugated cardboard (“OCC”) and has designated the qualifying instruments as cash flow hedges. The contracts each hedge 18,000 tons of OCC at $70 a ton for a term of three years. In November 2004, we entered into a contract effective January 1, 2005, to hedge another 18,000 tons of OCC at $90 a ton for a term of three years. In April 2005, we entered into another contract effective January 1, 2006, to hedge 18,000 tons of OCC at $83 per ton for a term of three years. The notional amounts hedged under these agreements represent approximately 33% of the Company’s OCC volume at March 31, 2005.

 

15


The Company measures effectiveness of the commodity swaps by its ability to offset cash flows associated with changes in the rates received for its monthly OCC volumes. To the extent the commodity swaps are considered to be effective, changes in fair value of the instrument are recorded, net of income tax, in shareholders’ equity as a component of accumulated other comprehensive income (loss). To the extent the instrument is considered ineffective, any changes in fair value relating to the ineffective portion are immediately recognized in the accompanying consolidated statements of operations as a reduction of recycled commodity revenue. The commodity swaps were fully effective for the three-month periods ended March 31, 2004 and 2005.

 

The fair value of the Company’s commodity swap contracts was obtained from a dealer quote. This value represents the estimated amount the Company would receive or pay to terminate the commodity swap contracts taking into consideration the difference between the contract value of the OCC volume and values currently quoted for agreements of similar term and maturity. The fair value of the commodity swap agreements represented a liability of $475,000 and $258,000 at December 31, 2004 and March 31, 2005, respectively.

 

The components of comprehensive income, net of related income taxes, are as follows (in thousands):

 

    

Three Months Ended

March 31,


 
     2004

    2005

 

Net income

   $ 2,825     $ 2,772  

Other comprehensive income

                

Unrealized gains on cash flow hedges, net of deferred income taxes of $12 and $255 for the three months ended March 31, 2004 and 2005, respectively

     20       420  
    


 


Comprehensive income

   $ 2,845     $ 3,192  
    


 


    

Three Months Ended

March 31,


 
     2004

    2005

 

Change in unrealized gains on cash flow hedges

   $ 239     $ 461  

Less: reclassification adjustment for net charges included in net income

     (219 )     (41 )
    


 


Net change in unrealized gains on qualifying cash flow hedges

   $ 20     $ 420  
    


 


 

On December 28, 2004, the Company entered into a heating oil hedge contract, effective January 1, 2005, to cap its exposure on 1.2 million gallons of diesel fuel at $1.90 per gallon. The hedge coverage represented approximately 80% of the Company’s first quarter 2005 diesel fuel requirements, and expired on March 31, 2005. The Company recorded approximately a $109,000 net benefit as an offset to fuel charges in the first quarter of 2005 due to this contract.

 

16


9. COMMITMENTS AND CONTINGENCIES

 

Certain claims and lawsuits arising in the ordinary course of business have been filed or are pending against the Company. In the opinion of management, all such matters have been adequately provided for, are adequately covered by insurance, or are of such kind that if disposed of unfavorably, would not have a material adverse effect on the Company’s financial position or results of operations.

 

In addition, the Company has identified the following matters which could have an impact on the Company’s financial position or results of operations:

 

Solid Waste Management Authority of Crisp County

 

The Company’s subsidiary TransWaste Services, LLC (“TransWaste”) provides waste collection, hauling and disposal services for the Solid Waste Management Authority of Crisp County, Georgia (“the Authority”) pursuant to three 25-year collection, transportation and service agreements with the Authority dated December 20, 1996. Pursuant to these agreements, TransWaste is the exclusive provider of waste collection and transfer services to the Authority, which consists of approximately 30 municipal members or participants.

 

At its inception, the Authority issued bonds in the original face amount of approximately $69.5 million to construct and operate a waste facility. Financial Security Assurance, Inc. (“FSA”), is the insurer for those bonds, is a creditor of the Authority and has been providing debt service on the bonds. In that capacity, FSA appears to be directing the operations of the Authority.

 

TransWaste filed a lawsuit against the Authority in September 1999 for amounts due and owing for services rendered and obtained a judgment on one of its claims in the principal amount of approximately $1.0 million plus interest, although TransWaste has yet to collect on this judgment and has established a reserve against the possibility of non-payment. The Authority filed counterclaims against TransWaste seeking to recover approximately $2.0 million allegedly due from TransWaste on the theory that TransWaste had breached a “break-even guarantee” from the period of July 1 through December 31, 1998. TransWaste’s remaining claim and the Authority’s counterclaims have not been litigated and remain pending on a presently inactive trial calendar in the Superior Court of Crisp County, Georgia (Case No. 99-V-419).

 

Since August 2001, TransWaste has provided trash collection, transportation and disposal services on behalf of the Authority to the approximately 30 municipalities that have contracted with the Authority for such services via a “diversion plan” that contains understandings and obligations that are materially different than the terms of the December 1996 agreements. While not reduced to a written document signed by the parties, it is TransWaste’s position that the diversion plan has been approved and accepted by the Authority and FSA and constitutes a modification to the agreements due to the course of conduct of the parties. The Authority and FSA dispute this position. At this time, TransWaste, FSA and the Authority are pursuing a global resolution of these issues through negotiation.

 

In June 2004, the Authority received a judgment in the amount of approximately $740,000, plus interest and legal fees and expenses, for amounts due from a participant for services rendered by TransWaste on behalf of the Authority. The participant has appealed the decision and as such TransWaste has established a reserve against the possibility of non-payment.

 

Landfills

 

Landfill closure and post-closure costs represent an estimate of the current value of the future obligations associated with closure and post-closure monitoring of non-hazardous solid waste landfills currently owned by the Company. Closure and post-closure monitoring and maintenance costs represent the costs related to cash expenditures yet to be incurred when a landfill facility ceases to accept waste and closes. Accruals for

 

17


closure and post-closure monitoring and maintenance requirements in the United States consider final capping of the site, site inspection, groundwater monitoring, leachate management, methane gas control and recovery, and operating and maintenance costs to be incurred during the period after the facility closes. Certain of these environmental costs, principally capping and methane gas control costs, are also incurred during the operating life of the site in accordance with the landfill operation requirements of Subtitle D and the air emissions standards. Reviews of the future cost requirements for closure and post-closure monitoring and maintenance for the Company’s operating landfills by the Company’s personnel and consultants are performed at least annually. The impact of changes determined to be changes in estimates, based on the annual update, are accounted for on a prospective basis.

 

While the precise amounts of these future obligations cannot be determined, the Company provides accruals for these estimated costs as the remaining permitted airspace of landfills is consumed. The Company’s estimate of these costs considers when the costs would actually be paid and factors in inflation and discount rates. At December 31, 2004 and March 31, 2005, the Company had accrued approximately $5.3 million and $5.6 million for such costs. Significant revisions in estimated lives of the Company’s landfills or significant increases in its estimates of landfill closure and post closure costs could have a material adverse impact on the Company’s financial condition and results of operations.

 

TransWaste Services, LLC, f/k/a TransWaste Services, Inc. v. Maple Hill Landfill, Inc., U.S. District Court for the Middle District of Georgia, Albany Division, Civil Action No. 1:04-CV-126-4 (WLS)

 

In September 1998, the Company’s subsidiary TransWaste Services, LLC entered into an agreement with Maple Hill Landfill, Inc. (“Maple Hill”) that provides that, upon the satisfaction of certain conditions, Maple Hill has the option to sell a landfill near Albany, Georgia to TransWaste for $8.0 million or to accept waste from TransWaste at a per ton rate that is favorable to TransWaste for up to ten years. None of the conditions has been satisfied. In August 2004, TransWaste sued Maple Hill seeking a judicial declaration that the agreement is unenforceable for, among other reasons, failure to satisfy these conditions within a reasonable amount of time. Maple Hill has indicated that, if and when it satisfies the conditions to the agreement, it intends to seek both specific performance of the agreement and any damages caused by TransWaste’s renunciation and anticipatory repudiation of the agreement. TransWaste intends to vigorously pursue its claims and defend against any potential counterclaim by Maple Hill. If TransWaste is not successful on this matter, TransWaste could be obligated to purchase the landfill or could be liable for damages.

 

One of the owners of Maple Hill is a former director and officer of the Company. See Note 10, Related Party Transactions.

 

U.S. Department of Justice

 

During 2004, the Company received from the U. S. Department of Justice document and other information requests relating to the Company’s purchase and sale in August 2003 of non-hazardous solid waste service operations to and from Allied Waste Industries, Inc. in Charlotte, North Carolina; Sumter, South Carolina; Mobile, Alabama; Biloxi, Mississippi; Norfolk, Virginia; and Clarksville, Tennessee. These requests included a Civil Investigative Demand seeking to determine whether the Company’s acquisition from Allied of front-end commercial hauling routes in the south of the James River, or Tidewater, portion of the Norfolk, Virginia market has had the effect of lessening competition in that market. The Company voluntarily responded to the document and information requests from the DOJ and has cooperated with the DOJ in its investigation. The Company does not believe that the transactions or its subsequent operations have had any effect of lessening competition in the Tidewater market, and believes that, in fact, competition in the area is more robust than ever. However, the Company might not be able to resolve this matter without litigation or other results that could be adverse to its Tidewater business.

 

18


Other

 

The Company has unconditional purchase obligations as of March 31, 2005 to acquire certain fixed assets of approximately $2.9 million.

 

At December 31, 2004 and March 31, 2005, the Company had entered into irrevocable letters of credit including performance bonds with available credit totaling approximately $41.8 million and $42.9 million, respectively. At December 31, 2004 and March 31, 2005, no amounts were drawn under the outstanding letters of credit.

 

10. RELATED PARTY TRANSACTIONS

 

In 1998, the Company purchased TransWaste Services, Inc. from Thomas C. Cannon, a former director of the Company. Mr. Cannon remained President of TransWaste, one of the Company’s wholly owned subsidiaries, until his resignation effective October 1, 2002. Mr. Cannon was elected to the Company’s Board of Directors (“Board”) in 2000 and served on the Board through May 24, 2004. At the time of the Company’s acquisition of TransWaste from Mr. Cannon, he owned, and still owns, a 50% interest in a company that is developing a construction and demolition solid waste (“C&D”) landfill. Simultaneously with the Company’s purchase of TransWaste, and in order for management to position TransWaste to realize the potential benefit of that future landfill, TransWaste entered into an agreement with the company that is 50% owned by Mr. Cannon whereby, upon the satisfaction of certain conditions, that company has the option to sell the landfill to TransWaste for $8,000,000 or to accept C&D waste from TransWaste or any affiliate at a per ton rate that is favorable to TransWaste for ten years. None of these conditions has been satisfied, so TransWaste has neither acquired, nor is it disposing of waste at, the proposed landfill. On August 20, 2004, TransWaste filed a complaint for declaratory relief asking the court to determine that the agreement between the two companies is unenforceable for, among other reasons, failure to satisfy such conditions within a reasonable amount of time.

 

Lonnie C. Poole, III is a member of a limited liability company that owns the building in Raleigh, North Carolina in which the Company leases its headquarters office space. The lease was entered into in June 1999 with a term of 10 years. Rental expense related to this lease was approximately $126,000 and $147,000 for the three months ended March 31, 2004, and 2005, respectively, and is included in selling, general and administrative expenses in the accompanying consolidated statements of operations. Management believes that the lease is on terms comparable to those with third parties.

 

The Company provides office space and administrative services to a company owned by Lonnie C. Poole, III. The amount billed for such services for the three months ended March 31, 2004 and 2005 was approximately $1,400.

 

The Company leases aircraft from time to time from companies owned in part by some of its officers. The amounts paid to these companies for rental of such aircraft for the three months ended March 31, 2004 and 2005 were approximately $3,000 and $28,000, respectively. The lease terms are comparable to those with third parties.

 

In January 2005, our Chairman, Lonnie C. Poole, Jr., purchased from the Company two life insurance policies which he previously assigned to the Company in connection with the settlement of prior loans. To purchase one of the policies, Mr. Poole transferred to the Company 17,617 shares with an approximate value of $219,500 and the Company subsequently cancelled such shares. The purchase of the other policy was settled in cash for $166,405. The aggregate consideration value of $385,905 was the cash value of the policies on September 30, 2004, the valuation date determined in accordance with the Board’s approval of the transaction. The Company recognized a loss of $40,400 related to the sale of these policies. For more information regarding this transaction, see the Company’s discussion under “Certain Transactions” in the 2005 Proxy Statement.

 

In 1998, the Company was offered the opportunity to purchase two tracts of land that had potential as a regional solid waste disposal facility. The Company had been looking for a landfill site and this land was

 

19


one of several sites the Company was considering. The owners of the land were unwilling to extend a purchase option for a period long enough to enable the Company to determine the feasibility of the site as a regional solid waste disposal facility and to obtain the necessary franchise from the county in which the landfill would be located and permits from the state in which the landfill would be located. The Company’s general practice is not to acquire property for which it does not have a plan for development in the short-term and for which it has not obtained, to the extent practicable, a site suitability determination and the necessary franchise and permits. Rather than forego this potential opportunity, management determined that it was in the Company’s best interest for an unrelated third party to purchase and hold the land until such time as the Company was able to develop a plan and obtain a site suitability determination and a franchise and permits for the landfill. After management was unable to identify a third party willing to undertake this endeavor in the very little time available, a limited liability company (“LLC”) owned by a trust controlled by Lonnie C. Poole, III, the Company’s Vice President, and Scott J. Poole, sons of Lonnie C. Poole, Jr., the Company’s Chairman of the Board of Directors, purchased the land in December 1998. As is customary for the Company when evaluating disposal sites, the Company has incurred normal engineering, legal, marketing, consulting and other due diligence expenses to determine site feasibility, but the Company has no obligation to purchase the site. The costs of acquiring and carrying the site were borne entirely by the LLC. If, after completion and analysis of the site suitability determination, the Company determines the landfill is feasible and is able to obtain a franchise for the facility and reasonably believes that the necessary permits could be obtained, the Company will have the option to purchase the site from the LLC upon negotiated terms, which would be reviewed and approved by a majority of the Company’s disinterested directors and, if deemed necessary, by a majority of disinterested shareholders voting on the transaction, as a condition to any purchase.

 

11. LANDFILLS

 

The Company has material financial commitments for final capping, closure and post-closure obligations with respect to its landfills. The Company developed its estimates of final capping, closure and post-closure obligations using input from its third party engineers and internal accounting staff. The Company’s estimates are based on its interpretation of current requirements and proposed regulatory changes and are intended to approximate fair value. Absent quoted market prices, the estimate of fair value should be based on the best available information, including the results of present value techniques in accordance with Statement of Financial Accounting Concepts, or SFAC, No. 7, Using Cash Flow and Present Value in Accounting Measurements. In general, the Company relies on third parties to fulfill most of its obligations for final capping, closure and post-closure. Accordingly, the fair market 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 obligations using internal resources. Where internal resources are expected to be used to fulfill an asset retirement obligation, the Company has added a profit margin onto the estimated cost of such services to better reflect its fair market value as required by SFAS No. 143. When the Company then performs these services internally, the added profit margin is recognized as a component of operating income in the period earned. SFAC No. 7 further states that an estimate of fair value should include the price that marketplace participants are able to receive for bearing the uncertainties in cash flows. However, when utilizing discounted cash flow techniques, reliable estimates of market premiums may not be obtainable. In this situation, SFAC No. 7 indicates that it is not necessary to consider a market risk premium in the determination of expected cash flows. In the waste industry, there is not an active market that can be utilized to determine the fair value of these activities, as there is no market that exists for selling the responsibility for final capping, closure and post-closure obligations 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 the Company’s determination of expected cash flows for landfill asset retirement obligations in accordance with SFAC No. 7.

 

Once the Company has determined the estimates of final capping, closure and post-closure obligations, the Company then inflates those costs to the expected time of payment and discounts those expected future costs back to present value. The Company is currently inflating these costs in current dollars until expected time of payment using an inflation rate of 2.5% and is discounting these costs to present value using a credit-adjusted, risk-free discount rate of 8.0%. The credit-adjusted, risk-free rate is based on the risk-free

 

20


interest rate adjusted for the Company’s credit standing. Management reviews these estimates at least once a year. Significant changes in future final capping, closure and post-closure cost estimates and inflation rates typically result in both (1) a current adjustment to the recorded liability (and corresponding adjustment to the landfill asset), based on the landfill’s capacity that has been consumed, and (2) a change in liability and asset amounts to be recorded prospectively over the remaining capacity of the landfill. Any change related to the capitalized and future cost of the landfill asset is then recognized in amortization expense prospectively over the remaining capacity of the landfill. 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.

 

The Company records the estimated fair value of final capping, closure and post-closure obligations for its landfills based on the landfills’ capacity that has been consumed through the current period. This liability and corresponding asset is accrued on a per-ton basis. The estimated fair value of each final capping event will be fully accrued when the tons associated with such capping event have been disposed in the landfill. Additionally, the estimated fair value of total final capping, closure and post-closure costs will be fully accrued for each landfill at the time the site discontinues accepting waste and is closed. Closure and post-closure accruals consider estimates for methane gas control, leachate management and ground-water monitoring and other operational and maintenance costs to be incurred after the site discontinues accepting waste, which is generally expected to be for a period of up to 30 years after final site closure. Daily maintenance activities, which include many of these costs, are incurred during the operating life of the landfill and are expensed as incurred. Daily maintenance activities include leachate disposal; surface water, groundwater, and methane gas monitoring and maintenance; other pollution control activities; mowing and fertilizing the landfill cap; fence and road maintenance; and third party inspection and reporting costs. For purchased disposal sites, the Company assesses and records present value-based final capping, closure and post-closure obligations at the time the Company assumes such responsibilities. Such liabilities are based on the estimated final capping, closure and post-closure costs and the percentage of airspace consumed related to such obligations as of the date the Company 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.

 

Interest accretion on final capping, closure and post-closure obligations is recorded using the effective interest method and is recorded as final capping, closure and post-closure expense, which is included as a component of operating costs in the accompanying consolidated statements of operations.

 

In the United States, the closure and post-closure obligations are established by the Environmental Protection Agency’s Subtitles C and D regulations, as implemented and applied on a state-by-state basis. The costs to comply with these obligations could increase in the future as a result of legislation or regulation.

 

Assets and liabilities associated with final capping, closure and post-closure costs consisted of the following at the dates presented (in thousands):

 

    

December 31,

2004


   

March 31,

2005


 

Landfill assets

   $ 109,465     $ 110,305  

Accumulated landfill airspace amortization

     (21,007 )     (22,139 )
    


 


Net landfill assets

   $ 88,458     $ 88,166  
    


 


 

21


    

December 31,

2004


  

March 31,

2005


Final capping

   $ 4,862    $ 5,131

Closure/post-closure

     410      454
    

  

Total landfill liabilities

   $ 5,272    $ 5,585
    

  

Current portion

   $ 3,162    $ 3,122

Long term

     2,110      2,463
    

  

Total landfill liabilities

   $ 5,272    $ 5,585
    

  

 

The changes to landfill liabilities were as follows for the three months ended March 31, 2004 and 2005 (in thousands):

 

     2004

    2005

 

Beginning balance

   $ 6,164     $ 5,272  

Obligations incurred

     369       224  

Obligations settled

     (276 )     (17 )

Interest accretion

     174       106  
    


 


Ending balance

   $ 6,431     $ 5,585  
    


 


 

12. SUBSEQUENT EVENTS

 

On May 11, 2005, the Company amended the Fleet revolver and Prudential term facilities to increase the permitted capital expenditures for the year 2005 and eliminate the fixed charge coverage ratio test for payment of dividends.

 

On May 11, 2005, the Board of Directors of the Company declared a semi-annual cash dividend of $0.08 per share payable to shareholders of record on May 23, 2005. Payment of the cash dividend will be June 3, 2005. In the future, the Company intends to pay dividends provided it has sufficient cash available to effect the dividend without impairing the Company’s ability to pay its debts as they become due in the usual course of business. In addition, the Company intends to pay dividends based on the availability of cash without reducing total assets below the sum of its total liabilities plus any amount that would be needed if the Company dissolved as of the payment date to satisfy all preferential rights upon distribution and to satisfy any preferential rights that are superior to those receiving the dividend. The Board of Directors will make any determination regarding the payment of dividends.

 

Subsequent to March 31, 2005, the Company acquired three operations for approximately $12.5 million.

 

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ITEM 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

 

Note Relating to Forward-Looking Statements

 

The following discussion should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004. Some matters discussed in this Management’s Discussion and Analysis are “forward-looking statements” intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as we “believe,” “anticipate,” “expect” or words of similar meaning. Similarly, statements that describe our future plans, objectives or goals are also forward-looking statements. Forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those currently anticipated, including general economic conditions, our ability to manage growth, the availability and integration of acquisition targets, regulatory permitting processes, the development and operation of landfills, impairment of goodwill, competition, geographic concentration, weather conditions, government regulation and others set forth in our Form 10-K. You should consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements.

 

OVERVIEW

 

We are a regional, vertically integrated provider of solid waste services. We operate primarily in North Carolina, South Carolina, Virginia, Tennessee, Mississippi, Georgia and Florida, providing solid waste collection, transfer, recycling, processing and disposal services for commercial, industrial, municipal and residential customers. At March 31, 2005, we operated 34 collection operations, 25 transfer stations, approximately 90 county convenience drop-off centers, 11 recycling facilities and 10 landfills in the southeastern United States. We had revenues of $69.2 million and operating income of $6.9 million for the three-month period ended March 31, 2004, and revenues of $72.0 million and operating income of $6.9 million for the three-month period ended March 31, 2005.

 

Percentages of our total revenue attributable to services provided are as follows:

 

    

Three Months Ended

March 31,


 
     2004

    2005

 

Collection:

            

Industrial

   29.7 %   27.2 %

Commercial

   27.5 %   26.9 %

Residential

   20.9 %   23.1 %

Disposal and transfer

   14.7 %   15.8 %

Recycling service

   1.9 %   1.8 %

Recycled commodity sales

   1.5 %   1.6 %

Other

   3.8 %   3.6 %
    

 

Total service revenues

   100.0 %   100.0 %
    

 

 

Our presence in growth markets in the southeastern United States has supported our internal growth. In addition, from 1990 through March 31, 2005, we acquired 87 solid waste collection or disposal operations.

 

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Current levels of population growth and economic development in the southeastern United States and our strong market presence in the region should provide us with an opportunity to increase our revenues and market share. As we add customers in our existing markets, our route density should improve, which we expect will increase our collection efficiencies and profitability.

 

RESULTS OF OPERATIONS

 

General

 

Our branch waste collection operations generate revenues from fees collected from commercial, industrial and residential collection and transfer station customers. We derive a substantial portion of our collection revenues from commercial and industrial services that are performed under one-year to five-year service agreements. Our residential collection services are performed either on a subscription basis with individual households, or under contracts with municipalities, apartment owners, homeowners associations or mobile home park operators. Residential customers on a subscription basis are billed quarterly in advance and provide us with a stable source of revenues. A liability for future service to be provided to residential customers is recorded upon billing and revenues are recognized in the month in which services are actually provided. Municipal contracts in our existing markets are typically awarded, at least initially, on a competitive bid basis and thereafter on a bid or negotiated basis and usually range in duration from one to five years. Municipal contracts generally provide consistent cash flow during the term of the contracts.

 

Our prices for our solid waste services are typically determined by the collection frequency, level of service, route density, volume, weight and type of waste collected, type of equipment and containers furnished, the distance to the disposal or processing facility, the cost of disposal or processing and prices charged in our markets for similar services.

 

While longer-term contracts can provide more consistent cash flow, increases in the cost of fuel and other operating costs during the contract’s term could reduce the contract’s profitability. To minimize this risk, we generally include price increases in our longer-term contracts. However, our ability to pass on price increases is sometimes limited by the terms of our contracts. Long-term solid waste collection contracts typically contain a formula, generally based on a predetermined published price index such as the Consumer Price Index, for automatic adjustment of fees, generally, on an annual basis, to cover increases in some, but not all, operating costs. These fee increases are recognized as revenue when earned (as the service is provided).

 

At March 31, 2005, we operated approximately 90 convenience collection sites under contract with 13 counties in order to consolidate waste in rural areas. These contracts, which are usually competitively bid, generally have terms of one to five years and provide consistent cash flow during the term of the contract since we are paid regularly by the local government. At March 31, 2005, we also operated 11 recycling processing facilities as part of our collection and transfer operations where we collect, process, sort and recycle paper products, aluminum and steel cans, pallets, plastics, glass and other items. Our recycling facilities generate revenues from the collection, processing and resale of recycled commodities, particularly recycled wastepaper and old corrugated cardboard. Through a centralized effort, we resell recycled commodities using commercially reasonable practices and seek to manage commodity-pricing risk by entering into hedging instruments. We also operate curbside residential recycling programs in connection with our residential collection operations in most of the communities we serve.

 

Operating expenses for our collection operations include labor, fuel, insurance, equipment maintenance and tipping fees paid to landfills. At March 31, 2005, we owned or operated 25 transfer stations that reduce our costs by improving our utilization of collection personnel and equipment and by consolidating the waste stream to gain more favorable disposal rates and transportation costs. At March 31, 2005, we operated 10 landfills. Operating expenses for these landfill operations include labor, equipment, legal and administrative, ongoing environmental compliance, host community taxes, site maintenance and accruals for closure and post-closure maintenance. Cost of equipment sales primarily consists of our cost to purchase the containers and compactors that we resell.

 

24


We capitalize some expenditures related to pending acquisitions or development projects. Indirect acquisition and project development costs, such as executive and corporate overhead, public relations and other corporate services, are expensed as incurred. Our policy is to charge to operating costs any unamortized capitalized expenditures and advances (net of any portion thereof that we estimate to be recoverable, through sale or otherwise) relating to any operation that is permanently shut down, any pending acquisition that is not consummated and any landfill development project that is not expected to be successfully completed. Engineering, legal, permitting, construction and other costs directly associated with the acquisition or development of a landfill are capitalized.

 

Selling, general and administrative expenses, or SG&A, include management salaries, clerical and administrative overhead, professional services, costs associated with our marketing and sales force and community relations expense.

 

Property and equipment is depreciated over the estimated useful life of the assets using the straight-line method.

 

To date, inflation has not had a significant impact on our operations.

 

Critical Accounting Policies

 

We have established various accounting policies in accordance with accounting principles generally accepted in the United States of America in the preparation of our financial statements. Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2004. Accounting policies require us to make significant estimates and assumptions that have a material impact on the carrying value of our assets and liabilities, and we consider these to be critical accounting policies. The estimates and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions that could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods.

 

We believe the following are critical accounting policies that require the most significant estimates and assumptions that are particularly susceptible to a significant change in the future:

 

Allowance For Doubtful Accounts

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our estimated allowance for doubtful accounts is based upon historical collection trends, type of customer, such as municipal or non-municipal, the age of the outstanding receivables and existing economic conditions. The allowance for doubtful accounts was $2.3 million and $2.5 million at December 31, 2004 and March 31, 2005, respectively. One customer, the Solid Waste Management Authority of Crisp County represented approximately $1.0 million and $0.9 million of the allowance for doubtful accounts at December 31, 2004 and March 31, 2005, respectively. Refer to Note 9 of our unaudited consolidated financial statements for additional information regarding the Authority.

 

Concentrations of Credit Risk

 

Financial instruments that potentially subject us to concentrations of credit risks consist primarily of accounts receivable. Credit risk on accounts receivable is minimized as a result of the large and diverse nature of our customer base. No single customer of ours accounted for more than 4.0% of our revenues for the three-month periods ended March 31, 2004 and 2005. One customer, the Authority, accounted for approximately 4% and 8% of our net accounts receivable balance as of December 31, 2004 and March 31, 2005, respectively. Please refer to Note 9 to our unaudited consolidated financial statements for further discussion of the Authority. We do not believe that the loss of any single customer would have a material adverse effect on our results of operations.

 

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Self-Insurance Reserves

 

We assume the risks for medical, dental, workers compensation, and auto insurance exposures up to certain loss thresholds set forth in separate insurance contracts. Our insurance accruals are based on claims filed and estimates of claims incurred but not reported and are developed by our management with assistance from third party experts. The insurance accruals are influenced by our past claims experience factors, which have a limited history. If we experience insurance claims or costs above or below our historically evaluated levels, our estimates could be materially affected. The frequency and amount of claims or incidents could vary significantly over time, which could materially affect our self-insurance liabilities. Additionally, the actual costs to settle the self-insurance liabilities could materially differ from the original estimates and cause us to incur additional costs in future periods associated with prior year claims.

 

In the first quarter of 2005, we increased the provision for workers compensation and accident claims by approximately $0.8 million in order to provide for our increased claims exposure as a result of increasing our plan deductibles effective January 1, 2005.

 

Landfills

 

We have material financial commitments for final capping, closure and post-closure obligations with respect to our landfills. We develop our estimates of final capping, closure and post-closure obligations using input from our third-party engineers and internal personnel. Our estimates are based on our interpretation of current requirements and proposed regulatory changes and are intended to approximate fair value. Absent quoted market prices, the estimate of fair value should be based on the best available information, including the results of present value techniques in accordance with Statement of Financial Accounting Concepts, or SFAC, No. 7, Using Cash Flow and Present Value in Accounting Measurements. In general, we rely on third parties to fulfill most of our obligations for final capping, closure and post-closure activities. Accordingly, the fair market value of these obligations is based upon quoted and actual prices paid for similar work. We intend to perform some of these capping, closure and post-closure obligations using internal resources. Where internal resources are expected to be used to fulfill an asset retirement obligation, we have added a profit margin onto the estimated cost of such services to better reflect their fair market value as required by SFAS No. 143. When we then perform these services internally, the added profit margin is recognized as a component of operating income in the period earned. SFAC No. 7 further states that an estimate of fair value should include the price that marketplace participants are able to receive for bearing the uncertainties in cash flows. However, when utilizing discounted cash flow techniques, reliable estimates of market premiums may not be obtainable. In this situation, SFAC No. 7 indicates that it is not necessary to consider a market risk premium in the determination of expected cash flows. In the waste industry, there is not an active market that can be utilized to determine the fair value of these activities, as there is no market that exists for selling the responsibility for final capping, closure and post-closure obligations independent of selling the landfill in its entirety. Accordingly, we believe that it is not possible to develop a methodology to reliably estimate a market risk premium and have excluded a market risk premium from our determination of expected cash flows for landfill asset retirement obligations in accordance with SFAC No. 7.

 

Once we have determined the estimates of final capping, closure and post-closure obligations, we then inflate those costs to the expected time of payment and discount those expected future costs back to present value. We are currently inflating these costs in current dollars until expected time of payment using an inflation rate of 2.5% and are discounting these costs to present value using a credit-adjusted, risk-free discount rate of 8.0%. The credit-adjusted, risk-free rate is based on the risk-free interest rate adjusted for our credit standing. Management reviews these estimates at least once per year. Significant changes in future final capping, closure and post-closure cost estimates and inflation rates typically result in both (1) a current adjustment to the recorded liability (and corresponding adjustment to the landfill asset), based on the landfill’s capacity that has been consumed, and (2) a change in liability and asset amounts to be recorded prospectively over the remaining capacity of the landfill. Any change related to the capitalized and future cost of the landfill asset is then recognized in amortization expense prospectively over the remaining capacity of the landfill.

 

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Changes in our credit-adjusted, risk-free rate do not change recorded liabilities, but subsequently recognized obligations are measured using the revised credit-adjusted risk-free rate.

 

We record the estimated fair value of final capping, closure and post-closure obligations for our landfills based on the landfills’ capacity that has been consumed through the current period. This liability and corresponding asset is accrued on a per-ton basis. The estimated fair value of each final capping event will be fully accrued when the tons associated with such capping event have been disposed in the landfill. Additionally, the estimated fair value of total final capping, closure and post-closure costs will be fully accrued for each landfill at the time the site discontinues accepting waste and is closed. Closure and post-closure accruals consider estimates for methane gas control, leachate management and ground-water monitoring and other operational and maintenance costs to be incurred after the site discontinues accepting waste, which is generally expected to be for a period of up to 30 to 40 years after final site closure. Daily maintenance activities, which include many of these costs, are incurred during the operating life of the landfill and are expensed as incurred. Daily maintenance activities include leachate disposal; surface water, groundwater, and methane gas monitoring and maintenance; other pollution control activities; mowing and fertilizing the landfill cap; fence and road maintenance; and third party inspection and reporting costs. For purchased disposal sites, we assess and record present value-based final capping, closure and post-closure obligations at the time we assume such responsibilities. Such liabilities are based on the estimated final capping, closure and post-closure costs and the percentage of airspace consumed related to such obligations as of the date we assume the responsibility. Thereafter, we account for the landfill and related final capping, closure and post-closure obligations consistent with the policy described above.

 

Interest accretion on final capping, closure and post-closure obligations 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 obligations are established by the Environmental Protection Agency’s Subtitles C and D regulations, as implemented and applied on a state-by-state basis. The costs to comply with these obligations could increase in the future as a result of legislation or regulation changes.

 

We routinely review our investment in operating landfills to determine whether the costs of these investments are realizable. Judgments regarding the existence of impairment indicators are based on regulatory factors, market conditions and operational performance of our landfills. Future events could cause us to conclude that impairment indicators exist and that our landfill carrying costs are impaired. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

 

While the precise amounts of these future obligations cannot be determined, at December 31, 2004 and March 31, 2005, we estimate our total landfill closure and post-closure costs to be approximately $5.3 million and $5.6 million, respectively, for the airspace consumed to date. We provide accruals for these estimated costs as the remaining permitted airspace of landfills is consumed. Our estimate of these costs considers when the costs would actually be paid and factors in inflation and discount rates. Significant revisions in the estimated lives of our landfills or significant increases in our estimates of landfill closure and post-closure costs could have a material adverse impact on our financial condition and results of operations.

 

Derivative Financial Instruments

 

We utilize cash flow hedge agreements to manage a portion of our risks related to fluctuation in interest rates and certain commodity prices. The fair values of all derivative instruments are recorded as assets and liabilities in our consolidated balance sheets. We formally document our hedge relationships, including identifying the hedge instruments and hedged items, as well as our risk management objectives and strategies for entering into the hedge transaction. Our derivative instruments qualify for hedge accounting treatment under SFAS No. 133. In order to qualify for hedge accounting, criteria must be met, including a

 

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requirement that both at inception of the hedge, and on an ongoing basis, the hedging relationship is expected to be highly effective in offsetting cash flows attributable to the hedged risk during the term of the hedge. When it is determined that a derivative ceases to be a highly effective hedge, we discontinue hedge accounting, and any gains or losses on the derivative instrument are recognized in earnings.

 

Allocation of Acquisition Purchase Price

 

Acquisition purchase price is allocated to identified intangible assets and tangible assets acquired and liabilities assumed based on our estimated fair values at the dates of acquisition, with any residual amounts allocated to goodwill. Independent specialists are utilized to assist management in the determination of fair values of tangible and intangible assets. We accrue the payment of contingent purchase price if the events surrounding the contingency are deemed assured beyond a reasonable doubt. The purchase price allocations are considered preliminary until we are no longer waiting for information that we have arranged to obtain and that is known to be available or obtainable. Although the time required to obtain the necessary information will vary with circumstances specific to an individual acquisition, the “allocation period” for finalizing purchase price allocations generally does not exceed one year from the consummation of a business combination.

 

We often consummate single acquisitions of solid waste collection or disposal operations. For each separately identified solid waste collection or disposal operation acquired in a single acquisition, we perform an initial allocation of total purchase price to the acquired operation based on our relative fair value. Following this initial allocation of total purchase price to the acquired operation, we further allocate the identified intangible assets and tangible assets acquired and liabilities assumed for each solid waste collection or disposal operation based on our estimated fair value at the dates of acquisition, with any residual amounts allocated to either goodwill or landfill site costs, as discussed above.

 

From time to time, we consummate acquisitions in which we exchange operations we own for operations owned by another solid waste company. These exchange transactions require us to estimate the fair market value of either the operations we receive or the operations we dispose of, whichever is more clearly evident. To the extent that the fair market value of the operations we dispose of differs from the fair market value of the operations we obtain, cash is either remitted or received to offset the difference in fair market values.

 

Intangible Assets

 

Intangible assets primarily consist of goodwill (indefinite life), customer lists (definite life) and noncompete agreements (definite life) acquired in business combinations.

 

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we discontinued amortization of goodwill effective January 1, 2002. On an ongoing basis, we perform an annual impairment test. At least quarterly, we analyze whether an event has occurred that would more likely than not reduce the goodwill’s enterprise fair value below its carrying amount and, if necessary, will perform a goodwill impairment test between annual dates. Impairment adjustment after adoption, if any, will be recognized as an operating expense. We adopted July 31 as our annual assessment date. We completed our annual impairment test as of July 31, 2004 and determined that there was no goodwill impairment.

 

Intangible assets with a definite life are amortized over their expected lives, typically five to eight years (see Note 3 to our unaudited consolidated financial statements), and are assessed for impairment on a quarterly basis. Intangible assets with a definite life are tested for impairment based on undiscounted cash flows and if impaired, written down to fair value based on either discounted cash flows or appraised values.

 

Long-lived Assets

 

In accordance with SFAS No. 144, Accounting For The Impairment of Long-lived Assets, we review long-lived assets for impairment on a market-by-market basis whenever events or changes in the circumstances

 

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indicate that the carrying amount of an asset might not be recoverable. If an evaluation is required, the projected future net cash flows on an undiscounted basis attributable to each market would be compared to the carrying value of the long-lived assets (including an allocation of goodwill, if appropriate) of that market. If an impairment is indicated, the amount of the impairment is measured based on the fair value of the asset. We also evaluate the remaining useful lives to determine whether events and circumstances warrant revised estimates of such lives. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

 

Three-Month Period Ended March 31, 2005 vs. Three-Month Period Ended March 31, 2004

 

The following table sets forth for the periods indicated the percentage of revenues represented by the individual line items reflected in our unaudited consolidated statements of operations.

 

    

Three Months Ended

March 31,


 
     2004

    2005

 

Total revenues

   100.0 %   100.0 %

Service

   99.7 %   99.8 %

Equipment

   0.3 %   0.2 %
    

 

Total cost of operations

   65.8 %   67.3 %

Selling, general and administrative

   13.6 %   13.1 %

Depreciation and amortization

   10.6 %   9.8 %

Impairment of property and equipment and other assets

   0.0 %   0.2 %
    

 

Operating income

   10.0 %   9.6 %
    

 

Interest expense

   3.7 %   3.3 %

Interest income

   0.0 %   0.0 %

Other expense (income)

   -0.1 %   0.0 %
    

 

Income before income taxes

   6.4 %   6.3 %

Income tax expense

   2.3 %   2.5 %
    

 

Income before cumulative effect of a change in Net income

   4.1 %   3.8 %
    

 

 

REVENUES. Total revenues increased approximately $2.8 million, or 4.0% for the three-month period ended March 31, 2005, compared to the same period in 2004. The increase for the three-month period ended March 31, 2005 was primarily attributable to increases in internal growth of approximately $2.0 million in collection revenue and approximately $0.8 million in disposal revenue offset by a decrease of approximately $1.3 million in transfer revenue for the three-month period ended March 31, 2005 compared to the same period in 2004. Revenue related to the effect of businesses acquired, offset by the disposition of businesses, during the year ended December 31, 2004, and three businesses acquired during the first quarter of 2005 resulted in a net revenue increase of approximately $1.3 million for the three-month period ended March 31, 2005. Of the businesses acquired and sold, nine were acquired in 2004, three were acquired in 2005, and three were sold in 2004.

 

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The following table provides the components of service revenue growth for the three-month periods ended:

 

     March 31,
2004


    March 31,
2005


 

SERVICE REVENUE GROWTH

            

Price

   0.5 %   1.2 %

Volume

   3.4 %   1.2 %

Energy surcharge

   0.4 %   -0.1 %
    

 

Total Internal Growth

   4.3 %   2.3 %

Commodities

   0.3 %   0.1 %

Acquisitions, net of dispositions

   5.9 %   1.7 %
    

 

Total Service Revenue Growth

   10.5 %   4.1 %
    

 

 

TOTAL COST OF OPERATIONS. Total cost of operations increased $2.9 million, or 6.4% for the three months ended March 31, 2005, compared to the same period in 2004. The following table provides the components of the costs of operations as a percentage of revenues for the three-month period ended March 31, 2005, compared with the same period in 2004.

 

     2004

    2005

    change

 

Labor and related benefits (1)

   18.0 %   17.3 %   -0.7 %

Third-party transfer and disposal (2)

   27.1 %   27.6 %   0.5 %

Fuel (3)

   3.5 %   4.3 %   0.8 %

Repairs and maintenance - fleet

   7.5 %   7.4 %   -0.1 %

Insurance (4)

   5.4 %   5.9 %   0.5 %

Other

   4.3 %   4.8 %   0.5 %
    

 

 

Total cost of operations

   65.8 %   67.3 %   1.5 %

(1) Health insurance costs decreased by approximately $0.4 million due to lower claims experience.
(2) Increased primarily due to growth of our national accounts program, resulting in reliance on third party services in some areas due to a lack of operational presence in certain markets.
(3) Increased 26% due to overall higher prices of fuel, even though we hedged approximately 80% of our first quarter fuel requirements
(4) We increased our provision for workers compensation, auto, and accident claims by approximately $0.8 million as a result of increasing our plan deductibles as of January 1, 2005.

 

SELLING GENERAL AND ADMINISTRATIVE (“SG&A”). SG&A increased approximately $48,000 or 0.5%, for the three-month period ended March 31, 2005, compared with the same period in 2004.

 

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The following table summarizes certain components of selling, general and administrative expense as a percentage of revenue for the three-month periods ended March 31, 2004 and 2005:

 

     2004

    2005

    Change

 

Labor and related benefits (1)

   7.4 %   6.8 %   -0.6 %

Provision for doubtful accounts

   0.7 %   0.8 %   0.1 %

Professional fees (2)

   0.8 %   1.1 %   0.3 %

Rent - site & building

   0.6 %   0.5 %   -0.1 %

Other

   4.1 %   3.9 %   -0.2 %
    

 

 

Total SG&A

   13.6 %   13.1 %   -0.5 %

(1) Labor and benefit expense decreased due primarily to lower bonus expense and a reduced amount of health insurance claims in 2005.
(2) Professional fees increased primarily due to increased costs associated with compliance with the Sarbanes-Oxley Act of 2002.

 

DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased $0.3 million, or 3.6%, to $7.1 million in the three-month period ended March 31, 2005 from $7.3 million in the same period in 2004. Depreciation and amortization, as a percentage of revenues, decreased to 9.8% in the three-month period ended March 31, 2005 from 10.6% in the same period in 2004. Of this decrease, $0.2 million was related to decreased closure/post-closure amortization costs due primarily to expansion permits obtained for our Sampson facility, previously deemed at airspace capacity.

 

INTEREST EXPENSE. Interest expense (net of interest income) decreased $0.2 million in the three-month period ended March 31, 2005 due to reductions in outstanding debt.

 

INCOME TAX EXPENSE. The effective income tax rate increased to 39.5% in the three-month period ended March 31, 2005 from a rate of 36.5% in the same period in 2004 due in part to a greater proportion of operations in states with higher taxes such as North Carolina and Georgia and an increase in our deferred income tax liabilities for the estimated increase in our overall effective rate.

 

NET INCOME. Net income decreased $53,000, or 1.9%, to $2.8 million in the three-month period ended March 31, 2005. This decrease was attributable to the changes explained above, most notably $2.8 million of increased sales revenue, offset by higher overall operating costs and an increased effective income tax rate.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our working capital at March 31, 2005 was negative $8.3 million compared to negative working capital of $6.9 million at December 31, 2004. The negative amounts were primarily the result of using cash generated from operations for capital expenditures, acquisitions, and long-term debt reduction. Our strategy in managing our working capital has been to apply the cash generated from operations that remains available after satisfying our working capital and capital expenditure requirements to reduce indebtedness under our bank revolving credit facilities and to minimize our cash balances. We generally finance our working capital requirements from internally generated funds and bank borrowings. In addition to internally generated funds, we have in place financing arrangements to satisfy our currently anticipated working capital needs in 2005. Prior to 2000, we had fully drawn upon our three $25.0 million term facilities with Prudential Insurance Company of America. Principal repayments are due annually on each of the $25.0 million term facilities. The Prudential facilities require us to maintain financial covenants, such as minimum net worth, net income, and limit our capital expenditures and indebtedness. We were in compliance with these financial covenants as of December 31, 2004 and March 31, 2005. Interest on the three Prudential facilities is paid quarterly, based on fixed rates for the three facilities of 7.53%, 7.21% and 7.09%, respectively.

 

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We have in place a revolving credit agreement with a syndicate of lending institutions for which Fleet National Bank acts as agent. This credit facility provides up to $175.0 million through February 2007. Virtually all of our assets and those of our subsidiaries, including our interest in the equity securities of our subsidiaries, secure our obligations under the revolver. Pursuant to an intercreditor agreement with Fleet, Prudential shares in the collateral pledged under the revolver. In addition, our subsidiaries have guaranteed our obligations under the Prudential term loan facilities. The revolver bears interest at a rate per annum equal to, at our option, either a Fleet base rate or at the Eurodollar rate (LIBOR) plus, in each case, a percentage rate that fluctuates, based on our leverage ratio, from 0.25% to 1.25% for base rate borrowings and 1.75% to 2.75% for LIBOR rate borrowings. The revolver requires us to maintain financial covenants and satisfy other requirements, such as minimum net worth, net income, and limits on capital expenditures and indebtedness. It also requires the lenders’ approval of acquisitions in some circumstances. We were in compliance with these financial covenants as of December 31, 2004 and March 31, 2005. As of March 31, 2005, an aggregate of approximately $75.0 million was outstanding under the revolver, with an average interest rate on outstanding borrowings of approximately 4.8%.

 

On September 10, 2003, we entered into a $9.5 million income tax exempt variable rate bond with Sampson County, North Carolina for the funding of expansion at our landfill in that county. This issue was in addition to our existing $30.9 million Sampson facility. Both bonds are backed by a letter of credit issued by Wachovia Bank N.A. as a participating lender under our Fleet syndication. The average interest rate on outstanding borrowings under both Sampson facilities was approximately 4.0% at March 31, 2005.

 

As of March 31, 2005, we had the following contractual obligations and commercial commitments (in thousands):

 

Contractual Obligations


   PAYMENTS DUE BY PERIOD

   Total

  

Less Than

1 Year


   1 to 3 Years

   4 to 5 Years

   Over 5 Years

Long-term debt (1) (2)

   $ 187,379    $ 18,030    $ 101,467    $ 10,614    $ 57,268

Expected landfill liabilities (3)

     5,585      3,122      2,463      —        —  

Disposal agreements

     948      948      —        —        —  

Capital expenditures

     2,900      2,900      —        —        —  

Capital leases

     674      501      173      —        —  

Operating leases

     7,114      2,483      3,020      1,409      202
    

  

  

  

  

Total contractual cash obligations

   $ 204,600    $ 27,984    $ 107,123    $ 12,023    $ 57,470
    

  

  

  

  


(1) Includes amounts outstanding as of March 31, 2005 of $75.0 million under our revolver, $35.7 million under the Prudential term facilities, and $40.3 million under the Sampson bond facilities. Our revolver allows us to borrow up to $175 million provided we are in compliance with the facility’s loan covenants. Availability under the revolver was approximately $42.3 million at March 31, 2005.
(2) As disclosed in Note 8 of our unaudited consolidated financial statements, we have entered into various interest rate swaps which fixed the interest rate for a portion of our debt through 2007. Additionally, we have entered into commodity swap contracts to hedge our recycling revenue received for old corrugated cardboard. The commodity swap contracts have a term of three years. As of March 31, 2005, the fair value of the interest rate swap agreements recorded on our consolidated balance sheets was an asset of approximately $1.0 million. The fair values of the commodity swap contracts are recorded on our consolidated balance sheets as a liability of approximately $0.3 million.

 

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(3) Landfill liabilities are based on current costs and include capping, closure, post-closure and environmental remediation costs. These costs represent the expected landfill liabilities we will incur for final capping, closure and post-closure for the airspace consumed to date. We will recognize additional liabilities for these costs as airspace is consumed in each landfill.

 

We use financial surety bonds for a variety of corporate guarantees. The two largest uses of financial surety bonds are for municipal contract performance guarantees and landfill closure and post-closure financial assurance required under certain environmental regulations. Environmental regulations require demonstrated financial assurance to meet closure and post-closure requirements for landfills. In addition to surety bonds, these requirements may also be met through alternative financial assurance instruments, including insurance and letters of credit.

 

     AMOUNT OF COMMITMENT EXPIRATION PER PERIOD

Commercial Commitments


  

Total Amounts

Committed


  

Less Than

1 Year


   1 to 3 Years

   4 to 5 Years

   Over 5 Years

Standby letters of credit

   $ 15,926    $ 15,926    $ —      $ —      $ —  

Financial surety bonds

     26,995      26,145      850      —        —  
    

  

  

  

  

Total commercial commitments

   $ 42,921    $ 42,071    $ 850    $ —      $ —  
    

  

  

  

  

 

Net cash provided by operating activities increased $0.5 million to $10.6 million for the three-month period ended March 31, 2005, compared to net cash provided by operating activities of $10.1 million for the three-month period ended March 31, 2004. The increase primarily consisted of increased non-cash adjustments, partially offset by reduced net income and unfavorable changes in operating assets and liabilities.

 

Net cash used in investing activities increased $4.2 million to $8.0 million for the three-month period ended March 31, 2005, compared to $3.8 million for the same period in 2004. The increase in cash used was primarily related to increased acquisitions of related businesses of $2.1 million and $2.8 million higher capital expenditures than those occurring in the first quarter of 2004.

 

We currently expect capital expenditures for 2005 to be approximately $38.0 to $39.0 million, compared to $32.2 million in 2004. In 2005, $14.0 million of the expected capital expenditures are earmarked for landfill site and cell construction. We expect to fund our planned 2005 capital expenditures principally through internally generated funds and borrowings under existing credit facilities. As an owner and potential acquirer of additional new landfill disposal facilities, we might also be required to make significant expenditures to bring newly acquired disposal facilities into compliance with applicable regulatory requirements, obtain permits for newly acquired disposal facilities or expand the available disposal capacity at any such newly acquired disposal facilities. The amount of these expenditures cannot be currently determined because they will depend on the nature and extent of any acquired landfill disposal facilities, the condition of any facilities acquired and the permitting status of any acquired sites. We expect we would fund any capital expenditures to acquire solid waste collection and disposal businesses, to the extent we could not fund such acquisitions with our common stock, and any regulatory expenses for newly acquired disposal facilities through borrowings under our existing credit facilities.

 

For the three-month period ended March 31, 2005, net cash used in financing activities decreased $4.5 million from net cash used of $8.7 million for the same period in 2004. This decrease was primarily due to lower net repayments of debt as well as cash received from stock option exercises.

 

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At March 31, 2005, we had approximately $151.8 million of total borrowings outstanding (including capital lease obligations) and approximately $42.9 million in letters of credit including performance and surety bonds. At March 31, 2005, the ratio of our total debt (including capital lease obligations) to total capitalization was 55.4%, compared to 57.2% at December 31, 2004.

 

Accounts receivable, net of deferred revenue decreased approximately $0.8 million to $23.4 million at March 31, 2005 from $24.2 million at December 31, 2004 due to collections and changes in the provision for doubtful accounts.

 

Trade accounts payable decreased approximately $1.8 million to $12.8 million at March 31, 2005 from $14.6 million at December 31, 2004 due primarily to timing of payments.

 

Current accrued liabilities and other payables increased approximately $1.0 million to $7.3 million due primarily to additional capital lease obligations and accruals for property and vehicle taxes.

 

New Accounting Pronouncements

 

In November 2004, the Financial Accounting Standards Board, or FASB, issued Emerging Issues Task Force, or EITF, Issue No. 03-13, Applying the Conditions in Paragraph 42 of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, In Determining Whether to Report Discontinued Operations. The EITF reached a consensus that classification of a disposed component as a discontinued operation is appropriate only if the ongoing entity:

 

    has no continuing direct cash flows (and further clarifies what constitutes a direct cash flow); and

 

    does not retain an interest, contract, or other arrangement sufficient to enable it to exert significant influence over the disposed component’s operating and financial policies after the disposal transaction.

 

We adopted EITF Issue No. 03-13 on January 1, 2005 and will apply it to components that are disposed of or classified as held for sale from that date forward. During the three months ended March 31, 2005, we did not dispose of any components. Exchanges of assets that occurred in 2004 were not required to be reported as discontinued operations, based on our interpretation of SFAS No. 144.

 

In March 2005, the FASB issued FASB Interpretation No. 47, or FIN 47, Accounting for Conditional Asset Retirement Obligations, which requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred, generally upon acquisition, construction, or development and/or through the normal operation of the asset. FIN 47 clarifies the term conditional asset retirement obligation as used in FASB No. 143 and clarifies when an entity would have sufficient information to reasonably estimate the fair value of the asset retirement obligation. The Interpretation becomes effective for our company no later than the end of the year ending December 31, 2005. We intend to adopt FIN 47 in the fourth quarter of 2005 and do not believe it will have a material impact on our financial position.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”). SFAS 123R requires all entities to recognize compensation expense in their statements of operations for all share-based payments (e.g., stock options and restricted stock) granted to employees based upon the fair value of the award on the grant date. The cost of the employee services is recognized as compensation cost over the period that an employee provides service in exchange for the award. Pro forma disclosure is no longer permitted.

 

SFAS 123R is now effective for issuers as of the beginning of the first fiscal year beginning after June 15, 2005, instead of at the beginning of the first quarter after June 15, 2005 as originally prescribed. Accordingly, the required effective date of SFAS 123R for calendar year-end public companies is January 1, 2006 instead of July 1, 2005. We expect to adopt the pronouncement on January 1, 2006. As permitted by SFAS 123, we currently account for share-based payments to employees using the intrinsic value method

 

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under Accounting Principles Board No. 25 Accounting For Stock Issued To Employees and, as such, generally recognize no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123R’s fair value method may have a significant impact on our results of operations, although it will have no impact on our overall cash flows or financial position. The impact of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the pro forma net income and earnings per share calculation in Note 1 of our unaudited consolidated financial statements.

 

RISK FACTORS

 

As previously mentioned in our Note Relating to Forward-looking Statements, there are numerous risks and uncertainties associated with our business. 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 year ended December 31, 2004 for a discussion of other factors that could materially affect the forward-looking statements in this Report.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Quantitative Disclosures

 

We entered into an interest rate swap agreement effective January 1, 2002 to modify the interest characteristics of our outstanding long-term debt and designated the qualifying instrument as a cash flow hedge. Under the terms of the agreement, the interest rate swap hedged notional debt values of $50.0 million with a fixed rate of 4.2%. The agreement expired November 2004.

 

In March 2004, we entered into additional interest rate swaps to hedge notional debt values of $30.0 million and $10.0 million, respectively. These swaps are effective for the period of November 2004 through February 2007 with fixed rates of 2.7%.

 

Our results of operations are impacted by fluctuations in commodity pricing. To reduce our risk to market fluctuations, we entered into two commodity swap contracts effective January 1, 2003 and June 1, 2003, respectively, to hedge our recycling revenue received for old corrugated cardboard, or OCC and have designated the qualifying instruments as cash flow hedges. The contracts each hedge 18,000 tons of OCC at $70.00 a ton for a term of three years. In November 2004, we entered into a contract effective January 1, 2005, to hedge another 18,000 tons of OCC at $90 a ton for a term of three years. In April 2005, we entered into another contract effective January 1, 2006, to hedge 18,000 tons of OCC at $83 per ton for a term of three years. The notional amounts hedged under these agreements represent approximately 33% of our current OCC volume.

 

We have used heating oil option agreements to manage a portion of our exposure to fluctuation in diesel fuel oil prices. To date, such agreements have not been significant to our financial condition and results of operations. On December 28, 2004, we entered into a heating oil hedge contract, effective January 1, 2005, to cap our exposure on 1.2 million gallons of diesel fuel at $1.90 per gallon. The hedge coverage represented approximately 80% of our first quarter diesel fuel requirements, and expired on March 31, 2005.

 

Qualitative Disclosures

 

Our primary exposure relates to:

 

    interest rate risk on long-term and short-term borrowings;

 

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    the impact of interest rate movements on our ability to meet interest expense requirements and exceed financial covenants; and

 

    the impact of interest rate movements on our ability to obtain adequate financing to fund future acquisitions.

 

We manage interest rate risk on outstanding long-term and short-term debt through the use of fixed and variable rate debt. While we cannot predict the impact interest rate movements will have on existing debt, we continue to evaluate our financial position on an ongoing basis.

 

We believe our quantitative and qualitative disclosures regarding market risk have not changed materially from those disclosures contained in our Annual Report on Form 10-K for the year ended December 31, 2004.

 

ITEM 4. CONTROLS AND PROCEDURES

 

As part of the preparation of our Annual Report on Form 10-K for the year ended December 31, 2004, the following matters were identified as reportable conditions and, together, a material weakness:

 

    inadequate analysis of deferred income tax balances and changes in our income tax provision;

 

    inadequate accounting for lease agreements including capitalization and expense recognition; and

 

    inadequate review of the adequacy of the allowance for doubtful accounts, specifically concerned with a complex customer arrangement and related exposure.

 

We have taken the following actions, including the analysis and policies and procedures noted, which are improvements to our disclosure controls and internal control over financial reporting, to address and correct these conditions, some of which were completed by March 31, 2005:

 

    engaged an independent contractor to develop a tax basis balance sheet

 

    completed an evaluation of necessary resources and are in the process of hiring personnel with the expertise to maintain this tax balance sheet and provide support in preparation of our income tax provision;

 

    implemented more stringent policies and procedures for approval of and accounting for lease arrangements, including utilization of a checklist to determine if operating leases meet the criteria for capitalization;

 

    devoted more resources to performing detailed analysis of major customer accounts receivable balances and activity; and

 

    evaluated staffing needs and are in the process of hiring additional accounting staff to allow for more timely detailed analyses of key accounts and procedures.

 

As of the end of the 90-day period covered by this report, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-14(c) under the Securities Exchange Act of 1934). Based upon our evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were not effective as of March 31, 2005 for gathering, analyzing and disclosing information required to be disclosed in connection with the filing of our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005. However, at the time of the preparation of this Quarterly Report, all of the changes discussed above, other than new hires remaining to be made, had been implemented, which we believe rendered the design and operation of our disclosure controls and procedures effective for gathering, analyzing and disclosing information required to be disclosed in connection with the filing of this Quarterly Report.

 

Except as discussed above, no changes were made in our internal controls or in other factors that could significantly affect our internal control over financial reporting during the last fiscal quarter that materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

A discussion of legal proceedings to which we are subject is contained in our Annual Report on Form 10-K for the year ended December 31, 2004. There have been no material developments in those proceedings since December 31, 2004.

 

ITEM 5. OTHER INFORMATION

 

On May 11, 2005, we amended our Fleet revolver and Prudential term facilities to increase the permitted capital expenditures for the year 2005 from $37 million to $42 million and to eliminate the fixed charge coverage ratio test for payment of dividends. The increase in capital expenditures for 2005 was necessary primarily because of increased expenditures anticipated for our Sampson County, North Carolina and Polk County, Georgia landfill sites. The elimination of the fixed charge coverage ratio reflects our improved leverage ratios as we have paid down our debt and increased our earnings in the last several years. Under the facilities, we may pay up to $3.5 million in cash dividends annually. Copies of the amendments to the facilities are filed as exhibits to this Report.

 

There is no relationship between our company or our affiliates and any of the lenders under the facilities.

 

ITEM 6. EXHIBITS

 

(a) Exhibits

 

Exhibit
Number


  

Exhibit Description


Exhibit 10.21    Amendment and Consent dated as of May 11, 2005 among the Company and Prudential Insurance Company of America and Affiliates
Exhibit 10.22    Second Amendment to Amended and Restated Revolving Credit Agreement dated as of May 11, 2005 among the Company and Fleet National Bank, Wachovia Bank, Branch Banking and Trust Company and other lenders
Exhibit 31.1    Certification of the Chief Executive Officer pursuant to rule 15d-14(a) under the Securities Exchange Act of 1934
Exhibit 31.2    Certification of the Chief Financial Officer pursuant to rule 15d-14(a) under the Securities Exchange Act of 1934
Exhibit 32.1    Certification by the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2    Certification by the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated: May 17, 2005  

Waste Industries USA, Inc.

   

(Registrant)

    By:  

/s/ Jim W. Perry


        Jim W. Perry
        President and Chief Executive Officer
Dated: May 17, 2005  

Waste Industries USA, Inc.

   

(Registrant)

    By:  

/s/ D. Stephen Grissom


        D. Stephen Grissom
        Chief Financial Officer

 

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